- July 6, 2025
- Posted by: Amit Mundhra CA
- Category: Income Tax Cases
In this article we will learn that how the Supreme Court’s ruling in the Engineering Analysis case clarifies the law on TDS on purchase of software from outside India, offering major relief to Indian businesses on royalty and withholding tax issues.
Introduction
In a landmark judgment delivered on March 2, 2021, the Supreme Court of India settled a long-standing controversy surrounding TDS on purchase of software from outside India in the case of Engineering Analysis Centre of Excellence Pvt. Ltd. v. CIT. The key issue was whether payments made by Indian companies to foreign software suppliers should be treated as ‘royalty’. If classified as royalty, such payments would become taxable in India, requiring Indian buyers to deduct tax at source under Section 195 of the Income Tax Act, 1961. This ruling provided long-awaited clarity on the tax treatment of cross-border software transactions, resolving confusion that had persisted for years among taxpayers, tax authorities, and the judiciary.
Background to the Controversy:
For nearly two decades, conflicting rulings from various High Courts particularly between the Karnataka and Delhi High Courts as well as differing views from the Authority for Advance Rulings (AAR), led to widespread confusion on the tax treatment of software payments. To resolve this uncertainty, the Supreme Court clubbed together 103 appeals and examined the nature of transactions by grouping them into four categories based on the agreements between foreign software suppliers or licensors and Indian distributors or end-users:
- Direct purchase of software by Indian end-users from foreign suppliers.
- Purchase of software by Indian distributors or resellers from foreign suppliers, which is then sold to Indian end-users.
- Sale of software by foreign vendors to Indian distributors or end-users, where the foreign vendors themselves acquired the software from other foreign suppliers.
- Sale of computer software embedded in hardware, supplied as a combined unit by foreign companies to Indian buyers.
The Income Tax Department (Revenue) argued that these software payments should be treated as ‘royalty’ under Section 9(1)(vi) of the Income Tax Act, 1961. They pointed to Explanation 2, which says that royalty includes payments made for transferring rights in a copyright. They also relied on Explanation 4, which was added in 2012 but made effective from 1976, to claim that even paying for the right to use software would fall under the definition of royalty.
On the other hand, the taxpayers contended that these were simple purchase transactions of copyrighted goods (not the copyright itself). Since there was no transfer of ownership in the copyright, they argued that the payments did not amount to royalty and were therefore not taxable in India.
Legal Principles for determination of TDS on Purchase of Software from outside India :
1. Copyright vs. Copyrighted Article:
The Supreme Court made an important distinction between two concepts—copyright and a copyrighted article. A copyright is a legal right that allows the owner to reproduce, modify, or distribute a creative work, like software. On the other hand, a copyrighted article is just a physical product, like a CD or pen drive, that contains the software.
The Court observed that when Indian companies buy software, they usually do so under End-User License Agreements (EULAs). These agreements don’t give the buyer any ownership or control over the copyright itself. Instead, they simply allow the buyer to use the software, often with some restrictions.
Because of this, the Court concluded that such transactions are just the purchase of goods, not payments for the use of copyright. So, these payments cannot be treated as royalty under tax law.
2. Definition of ‘Royalty’ in ITA vs. DTAAs:
The Supreme Court pointed out that the word ‘royalty’ means different things under Indian tax law and under tax treaties (DTAAs) that India has signed with other countries. Most DTAAs—based on the OECD model—define royalty in a narrower sense, covering only payments made for the use of, or the right to use, a copyright. Simply using a copyrighted product, like packaged software, doesn’t fall under this definition.
The Court stressed that Section 90(2) of the Income Tax Act allows taxpayers to choose the more beneficial option between domestic law and the relevant DTAA. So, if the DTAA gives a narrower definition of royalty, that definition should apply.
The Court also examined Explanation 4 to Section 9(1)(vi), which was added in 2012 but applied retrospectively from 1976. This explanation broadened the meaning of ‘royalty’ to include payments for the use of software. However, the Court clarified that this was a substantive change in law, not just a clarification. As a result, it could not be applied to past years, since taxpayers cannot be expected to deduct tax under a rule that didn’t exist at the time of payment. That would be both legally unfair and practically impossible.
3. Doctrine of First Sale/Exhaustion:
The Supreme Court referred to the Doctrine of First Sale, also known as the Exhaustion Principle, which is built into Indian copyright law under Sections 14(a)(ii) and 14(b)(ii) of the Copyright Act, 1957 (as amended in 1999). This principle says that once the copyright owner sells a legitimate copy of their work, they lose control over how that specific copy is distributed afterward.
Applying this idea to software, the Court said that when foreign software companies sell packaged (shrink-wrapped) software, their right to control what happens to those specific copies ends. So, if an Indian distributor buys that software and resells it in India, they are not violating copyright laws. They’re simply reselling something they lawfully bought, and such a transaction doesn’t involve any transfer of copyright or count as a royalty payment under tax law.
