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March 9, 2021

Indian Supreme Court rules on taxability of software payments

Executive summary

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.

Detailed discussion


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:

  • Sales of software directly to an end-user by a nonresident
  • Sales of software by a nonresident to Indian distributors for resale to customers in India
  • Sales of software by a nonresident to a foreign distributor for resale to customers in India
  • Software bundled with hardware and sold by foreign suppliers to Indian distributors or end-users

The following considerations were provided in the Supreme Court's decision.

  • An end user who obtains a non-exclusive, non-transferable and restricted right to a copy of the software makes a payment for the copyrighted software and not for use of the "copyright" of the owner. Similarly, where the end user does not obtain any rights in the copyright under the license agreement, making a copy of the software for internal use (as permitted by the license) does not involve the grant of a right in the copyright. The Supreme Court concurred with the view that a payment made by end users and distributors is akin to a payment for the sale of goods and not for the grant of a license in copyright under the Indian Copyright Act 1957 (ICA).
  • The designation given to a transaction is not a decisive factor, and the true effect of the agreement needs to be considered, taking into account the overall terms of the agreement and the relevant circumstances.
  • Prior to the expansion of the royalty definition under the domestic tax law in 20123 to specifically include software payments, an amount could only be treated as a royalty if there was a transfer of all or any rights in a copyright by way of license or other similar arrangement. If there was a payment for the grant of a license, such payment would constitute a royalty only if such license results in the transfer of the rights in the copyright under the ICA. As the licenses granted to the distributors and the end-users did not involve the grant of any rights in the copyright, the payments made for such licenses cannot be considered as royalties under both the domestic tax law (prior to 2012), and the tax treaties.
  • The 2012 expansion of the scope of the royalty definition in the domestic tax laws, which was intended to have retrospective application, could not oblige withholding agents to apply withholding on a retrospective basis.
  • If the tax treaty provisions are aligned with the Organisation for Economic Co-operation and Development Model Convention (OECD MC), such provisions may be interpreted using the OECD MC Commentary. India's position on the OECD MC Commentary would not be considered as a decisive factor for the interpretation of tax treaties, particularly when such positions are not stated in explicit language and are also not reflected in subsequent tax treaties concluded by India. The OECD Commentary supports the position that a payment to make a copy or adaptation of a computer program to enable the use of the software for which it was supplied does not constitute a royalty. This also supports the position that the payment made by distributors and end users should not constitute a royalty.
  • The Supreme Court reiterated their earlier ruling which confirms that a withholding agent is only required to withhold tax if the amount is chargeable to tax under both the domestic tax law and the tax treaty. The Supreme Court confirmed that the determination of the income of a nonresident chargeable to tax in India is subject to the provisions of the relevant tax treaty. If an item of income is not chargeable to tax under the tax treaty, then such income could not be chargeable to tax under the domestic tax law.4


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


1 The apex court of India.

2 Group of appeals, with the lead case of Engineering Analysis Centre Of Excellence Pvt. Ltd [TS-106-SC-2021].

3 Amended by the Finance Act 2012.

4 The Supreme Court decision in the case of PILCOM is not applicable to the current case as it related to payments made to nonresident sportspersons, which are governed by other provisions of the domestic tax law and were not linked with the chargeability under the domestic tax law.