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Microsoft EULA lands it with $175m Indian tax headache

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"The Product is licensed, not sold."

Those six words just cost Microsoft's Indian operation $87.5m (350 crore) in tax payments and the same again in interest.

Basing its ruling on the terms of Microsoft's own EULA (end-user license agreement), an Indian court has ordered the company to pay tax on royalty income generated in the country, Tax India Online (TIOL) reports.

For years, Microsoft argued that a wholly owned local subsidiary, GraceMac Ltd, which conferred license rights to Indian end users, derived no income from India. And for years GraceMac declared nil income, even though it has received anything from 35 per cent to 73 per cent of net revenues, through a sister company based in Singapore.

But Microsoft argued that money from India went to the coffers of another overseas subsidiary, Microsoft Regional Sales Corp. US, which sold software to local distributors. MRSC was taxed in the US, and so is free from paying income tax again, courtesy of the Double Tax Avoidance Treaty between the US and India.

But the Commissioner of Income Tax (Appeals) in New Delhi rejected this claim, TIOL notes:

++ A copy of software supplied by the appellant admittedly did not amount to a sale but it is a licence to use the software as stipulated in software licence agreement. This is because software is an intellectual property right (IPR) which can be licensed to one user and can be given further to any number of user. In other words the IPR in software still remain intact with the supplier.

++ income from software licence is in the nature of royalty both under the domestic law and DTAA and is taxable in India.

In a sideswipe, the CIT(A) lifted this robust declaration from an earlier case, for its Microsoft ruling:

“Unacceptable tax avoidance typically involved the creation of complex artificial structures by which, as though by the wave of a magic wand, the tax payer conjures out of the air a loss, or a gain, or expenditure, or whatever it may be, which otherwise would never have existed. These structures are designed to achieve an adventitious tax benefit for the taxpayer, and in truth are no more than raids on the public funds at the expense of the general body of taxpayers, and as such are unacceptable.”

Helpfully, TIOL has published an organisational matrix, which maps how Microsoft manages Indian affairs through sundry overseas subs. It says Microsoft will probably appeal the ruling all the way to India's Supreme Court. ®

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