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March 5, 2021
Indian Supreme Court rules on taxability of software payments
On 2 March 2021, the Indian Supreme Court1 ruled in favor of non-Indian taxpayers with computer software sales to Indian customers.2 The Court ruled that software sales should not be characterized as “royalties” under applicable tax treaty law, consequently not triggering Indian withholding tax in the absence of a permanent establishment (subject to the entity’s tax treaty eligibility).
This Alert summarizes the Supreme Court ruling and implications for taxpayers.
The taxation of income from the sale of computer software in cross-border transactions has been a contentious issue in India for many years, with the key question being whether such income should be characterized as royalties (triggering an Indian withholding tax) or as business income (triggering no Indian tax in the absence of a permanent establishment).
While the Indian domestic tax laws provide a very broad definition of royalties (covering payments for the transfer of all or any rights for the use of or right to use computer software), various tax treaties limit the definition of royalties to payments for the use of, or the right to use, any copyright of a literary, artistic or scientific work.
Indian tax authorities have generally taken the position that income arising from transactions involving the sale of software programs or licenses should be characterized as royalties, irrespective of the nature of rights acquired by the end-user or the reseller. However, taxpayers have often taken the position that the characterization under the applicable tax treaty should be based on the nature and extent of rights granted to the end-user.
Divergent views of the Indian judicial authorities over the course of two decades have resulted in the progression of the issue to the Supreme Court.
Supreme Court Ruling
The Supreme Court ruling covered the following categories of software payments:
The following considerations were provided in the Supreme Court’s decision.
The taxation of cross-border payments for the use of computer software has been a contentious issue in India for many years. This Supreme Court decision was much awaited to settle the controversy and to provide certainty on the issue.
The decision of the Supreme Court is binding on all Indian tax authorities and subordinate courts in India and will apply to all pending litigation and audits. Taxpayers who have disputes pending with Indian tax authorities/subordinate courts involving similar issues could resolve these cases by seeking to apply the Supreme Court ruling. In addition, taxpayers in certain cases could seek refunds of any withholding taxes that may have been deducted on past sales income from Indian customers.
This Supreme Court ruling highlights the significance of entitlement to tax treaty benefits given that these transactions may continue to trigger Indian withholding tax under the domestic tax law. Tax treaty benefits are subject to broad conditions, including the selling entity being the beneficial owner, holding a Tax Residency Certificate, and also complying with applicable anti-avoidance provisions including those introduced pursuant to the OECD Multilateral Instrument (MLI).
In addition, applicable from 1 April 2020, nonresidents will also need to evaluate the impact of the E-Commerce Supply or Services Equalisation Levy (including the expanded scope proposed under Budget 2021) and its interplay with the ruling.
For additional information with respect to this Alert, please contact the following:
Ernst & Young LLP (India)
Ernst & Young LLP (United States), Indian Tax Desk, New York
Ernst & Young LLP (United States), Indian Tax Desk, San Jose
Ernst & Young LLP – Indian Tax Desk, Singapore
Ernst & Young LLP (United Kingdom), Indian Tax Desk, London
Ernst & Young LLP (United States), Asia Pacific Business Group, New York