Tax Rules for Buying IT & GST Software from Overseas Vendors
In the current digital economy, businesses and individuals in India increasingly purchase software and digital tools from foreign vendors that lack a Permanent Establishment (PE) in the country. These purchases often encompass cloud services, SaaS subscriptions, and standard software licenses, typically facilitated through credit cards, PayPal, or various online payment gateways. While the transaction process is generally smooth, it comes with significant tax implications.
This article aims to clarify these requirements, assess whether they result in additional costs for buyers, and provide practical examples to illustrate the implications. A firm understanding of these regulations is essential for taxpayers to avoid unforeseen compliance challenges.
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Understanding Cross-Border Digital Service Transactions
When an Indian resident, whether an individual or a business, acquires software from a foreign supplier that lacks a Permanent Establishment (PE) in India, this transaction is classified as an import of services under Section 2(11) of the Integrated Goods and Services Tax (IGST) Act, 2017. Since the place of supply is determined to be India, the import is subject to taxation. Furthermore, software that is delivered online or accessed digitally is recognised as an OIDAR (Online Information and Database Access or Retrieval) service, particularly when it is automated and reliant on internet connectivity.
Payment channels like credit cards (Visa/MasterCard) and PayPal act as intermediaries in transactions and do not alter the tax implications involved. The core supply takes place between the purchaser in India and the foreign vendor. Since the foreign supplier lacks a Permanent Establishment (PE) and is not registered under the Goods and Services Tax (GST) in India, the responsibility for tax payment is transferred to the Indian recipient through the Reverse Charge Mechanism (RCM).
GST Liability: Reverse Charge Mechanism and Applicable Rates
GST plays a crucial role in transactions involving services, particularly under the Reverse Charge Mechanism (RCM) as stipulated in Notification No. 13/2017–Central Tax (Rate). According to this mechanism, the recipient of the service in India is responsible for self-assessing and paying the Integrated Goods and Services Tax (IGST) based on the transaction value, treating the supply as one received from a non-taxable entity.
For most Gen GST Software-related services, the standard GST rate is set at 18%. This rate aligns with the revisions made after the GST rationalisation in September 2025, which simplified service tax rates into two categories: 5% (without Input Tax Credit) and 18% (with Input Tax Credit). While basic productivity tools typically fall under the 5% tax category, customised or enterprise-grade software is generally subject to the standard 18% GST rate.
Importers are required to report their tax liabilities through the GSTR-3B form and can claim Input Tax Credit (ITC) when the imported software is utilised for taxable business activities. It's important to note that ITC cannot be claimed for personal use, which means the GST amount associated with such use becomes a direct expense for the individual. Exemptions from this rule are rare and are typically restricted to specific educational or government-related imports. The updates introduced in 2025 highlight the importance of obtaining Input Service Distributor (ISD) registration for businesses that distribute services across different branches. However, for direct purchases, the Reverse Charge Mechanism (RCM) process remains straightforward and unchanged.
Income Tax and TDS on Cross-Border Payments (Withholding Tax)
The income tax implications of software licensing payments hinge on the characterisation of those payments. When a software license involves the transfer of copyright or technical know-how, it is categorised as a 'royalty' under Section 9(1)(vi) of the Income Tax Act, 1961, and is subject to taxation in India. Notably, the Supreme Court's 2024 ruling in the case of Engineering Analysis Centre of Excellence Pvt. Ltd. v. CIT clarified that payments made for standard, off-the-shelf software do not qualify as royalty, which significantly lessens tax liabilities for such transactions. In instances where payments pertain to Software as a Service (SaaS) or cloud-based access, they are typically classified as service fees rather than royalties.
Under Section 195 of the Indian tax law, buyers are required to deduct Tax Deducted at Source (TDS) at a rate of 10% (plus applicable surcharge and 4% cess, bringing the total to approximately 11.7%) if payments are classified as royalty or fees for technical services (FTS). There is no minimum threshold for this deduction; however, TDS is applicable only when the income is considered to accrue or arise within India.
