Now the day’s companies have started providing smartness and security to smart phones by providing/selling insurance and anti theft application on mobile through software (mobile app) operated by them and other allied services to the consumers through their distributors and retailers. Now the following questions arise:

Whether the companies are liable for service tax or VAT ?

The working pattern of the companies are, they firstly become a Prime Distributor of a mobile phones for some area like state wise or nation wide. They sold following features to the consumers:

FEATURES: Anti Virus, Anti Theft, Contact & SMS Backup, SOS, Device Scan, SMS Scheduler, Cross Platform Contacts restore, Data Privacy, Do Not Disturb, Call Barring. Parental Locking, Access Locking, Smart Surfing, App Privacy Advisor, Remote Device Control, Multimedia Backup, Mobile Tracker, Multimedia Restore, Scream Via Friend’s Phone, App Privacy Lock, Phone Doctor, Smart Sense through ”mobile app”.

The definition of Mobile App retrieved from wikipedia as follows:

mobile app is a computer program designed to run on smartphones, tablet computers and other mobile devices. Apps are usually available through application distribution platform, which began appearing in 2008 and are typically operated by the owner of the mobile operating system, such as the Apple App Store, Google Play, Windows Phone Store, and BlackBerry App World.

Now the questions arises for consideration that whether the software offered is a good termed under sale of goods act or a service.

The Section 2(h) of Sales of Goods Act, 1930 reads as under:

“2(h) ‘goods’ means all kinds of movable property other than actionable claims, stocks, shares and securities, and includes all materials, articles and commodities including the goods (as goods or in some other form), involved in the execution of a works contract or those goods used or to be used in the construction, fitting out, improvement or repair of movable or immovable property and also includes all growing crops, grass and things attached to or forming part of the land which are agreed to be severed before sale or under the contract of sale and also includes motor spirit.”

“Sale” is defined in Section 2(n) as follows:

“2(n) ‘Sale’ with all its grammatical variations and cognate expressions means every transfer of the property in goods whether as such goods or in any other form in pursuance of a contract or otherwise by one person to another in the course of trade or business, for cash, or for deferred payment, or for any other valuable consideration or in the supply or distribution of goods by a society (including a co-operative society), club, firm or association to its members, but does not include a mortgage, hypothecation or pledge of, or a charge on goods.

Explanation I : A delivery of goods on the hire-purchase or any system of payment by instalments shall, notwithstanding the fact that the seller retains the title in the goods, as security for payment of the price, be deemed to be a sale.

Explanation II : Notwithstanding anything contained in the Indian Sale of Goods Act, 1930 (a) (Central Act III of 1930) a sale or purchase of goods shall be deemed, for the purpose of this Act to have taken place in the State, wherever the contract of sale or purchase might have been made, if the goods are within the State.

(i)         in the case of specific or ascertained goods, at the time the contract of sale or purchase is made; and

(ii)        in the case of unascertained or future goods, at the time of their appropriation to the contract of sale or purchase by the seller or by the purchaser, whether the assent of the other party is prior or subsequent to such appropriation.

Where there is a (b) single contract of sale or purchase of goods situated at more places than one, the provisions of clause (a) shall apply as if there were separate contracts in respect of the goods at each of such places.

Explanation III: Notwithstanding anything contained in this Act or in the Indian Sale of Goods Act, 1930 (Central Act III of 1930), two independent sales or purchases shall for the purposes of this Act, be deemed to have taken place.

(1)        When the goods are transferred from a principal to his selling agent and from the selling agent to his purchaser, or

(2)        When the goods are transferred from the seller to a buying agent and from the buying agent to his principal, if the agent is found in either of the cases aforesaid, –

(i)         to have sold the goods at one rate and to have passed on the sale proceeds to his principal at another rate; or

(ii)        to have purchased the goods at one rate and to have passed them on to his principal at another rate; or

(iii)       not to have accounted to his principal for the entire collections or deductions made by him, in the sales or purchases effected by him on behalf of his principal; or

(iv)       to have acted for a fictitious or non-existent principal.

Explanation IV : A transfer of right to use any goods for any purpose (whether or not for a specified period) for cash, deferred payment or other valuable consideration shall be deemed to be a sale.”

Is the software ‘Goods’ ?

The question is very important and is relevant to decide its taxability.

Under Article 366(12) of the Constitution of India,

“Goods include all materials, commodities, and articles.”

