Introduction
You purchase software from a US vendor — no bells, no whistles, just a license for internal use. Should you deduct tax at source (TDS)? Is it “royalty” under Indian tax law? Will the tax authorities raise a demand?
This very scenario gave rise to prolonged litigation until the Hon’ble Supreme Court decisively addressed the issue in 2021. However, while the ruling was taxpayer-friendly, its applicability is not automatic — and critically depends on proper compliance with DTAA (Double Taxation Avoidance Agreement) provisions.
The Supreme Court Ruling: Engineering Analysis Centre Case
In the landmark judgment of Engineering Analysis Centre of Excellence Pvt. Ltd. v. CIT – [2021] 432 ITR 471 (SC), the Supreme Court held that payments made by Indian end-users or distributors to non-resident software suppliers do not constitute “royalty”, and hence are not taxable in India, provided there is no transfer of copyright in the software.
Key Observations of the Supreme Court:
- A mere license to use software (without rights to copy, distribute, sub-license, or modify) constitutes a sale of a copyrighted article, not a transfer of copyright.
- The Court analyzed four transaction categories — including direct sales, sales through distributors, bundling with hardware (OEM), and resale by Indian affiliates — and held that in each case, absent a copyright transfer, the payment is not royalty.
- Importantly, the Court’s conclusion was based on the interpretation of relevant DTAA provisions (particularly Article 12 of the India–US DTAA), not merely on domestic tax law.
Taxability Under Domestic Law vs. DTAA
The Supreme Court ruling does not override domestic law. Under Section 9(1)(vi) of the Income-tax Act, 1961, software payments may still be treated as “royalty” and hence, taxable in India, even if used solely for internal purposes.
How the DTAA Overrides Domestic Tax Law:
| Aspect | Under Income-tax Act | Under DTAA |
| Definition of “Royalty” | Broader scope; includes software licensing | Narrower; requires transfer of copyright |
| Taxability of software payments | Taxable | Not taxable if only right to use (no copyright transfer) |
| TDS obligation (Section 195) | Yes | Can be avoided if DTAA benefit is claimed properly |
Thus, the favourable tax treatment envisaged by the Supreme Court flows from DTAA provisions — and taxpayers must actively claim such benefit to avail it.
DTAA Benefit Is Not Automatic
Section 90(4) of the Income-tax Act explicitly mandates that a non-resident must furnish a Tax Residency Certificate (TRC) from their country of residence in order to claim DTAA relief.
In addition, Rule 21AB and CBDT Circulars lay down specific compliance requirements for DTAA claims.
Minimum Documentation Required to Claim DTAA Benefit:
| Document | Purpose |
| Tax Residency Certificate (TRC) | Mandatory under Section 90(4) |
| Form 10F | Declares key treaty details; filed electronically |
| PAN of non-resident or Rule 37BC declaration | Avoids higher TDS rate under Section 206AA |
| Declaration of No Permanent Establishment (PE) and beneficial ownership | Ensures eligibility under treaty provisions |
📌 Failure to submit any of these may result in denial of treaty benefits and full application of domestic law provisions, including TDS.
Practical Scenarios: TDS Applicability
No TDS Required – If the following conditions are met:
- Software is licensed for internal use only
- No rights to modify, distribute, or sublicense are granted
- TRC, Form 10F, PAN (or Rule 37BC declaration) and other supporting documents are furnished
- Applicable DTAA excludes such payments from definition of “royalty”
TDS Applicable – If any of the following apply:
- The license includes rights in copyright
- The software is custom-developed or part of a technology transfer
- Non-resident does not furnish TRC, Form 10F, or PAN
- DTAA benefit is not properly invoked
Conclusion
The Supreme Court’s ruling in the Engineering Analysis case provides welcome clarity and relief for Indian businesses making payments to foreign software vendors. However, this benefit stems from DTAA provisions — not from a change in domestic law.
Therefore, merely relying on the SC judgment without ensuring compliance under Section 90(4) and Rule 21AB may lead to unwarranted tax exposure, interest, and penalties.
Taxpayers and professionals must recognize that:
The Supreme Court has opened the door — but it is up to the taxpayer to walk through it by complying with DTAA conditions.
Key Takeaways for Tax Professionals
- Review license agreements carefully to determine if any copyright is transferred.
- Analyze the relevant DTAA (especially Article 12 on royalties).
- Ensure all DTAA documentation — TRC, Form 10F, PAN, PE declaration — is in place before making remittances.
- Where ambiguity exists, consider filing an application under Section 195(2) for TDS determination.
- Maintain a robust audit trail and supporting documents for assessment or scrutiny purposes.
