Withholding tax on software and SaaS payments: the live issues.
Our international tax practice.
1. The question, in one paragraph.
When an Indian company pays a foreign software vendor for a licence to use software (off-the-shelf, customised, SaaS, perpetual licence, subscription), is the payment a royalty (taxable in India under the Act and under most DTAAs at 10% to 15%) or business income (taxable in India only if the vendor has a permanent establishment here, which is usually not the case)? The answer determines whether the Indian payer must withhold tax or not.
2. The Engineering Analysis Supreme Court ruling.
The Supreme Court's 2021 decision in Engineering Analysis Centre of Excellence v. CIT resolved decades of litigation. The court held that payments by Indian residents to non-resident software suppliers (including for shrink-wrap software, licenced software with restrictive end-use terms, and software bundled with hardware) do not constitute royalty under the DTAAs that India has signed, where:
- The end-user gets a non-exclusive, non-transferable licence to use the software.
- The end-user does not acquire the copyright in the software.
- The licence terms restrict the end-user from commercial exploitation.
In such cases, the payment is for the use of a copyrighted article, not for the use of the copyright itself. It therefore does not fall within the royalty article of the DTAA and is treated as business income, taxable in India only if the foreign vendor has a PE in India.
3. The post-ruling landscape.
Following Engineering Analysis, the WHT position on most standard software licensing has stabilised. Three points to note:
- The ruling is decisive for payments to vendors in DTAA countries. Where the DTAA's royalty article does not cover the payment (because the right transferred is not copyright in the work), the DTAA's business profits article applies, and PE absence means no Indian taxation.
- For payments to vendors in non-DTAA countries, the position is governed by the Act alone. The Act's royalty definition (after the 2012 amendments) is broader than the DTAA definitions, and may still cover software payments. WHT analysis for non-DTAA cases is therefore harder and more conservative.
- The Engineering Analysis principle does not extend to payments for customised software development, embedded source code, or arrangements where the Indian payer acquires rights closer to ownership. Those continue to fall within royalty.
4. SaaS vs traditional software licences.
SaaS (Software as a Service) arrangements - where the customer accesses the software hosted on the vendor's servers and pays a subscription - present a different question. The customer does not download or licence the software; the customer uses it remotely. The character is closer to a service than a licence.
Most Indian tax positions on SaaS therefore characterise the payment as fees for technical services (or business income, depending on the DTAA). The implications:
- Where the DTAA has an FTS article (with the make-available criterion or otherwise), the payment may attract WHT at the FTS rate.
- Where the DTAA does not have an FTS article (older treaties, e.g. India-Greece, India-Thailand), the payment falls under business profits and is taxable only with a PE.
- Some treaties (e.g. India-US, India-UK) require the FTS to "make available" technical knowledge / skill to the recipient. Standard SaaS access typically does not satisfy the make-available test and falls outside FTS even in those treaties.
The characterisation is fact-specific and the practical default in Indian practice is to start with the DTAA analysis and assess whether the payment is FTS, royalty, or business income based on the specific service description.
5. Practical compliance for the payer.
For an Indian company making payments to foreign software / SaaS vendors:
- Map every vendor relationship: what is the legal characterisation of the payment (licence, service, royalty, reimbursement)?
- For each, determine the DTAA position: business income, royalty, or FTS.
- Obtain TRC, Form 10F and beneficial-ownership representation from each vendor.
- Apply the appropriate WHT (or none) based on the characterisation.
- Maintain a written memorandum supporting the position for each material vendor.
6. Documentation that closes the position.
Documentation that should sit in the file for each material software / SaaS payment:
- Vendor agreement with the operative licensing or service clauses.
- Vendor's TRC (current) and Form 10F.
- Beneficial-ownership representation by the vendor.
- Treaty-position memo (DTAA article applied, characterisation, rate, BO analysis).
- For payments treated as business income with no WHT, a clear PE-absence representation from the vendor and a CA's certificate.
- The withholding-tax certificate issued under the applicable section of the IT Act, 2025.
Frequently asked
Is Engineering Analysis still good law?
Yes. The Supreme Court's ruling is binding and continues to be applied by ITAT and High Courts on similar facts. Subsequent amendments to the IT Act have not displaced its central holding for DTAA-protected transactions.
What if the software is customised for the Indian customer?
Customised software where the developer transfers code, source rights or modification rights to the customer may fall back into royalty (because the right transferred goes beyond use of a copyrighted article). The customisation contract terms drive the characterisation; a clean assessment is needed transaction by transaction.
Is GST applicable on imported software / SaaS payments?
Yes, separately. The recipient in India is liable to pay IGST under reverse charge on the import of software and SaaS services. The GST treatment is independent of the income-tax characterisation.
What about Equalisation Levy?
Equalisation Levy of 2% on non-resident e-commerce operators was applicable on the consideration received for e-commerce supply / services from Indian residents (and Indian-located buyers). The levy was withdrawn from 1 August 2024 for e-commerce supply / services. The 6% levy on online advertising payments to non-residents continues. The position on any reintroduction or change should be confirmed for the period of any payment.
If the vendor is in a non-DTAA country, what rate applies?
The domestic withholding rate under the IT Act (currently 10% on royalty / FTS under specified conditions, plus surcharge and cess where applicable). Some non-DTAA jurisdictions may also raise treaty-shopping concerns where intermediary entities are used to route payments through DTAA partners; substance and beneficial ownership are decisive.
