Part A Service tax : Information Technology Software

In Tata Consultancy Services (supra), it was also observed:

“In our view, the term’ goods’ as used in Article 366(12) of the Constitution of India and as defined under the said Act are very wide and include all types of movable properties whether those properties be tangible or intangible ….. The software and media cannot be split up. What the buyer purchases and pays for is not the disc or the CD. As in the case of painting or books or music or films, the buyer is purchasing the intellectual property and not the media i.e., the paper or cassette or disc or CD. Thus, a transaction sale of computer software is clearly a ‘sale of goods’ within the meaning of the term as defined in the said Act: …. “

It also held “we find no error in the High Court holding the branded software as goods. In both cases, the software is capable of being abstracted, consumed and used. In both cases, software can be transmitted, transferred, delivered, stored, possessed, etc. Even unbranded software when marketed/sold may be goods. We however, are not dealing with this aspect and express no opinion thereon because in case of unbranded software other questions like situs of contract of sale and/ or whether the contract is a service contract may arise.”

Thus, the above benchmark decision, which is widely followed, held branded/ canned software as ‘goods’ and the issue regarding unbranded or customised software whether is ‘goods’ or ‘service’ was not concluded and left open.

3.  Software and leviability of VAT:

Following the decision of Tata Consultancy Services (supra), Maharashtra Value Added Tax Act, 2002 (MVAT) notified software packages to be under Entry C-39 vide Notification dated 1-6-2005as goods of intangible or incorporeal nature and made liable for VAT @ 4%. Similarly, software is also liable for VAT in the States of Goa, Karnataka, etc.

Since canned software is determined as ‘goods’ and chargeable to VAT, it cannot be held as ‘service’ at the same time in terms of decision of the Supreme Court in the landmark case of Bharat Sanchar Nigam Ltd. & Anr. v. UOI & Ors., 2006 (2) STR 161 (SC). In para 46, the Court observed,

“The test for deciding whether a contract falls into one category or the other is as to what is the “substance of the contract”. We will for want of a better phrase call this the dominant nature test.”

Similarly, in Imagic Creative Pvt. Ltd. v. Commissioner of Commercial Taxes, 2008 (9) STR 337 (SC) also, exclusivity of sale and service is established. Also in the case of Gujarat Ambuja Cements Ltd. v. UOI, 2005 (182) ELT 33 (SC), it was held “the mutual exclusivity of taxes which has been reflected in Article 246(1) of the Constitution means that taxing entries must be construed so as to maintain exclusivity.” In principle, service tax has never been intended to be levied on sale of goods by the Union Government having regard to the framework defined by the Constitution i.e., to levy tax on an item covered under Article 246 read with List II – State List to Schedule VII of the Constitution of India. This intention is refleeted in CBEC Circular 96/7 /2007-ST of 23-8-2007 at 36.03/23-8-2007 in the context of services of authorised service station. – “Service tax is not leviable on a transaction treated as sale of goods and subject to levy of sales tax / VAT”. Similarly, the Circular /letter D.O.F. No. 334/1/2008 – TRUE, dated 29-2-2008 in the context of new service category of “transfer of right to use tangible goods” the Board clarified  –    “supply of tangible goods for use and leviable to VAT/ sales tax as deemed sale of goods is not covered under the scope of the proposed service. Whether a transaction involves transfer of possession and control is a question of facts and is to be decided based on the terms of the contract and other material facts. This could be ascertained from the fact whether or not VAT is payable or paid.” (emphasis supplied). Thus, when substance of a transaction is ‘sale’ of a software, it is exigible to VAT and is beyond the scope of service tax.

4.    Software: Scenario hitherto in the service tax law:

Till May 16, 2008, when information technology software service got notified as taxable service, the scenario under the service tax law was as follows:

5. Scope of information technology software service under service tax:

5.1  Statutory provisions:

S. 65(53a) of the Act:

‘Information technology software’ means any representation of instructions, data, sound or image, including source code and object code, recorded in a machine-readable form, and capable of being manipulated or providing interactivity to a user, by means of a computer or an automatic data processing machine or any other device or equipment.”

