Software Purchase Payments Cannot Be Treated as Royalty: Karnataka High Court Upholds ITAT Order in IBM Singapore Case

Case Background and Overview

The Karnataka High Court has dismissed the Revenue's appeal in PCIT Vs IBM Singapore Pvt. Ltd., firmly rejecting the Department's attempt to characterise payments received from software sales as royalty income. The appeal, filed under Section 260A of the Income Tax Act, 1961, challenged the Income Tax Appellate Tribunal's order dated 08.05.2023 in ITA No. 177/Bang/2023, which pertained to Assessment Year 2015-16.

At the heart of this dispute was a fundamental question of income tax law: does the purchase of software amount to acquiring a copyright, thereby attracting royalty taxation under Indian law? The Karnataka High Court answered this question decisively in the negative, reinforcing a position that has now been settled comprehensively by the Supreme Court of India.

The Revenue's Position: Software Payments as Royalty

The Assessing Officer had taken the view that payments received by IBM Singapore Pvt. Ltd. in connection with software sales constituted royalty within the meaning of Section 9(1)(vi) of the Income Tax Act, 1961. On this basis, it was contended that such payments gave rise to income deemed to accrue or arise in India, and consequently, the payer was obligated to deduct tax at source under Section 195 of the Act.

The Revenue further argued that the payments fell squarely within the scope of:

  • Explanation 2 to Section 9(1)(vi) of the Income Tax Act, 1961
  • The relevant provisions of the applicable Double Taxation Avoidance Agreement (DTAA)

The Department's position rested on the premise that the sale of software licenses inherently involves the transfer of some right or interest in the underlying copyright, thereby satisfying the definition of royalty under domestic law as well as the DTAA.

Substantial Questions of Law Raised by the Revenue

The Revenue presented five substantial questions of law before the Karnataka High Court, which are reproduced as framed in the appeal: