NOVEMBER 22, 2014

By Lukose Joseph, CA & Anil P Nair, CA

THE principle of Value Added Tax (VAT) is that cascading taxes should be eliminated. A lot has been written about multiple taxation of Software Industry. The golden goose, unless the Government acts, may end up on the plates!

Recently a writ appeal (WA No 1125 of 2013 of High Court of Kerala) against Kerala High Court single bench decision in Kerala Classified Hotels and Restaurants Association - 2013-TIOL-533-HC-KERALA-ST was dismissed by Division bench and it was confirmed that service tax cannot be charged on food at Hotels as the same is purely a sale of goods.

Can the analogy be made applicable to the Software Industry?

Excise Duty

Central Excise Duty has to be charged on manufacture of information technology software. (Entry 8523 80 20 TARIFF - 12%)

Chapter Note of Chapter 85 of Central Excise Tariff says:

"For the purpose of heading 8523, ‘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 an automatic data processing machine."

Thus Central Excise Duty will have to be paid on transfer of Software.

Goods that are subject to VAT

In 2005, however, the Supreme Court had held that the transfer of branded software constitutes a sale and is subject to sales tax levied by state governments under Entry 54, Schedule VII of the Constitution of India (Tata Consultancy Services v State of AP - 2004-TIOL-87-SC-CT-LB)

"The test to determine whether a property is goods for the purpose of sales tax is not whether the property is tangible or incorporeal. The test is whether the concerned item is capable of abstraction, consumption, and use, and whether it can be transmitted, transferred, delivered, possessed etc. If the software, whether customized or banded, satisfies all these attributes, it would be goods".

The same was the view in Infosys Technology Ltd v CCT - 2008-TIOL-509-HC-MAD-CT where Madras High Court held that both customized and non-customized software are goods subject to sales tax.

Also a Service!

Section 66E Clause (d) of the Finance Act, 1994 specifies software service as a declared service. It reads:

"Development, design, programming, customization, adaptation, up-gradation, enhancement, implementation of information technology software"

The term Information technology software is defined in Section 65B (28) as follows:

"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;"

Read the above with CBEC education guideline Para 6.4.4 and we are clear that Service tax is applicable on software.

The consolation is that Excise Duty and Service tax being under Central Government, only either will be applied. However VAT, at least till we welcome Goods and Services Tax (GST) is a subject matter for States as per the Constitution and hence the tug of war.

If Software is service, then how is VAT applicable on the same?

In the case of Infotech Software Dealers Association v. Union of India - 2010-TIOL-620-HC-MAD-ST, it was held that the software is ‘goods’ and whether the transaction would amount to a sale or a service would depend upon the individual transaction and for the reason of that challenge, the amended provision cannot be held to be unconstitutional so long as the Parliament has the legislative competency to enact law in respect of tax on service in exercise of its powers under Entry 97 of List of I of Schedule VII.

The terms and conditions of End User License Agreement (EULA) are material as far as finding an element of sale in a transaction of software sales. Though it was observed that when software is sold through medium of internet in downloadable format with password and not CD, the requirement of being goods is not satisfied, the law is not static and technological advancement can be considered in interpretations and hence they are necessarily ‘sale of goods’.

Hence by virtue of the above decision, VAT is also applicable.

The current trade/industry practice is to pay both Service Tax and VAT to avoid litigation with the departments on an issue on which a final decision is awaited.

In the case of Imagic Creative (P) Ltd v CCT & Ors - 2008-TIOL-04-SC-VAT, the Supreme Court held that a transaction (here, service for evolution of prototype conceptual design) can either amount to a ‘sale of goods’ or ‘service’ for the purpose of taxation. Thus, charging both 100% is against the judicial principles of mutual exclusiveness.

In the case of Works Contract, both Service Tax and VAT are applicable, but Service Tax law allows deduction for value of goods and VAT law allows deduction for service. Clause (c) of explanation to Valuation Rule 2A provides that where VAT has been paid on the actual value of transfer of property in goods involved under the state law, the said value adopted for the purpose of payment of value added tax shall be taken as value of transfer of property in goods.

Why the software industry is not considered similarly? What is the logic in concluding that software is 100% goods and 100% service? The judicial principles of mutual exclusiveness as pronounced in the case of Imagic Creative (P) Ltd should be followed.

Adding salt to wound, under section 194 J of the Income Tax Act, tax deducted at source (TDS) is @ 10% being a notified profession.

Software industry is burdened with taxes. Isn’t it time the Government considered more scientific methods to collect taxes from this goose now laying golden eggs? Should we kill it?