India's $5-billion domestic software industry can breathe a sigh of relief as finance minister Pranab Mukherjee on Wednesday assured that sale of locally made software will not be subjected to tax deduction at multiple levels.

The tax reprieve would not apply to multinationals such as Microsoft and Adobe. Income from sale of software for these MNCs will be counted as royalty payments, as the copyright for such software resides abroad.

The finance ministry would issue a circular to avoid multi-level taxation of software products, Mukherjee said. So far a 10% tax deduction at source was applicable at every level of the software sales distribution chain - from master distributor to reseller and further to retailer.

"I have approved issuance of a circular to avoid multi-level TDS on software under Section 194 J (of the Income-Tax Act) on the advice of Nasscom," Mukherjee said on the sidelines of an event in New Delhi.

The move is expected to benefit domestic companies that sell software products, including Tata Consultancy Services, Infosys and Tally Solutions. It would help them avoid the tax hassles they face at every level of the sales chain.

"Almost 40% of the value of software was getting stuck in TDS. It was getting very difficult for companies, and only increased software piracy," said Som Mittal, president of Nasscom that represents the India's $100-billion software services industry.

"Every year $5-6 billion worth of software gets sold in India. It was leading to an unsustainable model for software distributors who operate on very low margins," Mittal explained. In many cases the margins are as low as 5-6%, whereas TDS was eroding 40% value from the price of the product.

Indian software makers welcomed the move. "Almost 100% of my entire turnover of 227 crore passes through a complicated tax structure," said RL Prakash, chief financial officer at Tally Solutions, one of the largest home-grown software product companies. "Besides Tally, we have generally three distributors in our chain. Due to the 10% TDS at every level, my entire working capital was getting slaughtered every year."

Tally Solutions provides accounting software for small and medium businesses.

N Venkatraman, CFO of Bangalore-based Sonata Software, said that the current process of asking companies to withhold 10% tax at each step of sale is choking cash flows. "Our tax refunds of nearly 120 crore are pending with the government for the last 3-4 years," Venkatraman said. Sonata Software sells software and services worth over $300 million annually.

According to Section 194H and Section 194J of the I-T Act, a 10% tax deduction needs to be made at each point of sale.

"India has interesting laws for software taxation. Software products sold via electronic form attract a service tax while that sold on a CD to a customer attracts an excise duty and VAT," said Pranay Bhatia, partner at Economic Laws Practice. "We would have to wait and see the fine print in this case," Bhatia added.

Proceeds from software sold by MNCs are counted as royalties. Multi-level TDS deduction was leading to cash flow issues for the dealers as well as increase in cost of software. Dealers could not afford funds getting locked in for long durations. In many cases, a tax assessee was left to seeking a refund, processed only after 12-18 months after the tax returns are filed.

Indian Software Dealers Association (ISODA) said that it will wait for the fine print. "For the last four years, every clarification has had added to our problems, Harinder Salwan, secretary, ISODA, said.