Indian Income Tax on Software Licenses – An Unending Saga

By Rupak Saha, Girish Gurnani, Amit Rana

India’s aggressive source-based taxation approach is clearly manifest in its attempt to tax much of the outbound remittances from the country, particularly those made under the “current account”. Any consideration paid for imports into India of goods and services, including usage and other licenses, are closely scrutinized by the Revenue to determine whether the resulting income, or part thereof, can be argued to have been sourced from India. These have often led the Revenue to make startling tax claims against foreign recipients of such income or on their Indian payers. Often, Revenue makes the kinds of creative claims that would not find support in any tax regime.
The controversy has focused on the taxability of cross-border software license fees. Revenue initially adopted its position without any significant support in law, and contrary to international practice. Predictably, with few exceptions, the Indian courts ruled in favor of taxpayers in a number of cases. The controversy was expected to reach the Supreme Court of India for a final adjudication, but the law was changed earlier this year in an ungainly attempt by Parliament to legitimize Revenue’s contention. Worse, the changes were made applicable retroactively, along with multiple other retroactive and regressive amendments. Not surprisingly, the Government of India has faced a barrage of criticism for its tax policy in the past few months from investors and businesses. Fortunately, this criticism has caused the government to reconsider its position and has resulted in the convening by the Prime Minister of an expert committee (the “Rangachary Committee”) to make appropriate recommendations for the Government to correct its course. (N. Rangachary is a former chairman of the Central Board of Direct Taxes as well as of the Insurance Development & Regulatory Authority.)

The controversy over software relates to whether cross-border payments for use of standardized computer software (often referred to as shrink wrap) is a royalty under the Indian Income Tax Act of 1961 and provisions of tax treaties. The purchase of standardized software (such as operating systems like Windows or applications like MS Word) is accompanied by a license which entitles the buyer to use the software and protects the intellectual property (IP) of the seller by restricting any copying, modification or exploitation of the software.
Under the Act, as it stood before the recent amendment, royalty was defined as a consideration paid for the transfer of any or all rights in a copyright (including the right to grant license). Revenue has contended that the retrospective amendments have clarified that a transfer for use of software generates a royalty. India’s tax treaties, however, contain different language and do not consider a transfer for use to be a transfer of rights in the copyright in software. Accordingly, taxpayers have argued that payments for licenses for use of any software where the seller retains the right to exploit the copyright commercially, do generate a royalty under the Act and most tax treaties.

Revenue has argued in court that a payment under a software license is a royalty because it is a consideration for a right to use the copyright in the software. Taxpayers have argued conversely that the payment for use of a license of software is a consideration for the use of the software (i.e. the copyrighted product), and not the copyright in the software, and hence it cannot be considered as royalty. In short, taxpayers have argued that a license to use software does not convey the ownership rights in the copyright of the software. This is consistent with the view of the OECD and with most international tax jurisprudence.

In the case of CIT (International Tax), Bangalore v. Samsung Electronics Co Ltd (ITA No. 2808 of 2005), which is the leading case supporting Revenue’s view, the Karnataka High Court (Bangalore) held that under section 14 of the Indian Copyright Act, 1957, the right to make a copy of software is considered a right in the copyright. Therefore, the copy created by a user licensee of software to use the software in his computer system is the exercise of a right in the copyright. Hence the consideration to the licensor should be regarded as royalty. Section 52 of the Copyright Act, however, provides that making a copy for use or backup of software is not considered an infringement of rights in a copyright. Under sections 14 and 52 of Copyright Act, the right to create a copy is a right in the copyright, but creating a copy for one’s own use or backup (versus copying for commercial exploitation) is not considered an exercise of the copyright.

Recently, the Delhi High Court took a different view. In DIT v. Nokia Networks OY (TS-700-HC-2012 [Delhi]), the court distinguished between the copyrighted article and copyright. It held that payment received by a foreign company for sale of software to run a telecommunication system in India is not taxable as a royalty, despite the retrospective amendment to the Income Tax Act, 1961, because the applicable double tax avoidance treaty (in this case with Finland) did not view such a transfer as a transfer of the copyright in the software. Nokia contradicted Samsung, without specifically referring to it.

