Software licence payments and treaty protection: mere use of business software was not royalty, defeating withholding disallowance.

Payment for use of LARA, DIVA and Ocean software was treated as consideration for business use of operational tools, with no transfer of copyright or right to sublicense. On treaty analysis, the receipts were not royalty and were protected as shipping profits, so the domestic withholding and disallowance consequences did not arise; retrospective Explanation 4 to section 9(1)(vi) could not create a withholding duty for the relevant period. The TDS credit question was kept to verification, with direction to allow admissible credit in accordance with law.

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Issues: (i) whether the payment made for use of LARA, DIVA and Ocean software was chargeable to tax in India as royalty or fees for technical services so as to require deduction of tax at source and attract disallowance under section 40(a)(i) of the Income-tax Act, 1961; (ii) whether the assessee was entitled to credit of tax deducted at source.

Issue (i): whether the payment made for use of LARA, DIVA and Ocean software was chargeable to tax in India as royalty or fees for technical services so as to require deduction of tax at source and attract disallowance under section 40(a)(i) of the Income-tax Act, 1961.

Analysis: The software arrangements were examined as use of business tools for operational support, with no transfer of copyright or right to sublicense. The payment was held to be linked to the shipping business of the foreign enterprise and, on the treaty analysis, fell within shipping profits under the applicable treaty framework. The Court further held that the software-use payment did not amount to royalty under the treaty because it was only a licence to use the software for business needs, not a right to use copyright. As regards technical services, although software maintenance could fall within the domestic law concept, the treaty protection and the most favoured nation clause made the payment non-taxable in India. The retrospective insertion of Explanation 4 to section 9(1)(vi) could not fasten a withholding obligation for a period when the payer could not have deducted tax on that basis.

Conclusion: the disallowance under section 40(a)(i) was unsustainable and was deleted in favour of the assessee.

Issue (ii): whether the assessee was entitled to correct credit of tax deducted at source.

Analysis: The credit issue was treated as a verification matter and the tax authorities were directed to examine the record and allow the admissible credit in accordance with law.

Conclusion: the matter was decided in favour of the assessee by way of a direction for appropriate verification and grant of credit.

Final Conclusion: the appeal succeeded and the principal addition was deleted, with consequential relief on tax credit and interest.

Ratio Decidendi: a payment for mere use of software, without transfer of copyright or other taxable right, is not royalty under the treaty, and treaty protection prevails over the domestic withholding provision where the sum is not chargeable to tax in India.

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