Multinational software firms like Microsoft, SAP and Oracle -- which license software and earn royalty on it from Indian customers -- are facing the heat from assessing officers if they have not paid taxes on the gross royalty income.

According to a ruling by New Delhi-based commissioner Income Tax (Appeal), Microsoft has to cough up over Rs 700 crore in taxes and interest for the period 1999 to 2005.

The case pertains to Gracemac Corporation, a subsidiary of Microsoft. The CIT (A) ruled that the company was liable to pay income-tax on its gross royalty income from licensing of software to Indian customers.

The gross royalty income for the six assessment years is computed to be about Rs 2,240 crore. "The product is licensed, not sold" are the key words. Hence, it is treated as royalty and there's a 15 per cent tax on royalty. However, in response to a notice, Microsoft had filed returns of income for all these years, declaring nil income.

"Microsoft believes it is in full compliance with the Indian tax laws and income-tax treaty agreement between India and the US. This is an appellate order. Microsoft is reviewing the order and we will determine our course of action accordingly," said a Microsoft spokesperson.

This issue is being debated for the last 15 years, say Chartered Accountants, income-tax experts and analysts. They view this as an attempt to add newer revenue streams.

Opinions on the subject differ. "A copy of software supplied by the Microsoft does not amount to a sale. It is a licence to use the software as stipulated in the software licence agreement. This is because software is an intellectual property right, which can be licensed to one user and can be given further to any number of users. In other words, the IPR in software still remains intact with the supplier. Thus the income from software licence is in the nature of royalty according to domestic law and DTAA and is taxable in India," notes a tax expert.

However, K R Girish, partner BSR & Co, says: "Microsoft solutions will fall under the shrink-wrap software category. It is quite clear that the Right to use Copyright is liable for royalty but Right to use Copyrighted product does not demand royalty. And that is the case of Microsoft. I think the company, if it decides to go for a higher appeal, has a good case."