The revenue-starved government will have to cough up tens of thousands of crores of rupees over the next few months towards honouring the claims of refunds of the 10% ‘royalty tax’ to scores of non-resident software suppliers to Indian companies, following Tuesday’s Supreme Court (SC) ruling, tax experts said.
Companies importing software for sale have since 1998 been required to deduct the tax payable by the foreign software provider without a permanent establishment in India. While a sections of these importers have complied with the TDS obligation, others have been contesting the tax notices in various forums including tax tribunals and courts. Tax experts said that while a precise estimate of the aggregate TDS amount is not immediately available, they said the refunds, including interest accrued, could add up to Rs 50,000 crore or more.
In its ruling, the apex court has stated that amounts paid by resident Indian end-users/distributors to non-resident computer software manufacturers/suppliers, as consideration for the resale/use of the computer software through EULAs/distribution agreements, is not the payment of royalty for the use of copyright in the computer software. These amounts would be classified as business income for such software provider, which, in the absence of PE, will remain outside the tax net.
Asked whom the tax department would need to refund, a tax expert said, “ordinarily, the non-resident software provider”.
The SC has granted the benefit of the beneficial provisions of the Double Taxation Avoidance Agreements (DTAAs) despite the expansive definition of ‘royalty’ in India’s Income Tax Act. Since most overseas software providers operate form countries with which India has DTAAs, the ruling will practically cover the bulk of such transactions.
While the SC decided on a set of 115 appeals before it, a tax expert on condition of anonymity said: “Certainly, when you compute the implication (of the ruling), you don’t have to look at only the SC cases, but the impact it will have on all the cases that are before various tribunals and High Courts. Because now various tribunals and high courts are going to follow the Supreme Court orders, which may also have revenue implications. The tax department owes a lot of money to these companies.” All the cases which were lost in tribunals would have already paid 100% tax demand, he noted.
Of course, in cases where the 2% equalisation levy (EL) introduced via Finance Act 2020 for ‘on-line services’ provided to Indian persons by non-residents, the latter will be liable to pay the EL. Vishal Malhotra, National Tax Leader-TMT at EY India, said: “If software is supplied physically, then it will not apply. If software is contracted and provided via online platform, 2% equalisation levy will apply.”
“The authoritative pronouncement (by the SC) deals with the extensive arguments made by both sides and jurisprudence under tax and copyright law to conclude that there is no interest or right created in favour of the distributors/end-users, which would amount to use of or right to use any copyright. The primacy of tax treaties over the domestic tax law has once again been upheld while coming to this conclusion. Foreign software suppliers will breathe a sigh of relief with the long uncertainty finally reaching a well-founded outcome in their favour,” said Ravi Mahajan, partner at Ernst & Young LLP.
Software firms like IBM India, Samsung Electronics, GE India, Hewlett Packard India, Mphasis Ltd, Sonata Software Ltd and others who import software for sale in India are among the principal beneficiaries of the SC ruling. The ruling will lower the cost of software purchases for Indian firms across sectors as the overseas software sellers might chose to lower prices, taking advantage of the tax relief.
Earlier court rulings on the dispute were conflicting. In the case of Samsung Electronics, the Karnataka High Court had ruled in favour of the taxman while the Delhi High Court, in the Ericsson case, upheld taxpayer’s contention. The subsequent rulings by other high courts have been divergent.