The Indian Supreme Court (SC), vide its judgment dated 2 March 2021, has decided a two-decade long income-tax litigation in India in relation to whether payments to foreign vendors towards purchase of computer software ought to be characterised as ‘royalty’ or as purchase of goods.

The SC, through an unanimous judgment pronounced by a bench of three Judges, allowed the appeals of the companies (filed against a Karnataka High Court ruling decided against the companies) and rejected the Revenue appeals (filed against a Delhi High Court decided against the Revenue). In a fairly detailed judgment, the SC held that payments made to foreign vendors towards simpliciter purchase of software (either by Indian distributors, for onward distribution to end-users or directly by Indian end-users) cannot be said to be a payment towards use of the copyright therein. As such, the payments are not taxable in India in the hands of the foreign vendors as ‘royalty’, for the years prior to the 2012 amendment to the definition of ‘royalty’ in the Indian domestic tax law. No TDS (withholding tax) therefore applies. The SC held that the 2012 retroactive amendment to the ‘royalty’ definition has to be implemented only prospectively and not retroactively. The SC also held that given the Double Tax Avoidance Agreements (DTAAs) override principle in the Indian income-tax law, the payments would not be taxable as ‘royalty’ under most of India’s DTAAs, even after the 2012 amendment in the Indian domestic tax law.

This landmark pronouncement must bury the historical tax controversy on software taxation in India, even as the 2012 amendment to the ‘royalty’ definition could hold the sway in cases which are not amenable to beneficial outcome under the DTAAs. Whilst the taxpayers rejoice the outcome, the Revenue may seek a remedial course under revisionary powers of the Supreme Court despite the unequivocal ratio laid down in the ruling. The Revenue’s ability to access any remedy in this case, however, would not be free from legal lacunae or limitations.

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