ISSUE II : Taxation of computer software in international transactions



In the recent years, there has been a rapid advancement in computer technology as well as the transfer of such technology across borders. India is no exception to this trend. A matter of considerable importance, however, is the taxation of payments made as a consideration for purchase or license for usage of computer software supplied by a non-resident. Characterization of income from transfer of software has been a contentious issue that has come up for decision before the income tax authorities in India in various fact situations. This characterization of income from computer software depends on the facts of the case and the rights associated with the grant or sale of the software. This Bulletin seeks to analyze Indian jurisprudence on the contentious issue of taxation of computer software in international transactions.

1. Provisions of Income Tax Act

The Income Tax Act, 1961 (“Act”) casts an obligation upon any person responsible for making any payment to a foreign company, such as an interest payment or any other sum chargeable under the Act to deduct withholding tax.1 Further, the Act provides that the royalty received by a non-resident from a person in India is deemed to accrue or arise in India.2 In terms of the Act, royalty means consideration for, inter-alia, the transfer of all or any rights (including the granting of a license) in respect of any copyright.3

The Act also provides that if the provisions of a Double Taxation Avoidance Agreements (“DTAA”) between India and the country of a non-resident are more beneficial to such non-resident, then the provisions of the DTAA shall override the provisions of the Act.4 The terms of DTAAs executed by India define ‘royalty’ as “Payments of any kind received as 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 trademark, 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”. The non-resident taxpayer would be entitled to choose the definition given under the DTAA over the one given under the Act if the former is more beneficial.

Therefore, in terms of both the Act as well as the DTAA, any payment for transfer of any rights in respect of any copyright in a work5 constitutes ‘royalty’ on which withholding tax is deductible. Where no transfer of rights in a copyright is involved the transaction would be sales income of the payee and no withholding tax would be deductible.

The characterization of income of software supplier in India as ‘royalty’ or ‘sales’ is particularly important in the light of the fact that income characterized as ‘royalty’ would attract withholding taxes, whereas any income characterized as sales income would be a part of business profits of the supplier of software that is not taxable in India in the absence of a permanent establishment in India.6

2. Copyright in Computer Software

Software may be described as a programme, or series of programmes, containing instructions for a computer required either for the operational processes of the computer itself (operational software) or for the accomplishment of other tasks (application software).7 The rights in a computer software are a form of intellectual property, i.e. copyright.

The law of copyright is contained in the Copyright Act, 1957 that defines the rights which an author of a work has by virtue of creating the work.8 These rights are exclusive in nature. While the nature of the rights which are granted varies according to the type of work9 in question, and these include, inter alia, the right to (1) copy the work (reproduction right), (2) issue copies of the work to the public (distribution right),

(3) rent or lend the work to the public (rental or lending right).10 In addition to the aforesaid rights, owners of computer programme have the exclusive right to sell or give on commercial rent any copy of the computer programme.11

Coming back to the issue of characterization of payments made for supply of computer software by non-residents, it is important to consider whether the payments are made for transfer of any or all of the aforesaid rights that constitute the copyright in the computer software or whether what is being sold is merely a copyrighted article. If it is for copyright, it should be classified as royalty both under the Act and under the DTAA and it would be taxable in the hands of the assessee. If the payment is for a copyrighted article, then it only represents the purchase price of the article and, therefore, cannot be considered as royalty either under the Act or under the DTAA. The difference between ‘copyright’ and ‘copyrighted article’ is highlighted in the next section.

3. Copyright versus Copyrighted article

Ownership of copyright in a work is quite independent of the ownership of the physical material in which the work is fixed. For example, if a person buys a book he is the owner of the book but he does not have any right to reproduce the work or publish an abridgement or translation of the work. That right belongs to the author or copyright owner of the book. Copyright is different from the material object which is the subject matter of the copyright. Therefore, a transfer of the material object does not necessarily involve a transfer of the copyright. It is on this premise that the Income Tax Appellate Tribunal (“ITAT”)12

has decided various cases relating to taxation of income arising out of computer software supplied by non- residents which are discussed below.

In Sonata Information Limited v. Addl. CIT13, the assessee entered into distribution agreements with several overseas vendors that authorized the assessee to distribute the computer programme to end-users in India. The issue before the ITAT was whether the payments made by the assessee towards import of computer software was ‘royalty’. It was held that the copyright in the software is different from any right in the physical manifestation of the software contained in a compact disc or a floppy or hard disk in which the software is downloaded. When the assessee acts as the distributor for overseas vendors, he has not acquired the distribution right in the computer software or the right to give on commercial rental, i.e., the rights that constitute a copyright in the computer programme under the Copyright Act, 1957. The aforesaid rights continue to remain with the overseas vendors. The assessee has merely obtained the right to distribute the copyrighted material which is a property different from the intellectual property, i.e., the copyright in the software. ITAT further held that if the distinction between copyrighted material and property contained in the copyright is not borne in mind, it would lead to illogical consequences. Therefore, it was held that since none of the rights that constitute the copyright in a computer programme are being transferred, the payments made for import of computer programme cannot constitute ‘royalty’.