S. 65(105)(zzzze)  of the Act:

(zzzze)    “Taxable service means any service provided or to be provided to any person, by any other person in relation to information technology software for use in the course, or furtherance, of business or commerce, including, :

(i)    development of information technology software,

(ii)    study, analysis, design and programming of information technology software,

(iii)    adaptation, upgradation, enhancement, implementation and other similar services related to information technology software,

(iv)    providing advice, consultancy and assistance on matters related to information technology software, including conducting feasibility studies on implementation of a system, specifications for a database design, guidance and assistance during the start-up phase of a new system, specifications to secure a database, advice on proprietary information technology software,

(v)    acquiring the right to use information technology software for commercial exploitation including right to reproduce, distribute and sell information technology software and right to use software components for the creation of and inclusion in other information technology software products,

(vi)    acquiring the right to use information technology software supplied electronically.”

5.2 The Ministry in its Circular DOF No.334/1/2008-TRU, dated 29-2-2008 clarified as follows:

“4.1.2 Software consists of carrier medium such as CD, floppy and coded data. Softwares are categorised as ‘normal software’ and ‘specific software’. Normalised software is mass market product generally available in packaged form off the shelf in retail outlets. Specific software is tailored to the specific requirement of the customer and is known as customised software.

4.1.3 Packaged software sold off the shelf, being treated as goods, is leviable to excise duty @ 8%. In this budget, it has been increased from 8% to 12% vide Notification No. 12/2008-CE, dated 1-3-2008.

4.1.4 IT software services provided for use in business or commerce are covered under the scope of the proposed service. The said services provided for use, other than in business or commerce, such as services provided to individuals for personal use, continue to be outside the scope of service tax levy. Service tax paid shall be available as input credit under CENVAT Credit Scheme.

4.1.5 Software and upgrades of software are also supplied electronically, known as digital delivery. Taxation is to be neutral and should not depend on forms of delivery. Such supply of IT software electronically shall be covered within the scope of the proposed service.

4.1.6 With the proposed levy on IT software services, information technology-related services will get covered comprehensively.”
 
6. Scope  and  the criteria for taxability  :

6.1 Services provided unless used in the course or furtherance of business or commerce are not covered in the scope of taxable service. Thus, software service provided to an individual for personal use remains outside the purview of the levy.

6.2 It is not difficult to interpret and infer that services of study, analysis, design and programming of software (sub-clause ii) are covered within the scope of the ITSS. Similarly, adaptation, upgradation, enhancement, implementation and other similar services relating to software (sub-clause iii) are also enshrined in the definition. Some of these descriptions seem to overlap with each other. Likewise, some of the services covered under other categories like consulting engineer, management or business consultant and even ‘management, maintenance or repair’ service also find place in this definition. For instance, sub-clause (iv) lists services like advice, consultancy and assistance on matters related to software including feasibility studies on implementation of a system, specifications for a database design, guidance and assistance during start-up, etc. The term ‘study’ can include feasibility study also. Further, when the so-called ‘annual maintenance contracts’ for maintenance of software are entered into, more often than not, providing upgradation or assistance in implementation is included along with the services of troubleshooting, debugging, etc. Implementation services are not very different from guidance and assistance during a start-up phase or advice and/or consultancy services. Various words or terms appear to have been used in order not to – allow any ‘escape’ from the scope. Nevertheless, not much difficulty is felt in interpreting these functions as ‘services’.

6.3.1 The issue is whether sub-clause (i) includes the process of development of information technology software as ‘service’ or it covers as a whole only services in relation to development of software. A view has been formed by some professionals that only the services in relation to development of software are covered under this sub-clause and not the development of software per se. Accordingly, it is contended that services may comprise of writing of codes, providing consultancy, pre-implementation .. study, analysis, etc. The coded software is supplied to the client as ‘goods’ – it is either developed on the system of the client or supplied electronically or on a tangible medium such as a disc. If the software is developed by a person on one’s own and is only replicated for various users, such ‘development’ does not amount to ‘service’ and it is transferred on a tangible medium across the counter as ‘packaged goods’ without much or no involvement of any ‘service’, it is ‘sale’ of ‘goods’ and as such, charge-able to VAT as already analysed in para 3 above, following TCS judgment (supra).

