TDS on customised software from outside India, Income Tax

[Shrikanth Parmarthy]

Dear experts,

Please provide your views on the the following:

1. Is TDS applicable on purchase of customised software by a company from UK. The software is used for calculating discounts and rebates to be given to the customer. The software is tailored made as per the company requirements. The invoice is raised by the supplier in Euros

2. After the purchase year on year the company is paying annual subscription fee for providing access to the software to a certain number of users. Is TDS deductible on the subscription fee to be paid to the vendor in Euro.

Posts / Replies

[YAGAY andSUN]

Legal Opinion

 

I. BACKGROUND FACTS

1. The Company has entered into an agreement with a non-resident entity incorporated and tax resident in the United Kingdom ("UK Vendor") for the procurement of a customized software solution. The software is developed specifically in accordance with the Company’s requirements and is intended to facilitate the computation of customer discounts and rebates. The UK Vendor has raised an invoice denominated in Euros for the said acquisition.
2. Subsequent to the acquisition, the Company continues to pay an annual subscription fee to the UK Vendor for ongoing access to the software for a specified number of users. These payments are also invoiced in Euros and relate to the right to access and use the software via the vendor’s platform.

II. ISSUES FOR CONSIDERATION

1. Whether the Company is required to withhold tax under Section 195 of the Income-tax Act, 1961 (“the Act”) in respect of the payment made to the UK Vendor towards the one-time purchase of the customized software?
2. Whether the Company is required to withhold tax under Section 195 in respect of the annual subscription fees paid to the UK Vendor for continued access to the software?

III. LEGAL FRAMEWORK & ANALYSIS

Issue 1: TDS on Purchase of Customized Software

• Under Section 195 of the Act, any person responsible for paying a sum to a non-resident which is chargeable under the provisions of the Act is required to deduct tax at source.
• In Engineering Analysis Centre of Excellence Pvt. Ltd. v. CIT [2021] 432 ITR 471 (SC), the Hon’ble Supreme Court held that payments made for the purchase of software (including customized software), where only usage rights are granted and there is no transfer of copyright, do not constitute “royalty” under Section 9(1)(vi) of the Act.
• In the present case, the Company is granted only the non-exclusive right to use the software for its internal business operations. There is no transfer of copyright or right to commercially exploit the software.

Conclusion: The payment made for the acquisition of the customized software does not constitute income chargeable to tax in India and thus, no TDS is required to be deducted under Section 195 on such payment.

Issue 2: TDS on Annual Subscription Fee

• The ongoing subscription payments for access to the software involve periodic payments to a UK-resident entity for enabling multiple users to access the software platform hosted outside India.
• Under Explanation 2 to Section 9(1)(vi) of the Act, payments for the use or right to use software are deemed to be royalty.
• However, the India–UK DTAA provides a narrower definition of “royalty” under Article 13, generally excluding mere access to standard software not involving transfer of copyright or know-how.
• Whether the subscription fees fall within the scope of “royalty” or “fees for technical services” under domestic law or under the DTAA would depend on:
  • The nature of rights granted under the agreement,
  • Whether any technical support, customization, or additional services are bundled with the subscription,
  • And whether the Company obtains a Tax Residency Certificate (TRC), Form 10F, and no-PE declaration from the UK Vendor.

Conclusion:
In the absence of valid DTAA documentation or if the nature of services exceeds mere access (e.g., involves technical support, custom features, etc.), the subscription fees may be treated as royalty or FTS and therefore subject to TDS under Section 195.

However, if the UK Vendor provides the requisite documentation and the arrangement is limited to access without any transfer of copyright or technical services, the payment may not be taxable in India under the DTAA, and consequently, TDS may not be required.

IV. RECOMMENDATIONS

1. For the purchase of customized software, the Company may treat the transaction as not subject to TDS, based on the Supreme Court’s decision in Engineering Analysis.
2. For annual subscription fees:
   • Obtain a Tax Residency Certificate, Form 10F, and a no-PE declaration from the UK Vendor.
   • Review the subscription agreement to confirm that there is no transfer of copyright or provision of technical services.
   • In case of ambiguity, consider seeking a Section 195(2) certificate from the Assessing Officer.
3. Maintain contemporaneous documentation to substantiate the Company's position in the event of a tax audit or scrutiny.

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