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Software Tax In India: Not Yet Decoded

Published on Wed, Jun 06,2012 | 21:53, Updated at Thu, Jun 07 at 15:00Source : 

By Manish Batra, Vice-President Tax, GE India

Eduardo Saverin’s relocation to Singapore in 2009, which received wide press around Facebook's IPO last month, set me thinking. Did he renounce his US citizenship to plan around a punitive tax on his IPO earnings, or is it a manifestation of the Pacific's growing importance over the Atlantic? I don't know the answer to that, but what I do know is that Eastern countries such as Singapore are consciously (& successfully) attracting talent, investment and innovation in the software/ knowledge sector through business-enabling regulatory and tax policies ... and in many respects, are a sharp contrast to India which for example, is taxing software retroactively, pretty much a step in the opposite direction.

Consider this … Singapore has, since the early 2000's, exempted import of shrink-wrapped software, downloadable software, software bundled with equipment and site licenses, from local income tax (ordinarily, 10%). So one would wonder whether anything further needed to be done. Well, in April 2012, the Inland Revenue Authority of Singapore issued a Consultation Paper to refine this approach by replacing these exemptions with a “Rights-Based Approach”, which is similar to what we see internationally, such as in the US, OECD, China, etc. Very simply, software transactions are proposed to be characterized based on underlying rights arising to the payer, rather than based on the type of software or its medium of communication. So if “copyright rights” in the software are obtained by the payer, then that would elicit a different treatment than if a “copyrighted article” is purchased.


Singapore has less than 6 million people but a USD 300 billion plus economy, with the added reputation of being the world's easiest place to do business1, the best investment potential nation2 and among the 3 most competitive economies of the world3. India has approx. 1.2 billion people and economy of approx. USD 1.7 trillion. Per Capita math will tell you that an average Singaporean earns almost 50 times an average Indian

A little more on this proposed regime in Singapore, and then I will get to India.

What is a "copyright right" … these are defined as rights to reproduce, modify, adapt, distribute to the public or reverse engineer the software. Where such rights are transferred to the payer, then the transaction would be one of sale resulting in "Business Income" or "Capital Gains" for the seller (depending on whether or not such rights form stock-in-trade). Where however, rights are not transferred but allowed to be used through a license, then the transaction would result in "Royalty" income for the licensor. An example could be that of a magazine editor who gets say, non-exclusive copyright rights to download digital images and reproduce them in his publication – that would result in "Royalty", and be taxed in Singapore.

What is a "copyrighted article" … this would cover situations where the payer is only allowed rights that enable operation and use of the software in business or personally… very commonly, rights to make an electronic copy on the user's computer or device that is essential to using the software. Such a transaction would be one of sale of a copyrighted article, which would result in "Business Income" for the seller, and not "Royalty" – not taxable in Singapore for a foreign seller, unless it has a Permanent Establishment (PE) in Singapore. An example being a gamer downloading a game electronically from a website hosted outside Singapore, to use on his machine … no Singapore tax for the gaming company unless it has a PE.

None of this should come as a surprise to anyone who follows taxation of software internationally, as we see similar approaches elsewhere in other countries. But what is interesting is why Singapore is proposing this change. They are doing away with blanket tax subsidies which are generally looked down upon, while not becoming tax isolationist say, by imposing a "Royalty" tax on all software transactions. A perfect example of protecting one's tax base while remaining competitive and aligned with international norms!

Para 5.3 of the Consultation Paper sums up the rationale for this approach, and I quote: "Adopting the rights-based approach also aligns our tax treatment with international practices at large, where such payments will be characterized based on broad principles. The move is consistent with the Government's thrust of maintaining Singapore's competitiveness as a knowledge-based economy. The approach provides for greater transparency and is less restrictive compared to the exemption-based approach. Consequently, it should help ease the compliance burden of the businesses."

In sharp contrast, let's look at the Indian software space. Many Indian companies importing licensed software for their business use have traditionally taken the view that unless copyright rights in the software are obtained, the transaction is not taxable as "Royalty" and hence they are not supposed to withhold 10% - 20% income tax while paying their foreign suppliers. After a series of litigations across the country at Tax Tribunals and State Courts, the stage is now set for the Supreme Court to opine conclusively on this matter. However, the Finance Act of 2012 has sought to retroactively tax software imports from June 1, 1976, irrespective of the nature of rights involved in the transaction, thereby threatening to increase the cost of such software for Indian users. Time will tell whether this retroactive amendment will hold water before the Supreme Court, but what is disconcerting is the following:

First … instead of continuing to encourage India's development as a knowledge-based economy by increasing our competitiveness in this area, we are moving in the opposite direction;

Second … I can still understand that we cannot exempt the software sector given the country's fiscal situation, but what I cannot rationalize is why we want to tax it retroactively? And completely undermine the principles of fairness and equity that have been the cornerstones of our tax policy making ethos. We are completely eroding the faith of Indians and foreigners doing business in India, who have taken a view based on extant law that did not authorize the levy of tax on software until this Finance Act of 2012.

Third … the taxation of software transactions, is not yet fully certain for suppliers of software from treaty jurisdictions, many of whose tax treaties with India drafted way back in the 1980s and 1990s, do not explicitly envisage tax on software under the definition of "Royalty" in such treaties [for example, tax treaties with US, UK, Singapore, Japan, Australia, and many more]. On the contrary, there are treaties with Malaysia, Russia, Trinidad & Tobago, Turkmenistan, Namibia and Morocco, etc, where taxation of computer software is specifically envisaged under the "Royalty" article of the treaty. While the position on these latter countries is clear, the question is about the fate of suppliers from the former jurisdictions, and equally of Indian companies who have acquired software from such jurisdictions? Will the Income Tax Department argue in court that the amended definition of Section 9(1)(vi) extends to all of India's tax treaties even though the definition of "Royalties" under such treaties did not specifically cover software transactions? One would hope that India would honor the treaty definitions and not seek to override treaties with this domestic law change. However, in a May 28, 2012 decision of the Mumbai Tribunal involving B4U International Holdings Ltd, the Income Tax Department argued treaty override in the context of satellite transmission, which has been similarly "clarified" to be included within the definition of "Royalty" under Section 9(1)(vi) by the Finance Act of 2012 … again, with retroactive effect from June 1, 1976. Fortunately, Mumbai Tribunal ruled in favor of the taxpayer, but many Indian companies are apprehensive that the issue of treaty override will come alive again when the Supreme Court takes up the issue of software taxation later in 2012.

It would greatly help if the Indian Government puts an end to this uncertainty, this time in favor of the taxpayer, by clarifying that the amended provisions of Section 9(1)(vi) will not seek to undermine the provisions of India's tax treaties and India will respect the definitions as agreed under the respective tax treaties ... maybe, even urge the Tax Department, through instructions, to not argue this at the courts.

This point on treaty override is also critical to not trigger similar retaliatory measures by our treaty partners against Indian companies exporting software to those countries. If that were to happen (& we have seen similar retaliatory actions by Japan in the past in the context of software), Indian companies will stand to lose given our strength in the software
export domain, and may impact their competitiveness versus other software exporters from say US, Ireland and other BRICs. We definitely do not want that.
India should take a leaf out of Singapore's book on this one and proactively, reinvigorate business confidence in the software sector by reinforcing its bilateral commitments under our tax treaties … and more importantly, reinvigorate business confidence in India's policies. It's time!

Manish Batra (with inputs from Gagandeep Bindra & Ashish Choraria)

The authors' views are entirely personal


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