Software and Royalty: Further Controversies

In an earlier post, I had stated:
“The judgment in TCS as also the subsequent decision of the ITAT in Sonata, (2007) 106 T.T.J. (ITAT) 797, make it abundantly clear that payments for shrink-wrapped software would not be chargeable to tax in India. V. Niranjan, in a recent article published in the Journal of Business Law describes the decision in Sonata thus:
The leading case is Sonata Information Technology v Additional Commissioner of Income Tax, International Taxation. The Income Tax Assessing Officer considered that the payment for software import constituted “royalty” under s.9(1)(vi) of the Income Tax Act 1961, on the reasoning that there was no sale of software as there was no transfer of ownership rights and sale, if any, was only restricted to the CDs in which the software is transacted… Royalty is payable only if the copyright itself is transferred, and Sonata correctly observed only a copy of the copyrighted software is licensed to the user. However, Sonata then followed Tata Consultancy Services to hold that it is a sale of goods, which by definition does not attract royalty.“[Footnotes omitted]
(See: V. Niranjan, “A Software Transfer Agreement And Its Implications For Contract, Sale Of Goods And Taxation”, [2009] 8 J.B.L. 799)”
This general statement of the law on the point may have to be modified in view of the recent decision of the Delhi Bench of the Income Tax Appellate Tribunal, in Gracemac v. ADIT and Microsoft v. ADIT, where payment for supply of off-the-shelf, shrink-wrapped software was considered to be royalty. The decisions in TCS and Sonata were distinguished. We will subsequently discuss whether this treatment of the previous cases was based on genuinely relevant factual differences, or whether the decision of the Delhi Bench amounts to a categorical change in the legal position. Meanwhile, the decision itself (along with a summary) is available on the ITAT Bar Association website, here.

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Mihir Naniwadekar

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