The Supreme Court has ruled that payments made by resident Indian end users or distributors (such as technology companies) to overseas suppliers on import of ‘shrink-wrapped’ software generally known as off-the-shelf software- is not a royalty’ payment. Thus, no withholding tax obligation arise in India against such payments.
During assessments payments made for import of shrink-wrapped software to overseas suppliers were held assessable to tax as ‘royalty’ under section 9(1)(vi) of the Income Tax Act and Article 12 of the respective tax treaties. This classification as ‘royalty’ required tax to be deducted at source (TDS) when making payment to the overseas suppliers.
The contention of companies was that the use of software by the Indian importer was limited to making a backup copy and /or redistribution. They did not have the right to modify the shrink-wrapped software that was imported. So, the payment made to overseas supplier could only be treated as business income in the hands of the entity – instead of as ‘royalty’ – and no tax withholding obligation arose.