income tax
The term 'Royalty' has its roots in the French language. Recently, it gained worldwide attention due to an interview involving the UK’s former royal couple. However, in India, the focus on royalty has emerged from a landmark ruling by the Honourable Supreme Court in the case of Engineering Analysis Centre of Excellence Pvt. Ltd and others. This decision has definitively addressed the long-standing controversy regarding the taxability of royalty.
The tax treatment of royalty payments and the associated withholding tax obligations have been contentious issues for some time. The expansive definition within the Income Tax Act has led to scrutiny of payments from residents to non-resident software service providers, placing them under the Revenue’s tax ambit in India. Fortunately, the judiciary’s recent ruling has subtly rebuffed the Revenue's claims in this area.
The core issue before the court was whether payments made by residents in India to non-resident foreign software suppliers constituted royalty. If deemed royalty, these payments would represent taxable income in India under section 9(1)(vi) of the Income Tax Act, 1961, necessitating tax deductions at source in accordance with section 195 of the Income Tax Act.
In its judgment, the Supreme Court delved into the pertinent provisions of the Income Tax Act, 1961, and the Double Taxation Avoidance Agreements (DTAAs), as well as related laws that influence the transactions in question.
The principle of 'substance over form' is universally applicable and foundational in accounting and taxation. In the context of the Income Tax Act, 1961, Sections 4, 5, and 9 are considered charging sections, representing the "substance," while the remaining provisions are machinery provisions that serve to calculate income and tax liability, representing merely the "form."
In summary, any income falling outside the charging sections is not subject to tax.
Moreover, a holistic approach is necessary when interpreting the Act. Section 90 empowers the Central Government to negotiate agreements with foreign nations to avoid double taxation. Section 90(2) emphasizes that for assessees covered by such agreements, the more favorable provisions apply. As established in the landmark case of Azadi Bachao Andolan, DTAA provisions have precedence over the Income Tax Act.
To ascertain the chargeability of income subject to double taxation, consider the following steps:
The Supreme Court adhered to these steps in its ruling and rendered a decisive pronouncement.
Prior to this judgment, whenever a resident taxpayer entered into agreements with non-resident parties for software purchases, the Revenue typically viewed the income as taxable under the royalty provisions. Consequently, residents were required to deduct tax under section 195 of the Act; failure to do so resulted in the label of “Assessee in Default.”
This judgment clarifies the distinction between the sale of copyright and the sale of copyrighted goods. When residents procure software from non-residents, they are purchasing "goods," not rights. They do not acquire the rights to reproduce or resell but are permitted to use the software for their own purposes.
Since the sale of software for end-use qualifies as business income for the non-resident and, in the absence of a Permanent Establishment (PE), this income is not taxable in India, thereby eliminating withholding tax obligations for the buyer.
By issuing bold and significant judgments, the Supreme Court continually reinforces the trust of honest taxpayers in this nation.