Since past two-decade, software industry has undergone tremendous technological changes and accordingly such industry has emerged to be one of the fastest growing industry worldwide. India being a developing country provides ample opportunities for Multi-national Enterprises (MNEs) to expand their business in India. The technological advancement has acquainted such MNEs to expand with negligible physical presence.
Such growth and entry of MNE’s has also been a focus point for the Indian Revenue Service (Income Tax)- (IRS). The cross-border transactions with such MNE’s /foreign companies has always been under the radar of IRS.
One of such cross-border transactions, which has been the subject matter of litigation is taxability of sale of software.
Software can be in various forms/model like single/multiple licence model, distribution model, shrink wrap software, customised software, software embedded in hardware etc., and taxability of the same has been discussed in plethora of case laws.
There have been various conflicting judgements on the subject transaction wherein key issue is centred around interpretation of the term copyright as cited in section 9(1)(vi) of the Income-tax Act, 1961 (“Act”) and Tax treaty (“DTAA”) to constitute the same as “royalty”.
The scope of ‘royalty’ as per the definition in DTAA is narrower as compared to the definition as provided under Income-tax Act. The definition under the DTAA is a restrictive definition, whereas, the definition of the royalty under the Income-tax Act is comparatively wider.
The scope of royalty was expanded in Finance Act, 2012 by insertion of Explanation 3 and 4 to section 9(1)(vi) of the Act. Relevant extracts are reproduced as under:
Explanation 3.—For the purposes of this clause, “computer software” means any computer programme recorded on any disc, tape, perforated media or other information storage device and includes any such programme or any customized electronic data.
Explanation 4.—For the removal of doubts, it is hereby clarified that the transfer of all or any rights in respect of any right, property or information includes and has always included transfer of all or any right for use or right to use a computer software (including granting of a licence) irrespective of the medium through which such right is transferred.
Above definition provides that the transfer of rights in respect of any right, property or information includes and has always included the right for use or right to use a computer software including granting of a license.
Hence, the computer software has been included in the definition and within the scope of the words ‘right’, ‘property’ or ‘information’ as provided under clauses (b) and (c) to section 9(1)(vi).
However, it is pertinent to note that the consideration paid for ‘computer software’ has not been specifically included under the definition of royalty in DTAA and definition of ‘royalty’ in majority of DTAAs with different countries isalmost identically worded.
Royalty definition in DTAA is narrower in scope and covers only a part of the items mentioned under sub-clauses (i) to (vi) to Explanation 2 to section 9(1)(vi). As per India-USA DTAA, “royalty” means
(a) payments of any kind received as a consideration for the use of, or the right to use, any copyright of a literary, artistic, or scientific work, including cinematograph films or work on film, tape or other means of reproduction for use in connection with radio or television broadcasting, any patent, trade mark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience, including gains derived from the alienation of any such right or property which are contingent on the productivity, use, or disposition thereof ; and
(b) payments of any kind received as consideration for the use of, or the right to use, any industrial, commercial, or scientific equipment, other than payments derived by an enterprise described in paragraph 1 of Article 8 (Shipping and Air Transport) from activities described in paragraph 2(c) or 3 of Article 8.
The right to use a computer software/programme has not been specifically mentioned in the DTAA. Hence, what is relevant to be examined is that whetherthe consideration is being paid ‘for the use of’ or the ‘right to use’ any copyright or not.
For the purpose of the same, it is pertinent to examine the relevant definitions/scope related to’Literary work’/’copyright’ as provided under Copyright Act, 1957
Implication and inference of the Copyright Act, 1957 has been discussed in various judicial pronouncements, however before we reveal the same, it is relevant to explore relevant provisions of Copyright Act, 1957.
Section 14 of the Copyright Act, 1957 states:
For the purposes of this Act, “copyright” means the exclusive right subject to the provisions of this Act, to do or authorise the doing of any of the following acts in respect of a work or any substantial part thereof, namely:—
(a) in the case of a literary, dramatic or musical work, not being a computer programme,—
(i) to reproduce the work in any material form including the storing of it in any medium by electronic means;
(ii) to issue copies of the work to the public not being copies already in circulation;
(iii) to perform the work in public, or communicate it to the public;
(iv) to make any cinematograph film or sound recording in respect of the work;
(v) to make any translation of the work;
(vi) to make any adaptation of the work;
(vii) to do, in relation to a translation or an adaptation of the work, any of the acts specified in relation to the work in sub-clauses (i) to (vi);
(b) in the case of a computer programme,—
(i) to do any of the acts specified in clause (a);
(ii) to sell or give on commercial rental or offer for sale or for commercial rental any copy of the computer programme:
Provided that such commercial rental does not apply in respect of computer programmes where the programme itself is not the essential object of the rental;]
Elucidation of relevant provisions the Copyright Act, 1957 in the case of Reliance Industries Ltd.
The assessee purchased software to use it in its business of oil and gas exploration. Mumbai ITAT in the case of Reliance Industries Ltd. have tried to carve out the instinct of term ‘copyright’ and have discussed the relevant provisions of Copyright Act, 1957 in detail.
Section 14 of Copyright Act, 1957 lays down certain actions which shall constitute copyright. As per section 14, right to use a software is not covered under such actions which means right to use a software would not constitute the use of copyright. Also, use of software shall not tantamount to infringement.
