Software Licensing impacts you.
Whether you are reading this on your phone, tablet or computer, you are reading this because you have a license (we hope) to use the software facilitating you to do so – and you would be surprised by the number of licenses you have agreed to already.
A recent decision by the Supreme Court of India gives us the opportunity to revisit some fundamentals of software licensing while also getting into the crux of the judgment and its impact for corporates that either have licenses to use or resell foreign software. As always, we promise not to inundate you with overtly technical elements but instead provide you with insights to better understand the relevance of this development.
What is a Software License?
Let’s say you love reading (at this stage, we presume you are at the very least okay with the concept since, well, you have gotten this far, we hope) and you would like to read the latest George R. R. Martin book (it’s not actually out yet, so stick with us); you could either –
- Purchase a copy from your nearest bookstore – we (lawyers?) call this ownership;
- Borrow it from a friend – we call this possessing your friend’s belongings; or
- Issue a copy from your nearest library for a fee and eventually return it depending on your library membership – we call this a license.
The fundamentals of licensing remain the same whether we speak of books, apartments or software – a license provides you with limited rights as opposed to owning something; for example, you could deface a book you own as you please with no repercussions because you have the right to do with it as you please (or do you? More on this later), but doing so with a library book would be in violation of the terms and conditions between you and the library – you have the right to read and enjoy the book, but not to deface, change or keep it beyond what is agreed upon.
The fundamentals of licensing remain the same whether we speak of books, apartments or software – a license provides you with limited rights as opposed to owning something.
Of course, G.R.R. Martin (and almost every other author) doesn’t enter into contracts with every bookstore around the globe to sell his books, he engages a publisher who pays him a set amount for the book’s manuscript along with royalties – the publisher gets the right to, well, publish the book and sell it to make profits while G.R.R. Martin effectively sells his work and most of the rights attached to it (such as reproducing, distributing and selling it) to the publisher. Publishers in turn sometimes hire distributors to get the book in circulation and to your nearest bookstore so you can in turn buy it.
Now keep in mind, merely buying a book does not mean you have the right to copy it and resell it yourself – that right rests with the publisher because G.R.R. Martin sold the right to reproduce and distribute to the publisher. Even the distributor (if there is one) only has the right to distribute and not reprint / reproduce the book. The rule of thumb here is that you can’t give what you don’t have – if the publisher hasn’t provided the bookstore with the right to reprint, reproduce and recirculate the book, the bookstore cannot give you that right either. Completing this analogy, Martin, the author is the original holder of the ‘copyright’ (fundamentally, only the author of a work has a ‘right’ to ‘copy’ his / her work, unless such a right is explicitly transferred) to his work and every subsequent holder has a license to use his copyrighted work in a specific way.
The rule of thumb here is that you can’t give what you don’t have.
That was a very long analogy – how is it relevant to Software Licenses?
Software, at its core, consists of lines of code programmed to function a particular way. Within the sphere of intellectual property law (of which copyrights form a subset), software is typically copyrighted to protect the rights of the original author(s) in the code forming such software. Similar to books, software is typically authored or ‘developed’ and its copies subsequently distributed to end users like you and I, who have limited rights or licenses to use such software. Limitations could range from restrictions on copying and reproducing software to the number of users that can use a particular software (organisations, for example, purchase licenses to use software for multiple people, usually their employees). Furthermore, the concept of publishers, distributors and resellers extends to software as well, each with limited rights to use the software in question. Reproduction is rarely allowed at levels beyond the publisher – distributors only distribute via their logistics channels, resellers only resell and end users only use the software for their business or personal needs.
The important aspect to keep in mind here is that the license to the copyright itself isn’t transferred and sold to the distributor, reseller or the end user – however, when the publisher (who has a direct link to the copyright holder) reproduces and circulates copies of the software through its channels, it typically pays royalties, calculated on the basis of copies sold, to the copyright holder since it has a license to the copyright itself, i.e., the license to reproduce.
When the publisher reproduces and circulates copies of the software through its channels, it typically pays royalties, calculated on the basis of copies sold, to the copyright holder since it has a license to the copyright itself, i.e., the license to reproduce.
Why is it necessary that we draw a distinction between the license to a copyright and the license to use copyrighted software? And how are royalties relevant?
Without going too deep into the modalities of direct and indirect taxation as well as double tax avoidance structures between countries, simply put, entities in India are liable to pay taxes deductible at source (TDS) when making payments in the nature of royalties to software companies overseas who own the copyright to a particular software. Such entities could range from distributors to resellers to even end users. The pertinent question, however, is whether payments made to copyright holders to distribute, resell or use a software license amounts to payments in the nature of royalties.
India’s apex court in the case in question went on to hold that such payments are not in the nature of royalties, since the licenses purchased via such models are not to licenses to the copyright itself (that is, a license to reproduce and replicate is not inherent to such arrangements), but instead to use the copyrighted software in a particular way depending on the license arrangement – therefore, such payments to distribute, resell and use copyrighted software would not be subject to TDS payments to Income Tax authorities in India.
Entities in India are liable to pay taxes deductible at source (TDS) when making payments in the nature of royalties to software companies overseas who own the copyright to a particular software.
That’s good news for everyone but the Indian Income Tax Department, isn’t it?
Absolutely. Any form of tax eventually translates into higher costs at the end user level – this distinction between a license to a copyright (i.e., a license to reproduce) and a license to use copyrighted software, while semantic to the ordinary citizen, is a positive, and in our view, correct interpretation of copyright law both overseas and domestic. The idea of labelling such payments as royalties was absurd to begin with – we don’t directly pay royalties to our favourite authors now, do we?
However, from the perspective of distributors and resellers, it is imperative that distribution and reseller contracts be re-evaluated from this perspective – ambiguous language referencing any form of sub-licensing of the copyright to the software itself is to be avoided at all costs – business and legal teams need to ensure that licensing provisions with respect to software be clear and specific to the rights in question that are being licensed. While tempting to negotiate contracts to provide for greater licensing rights, distributors and resellers need to keep in mind the tax implications of having such verbiage in their contracts (assuming that unwitting software licensors agree to such verbiage in the first place). End User License Agreements, or EULAs, typically entered into directly between the copyright holder developers and end users, need to explicitly call out the nature of the arrangement and the limitations with respect to copyright provisions.
Ambiguous language referencing any form of sub-licensing of the copyright to the software itself is to be avoided at all costs – business and legal teams need to ensure that licensing provisions with respect to software be clear and specific to the rights in question that are being licensed.
Lastly, copyright holding developer companies overseas with subsidiaries in India need to ensure that such Indian subsidiaries, while entering into contracts on behalf of their parent companies overseas, do not represent to own the copyrights to software themselves – in cases wherein such domestic subsidiaries do own the copyright license involving the right to reproduce software, such structures may need to be reevaluated in the backdrop of the taxation discussion.