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Taxability of Royalty

Case Study : Taxability of Software Licences as Royalty

Whether income from Software Licences and support, maintenance and training services in respect of such software licenses rendered in India by Non-resident is taxable as per provisions of Indian Income tax Act?

After Supreme Court of India Verdict in March 2021 in case of Engineering Analysis Centre of Excellence Private Limited Vs. CIT (2021) 432 ITR 472:

Taxability under the Income Tax Act:

  • Section-9 (1) (vi) of the ITA provides that income from royalty shall be deemed to accrue or arise in India if it is payable by Government or person who is Resident in India or person who is Non-resident in India to a person who is Non-resident as per definition of Royalty as provided in Explanation 2 and Explanation 3 of this clause and further clarified by Explanation 4 of this clause inserted by Finance Act 2012 w.e.f. 1.6.1976.
  • Accordingly, it was considered that any income from software licenses and other related activities is covered under above clause as Royalty income of the Non-resident (who is not have any permanent establishment in India) irrespective of the fact whether or not, the Non-resident is having residence or any fixed place of business or rendered such services in India.
  • The Apex court in case of Engineering Analysis (supra) clearly stated that Explanation 4 to Section-9 (1)(vi) inserted by Finance Act is not clarificatory as it expands the scope and hence prospective. Therefore, extended scope of Royalty is applicable from year 2012-2013 not from 1.6.1976 as originally enacted.

Therefore, income from royalty shall be deemed to accrue or arise in India in the hands of Non-resident with extended scope of Royalty as clarified by Explanation 4 shall be from 1.4.2012.

Taxability under Double Taxation Avoidance Agreements (DTAAs)

  • In most of the DTAAs the term royalty has been defined as payment of any kind received as a consideration for the use of, or the right to use:

(i)     Any copyright of a literary, artistic or scientific work, including cinematography film or films or tapes used for 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, property or information

(ii)    Any industrial, commercial or scientific equipment, other than payments derived by an enterprise from activities described in paragraph 4(b) or 4(c) of Article 8

  • Hon‟ble Supreme Court in Engineering Analysis Centre of Excellence Pvt. Ltd. Vs. CIT (2021) 432 ITR 472 (SC) held that

(i)     Ownership of copyright in a work is different from the ownership of the physical material in which the copyrighted work may happen to be embodied.

(ii)    Parting with copyright entails parting with the right to do any of the acts mentioned in section 14 of the Copyright Act.

(iii)   Where the core of a transaction is to authorize the end-user to have access to and make use of the “licensed” computer software product over which the licensee has no exclusive rights, no copyright is parted with.

Therefore, income from software licenses and support, maintenance and training services in respect of such software licenses rendered in India by Non-resident cannot be brought within the definition of Royalty as defined in relevant DTAAs. It will obviously be in the nature of “Business Profits‟ under the DTAA. In order to bring `Business profits‟ of a resident of the other country to tax in India within the ambit of Article 7, it is sine qua non that the foreign enterprise must have a Permanent Establishment (PE) in India in terms of Article 5 of the DTAA. In the absence of a PE, the taxability under Article 7 does not trigger.

 

(Disclaimer: This content is meant for our clients or professional friends only for stimulating discussion on the subject matter not to frame any commercial opinion. All efforts are made to compile correctly with no guarantee of extreme accuracy)

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