Software licence payments for copyrighted articles are not royalty, so no withholding tax arises absent chargeable income.

Standard software licence and resale payments to non-resident suppliers were treated as payments for copyrighted articles, not as royalty for use of, or right to use, copyright, because no copyright rights such as reproduction, sub-licensing, adaptation or commercial exploitation were transferred. As the sums were not chargeable to tax in India as royalty, section 195 did not require tax deduction at source under the applicable DTAA and the Income-tax Act. The retrospective insertion of Explanation 4 to section 9(1)(vi) could not be used to impose withholding obligations for earlier years, since tax compliance must be tested against the law in force when payment was made.

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Issues: (i) Whether payments made by resident Indian end-users or distributors to non-resident software suppliers under standard software licence or distribution arrangements constituted royalty for the use of, or the right to use, copyright. (ii) Whether section 195 of the Income-tax Act, 1961 required deduction of tax at source on such payments in the light of the applicable DTAA provisions and the Copyright Act, 1957. (iii) Whether the retrospective amendment inserting explanation 4 to section 9(1)(vi) could be applied to past assessment years so as to fasten TDS liability.

Issue (i): Whether payments made by resident Indian end-users or distributors to non-resident software suppliers under standard software licence or distribution arrangements constituted royalty for the use of, or the right to use, copyright.

Analysis: The defining question was whether the transactions involved transfer of any rights comprised in copyright, or only a transfer of copyrighted articles. The Copyright Act distinguishes copyright, which is an exclusive right to do the acts enumerated in section 14, from the physical medium embodying the software. A non-exclusive, non-transferable licence that merely permits installation, use, or resale of software without conferring any right to reproduce, sub-license, adapt, or commercially exploit the copyright does not part with copyright itself. The agreements before the Court showed that distributors and end-users received only limited rights to use the software, while title and all intellectual property rights remained with the foreign supplier. The Court approved the line of authority that treats such transactions as involving copyrighted articles and not a transfer of copyright.

Conclusion: The payments were not royalty for the use of, or the right to use, copyright and were in favour of the assessee.

Issue (ii): Whether section 195 of the Income-tax Act, 1961 required deduction of tax at source on such payments in the light of the applicable DTAA provisions and the Copyright Act, 1957.

Analysis: Section 195 operates only where the sum paid is chargeable to tax in India. The obligation to deduct tax at source is linked to the charging provisions and, where a DTAA applies, the treaty prevails to the extent it is more beneficial. Under the relevant treaty provisions, royalties are confined to payments for the use of, or the right to use, copyright. Since the software transactions did not involve such rights, the payments were not chargeable to tax as royalty. The Court also rejected the attempt to sever withholding obligations from chargeability, and held that the Revenue's contrary reading would ignore the words "chargeable under the provisions of the Act".

Conclusion: No tax was deductible under section 195 and the issue was in favour of the assessee.

Issue (iii): Whether the retrospective amendment inserting explanation 4 to section 9(1)(vi) could be applied to past assessment years so as to fasten TDS liability.

Analysis: The Court held that a person cannot be required to comply with a legal fiction which was not actually on the statute book at the relevant time. The retrospective expansion of the royalty definition by explanation 4 could not be used to impose a deduction obligation for earlier assessment years when the payment was made and the withholding decision had to be taken. The maxim lex non cogit ad impossibilia was applied to reject the suggestion that a payer could be deemed to have failed to deduct tax under a provision that did not then exist in the relevant form.

Conclusion: The retrospective amendment could not be used to create TDS liability for the earlier years and the issue was in favour of the assessee.

Final Conclusion: The Court held that standard software resale or licence payments under the arrangements in question did not amount to royalty, were not chargeable to tax in India as such, and therefore did not attract withholding under section 195. The contrary High Court and AAR rulings were set aside or dismissed accordingly.

Ratio Decidendi: A payment for a copyrighted article, where no rights in the copyright are transferred and the recipient obtains only a limited right to use or resell the software under restrictive conditions, is not royalty within the treaty or section 9(1)(vi); consequently, section 195 applies only when the sum is actually chargeable to tax in India.

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