MARCH 2, 2010

Taxation of IT software: Confusion persists!

By V. Lakshmikumaran, Managing Partner, Lakshmikumaran & Sridharan, Advocates

WORLD over, there seems to be a certainty on tax liability on Information Technology (IT) software. However, in India, IT software is subjected to Central excise duty/ Counter Veiling duty (CVD) and service tax by the Centre and VAT (sales tax) by the States. The industry is suffering due to such multiple taxation. In this article, I would like to highlight the utter confusion prevailing in the software industry regarding the applicability of CVD/ excise duty and/or service tax and examine whether the recent Budget clarifies or adds to the confusion.

2. Typically, software supplied in media comprises of two cost components: (a) the value of media and the cost of recording of software on media; and (b) the value of license to use software representing the consideration towards Intellectual Property (IP). The controversies are primarily relating to the taxation of license value, wherein virtually all the money is involved.

3. Even though Basic Customs Duty (BCD) is not payable on IT Software imports, Central Excise duty was charged on IT software manufactured in India from March, 2006 and consequently, CVD became payable. Service tax was also introduced on providing license to use IT software from May, 2008 onwards.

4. Based on various circulars issued by the Government, the legislative intent seems to be to tax the value addition in the form of software license only once , either by way of excise duty (CVD) or service tax. However, the million dollar question remains which one will apply and who will decide.

5. Huge demands have been raised on the license value either under customs or under service tax. Companies, which had paid CVD, are being asked to pay service tax and vice versa. In some cases, demands have been simultaneously raised under both customs and service tax. This has resulted in a lot of business uncertainty. The extra duty/ tax demand of 10% along with interest and penalty will more or less wipe out the entire profits earned by software companies in the past years.

6. Simple request of the industry to the Government has been to make it clear that if excise duty/ CVD is paid on the license value, then no service tax is payable and vice versa.

7. In the last year's budget, excise and customs notifications were issued to the effect that excise duty/ CVD shall be exempt if service tax is paid on the license value. However, the said exemptions were strangely restricted to transfers for commercial exploitation of software. This anomaly has been removed this year by removing the condition of commercial exploitation.

8. The industry, though happy with the above exemptions, was eagerly looking for one more clarification to the effect that no service tax would be payable if excise/ CVD is paid on license value. This was necessary because many companies, who had already paid CVD in the face of investigations by the customs department, were also being pressurized by the service tax department to pay service tax on the same value.

9. Further, such a clarification was required for one more reason. As we know, software licensing involves some of the most complex business models, like shrink-wrapped license, multi-user volume licenses, subsequent top-up licenses, periodic updates, etc. Depending on the business model, the companies need freedom to choose between excise/CVD and service tax for each type of licensing.

10. Thus, it is best to leave it to the industry to decide whether to pay CVD/ Excise duty or service tax on the value of license to use software. It is important to give this choice to the industry and not to the tax collectors.

11. A step in this direction seems to have been taken in this year's Budget by way of issuing a couple of notifications (Nos. 2/2010-ST and 17/2010-ST) to the effect that no service tax is payable on license value if excise duty/ CVD is paid on the same by manufacturer or duplicator or holder of IP or importer, as the case may be. However, the following issues need to be highlighted on the new set of notifications:

(i) The exemption is restricted to shrink wrapped-single user software license. There is no exemption for multi-user licenses, where bulk of the dispute is involved.

(ii) The scope of these notifications, in terms of transactions to which they apply, is also not clear. Is it applicable to service tax payable on reverse charge basis by a manufacturer or distributor in India on license fee remitted to foreign software company? or Is it exempting the only the local transaction of sale of software to customers in India?

(iii) Notification No. 17/2010-ST contains a strange condition (ii) that the importer must have paid CVD on the entire amount received from the buyer . How can an importer be asked to pay CVD on the license value of software realized from sale to customer in India subsequent to importation? This condition seems to have inadvertently traveled into this notification from the other notification (No. 2/2010-ST) relating to excise due to an obvious copy-paste error.

12. In view of the above, we are far away from reaching any level of comfort on this issue. The basic problem seems to be lack of understanding in the revenue department about the complex software industry. A sincere effort on the part of the department, with the help of representations from the industry, can resolve this issue in no time, once and for all.

13. Tax laws should be simple, straight forward and unambiguous for all the stakeholders to understand and ensure compliance. It should not be in the nature of puzzles or brainteasers resulting in business uncertainty and litigation. Such complex tax laws do not help either the business or the revenue authorities. The only people who get benefited are the lawyers, like the one writing this article. Hope the issue gets resolved at the earliest and the IT software industry gets the much desired and well deserved peace of mind.