Sunday, November 28, 2010

ITAT Rules Against Microsoft In Software Royalty Tax Case

Microsoft finds itself on the wrong side of a ruling by the Delhi Income Tax-Appellate Tribunal(ITAT) stating that “The income received for supply of software is assessable as “royalty” as a copyright subsists in a computer programme and it is also a literary as also a scientific work.” According to a BusinessLine Report in May 2008, this decision could be worth about Rs.700 crore – including interest.

While the Redmond based software giants considers sales of its licensed software to be business profits which are non taxable in India since it does not have a permanent establishment here. From January 1st, 1999 Microsoft scrapped its earlier business model under which it dealt with Indian Distributors on a principle-to-principle basis which means that “No liability will arise on accrual basis to the non-resident on the profits made by him where the transaction of the sale between the two parties are on a principal to principal basis.” Under the new business model, however, Microsoft granted an exclusive license to Gracemac Corporation – a US based company – to manufacture Microsoft Software. Gracemac on its part had entered into a non-exclusive agreement with Microsoft Operations Pte Ltd, a Singapore-based wholly-owned subsidiary of Microsoft Corporation, to reproduce Microsoft software in Singapore. This company then sold these copies to MRSC (Microsoft Regional Sales Corporation) which delivered them to Indian Distributors ex-warehouse in Singapore. These copies were distributed to resellers across the country. Ex-warehouse is an arrangement where the seller makes the goods available at a particular warehouse. It is then the responsibility of the buyer to arrange for the goods to be transported along with the necessary formalities.


According to the ITAT since copyright restrictions persist on these distributed copies income from them are to be treated as royalties and not business profits. The tax on royalty is 10% of the gross payment and the entity responsible for “sending” the software from outside India into India is liable to pay this tax. The ruling has thus upheld the Revenue Department’s stance that these sales proceeds are indeed royalties and should be taxed. A decision against which Microsoft had appealed.

The ITAT ruling is contradictory to the views held by the OECD and U.N. Treaties in their treatment of royalties. Under the OECD model only the country of residence can tax royalty income. While the U.N. Model allows the source country to impose a tax as well. According to an article in the Federal Taxation Developments Blog points out that countries like Canada, Spain, Korea, Portugal and Mexico also disagree with this approach and impose some sort of withholding tax on royalty income.

The reaction of several other Software Giants to this news will be something to watch out for. As of now Microsoft has said that it is reviewing this decision and also expressed its disappointment over the ruling.

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Categories: News
Tags: BusinessLine, Ex-warehouse, Gracemac Corporation, ITAT, Microsoft, Microsoft Regional Sales Corporation, MSRC, OECD, Royalty, Royalty Tax, Shrink Wrap Software, Taxation, UN

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