Cross-Border Royalty & FTS Withholding Post-Engineering Analysis: Section 9(1)(vi) vs DTAA Most Favoured Nation (MFN)
Updated: 3 days ago
The cross-border taxation of software licenses, cloud computing subscriptions, and cross-border engineering services occupies the epicenter of Indian international tax controversy. For decades, the Indian Revenue and non-resident technology licensors were locked in intense litigation regarding whether outbound software payments constitute taxable Royalty under Section 9(1)(vi) of the Income-tax Act, 1961, or business profits governed by Double Taxation Avoidance Agreements (DTAAs).
The historic three-judge bench ruling of the Hon'ble Supreme Court of India in *Engineering Analysis Centre of Excellence Pvt. Ltd. v. CIT (2021) provided monumental clarity, drawing a sharp statutory demarcation between the transfer of 'copyright' and the sale of a 'copyrighted article'. However, subsequent jurisprudential developments—most notably the Supreme Court's ruling in Assessing Officer v. M/s Nestle SA (2023) regarding Most Favoured Nation (MFN) protocols—have dramatically reshaped outbound withholding compliance under Section 195*.
Domestic Law Overreach vs Treaty Protection: Section 90(2)
Under Section 9(1)(vi) of the Income-tax Act, Parliament enacted extensive retrospective amendments (Explanations 2, 4, 5, and 6) expanding the definition of 'Royalty' to encompass:
Payments for the use or right to use computer software (including granting of licenses), irrespective of the medium of delivery.
Transmission by satellite, cable, optic fiber, or similar technology.
Any right, property, or information, whether or not the process is secret.
However, Section 90(2) of the Act establishes that where India has entered into a bilateral DTAA, the provisions of the tax treaty override domestic law to the extent they are more beneficial to the non-resident taxpayer. Under OECD and UN Model Conventions, Article 12 restricts 'Royalty' strictly to payments received as consideration for the use of, or the right to use, any copyright of literary, artistic, or scientific work.
The Supreme Court Ruling in Engineering Analysis
In Engineering Analysis, the Supreme Court analyzed four distinct business models:
Software purchased directly by an Indian end-user from a non-resident vendor.
Software purchased by Indian distributors from non-resident vendors for resale to Indian end-users.
Software purchased by non-resident distributors from non-resident vendors and resold to Indian end-users.
Software bundled with integrated hardware (OEM hardware sales).
#### Key Jurisprudential Principles Established:
Copyright vs Copyrighted Article: The Court held that an End User License Agreement (EULA) granting a non-exclusive, non-transferable license to use computer software does not confer any parting of copyright. The buyer merely acquires a 'copyrighted article' (akin to buying a physical book) rather than the underlying 'copyright' (the right to reproduce, modify, or commercially exploit the author's work).
Inapplicability of Domestic Retrospective Amendments to Treaties: Retrospective amendments introduced into Section 9(1)(vi) by the Finance Act, 2012, cannot be unilaterally read into bilateral tax treaties signed prior to such amendments.
Nil Withholding Requirement: Consequently, payments made by Indian residents to non-resident vendors for standard off-the-shelf software or SaaS subscriptions do not constitute Royalty under DTAAs and are not subject to withholding tax under Section 195, in the absence of a Permanent Establishment (PE) in India.
Fees for Technical Services (FTS) & the 'Make Available' Clause
Parallel to software royalties, cross-border payments for management consultancy, cloud architecture design, and technical assistance are evaluated under Article 12/13 (Fees for Technical/Included Services).
Under several key Indian DTAAs (including the United States, United Kingdom, Singapore, and Canada), technical services are taxable as FTS only if they satisfy the stringent 'Make Available' condition:
Practice guide for professionals
For a clause-by-clause working reference with worked examples, see the Amended Form 3CD Practical Guide (PDF, ₹299).
Technical services are deemed to be 'made available' only if the service provider enables the recipient of the service to acquire the technical knowledge, skills, experience, or processes, such that the recipient can apply them independently in the future without perpetual reliance on the service provider.
Routine consultancy, automated data processing, and hosted IT infrastructure management do not 'make available' technical knowledge to Indian payers, insulating them from domestic FTS withholding.
The Nestle SA Ruling: Restricting MFN Treaty Clauses
While Engineering Analysis expanded treaty relief, the Supreme Court's ruling in *Assessing Officer v. M/s Nestle SA (2023)* fundamentally tightened treaty access:
Mandatory Section 90(1) Notification: The Court ruled that an assessee cannot automatically claim the benefit of a lower tax rate or narrower scope under a Most Favoured Nation (MFN) clause appearing in a treaty protocol (e.g., in treaties with the Netherlands, France, Switzerland, or Spain) unless the Central Government has officially issued a separate notification under Section 90(1) importing that beneficial treatment into domestic law.
OECD Membership Benchmarking: The third-party country conferring the lower rate must have been an OECD member at the time of concluding its bilateral treaty with India, invalidating claims based on subsequent OECD accessions.
Impact on Withholding Practice: Remitters who previously withheld at a concessional 5% or 10% rate under MFN protocols must now withhold at standard treaty rates or seek formal lower deduction orders.
Section 195 Compliance & Form 15CA/15CB Operational Protocols
For Indian corporate finance teams executing foreign remittances, compliance under Section 195 requires meticulous documentation:
Verification of TRC & Electronic Form 10F: The non-resident vendor must furnish a valid Tax Residency Certificate issued by their foreign sovereign tax authority, along with an electronically filed Form 10F as examined in Tax Residency Certificate (TRC) vs Form 10F vs PE Risk.
No-PE & Beneficial Ownership Declarations: Signed declarations confirming that the vendor has no fixed place, agency, or service PE in India, and is the true beneficial owner of the remittance.
Section 195(2) / Section 197 Lower Deduction Certificate: Where ambiguity exists regarding whether a cloud or SaaS tool involves embedded intellectual property, filing Form 13 with the International Taxation Assessing Officer provides definitive statutory insulation against payer disallowance under Section 195 NRI Tax Withholding & Form 13 Lower Deduction.
Form 15CB Chartered Accountant Certification: Independent scrutiny of the underlying master service agreement, EULA, invoices, and payment gateways before uploading the electronic certificate on the income tax portal.
Enterprises must also evaluate whether offshore payments escape royalty classification but trigger digital nexus rules under Significant Economic Presence (SEP) or the post-repeal landscape of Equalisation Levy 2% Repeal & Transition.
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Cross-Border Tax Advisory & Litigation Defense by PGT & Associates
PGT & Associates provides specialized international tax structuring, DTAA interpretation, and withholding risk defense services for Indian multinationals and inbound foreign enterprises:
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