6.3.2 However, when software is developed for and on behalf of and as per specifications provided by the client, the question arises whether the fee received for the development of software is wholly chargeable as ‘service’, considering it as. covered under the sub-clause (i) or should the delivery of duly developed software be considered ‘goods’ liable for VAT,considering the test prescribed in the TCS decision (supra) as to determination of ‘goods’ that when software is capable of being transmitted, transferred, delivered, stored/possessed, etc. and even when it is customised, it has all the attributes present in it for being considered ‘goods’ and in such eventuality, only the value of services in relation to development of software be considered exigible to service tax. This is an extremely complex issue and only the facts of each case and the terms of agreement between the designer / developer of software and the user would determine as to whether the ‘contract’ relates to sale of ‘goods’ or ‘services’ or whether both the components are present in a contract. Then in such cases, the issue may arise as to whether the contract is indivisible or both the ingredients i.e., ‘sale’ and ‘service’ are defined separately and the consideration is also stated separately and therefore, the parties to the contract intend separate rights, etc. However, on applying ‘dominant nature test’ [as observed in BSNL’s case (supra) discussed in para 3 above], when the parties did not intend separate rights, there is no ‘sale’ even if the contract could be disintegrated, in a contract where dominant objective is provision of service. Therefore, taking an instance of a lump-sum contract which is focussed on development or designing of a software involves preliminary study and analysis of client’s specific organisational requirement. Thereafter, the process of development begins with services of collection of information and data, study, analysis, consultation, advice, designing systems, writing programs before a final product is designed and delivered and which may also include services of post development implementation, training, troubleshooting, etc. Although in the scenario, the final deliverable may be provided, transferred and installed on a tangible medium such as hard disc, it would be reasonable to view the transaction as one of service as services appear dominant in the entire deliverable which is analogical to illustrations of a hospital’s prescription and dispensing of pills, a lawyer’s preparation of a contract as a stamped document discussed in BSNL’s decision (supra) where dominant objective is ‘service’, although deliverable is provided as ‘tangible goods’. Thus, it may prima facie appear that the entire contract of development of software could be considered a service contract exigible to service tax under sub-clause (i) of ITSS. However, the term ‘service’ per se is not defined in the Finance Act, 1994. In the case of All India Federation of Tax Practitioners v. UOI, 2007 (7) STR 625 (SC), the Supreme Court observed that the word ‘service’ should be understood in contradiction to the word ‘goods’. So far as ‘goods’ is concerned, The Supreme Court in TCS’s case has observed that if an article has attributes having regard to (a) its utility (b) capable of being bought and sold and (c) capable of being transferred, delivered, stored and possessed, it should be goods and thus, converse can be inferred that if it cannot be possessed, stored, delivered or transferred and is not capable of being bought and sold, it should be considered ‘service’. In the context of the above instance of client-specific or a customised software, one has to admit that all the above ingredients are present. Further, distinguishing the transaction of development of software from a lawyer’s preparation of document or a doctor’s prescription is that the service once availed is utilised and consumed instantaneously. It is possible that the benefit therefrom can recur later at different events also. However, it gets consumed whereas the customer-specific software, although developed only for the customer, is deliverable, transferable, storable, usable and capable of being possessed. For instance, the client can claim and register proprietary rights over the customised software developed by the provider thereof to the exclusion of the developer of software.

6.3.3 Software: Dutiable  under  excise and customs.

Information technology software (canned as well as customised) is excisable goods under Tariff Entry 8523 8020 (earlier 852 49111, 8524 9112 and 85249113).The rate of duty was 12% with effect from March 01, 2008 (increased from 8% and again it attracts 8%). However, software other than canned software was exempted under Notification No. 6/ 2006-CE of 1-3-2006. When classification exists under the excise law, merely by declaring specific item of ‘goods’ as exempt, does the inherent ‘character’ of these goods got transformed into service or vice versa? If ‘customised software’ per se is not ‘goods’ and is ‘service’ only, can it be considered ‘exempted goods’ for the duty of central excise? (Or is this exemption somewhat analogical to exemption for value of goods or material sold by the service provider to the recipient of service under Notification No. 12/2003-Service Tax dated 20-6-2003 which per se cannot be made exigible to service tax ?). Simi-larly, under the customs law also, it is classified under Entry 8524 4011, but it is exempt. However, since excise duty is levied on canned software, while importing canned software, CVD is payable.

The Supreme Court in Gobindram v. Shamji K. & Co., AIR 1961SC 1285 (1290) held that the word ‘exempt’ shows that a person is not beyond the application of law. Thus, having been classified under the excise and customs law is it to be contended that software both canned and customised should be considered ‘goods’ and therefore development of software per se cannot be a service?

