The Income Tax Appellate Tribunal, Bangalore, has clarified that the licensing of standardized software without transfer of source code or copyright rights cannot be classified as royalty or fees for technical services under the Indo-Swiss Double Taxation Avoidance Agreement. This decision reaffirms the binding precedent set by the Supreme Court in Engineering Analysis Centre of Excellence Pvt. Ltd. v. CIT and provides critical guidance to foreign software vendors operating in India.
Background & Facts
The Dispute
The appellant, M/s. Beta CAE Systems, a Swiss-resident company, supplies computer-aided engineering (CAE) software to end users in India either directly or through local distributors. The Assessing Officer (AO) treated the consideration received for software licenses amounting to Rs. 50,93,03,724/- as royalty or fees for technical services (FTS) under Section 9(1)(vi) of the Income Tax Act, 1961, and denied exemption under Section 10(50). The dispute centered on whether the transaction constituted a sale of goods or a transfer of copyright rights attracting royalty taxation.
Key Facts
- The assessee is a non-resident company incorporated in Switzerland with no permanent establishment in India.
- The software is distributed via purchase orders placed by Indian customers or distributors, with license keys and passwords delivered electronically.
- The End User License Agreement (EULA) and Distribution Agreement explicitly prohibit:
- Transfer, reproduction, modification, reverse engineering, or decompilation of the software.
- Access to or use of the source code by any party.
- Installation of the software on any system other than the designated one.
- Sublicensing or resale of the software by end users.
- The license is time-bound (typically one year) and requires renewal upon expiry.
- The source code, algorithms, and proprietary logic remain exclusively with the assessee at all times.
- The assessee had already paid Equalisation Levy under Section 165A of the Finance Act, 2016, on the gross receipts.
- The assessee claimed exemption under Section 10(50) for business income earned from software licensing.
Procedural History
- 28.11.2022: Assessee filed return for A.Y. 2022-23 claiming refund of Rs. 2,22,94,950/-.
- 15.01.2025: Ld. AO passed final assessment order under Section 144(3) r.w.s. 144C(13), treating software license income as royalty/FTS.
- Prior to 15.01.2025: Draft assessment issued; objections filed before Dispute Resolution Panel (DRP).
- 15.01.2025: DRP confirmed AO’s view and directed issuance of final order.
- 13.01.2026: Hearing before ITAT Bangalore.
- 01.04.2026: Judgment pronounced by ITAT.
The Parties' Positions
For the Appellant
- Relied on Engineering Analysis Centre of Excellence v. CIT (2021) 432 ITR 472 (SC) to argue that software licensing without copyright transfer is a sale of goods, not royalty.
- Emphasized that no rights under Section 14 of the Copyright Act, 1957, were transferred; no license under Section 30 was granted.
- Highlighted that EULA and Distribution Agreement contain only usage restrictions, not copyright assignments.
- Contended that confidentiality clauses are standard commercial protections and do not imply copyright transfer.
- Argued that the transaction qualifies as business income under Section 10(50) and is exempt from tax in India under Article 12 of the Indo-Swiss DTAA.
- Cited ITAT Bangalore’s own decision in Arista Networks Ltd. (IT(IT)A No. 1159/Bang/2023) and Supreme Court rulings in Microsoft Regional Sales and MOL Corporation.
For the Respondent
- Argued that the transaction involved use of software and thus fell within the ambit of royalty under Explanation 2 and 4 to Section 9(1)(vi).
- Contended that the assessee’s case did not fall squarely within the four categories enumerated in Engineering Analysis.
- Relied on general confidentiality clauses in the agreements to infer implied rights of use.
- Sought to treat hardware replacement and support services as FTS.
Relief Sought
The appellant sought deletion of the addition of Rs. 50,93,03,724/- as royalty/FTS, confirmation of exemption under Section 10(50), and deletion of interest under Section 234B.
The Legal Issue
The central question was whether the receipt of consideration for granting a non-exclusive, non-transferable, time-bound license to use standardized software - without access to source code or any right to reproduce, modify, or sublicense - constitutes "royalty" or "fees for technical services" under Article 12 of the Indo-Swiss DTAA or Section 9(1)(vi) of the Income Tax Act.
