Composite software supply treated as fees for included services, while hardware was excluded from Indian taxability under the treaty.

A composite cross-border contract for automation system upgrade was treated as involving separate tax consequences for software/services and hardware. Customised software, installation, technical collaboration, system integration, testing, manuals and support were characterised as fees for included services under Article 12 of the India-US Tax Treaty and were taxable in India on the make-available standard. By contrast, the hardware portion, together with associated COTS software bundled with it, was treated as an outright offshore supply and excluded from Indian taxability. Correspondingly, tax had to be deducted at source on the taxable payments, with the withholding rate governed by Section 115A(1)(b)(BB) of the Income-tax Act, 1961.

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Issues: (i) Whether the payments made under the contract for software, installation and allied services were taxable in India under Article 12 of the India-US Tax Treaty, while hardware and associated COTS software were outside taxability; (ii) Whether tax was deductible at source on payments made to the non-resident supplier, and at what rate.

Issue (i): Whether the payments made under the contract for software, installation and allied services were taxable in India under Article 12 of the India-US Tax Treaty, while hardware and associated COTS software were outside taxability.

Analysis: The contract was treated as a composite arrangement for upgrading the automation system, not as a bare supply of software. The software was customised, installed and made operational through technical collaboration, system integration, testing, manuals and support. On that basis, the receipts relatable to software and installation/services were held to fall within Article 12, particularly the provision dealing with fees for included services and the make-available standard. At the same time, the hardware portion was accepted as an outright supply outside India, with title and risk passing abroad, and was therefore not taxable. The COTS software bundled with the hardware was also excluded to that extent.

Conclusion: The software, installation and allied service components were taxable in India, but the hardware and associated COTS software were not taxable.

Issue (ii): Whether tax was deductible at source on payments made to the non-resident supplier, and at what rate.

Analysis: Since the taxable receipts fell within Article 12, the payer was required to deduct tax at source on the amounts other than those attributable to hardware. The applicable withholding rate was held to be governed by the beneficial domestic provision under the Income-tax Act.

Conclusion: Tax was required to be deducted at source on the taxable payments, and the rate was to be determined under Section 115A(1)(b)(BB) of the Income-tax Act, 1961.

Final Conclusion: The ruling upheld taxability of the software and service components and rejected taxability only for the hardware segment, with corresponding withholding obligations on the taxable portion.

Ratio Decidendi: In a composite cross-border contract, customised software supplied and made operational through technical integration, testing, manuals and support may constitute fees for included services under Article 12, while hardware transferred outright outside India remains outside Indian taxability.

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