Transfer of computer software held taxable

FOREIGN ENTERPRICE

When a foreign company transfers computer software to an Indian Company from outside India, is the foreign company liable to pay income tax in India? This issue arose in a recent case of Airport Authority of India (AAI), which entered into two contracts with a US company – one for hardware and other for software. Whereas supply of hardware was held as non-taxable, but the supply of software was treated as “royalty” and “fee for technical services”.

Commercially there are two types of softwares, namely, “unbranded software which is specialised and exclusively custom made to cater to the needs of individual clients”, and “branded software” or “off the shelf software” which is standardised and marketed as such. The software supplied to AAI consisted of customised software.

AAI contended that when the US Company shipped the software and documentation, the property passed to AAI outside India. It also contended that the entire activities under the contract except some support activities were performed outside India. The essence of the contract is outright sale of some copyrighted software, but the software could be used only for the specified intended purpose.

The issue before the AAR was whether payment received by US Company under the transaction is liable to tax in India in the hands of the US Company? The AAI pleaded that the supply of software should be treated as sale of goods and the resulting income should be treated as business income.

Reliance was placed on a SC decision in the case of Tata Consultancy Services vs Union of India [2004-271 ITR 0401 {SC)] in which the supply of software was treated as sale of goods. It was also contended that there is a distinction between grant of licence to use a copyright and sale of a copyrighted article.

The Indian I-T Act does not contain any clear provision with regard to transfer of computer software. Therefore, a taxpayer is entitled to take help from internationally accepted commentaries like the OECD Commentary, which provides for treatment in case of transfer of full ownership rights as well as for partial alienation of rights. It is clear that even in case of partial alienation of rights, in certain circumstances, the consideration will be a business income and not royalty.

The AAR dismissed the assessee’s reference to OECD commentary which clarifies the distinction between the right to use copyright and transfer of a copyrighted article. According to OECD only a transfer that enables a transferee to commercially exploit software copyright will give rise to royalty income.

But where the transferee gets exclusive rights for use, though short of full ownership, it will nevertheless be a case of sale of software. In the Microsoft case also, the Tribunal rejected the assessee’s contention to rely on the OECD commentary. In this case, the payment in respect of supply of software with an exclusive right to use was treated as royalty and was hence held taxable in India. The Tribunal rejected the plea to rely on Tata Consultancy case.

Even if the rationale of the ratio laid down is not questioned, the judgments will have a tremulous effect on India’s outsourcing business which constantly requires new software besides modification and updgrade of the old one. The government should should take a practical view and clarify the Indian law to synchronise the same with OECD commentary.