Payment on shrink-wrapped software is royalty, rules High court of Karnataka

Payment on shrink-wrapped software is royalty, rules High court of Karnataka

‘Firms have an obligation to deduct tax at source from the amount paid'

In a major setback to information technology companies, the Karnataka High Court on Saturday ruled that payments made by these firms in India to their foreign software suppliers would amount to “royalty” and the companies had an obligation to deduct tax at source from the amount that they paid .

This order enables the Income Tax Department to recover tax dues from major IT companies from 2000 onwards, which may run into crores of rupees.

A Division Bench, comprising Justice V.G. Sabhahit and Justice Ravi Malimath, passed the order while allowing an appeal by the I-T Department, challenging the 2005 order of the Income Tax Appellate Tribunal.

The tribunal, on appeals by major IT companies, including Wipro, Infosys, HP, Samsung, Sonata, GE India and others, had said that the payment did not attract tax in India as there was no permanent establishment of non-resident foreign suppliers here.

Purchase

The IT companies, which had purchased software from Microsoft and other foreign companies, claimed that the software imported by them were shrink-wrapped products and the same was not customised.

Hence no tax was deducted on the payment made to the foreign suppliers as it was not taxable in India.

However, the I-T Department contended that the payment amounted to “royalty” and hence IT companies had an obligation to deduct tax at source under Section 195(1) of the Income Tax Act. The IT companies argued that this transaction did not come under the purview of royalty.

The court found that what had been transferred through the shrink-wrapped software to the IT companies was only the licence to use the copyright belonging to the non-resident companies, subject to various terms and conditions , which ultimately authorised the end-users to make use of the copyright software.

Transfer

“This would amount to transfer of part of the copyright and transfer of right to use the copyright for internal use of the IT companies as per the terms and conditions,” the court said while refusing to accept the contention that there was no transfer or copyright or part of copyright.

Right

“We hold that the right to make a copy of the software and use it for internal business by making a copy, storing it in the hard disk of the designated computers and taking back-up would itself amount to copyright under Section 14 (1) of the I-T Act and licence is granted to use the software by making copies, which work, but for licence granted would have constituted infringement of copyright and having obtained licence, the companies are in possession of legal copy of the software.

The price of this software is not the price of the compact disc alone or software alone nor the price of licence granted. This is a combination of all in substance. Unless the licence is granted permitting the end-users to copy and download the software, the dumb CD containing software would not have any help to the end users (IT companies) as software would be operative only if it is downloaded to a designated computer as per terms and conditions,” the court said while pointing out that this aspect make out the difference between the computer software and the copyright.

Ruling

Based on this observation, the court held that payments made by IT companies to non-resident foreign companies for supply of shrink-wrapped software would amount to “royalty” within the meaning of the Article 12 of the Double Taxation Avoidance Agreement with the respective foreign countries and that the payment made by way of royalty attracted income tax under Section 9(1) of the I-T Act.

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• Order enables I-T Department to recover tax dues from major IT companies

• The tax dues from 2000 will run into crores of rupees

Source: THE HINDU