India-Ireland DTAA & Software Taxation: Understanding the ITAT Bengaluru Ruling

 

Cross-border software transactions have long been a minefield of tax ambiguity. With rapid digitalization and the rise of cloud services, companies selling software internationally have faced uncertainty around whether their payments attract Indian taxation. Recently, the Income-tax Appellate Tribunal (ITAT) Bengaluru Bench delivered a decision that could reshape the landscape for software licensing between Ireland and India.

In a landmark ruling, the tribunal clarified that sales of standardised software licences—including cybersecurity software—by an Irish company to Indian clients do not qualify as Fees for Technical Services (FTS) under the India-Ireland Double Taxation Avoidance Agreement (DTAA). Additionally, software embedded in hardware, along with associated hardware support, was ruled not taxable as royalties or technical service fees.

This decision brings significant relief for both foreign software providers and Indian buyers, clarifying withholding obligations and potentially avoiding retroactive tax demands. Let’s break down the ruling, its implications, and what stakeholders need to know.

 

Understanding the India-Ireland DTAA

The India-Ireland DTAA is designed to prevent double taxation and encourage bilateral trade. It clearly defines income categories and allocates taxing rights between India (source country) and Ireland (residence country).

Some key features:

• Royalties: Payments for the “use of, or right to use” intellectual property such as copyrights, patents, trademarks, and designs.
• Fees for Technical Services (FTS): Payments for managerial, technical, or consultancy services across borders.

The challenge often arises in software transactions: is the payment for software a royalty, FTS, or simply the sale of goods? The answer carries substantial tax consequences.

 

Why Software Taxation Has Been Controversial

Software delivery models have evolved dramatically. Today, companies sell software via:

• Standalone licences (object code)
• Cloud subscriptions
• Embedded software within hardware
• Software-as-a-Service (SaaS) platforms

Traditionally, Indian tax authorities treated payments for software as royalties or FTS, imposing withholding taxes. But courts and tribunals have increasingly distinguished between transferring copyright versus selling a copyrighted product:

• Transfer of copyright: Taxable as royalty.
• Sale of copyrighted article: Generally not taxable.

Another key factor is whether the buyer “receives technical knowledge or expertise”. If the software comes pre-installed with no additional know-how shared, it is viewed as a sale of goods, not a service.

 

The Case Before ITAT Bengaluru

The Bengaluru Bench case involved an Ireland-based company specializing in cloud networking and cybersecurity solutions. The company:

• Sold standardised software licences to Indian customers
• Supplied embedded software bundled with hardware
• Provided hardware replacement and support services

Indian tax authorities had classified these transactions as:

1. Royalties (software licences and embedded software)
2. FTS (hardware replacement and support services)

This led to a taxable addition of INR 35.83 crores, prompting an appeal to ITAT.

 

Key Issues Examined by the Tribunal

The tribunal analyzed three core areas:

1. Software Licensing:
• Does granting a non-exclusive, non-transferable object-code software licence (no access to source code or modification rights) constitute royalty under Indian law or the India-Ireland DTAA?
2. Embedded Software Bundled with Hardware:
• Should software embedded in hardware be treated as part of the sale of goods or as a separate licencing transaction attracting royalty?
3. Hardware Replacement and Support Services:
• Are these services FTS, or simply the replacement of goods?

 

Tribunal Findings and Reasoning

1. Software Licensing

The tribunal ruled decisively that:

• Licences were restricted to object code, with no rights to copy, modify, or reverse-engineer.
• This constitutes sale of a copyrighted article, not a transfer of copyright.
• The Supreme Court precedent in Engineering Analysis Centre of Excellence Pvt. Ltd. v. CIT was relied upon to reinforce this distinction.

Implication: Payments for such software licences do not qualify as royalty under Section 9(1)(vi) of the Income-tax Act or Article 12 of the India-Ireland DTAA.

 

2. Embedded Software and Hardware

Regarding embedded software:

• The software lacked independent existence and was sold as an integrated product.
• Since the Irish company had no permanent establishment (PE) in India, Article 7 (Business Profits) did not apply.

Implication: Embedded software bundled with hardware is treated as goods, not royalty, and is not subject to Indian withholding tax.

 

3. Hardware Replacement and Support Services

The tribunal clarified:

• Replacement and support involved faulty hardware pre-installed with software.
• No technical knowledge was “made available” to the Indian buyer.
• The transaction resembled a goods replacement, not a technical service.

Implication: Payments for such support do not qualify as FTS under the India-Ireland DTAA.

 

Legal Anchors for the Decision

The ruling was grounded in:

• Article 12 (Royalty), India-Ireland DTAA: Payments for use of copyright and other intellectual property
• Article 7 (Business Profits): Taxing rights for enterprise profits only if a PE exists in India
• Section 9(1)(vi), Income-tax Act 1961: Income deemed to accrue in India from the use or right to use copyright

The tribunal prioritized substance over form, focusing on the rights actually transferred, not the labels used in contracts.

