Introduction:

In a significant reiteration of established legal principles, the Delhi High Court has reaffirmed that payments made by an Indian entity to a foreign company for the resale or use of their computer software do not constitute ‘royalty’ under Indian tax laws, and therefore, no Tax Deducted at Source (TDS) obligation arises in such cases. A division bench comprising Justice V. Kameswar Rao and Justice Vinod Kumar dismissed an appeal filed by the Income Tax Department against Xiocom (NZ) Ltd, a US-based software company, holding that such transactions are not taxable in India. The court’s decision heavily relied on the landmark Supreme Court judgment in Engineering Analysis Centre of Excellence Pvt. Ltd. v. Commissioner of Income Tax & Another (2021), which had conclusively held that consideration for off-the-shelf software does not amount to ‘royalty’. The ruling settles the controversy in the present case relating to the Assessment Year 2010–11, where the Department sought to tax software sales worth ₹19.24 crore made to Zylog Systems (India) Ltd for use in certain technology areas in India.

Arguments from the Appellant (Income Tax Department):

The Income Tax Department contended that the ₹19,24,80,000/- earned by Xiocom (NZ) Ltd from the software sale to Zylog Systems (India) Ltd was taxable in India as ‘royalty’ under Section 9(1)(vi) of the Income Tax Act, 1961. It further relied on Article 12 of the Indo–New Zealand Double Taxation Avoidance Agreement (DTAA) to argue that such consideration for the use of software falls within the definition of ‘royalty’ in international tax law as well. The Department asserted that the transaction was not a mere sale of goods but involved granting the Indian buyer a right to use the copyright embedded in the software. This, according to them, gave rise to income deemed to accrue or arise in India. Consequently, they argued that Zylog Systems, as the Indian payer, was under an obligation to deduct TDS under Section 195 of the Act before making payment to the foreign company. The Department challenged the orders of the Commissioner of Income Tax (Appeals) [CIT(A)] and the Income Tax Appellate Tribunal (ITAT) which had ruled in favour of Xiocom, claiming that both authorities erred in interpreting the scope of ‘royalty’ and failed to appreciate that the license agreement amounted to granting rights in the copyright.

Arguments from the Respondent (Xiocom (NZ) Ltd):

Xiocom, supported by findings of the lower appellate authorities, countered the Department’s claims by asserting that the transaction was purely a sale of off-the-shelf software, with no transfer of copyright or grant of any rights therein. The respondent argued that the Indian buyer merely received a non-exclusive, non-transferable right to use the copyrighted software product without acquiring any proprietary rights in the copyright itself. This, they submitted, was squarely covered by the precedent laid down in Director of Income Tax v. Infrasoft Ltd. (2013), where the Delhi High Court had held that payments for the use of copyrighted material—without transfer of the copyright—do not amount to royalty. Xiocom also relied heavily on the Supreme Court’s authoritative ruling in Engineering Analysis Centre of Excellence Pvt. Ltd. v. CIT (2021), which conclusively decided that payments for computer software under End-User License Agreements (EULAs) or distribution agreements cannot be treated as royalty. Under both domestic law and the DTAA, they maintained that the consideration in question was business income of a foreign entity without a permanent establishment in India and hence not taxable in India. Consequently, there was no obligation on the Indian buyer to deduct TDS under Section 195 of the Act.

Court’s Judgment:

The Delhi High Court examined the matter in light of the prevailing legal position established by the Supreme Court in Engineering Analysis Centre of Excellence (2021), which categorically held that consideration paid for resale or use of computer software through EULAs or distribution agreements is not royalty. Applying that ratio, the division bench observed that the present transaction involved no transfer of copyright but only the grant of a limited right to use the copyrighted product. The court agreed with the CIT(A) and ITAT that the payments in question did not give rise to income taxable in India either under Section 9(1)(vi) of the Income Tax Act or under Article 12 of the Indo–NZ DTAA.

The bench reiterated that the essence of a ‘royalty’ under Indian and international law lies in the transfer of rights in respect of a copyright, not in the mere use of a copyrighted product. In the absence of such transfer, payments made for software usage cannot be deemed royalty. The court dismissed the Department’s attempt to distinguish the facts of this case from those in Engineering Analysis, stating that the principles laid down by the apex court applied squarely here. It further noted that when there is no taxable income in India, Section 195 TDS provisions cannot be invoked against the Indian purchaser.

The judgment, therefore, upheld the decisions of the CIT(A) and ITAT, conclusively dismissing the Revenue’s appeal. The court’s firm reliance on the Supreme Court’s precedent reaffirms the settled position that, in cases of standard software sale without transfer of copyright, Indian entities are not liable to withhold tax at source while making payments to foreign companies.