August 11, 2022


Business Activity

Sale of Software program License is Exempt from Royalty Tax in India

The Pune Income-tax Appellate Tribunal (Tribunal) issued a ruling within the state of affairs of BMC Software program program Asia Pacific Pte Ltd. (taxpayer), regarding a Singapore-registered company which obtained money circulation from the sale of software program package deal licenses and steerage, maintenance and schooling firms rendered in relationship with software program program licenses getting marketed particularly or not directly via distributors in India.

The Tribunal, ruling on an analysis by the tax authorities (income) that resolved to tax these sorts of transaction in India, relied on the Supreme Courtroom state of affairs of Engineering Investigation Centre of Excellence Pvt. Ltd., to confirm that sale of a copyrighted report (i.e. a merchandise) with regard to make use of of “licensed” private laptop laptop software program doesn’t consequence in granting a licensee any particular authorized rights. Particularly, as no copyright is parted with, these sorts of income quantities are excluded from the indicating of “royalty” the 2 lower than Indian home tax authorized tips and underneath Submit 12 of the India–Singapore tax treaty (tax treaty).

The Tribunal appropriately concluded that transactions that deficiency the character of royalty are characterised as small enterprise cash, and will likely be exempt lower than Report 7 learn via with Posting 5 of the tax treaty, within the absence of the taxpayer constituting a everlasting institution (PE) in India.

Specifics of the Case

The taxpayer is a Singapore-primarily primarily based firm, an licensed program distributor that earns cash from the sale of software program package deal licenses, and from steerage, maintenance and coaching options rendered in reference to software program program licenses marketed straight or not directly via third get-togethers in India. The taxpayer didn’t file a tax return in India on the premise that it was considered an offshore distributor of software program program licenses within the Asia-Pacific space that didn’t private any software program licenses.

The earnings, on consideration of the small print, initiated reassessment proceedings and issued a display result in see to explain why income arising from the sale of program was not turning into made accessible for tax in India, by counting on the Substantial Court docket docket (Court docket docket) state of affairs of Samsung Electronics Co. Ltd. and different picks, and contested that cost been given by the taxpayer was within the path of provide of utility and rendition of application-related firms characterised as royalty underneath Indian home tax regulation and Submit 12 of the tax treaty.

The taxpayer, objecting to the reassessment buy, approached the Dispute Decision Panel (DRP), contending that the sum obtained was solely to the sale of software program licenses dealt with as enterprise income, and couldn’t be considered royalty in mom nature. The DRP, on inspecting the Court docket’s ruling, agreed that the income’s conclusion to cope with these cost on the market of laptop program was royalty and taxed this type of earnings in India.

The taxpayer disputed the DRP order and approached the Tribunal for discount.

Tribunal Ruling

The Tribunal, in a digital listening to, analyzed the character of the cost arising from the sale of utility and rendering of linked companies for taxability as royalty lower than Indian home regulation or the tax treaty. The Tribunal deemed if the sale of laptop system software program package deal transaction had the character of royalty or group revenue, in light of the Supreme Court docket ruling in Engineering Investigation Centre of Excellence Pvt. Ltd., the place by, working with an comparable topic, the Courtroom held that:

  • possession of copyright beneath Write-up 12(3) of the tax treaty in a piece is numerous from the possession of the bodily product wherein the copyrighted carry out is embedded
  • the principle of a sale transaction is to authorize the stop-consumer to have accessibility to and make use of “licensed” laptop system laptop software program resolution about which the licensee has no distinctive authorized rights the place by no copyright is expressly parted with
  • taxability of the consideration beneath “royalty” in Indian home regulation provides that “the switch of all or any authorized rights in regard of any applicable, property or information incorporates and has often concerned switch of all or any proper to be used or appropriate to make use of a pc system program (which embody granting of a licence) regardless of of its medium by means of which these sorts of appropriate is transferred”
  • this type of provision is simply clarificatory in mom nature and doesn’t prolong the scope and indicating of the time period “royalty” which can use prospectively
  • whether it is concluded that the receipt is just not characterised as royalty, will probably be within the nature of firm earnings under the related tax treaty and
  • to herald “enterprise earnings” tax within the supply place these sorts of as India under the ambit of Posting 7 it’s wanted that the international entity actually ought to represent a PE in India by way of Posting 5 of the tax treaty, absent which there is no such thing as a tax induced under Quick article 7.

The Tribunal, after substantial analysis, disregarded Samsung Electronics Co. Ltd., relied on by the earnings, however reversed by the Supreme Court docket docket case of Engineering Investigation Centre of Excellence Pvt. Ltd., consequently constructing the reassessment proceedings initiated by the earnings and confirmed by the DRP invalid. The Tribunal noticed that the factors of the immediate state of affairs had been equivalent to the Supreme Court docket state of affairs, to conclude that the amount of cash is exterior the purview of royalty beneath Posting 12 of the tax treaty, and the taxpayer, absent a PE in India beneath Submit 5 of the tax treaty, can’t be challenge to tax in India.