 

Implications of the Ruling

Benefits for Foreign Software Suppliers

• Provides clarity that standardised software licences may not attract Indian withholding tax
• Reduces compliance burden and retroactive tax exposure
• Encourages contract structuring without granting unnecessary rights that could trigger royalty

Benefits for Indian Buyers

• No obligation to withhold tax on licence payments if transactions are structured properly
• Reduces cash outflows and simplifies documentation

Guidance for Auditors and Tax Professionals

• Precedent for classifying software payments under DTAA and Indian law
• Helps structure transactions, maintain proper documentation, and mitigate withholding tax risk

 

Broader Industry Implications

• Technology and cybersecurity companies now have greater certainty when selling software to India under the DTAA
• Could encourage more cross-border sales from Ireland to India
• May prompt Indian tax authorities to revise guidelines for software, cloud subscriptions, and embedded solutions

 

Key Cautions

• The ruling applies only to standardised object-code licences with no modification or source-code access
• Presence of a PE in India changes tax analysis
• Different DTAAs may yield different results
• Subscription models like SaaS need individual evaluation

 

Common Misunderstandings

• Not all software payments are royalty: Only those transferring copyright or modification rights qualify
• Labelling alone does not guarantee tax exemption: The rights granted matter
• DTAA does not universally exempt software payments: Each case is fact-specific
• No PE alone does not guarantee no tax
• Decision does not automatically apply to other countries

 

Expert Analysis

Tax professionals consider this ruling landmark. By distinguishing sale of copyrighted article vs. transfer of copyright, the tribunal reinforced that substance prevails over form in treaty interpretation.

For cybersecurity companies:

• Provides strategic opportunity for structuring cross-border deals
• Legacy agreements should be reviewed for possible refunds or restructuring
• Contracts and documentation need careful drafting

 

Practical Action Steps for Stakeholders

1. Review Contracts
• Check rights granted: modification, source code access, exclusivity
2. Ensure Documentation
• Obtain Tax Residency Certificates (TRC)
• Specify transaction as sale/licence of software
• Enforce licence restrictions
3. Indian Buyers
• Verify withholding obligations
• Claim refunds if tax was wrongly withheld
4. Advisers
• Map each transaction model (licence sale, embedded software, SaaS) to relevant treaty provisions
5. Tax Authorities
• Update guidelines for emerging SaaS and cloud models

 

Future Outlook

Software is increasingly embedded and cloud-based. We can expect:

• More disputes around SaaS and hybrid models
• Clearer guidance from Indian and Irish tax authorities
• Opportunity for structured, tax-efficient cross-border software transactions

 

FAQs: Clarifying Software Taxation under India-Ireland DTAA

Q1. Does the ruling apply to all software sales from Ireland to India?
Only to standardised object-code licences and embedded software bundled with hardware. Each transaction must be factually assessed.

Q2. What if the supplier grants source code or modification rights?
The transaction may qualify as transfer of copyright, attracting Indian withholding tax.

Q3. How about SaaS or subscription models?
Subscription services may be classified as FTS depending on contract terms.

Q4. Steps for Indian buyers to ensure correct withholding?

• Obtain TRC of the supplier
• Ensure contracts specify sale/licence, not service
• Confirm no source code or modification rights
• Align invoices with the transaction structure

Q5. Can Indian tax authorities revisit previous years?
Yes, taxpayers should examine eligibility for refunds, keeping time limits and documentation in mind.

 

Conclusion: Navigating Software Taxation with Confidence

The ITAT Bengaluru ruling emphasizes that substance matters more than form in software taxation. For Indian buyers, foreign software suppliers, auditors, and tax professionals, this decision provides a clear roadmap under the India-Ireland DTAA.

While the ruling addresses standardised licences and embedded software, stakeholders should remain vigilant about SaaS, hybrid models, and future treaty interpretations. With careful contract structuring, proper documentation, and strategic planning, cross-border software transactions can now be tax-efficient and compliant.

At Manika TaxWise, we help businesses and individuals navigate complex cross-border taxation issues, ensuring compliance while optimizing financial outcomes. Whether you are a foreign software supplier or an Indian buyer, understanding such rulings is crucial for effective tax planning and risk management.

 

References

1. KNAV – “ITAT rules standardised software and embedded hardware sales not taxable as royalty under India-Ireland DTAA”
2. TaxGuru – “Sale of software not taxable in terms of India-Ireland DTAA”
3. SW-India article – “Revenue earned from sale/distribution copyrighted article is distinct … not chargeable as royalty under A12 of India-Ireland DTAA”
4. India-Ireland DTAA text (PDF) – Taxsutra
5. Income-tax Department booklet – “Royalty and Fees for Technical Services”

 

Author Bio:
Manoj Kumar, Chartered Accountant and Tax Expert with over 11 years of experience in cross-border taxation, corporate advisory, and compliance. Founder of Manika TaxWise, specializing in Indian taxation, DTAA advisory, and international tax planning.