Uncertainties in the taxation of Software

Software taxation still hangs fire

Evolving continually since the early 20th century, Indian Copyright law brought computer software within the ambit of literary work during the early 1980s. The insertion of ‘royalty’ as a form of income attracting deeming fiction of taxability in Finance Act 1976, appears to have planted the seeds of an ongoing tax controversy surrounding the characterization of software-related payments to non-residents. The controversy was specifically over whether payments are made towards the use of copyright, or the right to use a copyright, or the right to use a copyrighted material in light of their ostensible commercial purpose.

The latest testimony of the continuing controversy is a judgment pronounced by Delhi High Court: It is not royalty when the fee is for license to use customized software and make a single copy for specific business activity, while forbidding commercial use in the form of sub-licensing, selling, copying, decompiling, reverse engineering and so on. The license would bear the character of a permission to use a copyrighted material, and not the use of a copyright per se. This is in contradistinction to an earlier decision by the Karnataka High Court in another case, where it was held that the right to make a software copy for own business would also be copyright work under the Copyright Act. Therefore, fee for license to use software by making copies, even for self-use, would qualify as payment for transfer of a part of the copyright, and thus royalty. This earlier decision was subsequently followed by various tribunals across the country.

It is important to distinguish between incomes arising from various transactions involving computer software and similar intellectual property rights — namely, transfer of rights in the properties and transfer of rights in respect of the properties, limited right to use copyrighted articles.

While income from transfer of rights in the properties could be treated as capital gains, transfer of rights in respect of properties — namely, right to commercially use the property — could be termed royalty, income from right to use copyrighted articles could be characterized as business income. While the above conclusions are fraught with debatable aspects, one must also be mindful of the commercial element in such transactions — that is, whether the software is meant for internal use or replication for generating business income.

To add to the woes, following the retrospective amendment to the deeming fiction of royalty income since 1976 — inter alia characterising as royalty the transfer of any right for use, or right to use a computer software including granting a licence — taxpayers have little choice other than complying with the withholding tax provision in the case of domestic payments. Even for cross-border payments, the divergent views often mean that the payer has to withhold tax. With no effective redress, the income recipient could be impacted monetarily.

Thus, the entire controversy highlights the woes of a taxpayer whenever unilateral amendments to domestic law have been made. While one can certainly understand the Revenue department’s attempts to try and garner tax at source, uncertainties in the taxation of software payments should be allayed by obtaining a consensus over taxing rights through the OECD or the UN.

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