TDS on Software Purchase
TDS on Software Purchase: A Simple Guide for Businesses
In this post, we will discuss how TDS applies to software purchases, both from Indian vendors and foreign companies, and clear up common doubts with simple examples and key court rulings.
Lets look at these sections:
Introduction
Tax Deducted at Source (TDS) is a crucial component of India’s tax system, particularly when it comes to payments made outside the country. If a business in India is purchasing services or software licences from a foreign company, it’s essential to understand how TDS applies. Failing to understand this properly can lead to non-compliance and even penalties.
Types of software purchase
1.Domestic Purchase of Software (from Indian vendors):
a. Off-the-shelf / shrink-wrapped software:
- Ready-made software bought in physical or digital form.
- Treated as royalty if copyright is not transferred.
- TDS is applicable under Section 194J.<
b. Customised software development services:
- Software made specifically for the buyer.
- If technical skills are involved, it may be treated as a fee for technical services (FTS).
- TDS under Section 194J (professional/technical services).
c. Software as a Service (SaaS):
- Cloud-based Software with a subscription.
- If payment is only for using the service and no rights in the Software are transferred, TDS under Section 194C (contract) may apply; otherwise, 194J may apply.
2. Import of Software (from foreign vendors):
a. Purchase from a foreign company (no copyright transfer):
- Treated as royalty under Indian tax laws.
- TDS under Section 195.
- Rate as per Section 115A or DTAA, whichever is lower.
b. Purchase with copyright/license transfer:
- Considered royalty under the Income Tax Act and DTAA.
- TDS is applicable under Section 195.
c. SaaS from foreign provider:
- If access is provided without the transfer of any rights, it may be treated as FTS or royalty, depending on the applicable DTAA.
- TDS is still applicable under Section 195.
When Does TDS Apply to Software Purchase?
There has always been confusion about whether TDS should be deducted when buying Software, especially when it is referred to as ‘royalty‘ under the Income Tax Act.
1. What the Supreme Court Said
In a significant 2021 case (Engineering Analysis Centre of Excellence Pvt. Ltd. vs. CIT), the Supreme Court clarified the matter. It stated that if an Indian buyer or distributor purchases software solely for its own use (without any rights to copy or sell it), it’s not subject to royalty. So, there is no TDS under Section 195 in such cases.
2. What This Means
- No TDS for normal software purchases – If you’re just buying software to use, it’s treated like buying goods. No TDS.
- TDS applies when rights are transferred – If the deal gives you rights to copy, change, or sell the software, then it’s royalty. In this case, TDS of 10% must be deducted.
3. Important Points for Businesses
- If you’re importing services, TDS under Section 195 usually applies. The rate depends on the type of payment and any applicable tax treaty (DTAA).
- For buying software licenses, follow the Supreme Court rule.
- If you’re an exporter and you’re paying for services used only for earning income from abroad, TDS may not apply under Section 9(1)(vii)(b).
- Always check the agreement details and take expert advice so that you don’t end up paying unnecessary tax.
Relevant TDS Sections for Software Purchase
Meaning of Royalty (As per Explanation 4 to Section 9(1)(vi))
Royalty means any money paid for giving rights to use or transfer rights over a property, information, or software. Even if someone gives a license to use software, it is treated as royalty no matter how the license is given (CD, download, etc.).
TDS on Royalty - Section 194J (For Resident Payees)
If you are not an individual or HUF, and you pay someone in India royalty,
you must deduct TDS at 10% at the time of payment or credit, whichever is earlier.
But this applies only if the amount crosses ₹30,000 in a financial year.
Note: Even individuals/HUFs must deduct TDS if they were required to get their books audited under Section 44AB in the last financial year.
TDS on Royalty - Section 195 (For Non-Resident Payees)
If you are paying royalty to a non-resident or foreign company, you must deduct TDS at the time of payment or credit, whichever is earlier. The TDS will be as per the rate in force, generally 25% under Section 115A. But if the relevant DTAA gives a lower rate, that lower rate can be used.
Key Points
- Payment for software license is also royalty.
- If you buy software from someone in India, deduct 10% TDS under Section 194J.
- If you buy software from a foreign company, deduct TDS under Section 195 at 25% or DTAA rate.
Examples
Example 1:
XYZ Limited bought Software from someone in India for ₹1,00,000. Since this is treated as royalty, TDS has to be deducted at 10% under Section 194J. So, XYZ Limited should deduct ₹10,000 as TDS.
Example 2:
XYZ Limited purchased software from a company based in the USA for ₹1,00,000.
As it is royalty, TDS needs to be deducted under section 195.
The rate will be 25% as per Section 115A or the rate specified in the DTAA, whichever is lower.
Example 3:
During the financial year 2024-25, XYZ Limited bought software worth ₹1,00,000 from an Indian seller.
They paid the full amount without deducting TDS. Now, ₹30,000 will be disallowed while calculating income for AY 2025-26 as per section 40(a)(ia), because ₹10,000 was supposed to be deducted under section 194J but was not.
Example 4:
During the financial year 2024-25, XYZ Limited imported software from a U.S. company for ₹1,00,000.
They didn’t deduct any TDS. Therefore, the entire ₹1,00,000 will be disallowed under Section 40(a)(i) in AY 2025-26, as TDS was deductible under Section 195 but not deducted.
We have come to an end! Please share your thoughts in the comments box below; we would be pleased to address any questions.
