Payment for shrink-wrapped software taxable as royalty

Facts
 The taxpayers were either engaged in the business of development of computer software or were engaged in the distribution of computer software.
 These taxpayers imported shrink-wrap software from USA, France and Sweden and made payments to the non-resident suppliers, without deducting tax at source.
 The AO taxed these payments as royalty, which was also confirmed by the CIT(A).
 The Tribunal however held the payment towards shrink-wrap software did not amount to royalty and hence tax was not required to be withheld on the same.
 The Karnataka High Court had set aside the decision of Tribunal holding that on all payments made to non-residents, tax ought to be deducted at source unless a certificate for non-deduction of tax has been obtained from the tax authorities. The High Court had not decided the issue on taxability of shrink wrapped software.
 The Hon‟ble Supreme Court set aside the decision of the Karnataka High Court and remitted the matter back to the High Court for answering substantial questions of law on merits.
Issues before the Karnataka High Court
 Whether the payment for purchase of shrink-wrapped software is taxable as royalty?


Observations and Ruling of the Karnataka High Court
 On reading the agreement entered into between the parties, what is sought to be transferred is only a license to use the copyright belonging to the non-resident subject to the terms and conditions of the agreement. Further the non-resident supplier continues to be the owner of the copyright and all other intellectual property rights in the software.
 Copyright could be construed as a negative right. It is an umbrella of many rights and license is granted for making use of the copyright in respect of shrink-wrapped software / off-the-shelf software.
 The customer makes use of the copyright contained in the said software purchased and the same would amount to transfer of part of the copyright.
 The intent of the legislature in imposing Sales Tax and Income Tax are entirely different and therefore, mere finding that the computer software would be included within the term „Sales Tax‟ would not preclude from holding that the said payments made by the taxpayers to non-resident would amount to royalty. Accordingly, the Supreme Court ruling in Tata Consultancy Services (271 ITR 401) could not be relied upon to determine whether software payment amounts to „royalty‟ under the Income-tax Act („Act‟) or Double Taxation Avoidance Agreement („DTAA‟).
 Right to make a copy of the software and use it for internal business by making copy of the same and storing in the hard disk of the computer and taking back up copy would amount to copyright work.
 The amount paid to the non-resident supplier towards supply of shrink-wrapped software is not for the price of the CD alone nor software alone nor the price of license granted, but was for combination of all aspects, which were granted under a license.
 The transfer of copyright including the right to make copy of software for internal business and payment made in that regard would constitute royalty for imparting of any information concerning technical, industrial, commercial or scientific knowledge, experience or skill.


Conclusion
The Karnataka High Court has held that payment for shrink-wrapped software was for transfer of copyright including the right to make copy of software for internal business and payment made in that regard would constitute royalty.
It may be mentioned that the Mumbai Tribunal in a recent case of Novel Inc. v. DDIT (International Tax) 4(2), Mumbai (ITA No.4368/Mum/2010) has held that receipts by non-resident from sale of software to the Indian distributors for onward sale to its end customers was not taxable as royalty.
It may be observed that the controversy over the taxability of software under the Act or the relevant DTAA has still not been resolved and a ruling from the Supreme Court would set at rest the controversial aspects relating to software.