The Karnataka High Court has ruled that technology firms are subject to withholding tax - deduction of tax at source - when they purchase software from global vendors such as Microsoft. This would push tech firms and branded software distributors into a corner as they will be required to withhold anywhere between 10-20% of their software purchase payments in the future.

The division bench of Justice DV Shylendra Kumar and Justice Arvind Kumar pronounced the judgement on Thursday afternoon while upholding an appeal by the income tax department that tech firms were legally obliged to withhold tax on software purchases. The order is with retrospective effect.

The IT department argument was on the premise that any software purchase amounted to royalty payment for a licence to use it, and should not be deemed as a mere purchase of good that is excluded from withholding tax.

The order could impact branded software vendors such as Microsoft, their third party distributors like Sonata Software, hardware makers like Samsung and GE who bundles branded software with their products, tech firms like Infosys when they effect a licensing of software, or even the local arms of HP and IBM which could be licensing software from their parent.

This is the first court order that has gone against the taxpayer in Income Tax disputes relating to withholding tax on software purchase. In fact, the Karnataka High Court intervention came after the Income Tax Tribunal had ruled in favour of taxpayers prompting the department to go on appeal.

The bench did not venture into the question whether purchase of software amounted to royalty payment or not. The court merely said firms (buying software) should not sit on judgement whether the recipient is obliged to pay tax in the country. They have to deduct tax the moment they make payments to a non-resident party. To an extent, this leaves several issues open-ended, Abhishek Goenka, partner at BMR Advisors, said.

A clear perspective will emerge only after the affected parties study the court order in detail. On Thursday, the division bench read out the order and a certified copy on the same is expected only in the coming days.

Not surprisingly, most of the affected parties including tech firms, software distributors and hardware makers did not wish to offer comments when ET contacted them.

The high court had clubbed together several cases relating to withholding tax on software purchase in the judgment pronounced today.

More than technology services firms, it is branded software distributors and hardware manufactured who bundle software who are going to be affected in a significant way and several companies could become interested parties in this litigation going forward as they need to address the question whether they are obliged to pay taxes in the country for sale of software, Mr Goenka of BMR said.

It is believed withholding tax of roughly Rs 500-600 crore is locked up in the disputes before the high court. But this could not be verified independently.