4. OECD Commentary:
The Supreme Court acknowledged that the OECD Commentary on Article 12, which explains the meaning of ‘royalties’, is a reliable guide when interpreting tax treaties (DTAAs). The Commentary makes an important distinction: it says that payments made for the use of a copyright can be taxed as royalty, but payments made for buying a copyrighted product—like packaged software—are not royalty.
The Court also dismissed the tax department’s argument that India’s reservations or objections to the OECD Commentary could change how DTAAs are interpreted. It made it clear that if two countries want to change the terms of a tax treaty, they must do so together, through formal renegotiation. One country alone—like India—cannot change the treaty’s meaning just by stating a different view.
Supreme Court’s Final Ruling:
The Supreme Court made it clear that when Indian end-users or distributors pay foreign software companies for software—whether under End-User License Agreements (EULAs) or distribution agreements—these payments do not qualify as ‘royalty’. The reason? These transactions only involve using or reselling the software, not the transfer of any copyright in it.
Because of this, the Court ruled that no tax needed to be deducted at source under Section 195 of the Income Tax Act. This decision applies consistently to all four types of software transactions that were considered in the case.
Implications and Further Developments:
The Supreme Court’s decision has finally cleared the air on a long-disputed issue in tax law, offering major relief to software companies and businesses involved in cross-border software transactions. By holding that payments for standard, off-the-shelf software are not ‘royalty’, the ruling removes the confusion around TDS obligations under Section 195 and gives taxpayers greater confidence in relying on the more favourable provisions of tax treaties (DTAAs).
For many businesses, this opens the door to revisiting past tax assessments where TDS was deducted or demanded on software payments. In cases where tax was wrongly withheld, companies may now be eligible to claim refunds.
Although the judgment deals with income tax, its core principles could also influence how authorities interpret related issues under indirect taxes—such as customs duties, GST, and even the equalization levy, especially for cloud-based and SaaS-based software models.
A key development that reinforces this ruling is that the Revenue’s review petition was dismissed by the Supreme Court, citing both a delay of 515 days and lack of merit. This firmly establishes the binding and final nature of the judgment—even as tax systems continue to grapple with the complexities of new-age digital and technology-driven business models.
Download full Judgement of Supreme Court:
You can download Engineering Analysis Centre of Excellence Pvt. Ltd. v. CIT judgement here.
Frequently Asked Questions (FAQs)
1. Is TDS applicable on purchase of software license from outside India?
As per the Supreme Court’s Engineering Analysis ruling, if the software purchase does not involve the transfer of copyright, and only grants limited usage rights under an End User License Agreement (EULA), then the payment is not treated as royalty. Hence, no TDS is required under Section 195 for such purchases from foreign vendors.
2. What about TDS on software license subscription charges?
If the subscription gives only a limited right to use the software without transferring any copyright or ownership, then it is treated as a purchase of goods, not royalty. In such cases, TDS under Section 195 or 194J is not applicable, especially where a DTAA applies.
3. Is TDS applicable on purchase of software license in India?
If the software is purchased within India and involves a perpetual or limited license, it may be covered under Section 194J as a royalty, depending on the facts of the case and whether copyright is transferred. However, after the SC ruling, mere resale or usage rights without copyright transfer are not royalty and hence no TDS applies.
4. Does Section 194J apply to software purchases?
Section 194J applies only if the payment qualifies as royalty under the Income Tax Act. After the Supreme Court’s interpretation, standard software purchases without transfer of copyright do not fall under royalty—hence Section 194J does not apply.
5. Do we need to deduct TDS on software purchases made outside India in 2022 or later?
For payments made post the SC ruling in 2021, the judgment is applicable. So, if the transaction involves no transfer of copyright, no TDS is required even for purchases made in 2022 or later from foreign suppliers.
6. Is GST applicable on software purchase from outside India?
Yes. For software imported into India (even via download), IGST under the reverse charge mechanism (RCM) is applicable as an import of service, regardless of whether TDS is applicable or not under the Income Tax Act.
7. Is TDS applicable on antivirus software purchases?
Antivirus software typically comes under off-the-shelf software. If there’s no transfer of copyright, it will be treated as a purchase of goods, and TDS is not applicable, especially if bought from a foreign supplier.
8. Is TDS applicable on purchase of server space or cloud hosting services?
From Indian providers: Yes, TDS applies under Section 194J (technical services) or 194C (contract services), depending on the contract.
From foreign providers (like AWS, Google Cloud): TDS under Section 195 may apply only if the payment qualifies as royalty or technical service under the DTAA. If there’s no copyright/license transfer and no PE in India, no TDS is required.