Arguments Presented
For the Appellant
The appellant relied on the Supreme Court’s ruling in Engineering Analysis Centre of Excellence v. CIT, which held that payments for software licenses are not royalty if no copyright interest is transferred. The EULA and Distribution Agreement were shown to contain only usage restrictions, not rights under Section 14 of the Copyright Act. The absence of source code transfer, prohibition on reverse engineering, and time-bound nature of licenses confirmed the transaction was a sale of goods. The appellant further argued that Article 12 of the DTAA, which defines royalty narrowly as consideration for use of copyright, overrides the expansive definition under Explanation 2 and 4 to Section 9(1)(vi). The Equalisation Levy paid under Section 165A further supported the commercial nature of the transaction.
For the Respondent
The Revenue contended that the transaction involved "use" of software and thus attracted royalty under domestic law. It argued that confidentiality clauses implied a degree of access to proprietary information and that the assessee’s case did not fit the exact factual matrix of Engineering Analysis. It also sought to classify hardware replacement as FTS, despite invoices clearly indicating sale of hardware with embedded software.
The Court's Analysis
The Tribunal meticulously examined the EULA, Distribution Agreement, and Supreme Court precedents. It noted that the agreements explicitly state that ownership of the software, source code, algorithms, and intellectual property remains exclusively with the assessee. Clause 8.1, 8.2, and 8.3 of the Distribution Agreement affirm that no rights in the software’s copyright are transferred. Clause 9 prohibits installation on any system other than the designated one, and Clause 13 prohibits any form of reproduction or modification.
"The EULAs in all the appeals before us do not grant any such right or interest, least of all, a right or interest to reproduce the computer software."
The Tribunal emphasized that the Supreme Court in Engineering Analysis had drawn a clear distinction between a license that grants rights under Section 14 of the Copyright Act (which would attract royalty) and a license that merely imposes restrictions on use (which constitutes a sale of goods). The present case fell squarely within the latter category.
The Tribunal rejected the Revenue’s reliance on confidentiality clauses, holding that such clauses are standard in commercial contracts to protect proprietary interests and do not imply transfer of copyright. It cited Arista Networks Ltd. and Microsoft Regional Sales to reinforce that even post-amendment, the Supreme Court’s reasoning remains binding.
Regarding FTS, the Tribunal held that no managerial, technical, or consultancy services were rendered. The support provided was limited to hardware replacement, which was clearly invoiced as such and involved embedded software - not technical knowledge transfer.
The Tribunal also noted that the assessee had no permanent establishment in India, and under Article 7 of the DTAA, business profits are taxable only if attributable to a PE. Since no PE existed, the income could not be taxed in India even if it were classified as business income.
The Verdict
The appeal was allowed. The Tribunal set aside the assessment order dated 15.01.2025 and deleted the addition of Rs. 50,93,03,724/- as royalty or FTS. The income was held to be business income eligible for exemption under Section 10(50). The interest demand under Section 234B was dropped. The Tribunal directed the Assessing Officer to process the refund claim of Rs. 2,22,94,950/- within 8 weeks of the order.
What This Means For Similar Cases
Software Licensing Is Not Royalty Without Copyright Transfer
- Practitioners must now argue that any software license lacking source code access, reproduction rights, or modification permissions cannot be classified as royalty under DTAA or Section 9(1)(vi).
- EULAs must be analyzed holistically - restrictions on use are not equivalent to transfer of copyright.
- The burden shifts to the Revenue to prove actual transfer of rights under Section 14 of the Copyright Act.
DTAA Overrides Domestic Law on Royalty Definition
- Where a DTAA defines royalty narrowly (e.g., "use of copyright"), it overrides the expanded definition under Explanation 2 and 4 to Section 9(1)(vi).
- Taxpayers must invoke Section 90(2) to claim treaty benefits and cite Engineering Analysis as binding precedent.
- Revenue cannot rely on hypothetical interpretations or cherry-picked clauses to impose tax.
Hardware with Embedded Software = Sale of Goods
- Invoices clearly labeling hardware replacement as such, even when software is embedded, cannot be reclassified as FTS.
- The Engineering Analysis principle applies equally to preloaded software - the transaction is a sale of goods, not a service.
- Practitioners should ensure invoices and contracts clearly distinguish between hardware, software license, and support services.
Equalisation Levy Is a Strong Indicator of Commercial Nature
- Payment of Equalisation Levy under Section 165A supports the classification of software licensing as a commercial sale, not royalty.
- This strengthens the argument for exemption under Section 10(50) and against reclassification as FTS.
No PE = No Tax on Business Profits
- Even if software licensing were classified as business income, absence of a permanent establishment in India bars taxation under Article 7 of the DTAA.
- Practitioners must always verify PE status before accepting tax liability on foreign-sourced income.