For digital purchases that do not qualify as royalty or FTS, TDS may not be necessary. Instead, these types of transactions might be subject to a 2% Equalisation Levy (EL) on e-commerce supplies, which was introduced in 2020 and is payable by the foreign seller rather than the Indian purchaser. Additionally, the previous 6% EL on online advertisements was phased out as of April 2025, which has eased the compliance burden for digital transactions.
When individuals or small buyers make payments via credit cards or PayPal, it is often impractical for them to deduct Tax Deducted at Source (TDS) because banks and payment gateways typically do not withhold this tax. In situations where annual remittances exceed ₹5 lakh, buyers need to report the transaction using Form 15CA/15CB, which needs to be accompanied by a certificate from a Chartered Accountant (CA). It’s important to comply with these regulations, as failure to do so may result in penalties equating to the amount of tax that was not paid.
Payment Gateways: Do They Impact GST or Tax Compliance?
Payments made through credit cards or PayPal are considered direct remittances to non-resident sellers, attracting the same GST under RCM and any applicable TDS. While PayPal may apply its own withholding terms, Indian tax regulations ultimately govern the treatment. The absence of a PE simplifies matters for the foreign seller but shifts the compliance burden entirely to the Indian buyer. As of 2025, even with fintech advances like UPI-linked international cards, this position remains unchanged. RBI’s Liberalised Remittance Scheme (LRS) continues to cap individual foreign exchange spending at USD 250,000 per year, inclusive of taxes.
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The Nuance of Additional Cost for the Indian Buyer
Yes, these taxes do increase the overall cost, though businesses can offset the burden through the Input Tax Credit. Without ITC eligibility, however, the entire amount becomes an added expense—potentially raising the cost by up to 18% in GST alone.
Example 1: Business Purchase Scenario A Delhi-based startup purchases a $1,000 (approximately ₹84,000) annual SaaS subscription from a U.S. provider using a credit card. Transaction value: ₹84,000.
- GST: 18% IGST amounts to ₹15,120, which the startup must pay under the RCM (Reverse Charge Mechanism). This amount is generally claimable as Input Tax Credit (ITC), resulting in a net zero impact if the software is used for business purposes.
- TDS: Not applicable as the payment is not treated as royalty. Equalisation Levy (EL): 2% (₹1,680), payable by the US vendor. Total upfront outlay for the buyer: ₹84,000 + ₹15,120 = ₹99,120, with the IGST recoverable through ITC. Net cost remains ₹84,000 if ITC is available; without ITC (e.g., for exempt supplies), the full ₹15,120 becomes an added expense.
Example 2: Individual Freelancer Scenario A Mumbai-based freelancer purchases a $500 (approximately ₹42,000) Adobe subscription through PayPal for personal editing use.
- GST: 18% = ₹7,560 (RCM; no ITC as personal use).
- TDS: None (small value, non-royalty). Total: ₹42,000 + ₹7,560 = ₹49,560. Here, 18% is pure additional cost, inflating the budget by nearly one-fifth.
Case Study 3: High-Value B2B Software Transaction for an Enterprise A Bengaluru-based IT company purchases custom ERP software worth ₹10 lakh from a German vendor with no PE in India. If the payment qualifies as royalty, TDS at 10% applies, resulting in a deduction of ₹1,00,000. GST of ₹1,80,000 is payable under RCM, but the firm can claim full ITC. The effective outflow is ₹10 lakh plus GST (later offset through ITC) and TDS (borne upfront by the buyer but creditable to the seller). Additionally, post-2025 presumptive tax schemes for foreign companies may reduce their effective corporate tax burden to around 35%, offering indirect relief through DTAA provisions.
Across all scenarios, the buyer initially bears the GST and any applicable TDS, recovering them only when eligible. Even with the 2025 Budget’s simplified Equalisation Levy refund mechanisms, the immediate cash-flow impact remains significant.