Software purchase payments treated as trading receipts, not royalty, so tax withholding disallowance was unwarranted.

Payments made for purchase of software for onward sale in the Indian market were treated as a trading arrangement, not royalty. On that basis, the payer had no obligation to deduct tax at source, so disallowance under section 40(a)(i) was not justified. The Delhi High Court noted that, because the amount did not have the character of royalty, the withholding provision did not apply and the expenditure could not be disallowed.

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Issues: Whether disallowance of expenditure under section 40(a)(i) of the Income-tax Act, 1961 was justified on the ground that tax was not deducted at source on payments made for purchase of software.

Analysis: The payment was found to be for purchase of software from Microsoft for onward sale in the Indian market. On the facts, the transaction was treated as a trading arrangement and not as payment of royalty. Since the amount did not partake the character of royalty, the obligation to deduct tax at source did not arise and section 40(a)(i) had no application.

Conclusion: The disallowance was not sustainable and no substantial question of law arose.

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