The applicability of Tax Deducted at Source (TDS) for payments made to foreign software suppliers for the purchase of software depends on several factors under the Income Tax Act, 1961. TDS is required when payments are made to non-resident entities (including foreign software suppliers), and the payment falls under specific sections that deal with the taxability of payments made to non-residents.

Key Considerations for TDS on Payment to Foreign Software Suppliers:

  1. Nature of Payment (Purchase vs. Licensing):
    • The tax treatment depends on whether the payment is for the purchase of software (as a one-time purchase) or a license fee for software (for use over time).
    • Purchase of Software: If the payment is for the purchase of software, and the software is treated as copyrighted article, the payment might be categorized as a payment for the purchase of goods and, generally, would not attract TDS.
    • Licensing Fees or Royalty: If the payment is for software usage or for a license to use the software, it may be considered a royalty under Section 9(1)(vi) of the Income Tax Act. In such cases, TDS would apply.
  2. Section 9(1)(vi) – Royalty:
    • The term “royalty” under Section 9(1)(vi) includes payments made for the use of or right to use any copyrighted material, such as software. Payments for software licenses, maintenance, or upgrades could qualify as royalty.
    • TDS under Section 195: In case the payment qualifies as royalty, TDS must be deducted under Section 195 of the Income Tax Act at the prescribed rate.
  3. TDS Rate for Royalty:
    • The TDS rate for payments to foreign suppliers for royalty is typically 10% under Section 115A of the Income Tax Act, subject to the provisions of the Double Taxation Avoidance Agreement (DTAA) between India and the country of the foreign supplier.
    • If the supplier’s country has a DTAA with India, the reduced rate of TDS may apply as per the provisions of the agreement.
  4. Taxability of Copyrighted Software:
    • If the payment is for the purchase of copyrighted software (not a license fee), and the software is treated as goods (i.e., the transfer of ownership happens), TDS might not be applicable. This is because the transaction may be treated as a sale of goods, which does not involve the payment of royalty or fees for technical services.
    • However, if the purchase is coupled with ongoing maintenance services or software upgrades, those payments could qualify as royalty.
  5. DTAA (Double Taxation Avoidance Agreement):
    • If the foreign software supplier is in a country with which India has a DTAA, the provisions of the DTAA will apply. The DTAA may allow for a lower TDS rate than the rate specified under the Income Tax Act.
    • In such cases, the foreign supplier can claim the benefit of the reduced rate by providing a Tax Residency Certificate (TRC) and other necessary documents.

TDS Applicability Process:

  1. Check the Nature of Payment: Identify whether the payment is for the purchase of software or a royalty/license fee.
  2. Determine if TDS Applies:
    • If it’s a royalty or license fee, TDS is applicable under Section 195.
    • If it’s a one-time purchase of software, TDS may not be applicable (but the specifics should be reviewed based on the facts of the case).
  3. Rate of TDS: If TDS is applicable, determine the appropriate rate based on:
    • Section 115A (for royalty payments to non-residents).
    • Whether a DTAA applies (if applicable, refer to the provisions of the relevant DTAA).
  4. Withholding and Payment: Deduct the TDS at the applicable rate and remit it to the Income Tax Department.

Example:

  • Scenario 1: A company in India purchases a software license from a foreign supplier for use in India. The payment is considered royalty under Section 9(1)(vi), and TDS of 10% is applicable under Section 195, subject to the DTAA.
  • Scenario 2: A company in India purchases software (a one-time purchase of a copy) from a foreign supplier. No maintenance or licensing fees are involved. Since it’s treated as a sale of goods, TDS may not be applicable.

Conclusion:

  • TDS on software payments is primarily applicable to royalty or license fees paid for the use of software under Section 9(1)(vi) of the Income Tax Act.
  • Payments for the purchase of software (i.e., transfer of ownership) may not attract TDS, as they are treated as sales of goods.
  • The TDS rate for royalty payments is generally 10%, but the DTAA provisions may provide for a reduced rate.
  • It is important to check the nature of the payment (purchase vs. licensing) and whether the payment is considered royalty to determine if TDS is applicable.

As of April 1, 2023, the Tax Deducted at Source (TDS) rate on payments made to non-residents for royalty and fees for technical services (FTS) in India has been increased from 10% to 20% under Section 115A of the Income Tax Act, 1961. citeturn0search0

Key Points:

  • Increased TDS Rate: The TDS rate for royalty and FTS payments to non-residents has been doubled from 10% to 20%, effective from April 1, 2023. citeturn0search0
  • Effective Tax Rate: Considering the 5% surcharge and 4% health and education cess, the effective tax rate on such payments is approximately 21.84%. citeturn0search1
  • Impact on Non-Residents: This change affects non-residents receiving royalty and FTS payments from Indian entities. Non-residents may need to evaluate the impact of this increased tax rate on their income and consider the provisions of the Double Taxation Avoidance Agreement (DTAA) between India and their country of residence, which may offer a lower tax rate. citeturn0search1
  • Compliance Requirements: To avail the benefits under the DTAA, non-residents must provide a valid Tax Residency Certificate (TRC) and, if necessary, Form 10F to the Indian payer. Additionally, non-residents may be required to obtain a Permanent Account Number (PAN) in India and file an income tax return to claim the benefits of the DTAA. citeturn0search1

Conclusion:

The increase in the TDS rate to 20% on royalty and FTS payments to non-residents signifies a substantial change in India’s tax landscape. Non-residents should assess the implications of this change on their income and explore the benefits available under the DTAA to mitigate the impact of the higher tax rate.