6.3.4 It is relevant to note here, a decision of the Karnataka High Court which in the case of Inventa Software India Pvt. Ltd. v. AC Commercial Taxes, (2008) 17 VST 362, relying on the decision of Tata Consultancy Services (supra) held that development of application software in the areas like financial accounting, inventory control, sales analysis, etc. is ‘works contract’ attracting sales tax under Entry 22 of Sixth Schedule of the KST Act, 1957 under ‘programming and providing computer software’. This has generated further controversy mainly for the fact that a transaction of works contract involves ‘transfer of property’ in goods in execution of works contract. For instance, an ordinary illustration of a painting contract or a contract for construction pre-supposes supply of ‘goods’ in the first instance on which some ‘work’ or ‘labour job’ is carried out in order that a composite job is construed ‘works con-tract’ consisting of transfer of property in goods during its execution. It is doubtful in the case of ‘development of a software’ whether there exists any ‘goods’ prior to the execution or development of software. Even if it is assumed to be a ‘composite contract’, it is well accepted that all composite con-tracts are not works contracts. In case of software development, a series of services are combined and embodied in a ‘deliverable’ product, which is finally delivered on a tangible medium. It is comparable only with a musical or dramatic or such creative work on a tangible medium. The entire creative work, which is intangible and intellectual, is embodied on a tangible medium. Its division into ‘service’ and ‘goods’ does not appear a legally tenable proposal unless a ‘deeming fiction’ is enshrined in the law.

The Government appears to be seized with this issue. In the context of ‘video cassettes supplied for broadcasting on Betachem or a similar format – its instruction Dy No. 167/11/08-CX4, dated March OS, 2008 which  inter alia inquired:

(1)    Whether both service tax and excise duty are payable on the same activity or not?

(2)    Whether for both taxes, the same value is considered or different value is considered?

(3)    Practice of work adopted  by this industry  …  “.

(Note: The above was provided consequent upon representation by Film and Television Producers’ Guild and others).

6.3.5 In summation, the issue is complex. However, although final product passes the test of being a deliverable, transferable, usable, storable, etc., substantial amount of services are embodied in the finally delivered product or it is even appropriate to contend that the product delivered comprises only ‘service’ ingredient. Further, goods like cooked food also gets consumed immediately or has a short shelf life. However, before it is cooked, the raw material exists and service is embodied in the material to produce the cooked food. While developing software, no material is involved in the process of development and it is an intangible intellectual property. Therefore, the issue is arguable from both the sides and accordingly, terms of contract, dominant nature and intention of parties to the contract only may help determine taxability of a transaction. Yet the area being grey, tremendous amount of litigation can be expected if the Government does not act to resolve the matter.

Nevertheless, a contract pertaining to services provided in relation to development of software certainly would be covered by sub-clause (i).

6.4 Acquiring the right to use software for com-mercial production or supplied electronically (sub-clauses (v) and (vi).

The reading of these clauses to determine liability of service tax (if any) appears a Herculean task. If sub-clauses (v) and (vi) are read in the manner as the other three preceding clauses i.e., the sub-clause itself as a defined ‘taxable service’, it results in absurdity. Plain reading of these clauses along with the head note would mean as follows :

“Interpretation must depend on the text and the context. They are the bases of interpretation. One may well say if the text is the texture, context is what gives the colour. Neither can be ignored. Both are important. The interpretation is best which makes the textual interpretation match the contextual”.

Since service tax law defines ‘taxable service’ u/s. 65(105) of the Act, contextual interpretation that follows is that a service in relation to acquiring of right to use software supplied electronically or to use it for commercial exploitation is sought to be taxed by the inclusion of sub-clauses (v) and (vi). Analysing this from another angle also leads to such contention. Taxing transfer of right to use any goods under Article 366(29A)(d) of the Constitution vests in the States and accordingly is part of the extended definition of ‘sale’ under VAT laws.

As already discussed above in para 3, at least packaged software per se is held as ‘goods’ under the VATlaws, central excise and the customs laws. Similarly, supply of ‘right’ to use software through what is known in business parlance as ‘paper licence’ (a certificate issued by a copyright owner conveying right to use IT software), wherein delivery may be done on a tangible medium or electronically i.e., sent online, being a ‘deemed sale’ is chargeable to VAT.
 
The question that therefore arises is whether the same can be treated as ‘service’ when a dealer or a distributor acquires right to distribute and sell soft-ware which is a copyrighted product, developed by the developer of the product? Since the transaction is exigible to VAT,it cannot simultaneously attract service tax, as discussed above at para 3 in terms of constitutional limitation decisions of Imagic Creative (P) Ltd. (supra) and Bharat Sanchar Nigam Ltd. (supra) as also Board’s clarifications.

7.    Summing  up :