In the landmark judgment of Bharat Sanchar Nigam Ltd. v. Union of India, (2006) 1453 STC 91 — the Hon. Supreme Court held that a goods may be a tangible property or an intangible one, it would become goods, if it satisfies the test. It observed in para 56 of that.

This view was adopted in Tata Consultancy Services v. State of Andhra Pradesh, for the purposes of levy of sales tax on computer software. It was held:

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 these properties be tangible or intangible. We are in complete agreement with the observations made by this Court in Associated Cement Companies Ltd., (2001) 124 STC 59. A software programme may consist of various commands which enable the computer to perform a designated task. The copyright in that programme may remain with the originator of the programme, but the moment copies are made and marketed; it becomes goods, which are susceptible to sales tax. Even intellectual property, once it is put on to media, whether it be in the form of books or canvas (in case of painting) or computer disks or cassettes, and marketed would become “goods”. We see no difference between a sale of a software programme on a CD/floppy disc from a sale of music on a cassette/ CD or a sale of a film on a video cassette/ CD. In all such cases, the intellectual property has been incorporated on a media, for purpose of transfer. Sale is not just of the media which by itself has very little value. The software and the media cannot be split up. What the buyer purchases and pays for is not the disc or the CD. As in the case of paintings 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 of sale of computer software is clearly a sale of ‘goods’ within the meaning of the term as defined in the said Act. The term, “all materials, articles and commodities” includes both tangible and intangible/incorporeal property which is capable of abstraction, consumption and use and which can be transmitted, transferred, delivered, stored, possessed, etc. The software programmes have all these attributes.

The Supreme Court dismissed the appeal and held that canned software is “goods”.

A ‘goods’ may be a tangible property or an intangible one. It would become goods provided it has the attributes thereof having regard to (a) its utility; (b) capable of being bought and sold; and (c) capable of transmitted, transferred, delivered, stored and possessed. If a software whether customized or non-customized satisfies these attributes, the same would be goods.

‘Canned software’ means that is not specifically created for a particular consumer. The sale or lease of, or granting a license to use, canned software is not automatic data processing and computer services, but is the sale of tangible personal property. When a vendor, in a single transaction, sells canned software that has been modified or customized for that particular consumer, the transaction will be considered the sale of tangible personal property if the charge for the modification constitutes no more than half of the price of the sale.”

[See STATE-CASE APP-CT,OH-TAXRPTR 402-978 Ohio Board of Tax Appeals, Aeroquip Cop. Page 9 of 12]

This judgment more or less has defined the test to decide what are goods and the event when it becomes goods i.e., the moment copies are made and marketed, it becomes goods, which are susceptible to sales tax. Even intellectual property, once it is put on to media, whether it be in the form of books or canvas (in case of painting) or computer disks or cassettes, and marketed would become “goods”.

The Circular/Letter D. O. F. No. 334/1/2008-TRU, dated 29-2-2008 issued by Central Board of Excise & Customs discusses salient features of the changes made by the Finance Act, 2008.

It states in Para 4.4.1., that:

Transfer of the right to use any goods is leviable to Sales Tax/VAT as deemed sale of goods [Article 366(29A)(d) of the Constitution of India]. Transfer of right to use involves transfer of both possession and control of the goods to the user of the goods.

It also states in Para 4.4.2, that:

Excavators, wheel, loaders, dump-trucks, crawler carriers, compaction equipment, cranes, etc. offshore construction vessels & barges, geotechnical vessels, tug and barge, flotillas, rigs and high-value machineries are supplied for use, with no legal right of possession and effective control. Transaction of allowing another person to use the goods, without giving legal right of possession and effective control, not being treated as sale of goods, is treated as service.

It further states in Para 4.4.3, that:

Proposal is to levy Service Tax on such services provided in relation to supply of tangible goods, including machinery, equipment and appliances, for use, with no legal right of possession or effective control. 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.

Although the clarification is under the head Supply of Tangible Goods for Use, it is equally applicable in the present scenario.

What is value chargeable to Service Tax, if applicable?

Section 67 of the Finance Act, 1994 contains provisions for valuation of service for charging Service Tax and Rule 3 of the Valuation Rules provides Manner of determination of value of taxable service.

There are instances when some services are provided free of cost. The courts of law have held that no service Tax can be charged for free services.

(i) Bharati Cellular Ltd. v. CCE, (2205) 1 STT 73 (CESTAT)

(ii) Kamal & Co. v. CCE, (2007) 10 STT 481 (CESTAT SMB)

In, Indus Motor Company v. CCE, (2008) 12 STT 112 is a case very similar to the present one. Free service provided to automobiles by authorised service station (presumably at the time of sale) for which no payment is received from anyone and when its price is included in sale price of vehicle, it cannot be subjected to Service Tax.

