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Engineering Analysis Centre of Excellence Private Limited v. The Commissioner of Income Tax & Anr.

Civil Appeal · 2021 INSC 137Decided 2 Mar 2021
Civil Appeal Nos. 8733-8734 of 2018
Justice Rohinton Fali Nariman · Justice Hemant Gupta · Justice B.R. Gavai

Background

This batch of over 100 connected appeals addressed a recurring tax dispute: when an Indian resident (an end-user, distributor, or reseller) pays a foreign software manufacturer or supplier for the right to use "shrink-wrapped"/licensed computer software (such as under an End User License Agreement), is that payment "royalty" for the use of copyright, which would legally require the Indian payer to deduct tax at source under Section 195 of the Income Tax Act? The lead case involved Engineering Analysis Centre of Excellence Pvt. Ltd., an Indian company that imported shrink-wrapped software directly from the USA. Tax authorities treated the payments as royalty and penalized the company for not deducting TDS; the Karnataka High Court had sided with the tax department (following its earlier Samsung Electronics ruling) in several cases, while the Delhi High Court had ruled in favour of the assessees in others, creating conflicting precedents that the Supreme Court was asked to resolve.

Decision Breakdown

The Supreme Court held that under the relevant Double Taxation Avoidance Agreements (DTAAs) and their definition of "royalty," payments made by Indian end-users or distributors for the mere right to use software, without any transfer of the underlying copyright itself (such as rights to reproduce, modify, or commercially exploit the software code), do not constitute royalty. Since a EULA or distribution agreement typically only grants a limited, non-exclusive license to use the software as-is (like buying a copyrighted book, not the copyright in it), no "use of or right to use any copyright" takes place. Because the DTAA definition, being more beneficial to the taxpayer, prevails over the wider domestic Income Tax Act definition, there was no obligation to deduct TDS under Section 195, and the Karnataka High Court's Samsung-line of judgments were overruled, while the Delhi High Court's judgments favouring assessees were upheld. This single ruling settled the law uniformly across all four categories of software transactions considered (direct end-user purchase, resale by Indian distributors, resale by foreign distributors, and software bundled with hardware).

Lesson Learnt

Buying a license to merely use software (like most off-the-shelf or cloud software purchases) is legally different from buying the copyright in that software; such routine software purchases from foreign suppliers do not attract India's royalty-withholding tax rules, which brought much-needed clarity and relief for businesses and individuals who import or resell licensed software.

Official source (sci.gov.in)View Judgment (PDF)

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