Summary: The Supreme Court’s landmark judgment in Engineering Analysis Centre of Excellence Pvt. Ltd. v. CIT (2021) clarified the tax treatment of payments made by Indian businesses to foreign software suppliers. The Court held that payments for standard computer software supplied under end-user licence agreements or distribution arrangements do not constitute royalty where the purchaser merely acquires the right to use a copyrighted product without obtaining rights in the underlying copyright. Consequently, such payments are generally not taxable as royalty under applicable Double Taxation Avoidance Agreements (DTAAs), and tax deduction at source is not required where the income is not chargeable to tax in India. The retrospective amendments to Section 9(1)(vi) of the Income-tax Act, 1961, do not override the definition of royalty under tax treaties. However, agreements permitting reproduction, sublicensing, modification or commercial exploitation of software may attract royalty taxation, while customised software, bundled technical services and cloud-based arrangements require separate examination. Where treaty benefits are unavailable, domestic income-tax provisions must be considered. Indian businesses making payments to foreign software vendors must examine withholding obligations under Section 393 of the Income-tax Act, 2025, and applicable foreign-remittance reporting requirements through Forms 145 and 146. Supporting documentation should include the software licence agreement, tax residency certificate, Form 10F where applicable, and a documented assessment of taxability. Failure to comply with applicable withholding provisions may result in tax demands, interest and penalties.
Introduction
An Indian company buys software or a software licence from a foreign vendor and pays an invoice. Should it deduct tax at source, and at what rate? For many years the answer depended on the view taken by the officer. The Supreme Court’s decision in Engineering Analysis Centre of Excellence Pvt Ltd v CIT (2021) settled the main point for many common transactions.
What the Supreme Court decided
The court held that payments by Indian distributors or end users to foreign suppliers for the resale or use of computer software, supplied under an end-user licence or a distribution agreement, are not royalty for the use of copyright. The right granted is to use a copyrighted article, and not to use the copyright itself. The retrospective amendments made in 2012 to section 9(1)(vi) did not change the position for tax treaty purposes, because the treaty definition of royalty was not amended.
What this means in practice
Where the payment is for a standard software licence for use, with no right to copy, adapt or commercially exploit the source, the amount is generally not royalty and, absent a permanent establishment, is not taxable in India under the treaty.
Where the agreement gives the payer rights to reproduce, sub-license, modify or exploit the software commercially, the payment may be royalty and the analysis must be done again.
Software that is customised or developed for the payer, or paid for along with services, needs a review of whether the fee is for technical services.
Domestic law provisions apply where the vendor is in a country without a treaty, or where the treaty wording differs.
Withholding procedure
Even where the payment is not taxable, the payer must follow the procedure for remittances. The usual route is a certificate from a chartered accountant in Form 145 and a declaration in Form 146. The payer can apply for a lower or nil deduction certificate under section 395 if the tax position is uncertain and the amount is large. If the payer decides not to deduct tax and later loses, the liability for tax, interest and penalty falls on the payer as an assessee in default.
Documents to keep
The licence agreement, with a clear statement of the rights granted.
A tax residency certificate from the vendor and Form 10F where needed.
The reasoning for non-deduction, in a note signed off before payment.
The decision made the tax position clearer for ordinary purchases of software. The difficulty now lies in the contracts that mix licences, services and cloud access, which have to be examined one by one.
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Author bio
N. Sudheer, M.Com., FCS, LL.B., Partner at A2 Consultants