On prime of that, within the absence of the make on the market clause being happy within the examine course of rendering of options by the taxpayer, the businesses rendered for bills together with the sale of laptop program is equally not challenge to tax in India lower than Submit 12(3)(b) of the tax treaty.

Important Takeaways

The subject material of cross-border tax on sale of laptop software program options/licenses has been the subject material of a distinguished dispute in India amongst the earnings and the taxpayer for a lot of yrs. The controversy is especially owing to the broader scope of “royalty” beneath Indian home tax legislation in comparison with the narrower definition under the Group for Financial Cooperation and Development (OECD) Product Tax Convention.

The favorable Tribunal ruling reasserts the speculation that outright sale of software program package deal merchandise and options/licenses cannot be characterised as royalty in character under Quick article 12 of the tax treaty, and it’s worthwhile to refer the Delhi Tribunal case of Digite Inc. v. ADIT which verified that sale of copyrighted program licenses was enterprise cash not answerable for any tax in India as royalty beneath Quick article 12 of the India–U.S. tax treaty absent a PE in India.

The important thing place to find out taxability arising from sale of software program is that if there’s grant of a copyright, solely then can the provision state tax it as royalty on a useful resource foundation alternatively, if the transaction is characterised as sale of a copyrighted quick article (i.e. a product), the provision place has the proper to tax solely within the occasion the vendor has a PE in that nation.

Aiming to spice up certainty, the UN Tax Committee produced a dialogue draft on “Inclusion of laptop software program funds within the definition of royalties” within the UN Mannequin Double Taxation Convention by proposing an modification to Submit 12 on “royalties.” The proposal, if applied in bilateral treaties, may make laptop software program funds taxable within the supply nations, set to rest the continuing litigation in India with different worldwide places on laptop software program funds, and provide tax certainty by aligning the treatment underneath tax treaties and the home tax legislation.

The aim of the proposed modification is to offer readability on the controversy of whether or not cost in path of a applicable to make use of this system constitutes royalty and dilutes the non-taxability state of affairs adopted by distributors who acquire and provide software program package deal in a number of modes/media then again, the controversy all-around royalty characterization in circumstances wherever utility is pre-put in/embedded in a merchandise (this type of as laptop computer elements and telecommunications merchandise) may even now go on proper till the proposal is authorized by the OECD lower than the blueprint of Pillar 1 and Two steerage launched late final 12 months.

It’s also relevant to discuss with the latest Two-Pillar technique agreed by the OECD/G-20 Inclusive Framework on BEPS, precisely the place:

  • Pillar A single goals to make certain a fairer distribution of income and taxing authorized rights amongst nations around the globe with respect to the most important multinational enterprises, with the caveat that constructing worldwide places will be capable to profit from an elective mechanism in sure circumstances, guaranteeing that the principles will not be far too onerous for some of these nations. The settlement to re-allocate earnings underneath Pillar 1 incorporates the elimination and standstill of digital services and products taxes and different pertinent comparable steps, bringing an cease to commerce tensions ensuing from the instability of the worldwide tax program.
  • Pillar Two dissolves tax ranges of competitors on company money circulation tax with the introduction of a world minimal firm tax at a degree of 15% that nations can use to defend their tax bases (the World laws). Tax incentives furnished to spur appreciable monetary train will likely be accommodated by a carve-out guarding the right of manufacturing nations to tax explicit foundation-eroding funds (like fascination and royalties) when they don’t seem to be taxed as much as the naked minimal quantity of 15%, via a “Topic to tax rule.”

It’s also important to notice that the U.S. will terminate its proposed commerce actions in the direction of India pertaining to the two% equalization levy (EL) and India is just not essential to withdraw the EL guidelines relevant in circumstances for cost of royalty proper till Pillar A single is created profitable. Additional, India will make it potential for a credit standing of the two% EL chargeable on international e-commerce operators via the “interim interval” in the direction of multinational enterprises’ future Pillar An individual tax obligation when Pillar Only one tips are in consequence. In accordance to the push launch issued the interim interval will likely be from April 1, 2022 proper up till the implementation of Pillar One or March 31, 2024, whichever is beforehand.

This put up doesn’t at all times mirror the view of The Bureau of Countrywide Affairs, Inc., the writer of Bloomberg Regulation and Bloomberg Tax, or its householders.

Creator Data

Shailendra Sharma is a Chartered Accountant related to a multinational financial services and products enterprise, India.