Hence it has been held that in the absence of transfer of rights to authorise doing certain act, as referred in section 14 of the Copyright Act, 1957, it cannot be said that there was a transfer of copyright and hence payment for sale of software should not constitute ‘Royalty’.
Similar view has been held in I.T.C. Limited v ADIT  79 taxmann.com 206 (Kolkata ITAT), ADIT vs. Baan Global BV  49 ITR (T) 73 (Mumbai ITAT), DCIT v. Atmel R & D India (P.) Ltd.  74 Taxmann.com 106 (Chennai ITAT),Qad Europe B.V. v. DDIT  53 ITR(T) 259 (Mumbai ITAT).
Delhi High court in the landmark judgement of Infrasoft had laid down the distinction between transfer of copyrighted right and copyrighted article.
It has been held that right to use a copyrighted article with the owner retaining his copyright, is not same as assigning rights in relation to the copyright. A non-exclusive and non-transferable licence enabling the use of a copyrighted product for internal business purpose cannot be construed as an authority to enjoy any or all of the enumerated rights ingrained in Article 12 of DTAA.
The licensee wasn’t allowed to exploit the computer software commercially.It had acquired only the copyrighted software which by itself is an article and didn’t acquired any copyright in the software. The licensee was allowed to make only one copy of the software and associated support information for backup purposes with a condition that such copyright shall include Infrasoft copyright and all copies of the software shall be exclusive properties of Infrasoft. Licensee was allowed to use the software only for its own business as specifically identified and was not permitted to loan/rent/sale/sub-licence or transfer the copy of software to any third party without the consent of Infrasoft.
There is no transfer of any right in respect of copyright by the assessee and it is a case of mere transfer of a copyrighted article. The payment is for a copyrighted article and represents the purchase price of an article and cannot be considered as royalty either under the Income-tax Act or under the DTAA.
Similar view has been held in Quaolcomm India (P.) Ltd. v. ADIT  162 ITD 493 (Hyderabad ITAT), Motorola Inc.  (95 ITD 269) (Delhi ITAT), Sonata information Technology Ltd v/s Addl. CIT  (103 ITD 324) (Bangalore ITAT), Sonic Biochem Extractions (P.) Ltd. v ITO  59 SOT 4 (Mumbai – ITAT.)
It Is vital to examine the other side of coin as well. Various courts and appellant authorities have expressed their view in favour of revenue authorities.
Karnataka high court in the case of Samsung Electronics Co. Ltd. expressed that grant of license to use the software extend rights to the licensee to use the copyrighted work.Without the license, the CD is of no use and any unauthorised use of such CD shall lead to infringement.
Hence, the licence to use such software and make back-up copies is a part of copyright.
Copyright constitutesvarious rights and license granted for making use of the copyright in respect of shrink wrapped software/off-the-shelf software which authorizes the end user, to make use of the copyright program contained in the said software and the same would amount to transfer of part of the copyright and transfer of right to use the copyright. Hence such income shall be considered as income from royalty and liable to betaxed in India.
Similar view has also been held in Commissioner of Income-tax, International Taxation v. ING Vysya Life Insurance Co. (P.) Ltd.,  24 taxmann.com 226 (Kar.), Autodesk Asia Pte Ltdv. Joint Director of Income-tax  56 taxmann.com 92 (Bangalore – Trib.)
Karnataka high court in the case of Samsung Electronics Co. Ltd emphasised on section 51 read with section 52 of the Copyright Act, 1957 stating that use of software shall not tantamount to infringement only if a license is granted by the owner and since a license is being granted to use such software, then it shall tantamount to authorising the user to use the copyright work in such software.
However, the high court failed to appreciate the fact that mere granting of licence shall not qualifycopyright unless any actions as specified in section 14 of the Copyright Act, 1957 is beingperformed by user.
As discussed supra, mere ‘use of software’ shall not be considered as copyright since ‘right to use a software’ is not covered under such actions as prescribed under section 14 to qualify as copyright.
Hence, as rightly held in the case of Reliance industries limited (supra), use of software should not be considered as royalty.
By virtue of section 90 of the Act, since, the definition of royalty provided in the DTAA is more beneficial, the definition of royalty as provided under DTAA shall prevail.
Few of the relevant factors to be considered while examining the taxability of sale of software are as under:
a. Licensor should provide a non-exclusive restricted license.
b. All the copyrights and intellectual property rights in the software should be owned by licensor and only licensor should have the control to grant licence rights for use of the software
c. Copy of the software should be permissible for backup purposes only and such copy should be property of Licensor.
d. Such software should be allowed to be used in own business and not permitted to loan/rent/sale/sub-licence or transfer the copy of software to any third party without the consent of licensor.
e. The licensee should be prohibited from copying, de-compiling, de-assembling, or reverse engineering the software without the written consent of licensee.
f. Licensee should not exercise any act other than the exception mentioned in section 52 of the Copyright Act, 1957.
However, given the aggressive approach of revenue authorities and contrary judgments, litigation especially at the lower level revenue authorities cannot be ruled out till the verdict of the apex court in this matter.
Taxability of the software transactions is purely a fact-based issue and such facts are highly technical in nature containing complex structure, coding&conditions. Hence CBDT must lay down some principles to determine the taxability to settle down this long-disputed controversy.
 Director of Income-tax v. Infrasoft Ltd.  39 taxmann.com 88(Delhi HC)
Authors Details- Sumit Jain and Ravi Sanguri