TDS on Software Purchase in India: A Complete Guide for Businesses

In today’s digital economy, businesses frequently purchase software for operations, productivity, and client services. However, what many overlook is that these transactions can attract TDS (Tax Deducted at Source) obligations under the Income Tax Act. Understanding the TDS on software purchase, especially after key judicial rulings, is essential for ensuring compliance and avoiding penalties.

This article explains when and how TDS applies to software transactions, relevant sections, and what the Supreme Court’s landmark judgment means for Indian businesses.

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TDS

Introduction to TDS on Software

Software purchase transactions are often treated differently under Indian tax law because payments made for the use or transfer of software are considered royalty payments . Since “royalty” is specifically taxable under the Income Tax Act, these transactions fall within the scope of TDS provisions.

The key question businesses must answer is whether the software purchase represents a transfer of copyright or merely the right to use the software. The answer determines whether TDS applies and under which section.

Types of Software Purchases

TDS treatment varies based on whether the software is purchased from a domestic supplier or an overseas vendor.

Domestic Software Purchase from Indian Vendors

When a business purchases software from an Indian company, such payments may be treated as royalty if the buyer receives the right to use, modify, or reproduce the software. In such cases, TDS under Section 194J applies.

If the transaction is a simple purchase of an off-the-shelf (shrink-wrapped) software product without any transfer of copyright or ownership, it is treated as a goods purchase and TDS is not applicable.

Import of Software from Foreign Vendors

When software is imported from a foreign company, TDS implications are governed by Section 195 of the Income Tax Act.
If the payment qualifies as “royalty” under Indian law or under the Double Taxation Avoidance Agreement (DTAA) with the vendor’s country, the buyer (Indian company) must deduct TDS before making payment.

When Does TDS Apply on Software Purchase?

The application of TDS on software purchase has been a subject of debate for years, leading to litigation and confusion. The issue was finally clarified by the Supreme Court in a landmark ruling.

Key Supreme Court Ruling on Software TDS

In Engineering Analysis Centre of Excellence Pvt. Ltd. vs CIT (2021), the Supreme Court ruled that payments made for the purchase of off-the-shelf or shrink-wrapped software do not constitute royalty. Hence, no TDS is required under Section 195 when such software is purchased for personal or internal use.

The Court differentiated between:

Transfer of copyright rights (royalty income – taxable), and
Transfer of copyrighted article (sale of goods – not taxable as royalty).

Thus, if the buyer only receives the right to use the software and not the underlying copyright, the payment is not considered royalty, and TDS does not apply.

What This Judgment Means for Businesses

Following this decision, businesses are not required to deduct TDS when purchasing software licenses that do not involve a transfer of copyright. However, companies must carefully review licensing agreements to confirm that the payment is indeed for use and not ownership transfer.

Important Compliance Points to Remember

Review every software license agreement to determine the nature of the transaction.
If the vendor grants rights to reproduce, modify, or distribute the software, it is treated as a royalty payment, attracting TDS.
Maintain documentation (invoices, contracts, and agreements) as evidence of compliance decisions.

For foreign vendors, always refer to applicable DTAA clauses to determine the correct withholding rate.

Relevant TDS Sections for Software Transactions

The Income Tax Act specifies different TDS sections based on the residency status of the payee and the nature of the payment.

Meaning of Royalty Under the Income Tax Act

The term royalty, under Section 9(1)(vi), includes consideration for:

Transfer of rights in a patent, invention, model, design, or trademark.
Use or right to use any copyright, including computer software.
Rendering of services in connection with such usage.

Hence, software payments involving such rights are classified as royalty payments.

TDS on Royalty Payments – Section 194J (Residents)

For payments to Indian vendors, TDS under Section 194J applies at 10% of the payment amount (excluding GST) if the software payment is treated as royalty.

Applicable when the payer is a business or professional.
TDS to be deducted when payment or credit, whichever is earlier, is made.
No TDS if total annual payments to a vendor are below ₹30,000.

TDS on Royalty Payments – Section 195 (Non-Residents)

For software purchased from foreign vendors, Section 195 applies.

TDS is deducted at rates prescribed under the Income Tax Act or DTAA (whichever is lower).
Generally, the TDS rate for royalty payments under DTAA ranges between 10% and 15%.

The payer must obtain a Tax Deduction Account Number (TAN) and deposit TDS with the government before remitting payment abroad.

Conclusion

Understanding TDS applicability on software purchase is crucial for businesses in India. After the Supreme Court’s ruling, the distinction between use of software and transfer of copyright has become clearer.

In short:

No TDS on standard software purchase for internal use.
TDS applies on software payments treated as royalty (transfer of rights).
Domestic payments attract Section 194J, and foreign payments attract Section 195.

Businesses should maintain proper documentation, consult tax advisors when in doubt, and ensure that TDS is correctly deducted and reported wherever applicable.

Susheel Kumar

Chartered Accountant

MRN No.: 096252

City: Delhi

I am a Chartered Accountant with over 20 years of experience and a finance content writer. I focus on educating people about finance and taxation. I have written many blog posts on finance, taxation, trading, and investment on the BUSY website. My goal is to increase financial understanding by making complex concepts easier to grasp and to support educational programs in India.

Frequently Asked Questions

Is TDS applicable on all software purchases in India?

No. TDS applies only when the software purchase qualifies as a royalty transaction involving the transfer of copyright or rights to reproduce or modify the software.
What did the Supreme Court rule on TDS for software?

The Supreme Court clarified that payments for the purchase of standard or off-the-shelf software are not royalty payments and do not attract TDS.
Which TDS sections apply to domestic and imported software?

For domestic software purchases from Indian vendors, Section 194J applies. For software purchased from foreign vendors, Section 195 governs TDS on payments to non-residents.
How should businesses deduct TDS on foreign software payments?

Businesses must calculate TDS based on the applicable DTAA rate, deduct it before making payment, and deposit it with the government through the prescribed challan.
Can businesses claim credit for TDS deducted on software purchases?

Yes. Businesses can claim TDS credit in their tax return if deducted correctly and reflected in Form 26AS.

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