According to Notification No. 21/2012 dated 13.06.2012, any person (referred to as the transferee) who acquires software from another resident person (referred to as the transferor) shall not be subject to any tax deduction on the following payment.

where-

(i)  The software has been obtained through a subsequent transfer, and the transferor has transferred the software without making any alterations

(ii) Tax has been deducted-

(a) Under section 194J on payment for any previous transfer of such software; or

(b) Under section 195 on payment for any previous transfer of such software from a non-resident, and

(iii) The transferee obtains a declaration from the transferor that the tax has been deducted either under sub-clause (a) or (b) of clause (ii) along with the Permanent Account Number of the transferor.

As per Section 194J

A person, other than an individual or Hindu Undivided Family (HUF), who is liable to pay a royalty to a resident, must deduct a TDS of 10% at the time of crediting or paying the sum, whichever comes earlier. This deduction applies if the amount of the sum or the aggregate amount of such sums during the financial year is more than Rs. 30,000/-.

In contrast, individuals or Hindu Undivided Families (HUFs) must deduct TDS if they were subject to the provisions of Section 44AB during the immediately preceding financial year

As per Section 195

A person who is liable to pay any sum by way of royalty to a non-resident or a foreign company must deduct TDS at the applicable rates at the time of crediting such sum or making payment, whichever occurs earlier.

1) The definition of royalty encompasses any payment received for the transfer of all or any right to use computer software.

2) Royalty includes any payment received for the transfer or granting of a license for computer software.

3) On purchase of software from a resident TDS shall be deducted @10% under section 194J.

4) On purchase of software from a non-resident TDS shall be deducted under section 195 at the rates in force. (i.e. @ 25% as provided in section 115A or if relevant DTAA provides a lower rate then that rate shall apply instead of 25%)

In order to benefit the software sector significantly, the Indian government decided to eliminate the complicated multi-level Tax Deduction at Source (TDS) system under Section 194J with effect from July 1, 2012.

The Income Tax Act does not provide a definition for the term “software”. Typically, the term “software” is commonly understood to refer to computer software.

Computer Software

Explanation 3 to Section 9(1)(vi) of the Income Tax Act defines computer software as any computer program that is stored on a disc, tape, perforated media, or any other information storage device. This definition also includes any such program or customized electronic data.

Information technology software

As per Notification No. 18/2008-S.T. dated 10.05.2008, the definition of ‘Information technology software’ includes any representation of instructions, data, sound, or images that are recorded in a format that can be read by a machine. This definition also includes source code and object code.

This software can be manipulated or made interactive for a user by utilizing a computer, an automatic data processing machine, or any other device or equipment. (Section 65(53a) of Finance Act, 1994 as amended)

It should be noted that this notification pertains only to a standardized software and does not apply to customized or specialized software.

The aforementioned notification’s benefit would not be applicable if the payment is made for  specialized software that is specifically customized to fulfill the requirements of a particular client.

Conclusion

Amount paid for the purchase of computer software is royalty and shall be allowed as a deduction under section 37(1) as revenue expenditure subject to the provisions of section 40(a)(i) and section 40(a)(ia)

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