Payment for Computer Software Not Royalty, No TDS Deduction Required: Delhi High Court

Payment for Computer Software Not Royalty, No TDS Deduction Required: Delhi High Court

Introduction

The Delhi High Court has reiterated that consideration paid by an Indian entity to a foreign company for the resale/use of computer software is not ‘royalty’. Accordingly, the Indian entity is not liable to deduct Tax Deducted at Source (TDS) under Section 195 of the Income Tax Act, 1961 in such cases.

Factual Background

The Income Tax Department had initiated proceedings against Xiocom (NZ) Ltd., a foreign company engaged in designing and providing off-the-shelf software solutions.

• During Assessment Year (AY) 2010–11, the respondent sold software to Zylog Systems (India) Ltd. for use in certain areas in India.
• The Department argued that the income of ₹19,24,80,000/- earned by the respondent was taxable in India as “royalty” under Section 9(1)(vi) of the Income Tax Act, 1961 and Article 12 of the Indo-NZ Double Taxation Avoidance Agreement (DTAA).

Procedural Background

• The Commissioner of Income Tax (Appeals) set aside the tax demand, relying on Director of Income Tax v. Infrasoft Limited (2013), where it was held that if the right transferred is merely to use the copyrighted material and not the copyright itself, the payment cannot be treated as “royalty.”
• The Income Tax Appellate Tribunal (ITAT) upheld the CIT(A)’s decision.
• The Department then appealed before the Delhi High Court.

Issues

1. Whether the consideration paid for the use of computer software amounts to “royalty” and is taxable in India?

2. Whether the Indian entity is liable to deduct TDS on such payments under Section 195?

Contentions of the Parties

• Department’s Contention: The Department argued that the income received by the foreign entity was taxable in India as royalty, making the Indian entity liable to deduct TDS.
• Respondent’s Contention: The respondent relied on the Supreme Court ruling in Engineering Analysis Centre of Excellence Pvt. Ltd. v. CIT (2021), which categorically held that payments for the use of software do not constitute royalty and therefore do not give rise to taxable income in India.

Reasoning and Analysis

The division bench of Justices V. Kameswar Rao and Vinod Kumar observed that:

• The issue was squarely covered by the Supreme Court’s ruling in Engineering Analysis Centre of Excellence (2021).
• Payments made under End-User License Agreements (EULAs) or distribution agreements are only for the right to use the software, not the copyright itself.
• Therefore, such payments cannot be categorized as “royalty” under the Income Tax Act or the DTAA.

The Court concluded that since there is no taxable income in India, there is no obligation to deduct TDS under Section 195.

Outcome

The Delhi High Court dismissed the Department’s appeal, affirming that:

“The consideration for resale/use of computer software through EULAs/distribution agreements is not royalty for the use of copyright of the software. Such consideration does not give rise to taxable income in India, and therefore, no liability arises to deduct TDS under Section 195.”

Appearance

The appellant (Department) was represented by Mr. Ruchir Bhatia, SSC with Mr. Anant Mann, JSC & Ms. Aditi Sabharwal, Advocates.