To Withhold Or Not To Withhold?

Karnataka High Court says yes; Delhi High Court says no- caught in the middle are a whole host of companies who don't know whether they should withhold tax on payments made for imported software. Payaswini Upadhyay examines the similarities and differences in the two cases and ask experts the question companies are asking - to withhold or not to withhold?
In a span of two months, two High Courts have ruled differently on one question of law- whether income from supply of software has to be taxed as royalty.

Let's rewind to October last year when the Karnataka High Court heard a batch of appeals on this issue.

Major IT companies Samsung, Wipro, Infosys, HP, Sonata, GE India had downloaded imported packaged software for internal business purpose. When making payments to the overseas software supplying companies, the Indian companies did not deduct withholding tax. Now, based of the double taxation treaties, withholding tax must be deducted between 10-20% in the case of royalty payments and royalty is paid on buying a copyright.
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But IT companies argued that the payments made were for copyrighted articles, not a copyright and hence cannot be treated as royalty payments. Revenue argued that buying of software is a grant of copyright, the payments - royalty and hence tax should have been withheld.  The Karnataka High Court agreed with revenue and ruled that the license to use the software enabled these companies to copy and download the software and so the payments were in the nature of royalty. A judgment the companies don't agree with.
 
Amit Rana
VP- Tax, GE India
"That's how the technology works. There is no other way I could use the software without creating that one copy. And in fact the Copyright Law specifically addresses this issue and it says that creating that one copy is not really a violation of the Copyright. So, I think, they are reading it or interpreting it wrong."
 
Rajan Vora
Partner- Tax & Regulatory Services, EY
"What we have to examine is the definition of copyright as per the Indian Copyright Act - if I have a right only for personal use without right to copy, adopt, convert or alter, then it is not a license as contemplated under the Copyright Act. Therefore, it is actual user license and therefore it a mere back-up copy cannot be treated as a license. Therefore, in our view, the Karnataka High Court decision doesn't lay down the correct principles of law.
 
SR Wadhwa
Former Chief Commissioner, Income-tax
"One copy of the software that was to be copied by the Indian buyer was in the nature of copyrighted article particularly because it was off the shelf product and it was not customized. Therefore, the judgment of the Karnataka HC appears to require reconsideration."
 
But revenue's win in the Karnataka HC was short-lived. Just two months later, in the case of Ericsson AB - the tax department lost on the same argument in the Delhi HC.
 
Ericsson AB had provided licensed software to cellular operators in India. The software was sold as part of hardware and hence could not be used independently.
 
Distinguishing between a Copyright and a Copyright article, the Delhi High Court ruled that the payments made by cellular operators can be treated as royalty only if they obtained copyrights for the software.
 
Ketan Dalal
Joint Tax Leader, PwC
"Yes, they did make the distinction between what they call copyright right and copyright article. And the distinction is that in the case of copyright right, it is something which has the ability to be reproduced for revenue generating purposes whereas in the case of a copyrighted article, it is something similar to acquiring a book and that distinction is important because a copyright right should be characterized as a software but the copyrighted article, as indeed the Delhi HC held, should not be considered as royalty."
 
The 2 cases in this story are different - the Karnataka High Court ruled in the case of shrink wrapped software whereas Delhi High Court ruled in the case of software embodied with hardware. But there are similarities in the broader principles. Infact, though it did not need to - the Delhi High Court has, in the Ericsson case judgment, dwelt on the issue of payments for standalone software. The court said purchasing shrink wrapped, off-the-shelf software involves the transfer of a copyrighted article, the payment for which is not royalty; nor withholdable. And in saying so the Delhi High Court has echoed an OECD principle followed in most jurisdictions.
 
Amit Rana
VP- Tax, GE India
"If I have a software and I give it to someone to commercially exploit it, that's when the payment should be considered royalty. If I am simply taking it to use for my personal purposes, then it should not be considered royalty. So that's how international jurisprudence is evolving. Unfortunately in India, even if India wanted to be liberal, the law doesn't permit it because of the way the Copyright law is worded- to that extent, I would say, there is a limitation in the law for India to go whole hog and just not tax any transaction as long as its for commercial purposes but the way Karnataka is looking at it and taxing even making that one copy  for personal use which a user has to make to be able to use the software, that's going beyond what the extant law is."
 
SR Wadhwa
Former Chief Commissioner, Income-tax
"Our country has to now view this situation in a different light that India is also an exporter of technology of software just like it has been importing on a larger scale in the past. Therefore it has to follow OECD interpretation so that there is uniformity with regards to categorization of the payments and the foreign suppliers do not suffer double taxation."
 
Two  judgments, two different views - what should companies do? Well, according to judicial discipline, companies under the jurisdiction of the Delhi High Court and also those who are not under the jurisdiction of Karnataka High Court can take advantage of the favourable judgement in the Ericsson case. And since Samsung has already appealed the Karnataka High Court decision in the Supreme Court, there is hope that India's position on this issue will get settled soon.

In Mumbai, Payaswini Upadhyay