Parliament’s amendment of the Income Tax Act, 1961, to retroactively define all payments for a license to use software as a royalty, even where the purchaser only makes a copy for his or her own use, and even where no rights in the underlying copyright are in any way commercially exploited, has only created more uncertainty and controversy.
The most important issue, of course, is the regressive impact of the retrospective nature of the amendments. A more compelling concern is whether the retroactive aspects of the amended law will apply to India’s tax treaties. In Nokia Network OY, the Delhi High Court made note of the retroactive changes in the Act but agreed with taxpayer that the law’s retroactive provisions did not apply to the India-Finland Tax Treaty.
Virtually all tax treaties contain interpretation provisions which state that terms undefined in the treaty will take meaning from domestic law. Fortunately for the taxpayer, royalty is already defined in most of India’s tax treaties, as it was in the tax treaty with Finland. There is little cause for concern that the retroactive nature of the amendment will apply to India’s tax treaties. Yet some fear that Revenue will find ways to argue that royalty is not defined in tax treaties. While the Nokia judgment held that the amendment cannot apply to tax treaties, there is no sufficient reasoning and analysis behind this conclusion, which may open the door to Revenue continuing to litigate the issue.

The retroactivity of the changes have been decried by investors in India and internationally. Despite India’s respected judiciary, which largely keeps some of Revenue’s excesses in check, the tax regime has generally been perceived negatively by investors. Such retroactive changes, which seem to be undertaken on tax collection considerations alone, do not help to alleviate such negative perceptions, and indeed, defeat other positive steps the Government of India takes to improve investor confidence.

India, like many countries, is plagued by government deficits. It is also a major importer of software. Most will agree that software imports should be taxable. Few can legitimately object to the Government’s determination to garner as much tax revenue as it can from this source. Businesses expect to pay taxes, but require certainty, clarity and adequate advance notice for such taxes so that they can be factored into their business decisions. If prospective changes are made in the tax laws, businesses can take an objective view on whether they want to continue to operate in the Indian market. But retroactive application of newly enacted laws is bad policy simply because it destroys business confidence. Retroactive laws in business matters are no different from arbitrary laws. No one doubts the Government’s ability to flex its muscle by cobbling together a majority in Parliament to enact laws to retroactively override judicial interpretation of longstanding statutory law. But the Government should consider that its victories in passing retroactive laws may merely be Pyrrhic ones. Retroactive legislation destroys business confidence.

The Rangachary Committee, officially known as the Committee to Review Taxation of Development Centres and the IT sector, is to look into issues faced by the IT sector, including the taxability of software. (“Development Centres” are where many multinational corporations carry out research and development activities). As the Rangachary Committee ponders its recommendations it would do well to be mindful that global software vendors are unlikely to accept Indian taxes on their receipts from Indian customers.

Indeed, Revenue may simply not see the kind of tax receipts it hopes for because global software vendors are certain to pass through their Indian tax obligation to the Indian importers. This may well add to Indian industry’s costs sufficiently to slow growth in information technology and outsourcing both of which are large importers of software. More than that, the Government seems oblivious to the possibility of retaliatory taxes by other countries, as happened with Japan a few years ago.

Finally while India has, and must chart, its own tax policy, it cannot afford to isolate itself from tax norms around the world. Availability of capital is scarce, and India needs to be sensitive to how such capital is being allocated. India needs to be aware that it lives in a competitive world. In short, India needs to be cognizant of how other capital importers are conducting their tax regime and whether India is straying violently away from the mainstream.

Amit Rana is Vice President, Tax, at GE India based in Gurgaon and is responsible for direct / indirect taxes for multiple GE businesses in India including aviation, energy and financial services. He can be reached at

Girish Gurnani is Vice President, Tax at GE India, based in Gurgaon, and is responsible for various industrial business. He can be reached at

Rupak Saha is India Tax Head for GE India / GE capital businesses, based in Gurgaon. He can be reached at


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