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Income Tax and TDS requirements

Income tax on seller’s income 
The seller is required to pay income tax in all cases of sale of software. The seller will also have to pay income tax on the income from the software transactions, which will be calculated after deducting all his business costs and expenses as per the Income Tax Act (see above for details on deduction of business expenses).

TDS requirements for the purchaser
Sale of branded software is not treated a sale of goods, but as a ‘license’ transaction and the payment is considered a ‘royalty’. (See judgment of the Karnataka High Court in CIT vs. Lucent Technologies)Therefore, in case of purchase of branded software, TDS may have to be deducted by the purchaser (as long as the purchaser is not an individual). The Income Tax Act prescribes a 10% rate (on the entire amount paid) for TDS on royalties. Also, no deduction of expenses is permitted against the royalty payment.


TDS on software imports
In case of software imports (where the payment qualifies as royalty), the importer will have to deduct TDS under the Income Tax Act, at the lower of the following:

(i) The rate in respect of royalties payable to non-residents, prescribed under the Income Tax Act, 1961 (that is, 20%).

(ii) The rate for royalties under the Double Taxation Avoidance Agreement (DTAA) with the country of the exporter. As DTAAs are entered into for the purpose of granting the tax payer relief from taxation on the same income in two states the DTAA entered with the exporter’s country is likely to prescribe a lower rate for withholding tax.



TDS on software transactions between distributors
Often, software is sold to the end-customer through a long chain of dealers/ distributors, with each of them being required to deduct tax at this flat rate of 10%. As profit margins on softwares in the IT industry are low, TDS obligation led to a significant financial burden on software manufacturers and distributors. TDS paid was actually higher than the actual income tax liability for the business, as a result of which distributors were claiming refunds from the government in respect of the TDS that was paid (the government is authorized to refund tax under the Income Tax Act). As of 30 May 2012, the Finance Minister had issued a circular to avoid this ‘multi-level TDS’ on software.



Note: Export of software services is exempt from service tax.

The mindmap can be accessed here.

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