In Chandravadan Desai v. CCE, (2007) 11 STT 326 (CESTAT), the assessee who was a stockbroker did not charge brokerage in respect of certain transactions, it was held that S. 67 does not have any deeming provision and hence Service Tax is not leviable.

Very important observations are made by the Supreme Court in the case of Bharat Sanchar Nigam Ltd. v. Union of India, (2006) 3 SCC 1.

The Court observed that the definition of the word Sale in Article 366(12) was not altered and hence the same has to be understood as under the Sale of Goods Act, 1930.

Further, important test laid down by the Court in deciding a composite contract not covered by Article 366(29A), that the ‘dominant nature test’ continues to be applied.

The Court observed that after 46th Amendment to the Constitution, only 3 specific situations were chosen from several composite transactions which involve service as well as sale and out of those 3, only works contract and catering contract involve both the elements of service and sale. Therefore except these, no other sale was contemplated to be covered or bifurcated.

The test therefore for composite contracts other than those mentioned in Article 366(29A) continues to be — did the parties have in mind or intend separate rights arising out of the sale of goods. If there was no such intention, there is no sale even if the contract could be disintegrated. 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.”

In view of the above test, it can well be concluded that unless the transaction in reality contemplated two distinct contracts, a composite contract cannot be bifurcated for levy of Service Tax. One has to go by the substance of the agreement in the transaction.

The Hon’ble Supreme Court in Imagic Creative Pvt. Ltd. v. Commissioner of Commercial Taxes, (2008) 12 STT 392 (SC) that:

The Court must also bear in mind that where the application of a Parliamentary and a legislative Act comes up for consideration, endeavours shall be made to see that provisions of both the Acts are made applicable (Para 27).

Payments of Service Tax as also VAT are mutually exclusive. Therefore, they should be held to be applicable having regard to the respective parameters of Service Tax and sales tax as envisaged in a composite contract as contradistinguished from an indivisible contract. It may consist of different elements providing for attracting different nature of levy. It was, therefore difficult to hold that in a case of instant nature, sales tax would be payable on the value of the entire contract, irrespective of the element of service provided — the approach of the assessing authority, thus, appeared to be correct. (Para 28)


Considering all the relevant facts, and the law as discussed hereinabove, and relying and based on the same as mentioned above, it is concluded that:

In case of the manufacturer/developer, he sells the right to use of the software. However in case of the software dealer the position is slightly different. The software is not developed by him, but he has got the rights to sale/market/deployment of the licence/right to use. Except this, there is no difference between the two. It is permitted to make only minor modifications to the extent of incorporating the name, etc. as per the specific requirements/parameters of the purchaser, without changing any basic structure of the software. The vendor is also in some cases, making requirement/GAP analysis study, data migration from all earlier software, and arranging pre- and post-installation system audit, which are either free of cost or included in the software price itself, except in case of system audit. This is normally required to be carried out by an independent third party and is paid separately by the buyer to the third party.

It is evident that the sale involves both a Sale and a Service. The grant of licence is a right to use the software, with a legal right of possession and effective control, allowing another person (purchaser) to use the goods (software).

This is done by copying the original software and then given possession and control to the buyer. The moment this is copied for Sale, it becomes goods, as defined by the Supreme Court of India.

Hence, this is a Sale of Goods under Article 366(12) of the Constitution of India, The position for the developer of the software and the dealer is the same. This portion being in List-II, i.e., State List of Schedule VII to the Constitution of India, cannot be subjected to Service Tax. It could, if any consideration for the service is received separately in any manner.

Normally the pre-installation, installation, modifications and successful commencement of use of software, etc. are provided free of cost.

As held by the Supreme Court, the dominant intention of parties is to buy and sell. Hence, the sale price cannot be disintegrated for the purpose of Service Tax and as per the Terms & Conditions of company it can be concluded that they are offering a software which is operated by them. Hence, in my opinion these are not chargeable to Service Tax. Hence, under the State Vat, the position is now amply clear. But, there has to be suitable amendment in the Valuation Rules and a basic clarification in the definition and the scope of the service, to tax services part only under the Service Tax and not the goods part.

Scope of Limitation: The views expressed are strictly personal in nature and author is not responsible or liable for any loss or damage caused to anyone due to any interpretation of law.

(Rishi Chanan, Advocate – Mob:-098158-28244)

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