Introduction When there are two different authorities to levy tax of a similar nature, there is bound to be a controversy. And one such controversy going around is whether development charges for software are liable to VAT or service tax? The issue is debatable as both the authorities consider the same under their jurisdiction.
There are certain judgments, mainly about aspect theory, under which the respective authorities under VAT and service tax consider some aspect of the transaction as liable to tax under their respective law and try to levy tax. This results in overlapping and also leads to double taxation of the same transaction. However, without making any attempt to analyse the theory of double taxation, etc., let’s try to understand the correct position of taxation of software development charges.
Software, whether goods?
The first issue in relation to taxation of software is whether softwares are goods. This issue has already been settled by the Supreme Court. Reference can be made to the judgment of the Supreme Court in the case of Tata Consultancy Service v. State of Andhra Pradesh, (137 STC 620) (SC).
In para 17 the Supreme Court has observed as under:
“17. Thus this Court has held that the term ‘goods’, for the purposes of sales tax, cannot be given a narrow meaning. It has been held that properties which are capable of being abstracted, consumed and used and/or transmitted, transferred, delivered, stored or possessed, etc. are ‘goods’ for the purposes of sales tax. The submission of Mr. Sorabjee that this authority is not of any assistance as ‘software’ is different from electricity and that software is intellectual incorporeal property, whereas electricity is not, cannot be accepted. In India the test, to determine whether a property is ‘goods’, for purposes of sales tax, is not whether the property is tangible or intangible or incorporeal. The test is whether the concerned item is capable of abstraction, consumption and use and whether it can be transmitted, transferred, delivered, stored, possessed, etc. Admittedly in the case of software, both canned and uncanned, all of these are possible.”
Thus, in relation to ready software whether canned or uncanned, the Supreme Court has observed that they are goods and hence can be subjected to sales tax including VAT, as presently levied.
However, the issue still remains whether all uncanned softwares are liable to VAT. There may be two situations under the above category of uncanned software:
One is that uncanned software may be developed for a particular customer as per his specifications. The software developer reserves all IPR including copyright in the said software unto himself. He will transfer the same to the customer after the software is ready against consideration. The transaction satisfies the test laid by the Supreme Court.
The other situation is that the customer while putting the order for development of software may reserve his copyright and IPR in the said software to be developed unto himself right from original stage of development of the software. Under the above circumstances it can be said the developer is not developing any software as his property which he can transfer to the customer. In this case the software coming into existence belongs to the customer as copyright lies with him as and when the software is being developed. Therefore the software developer can be said to be rendering services for development and not selling any software. In such a case there is no justification for levy of VAT. If at all, applicable service tax may be leviable, but not VAT.
This issue has been decided now by the Karnataka High Court in the case of Sasken Communication Technologies Ltd. v. The Deputy Commissioner of Sales Tax, DVO-5 (W.A. Nos. 90-101/2011 dated 15-4- 2011). In this case also similar issue was involved. The dealer M/s. Sasken Communication Technologies Ltd. developed software for its customers. However, as per agreement the copyrights and IPR in the said software belonged to the customer right from original stage of development. The Karnataka High Court held that since the copyright belonged to the customer right from the beginning, the software coming into existence after development belonged to the said customer and therefore there is nothing in the hands of the developer to transfer the same to the customer. In other words there was no sale of goods against consideration so as to attract VAT. This was nothing but rendering of development services for software.
The High Court has observed as under about the nature of transaction:
“39. From the aforesaid Clauses it is abundantly clear that the parties have entered into an agreement whereby the assessee renders service to the client for development of software, i.e., for software development and other services. Pursuant to the agreement and the work orders, the service shall be performed by the assessee. Services must be requested by issue of a valid work order together with a statement of work. As compensation for the service rendered to the customer, the fees specified in the relevant work order or in the statement of work is payable and billing is done on a time and material basis or on a fixed price or on a monthly basis. Pricing for time and material projects shall be fixed at a rate set forth in Annexure-A to the agreement.
40. The assessee agrees that all patentable and unpatentable, inventions, discoveries and ideas which are made or conceived as a direct or indirect result of the programming or other services performed under the agreement shall be considered as works made for hire and shall remain exclusive property of the client and the assessee shall have no ownership interest therein. Promptly, upon conception of such an invention, discovery, or idea, the assessee agrees to disclose the same to the client and the client shall have full power and authority to file and prosecute patent applications thereon and maintain patents thereon. At the request of the client the assessee agrees to execute the documents including but not limited to copyright assignment documents, take all rightful oaths and to perform such acts as may be deemed necessary or advisable to confirm on the client all right, title and interest in and to such inventions, discoveries or ideas, and all patent applications, patents, and copyrights thereon. Both the source code of developed software and hardware projects of worldwide intellectual property in and each shall be owned by the client. The assessee acknowledges that all deliverables shall be considered as works made for hire and the client will have all right, title including worldwide ownership of intellectual property rights in and each deliverable and all copies made from it. If acceptable to the client, the client may reuse all or any of the components developed by the assessee outside the scope of those contracts for the execution of the projects under this agreement.
41. Therefore, even before rendering service, the assessee has given up his rights to the software to be developed by the assessee. The considerations under the agreement is not for the cost of the project, the consideration is for the service rendered, based on time or man-hours. Once the project is developed, all rights in respect of the said project including the intellectual property rights vest with the customer and he is at liberty to deal with it in any manner he likes. The assessee has agreed to execute all such documents which are required for the exercise of such absolute rights over the software developed by the assessee.
42. The ‘deliverables’ has been defined under the agreement to mean all materials in whatever form generated, treated or resulting from the development, including but not related to the software modules or any part thereof, the source code and or object code, enhancement applications as well as any other materials media and documentation which shall be prepared, written and or developed by the developer for the client under this agreement and/or project order. If the customer agrees to provide any hardware, software and other deliverables that may be required to carry out the development and provide the deliverables he may do so. Otherwise the assessee has to make or provide all those hardware and software to develop the deliverable and the final product. No doubt at the end of the day, this software which is developed is embedded on the material object and only then the customer can make use of the same. The software so developed even before it is embedded on the material object or after it is embedded on a material object exclusively belongs to the customer. In the entire contract there is nothing to indicate that the assessee after developing the software has to embed the same on a material object and then deliver the same to the customer so as to have title to the project which is developed. The title to the project/software to be developed lies with the customer even before the assessee starts rendering service.”
The above observations of the High Court entirely cover the debatable issue. The parties can now very well decide whether the transaction of development of software will be covered by VAT or service tax based on ownership in the copyright and IPR. We hope that the controversy will rest here and the future transactions will be free from any dispute.
A market is never saturated with a good product, but it is very quickly saturated with a bad one.
— Henry Ford