The landmark judgment of the ITAT in Motorola Inc., Erisson Radio Systems A.B. and Nokia Networks OY v. Deputy C.I.T14, discussed the issue of characterization of income from sale of software embedded into hardware to Indian telecom operators under the terms of a supply contract that could, in substance, be divided into two agreements, sale of hardware and licensing of software. The ITAT reiterated the rights that constitute the copyright in a computer programme15 and held that the determining factor is whether the telecom operators can exercise any of such rights. If the telecom operators cannot exercise any of the rights, it can be concluded that what they have acquired is the copyrighted software, which is an article by itself and not any copyright therein.

The terms of the supply agreement were referred to answer this question. It was observed that telecom operators had a “non-exclusive” right which was different from an “exclusive right” contained in Section 14 of the Copyright Act. Further, in terms of the supply agreement, the telecom operators could not license or sell the software. In contrast, under Section 14(b)(ii) of the Copyright Act, the holder of the copyright can license or sell the copyright. A conjoint reading of the terms of the supply contract and the provisions of the Copyright Act, 1957 clarified that the telecom operator could not exploit the computer software commercially which is the very essence of a copyright. In other words, a holder of a copyright is permitted to exploit the copyright commercially, and if he is not permitted to do so then what he has acquired cannot be considered as a copyright. In that case, he has acquired a copyrighted article. Accordingly, the ITAT held that the payments made under the supply agreement could not be constituted ‘royalty’ either under the provisions of the Act or the DTAA. It was clarified that the word “license” was used in connection with the payment for software only because the software was given to the telecom operators with certain restrictive conditions and from the mere use of that word, it cannot be inferred that the payment was similar to a license fee or royalty.

The Supreme Court in the case of Tata Consultancy Services v. State of Andhra Pradesh16 held that the sale of off-the-shelf software was in the nature of sale of goods and not provision of services. In determining whether off-the-shelf software17 are ‘goods’, the Supreme Court held that intellectual property in the software remains with the creator of the software, even though the software was been purchased, and therefore payments for such purchases cannot be held as royalty.

The view taken by ITAT is evident from the aforesaid cases. Whether there is a transfer of rights that constitute a copyright or only of a copyrighted article should be determined taking into account all the facts and circumstances of the case and the benefits and burden of ownership that have been transferred. However, the Indian revenue authorities, despite being bound by the decisions of ITAT have more often than not characterized income from computer software as ‘royalty’ without taking into consideration the nature of rights being transferred in each case.


The taxation of computer software in international transactions has been a contentious issue in India. The debate has mainly centered on characterizing such transactions as generating either ‘royalty’ or ‘sales income’. The Indian revenue authorities have generally taken a view that income arising from such transactions should be characterized as ‘royalty’, irrespective of the nature and extent of rights acquired by the end-user. However, through a number of decisions of ITAT, it is well-settled that if the consideration is for a right to commercially exploit the intellectual property in the software, then it would tantamount to royalty. In other words, consideration paid for acquiring any of the rights that constitute the copyright in the computer software, would be ‘royalty’. On the other hand, the payments made for transfer of the copyrighted article, i.e., computer software, and not for any of the rights therein cannot be ‘royalty’ payments.

The treatment of income as ‘royalty’ or ‘sales’ has obvious consequences as the income characterized as ‘royalty’ would attract withholding taxes, whereas any income characterized as sales income would be a part of business profits of the supplier of software that is not taxable in India in the absence of a permanent establishment in India. Thus, ITAT has taken a progressive view in matters of taxation of computer software, that saves the foreign companies from undue hardship and is conducive to the cross-border transfer of computer technology.

1 Section 195 of the Act.
2 Section 9(1)(vi) of the Act.
3 Clause (v) of Explanation 2 to Section 9(1)(vi).
4 Section 90(2) of the Act.
5 Section 2(z) of Copyright Act, 1957 provides that ‘work’ means a literary, dramatic, musical or artistic work, a cinematograph film, or a sound recording.
6 The terms of the DTAA between India and the country of non-resident would determine whether the non-resident has a permanent establishment in India. In case there is a permanent establishment, the income of such non-resident attributable to operations in India would be taxable in India.
7 Sonata Information Limited v. Addl. CIT, 103 ITD 324.
8 Section 14 of the Copyright Act, 1957.
9 Supra, n.5. Further, section 2(o) provides that ‘literary work’ includes computer programme.
10 Section 14(b)(i) of the Copyright Act.
11 Section 14(b)(ii) of the Copyright Act.
12 In India, the Assessing Officer (“AO”) is at the lowest level in the hierarchy of income tax authorities. An appeal against the orders of AO is made to Commissioner of Income Tax and an appeal against the order of the latter is made to ITAT. An appeal against the
order of ITAT is filed with the High Court in the state concerned if there is a substantial question of law involved. An appeal against the order of High Court can be filed with the Supreme Court of India.
13 103 ITD 324.
14 (2005)96TTJ(ITAT)1.
15 Discussed under section 3 of this bulletin.


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