Order of the Madras HC on the legislative competency of the Parliament to levy Service Tax on Information Technology Software Services

Brief : Info tech Software Dealers Association (hereinafter referred to as “the ISODA” or the “Petitioner”) is a society registered under the Societies Registration Act having its headquarters at Mumbai. Members of ISODA are engaged in the business of reselling of computer software products falling under 3 categories – (i) Shrink Wrap Software; (ii) Multiple User Software/ Paper License and (iii) Internet Download.

The ISODA filed the subject petitions under Article 226 of The Constitution of India, praying for the issue of a Writ of Declaration to declare Section 65(1 05)(zzzze) of Chapter V of Finance Act, 1994 (as amended by Finance No. 2 Act of 2009) (hereinafter referred as “the Finance Act”) in relation to the business activities of the members of the Petitioner as:

• Null and void;

• Ultra vires and unconstitutional of the provisions of Article 245, Entries 92C and 97 of List-I, Entry 54 of List-II of Schedule VII of the Constitution of India; and

• Contrary to provisions of Articles 14, 19(1)(g), 265 and 268A of the Constitution of India.

The writ petitions raised the following three questions:

• Whether software is goods?

• Whether supply of software pursuant to the End User License Agreement is to be treated as sale or service?

• Whether the Parliament has the legislative competency to levy Service Tax on Information Technology Software Services?

Citation: Order of the Madras High Court dismissing the Writ Petitions filed by Info tech Software Dealers Association (W.P. Nos. 3811 and 18886 of 2009)

Court : Madras High Court

Contentions of the Petitioner:- The Petitioner put forth the following contentions:

· As the ultimate transaction in resale of software is only sale of goods, an element of service is absent and in such circumstances, the State Government alone is competent to enact a law under Entry 54 of List II of Schedule VII of the Constitution of India. Accordingly, the provisions of Section 65(105)(zzzze) of the Finance Act, particularly sub-clauses (v) and (vi) are unconstitutional in the facts of the case, as it is beyond the legislative competence of the Parliament.

• · As the measure and the value of tax have been done arbitrarily, particularly when the service element is absent, the levy of service tax on the value would be violative of Article 14 as well as Article 19(1)(g) of the Constitution of India.

Contentions of the Respondents:-The contentions of the respondents were as follows:-

· The amendment would fall under Entry 97 of List I of Schedule VII of the Constitution of India and the challenge to the legislative competency of the Parliament is totally unsustainable.

• · Standardized Software License licensed and available across the shelf or downloaded from internet is not a finished product; updates are given by the original manufacturer to the end user for an agreed period.
• · At no stage an end user who runs the software becomes absolute owner of the software; Right to use excludes certain rights, particularly right to modify, right to work and right to commercial exploitation.
• · Each transaction should be considered individually to find out whether it is a sale or service. The writ petitions are premature, as no action is taken in terms of the amended provision of the Finance Act.
• · The service element is clearly discernible in the customized software which is liable for service tax.

Observations of the High Court:- The following observations were made by the High Court of Madras

· Article 366(12) of the Constitution of India defines the expression “goods”, which includes all materials, commodities and articles. It is an inclusive definition.

• · Based on various judicial precedents of the Supreme Court and the High Courts:

– The law as to whether the software is goods or not is no longer res integra.

– 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, delivered, stored, possessed etc. A software is an intellectual property and it is an article of value.

– Indian law does not recognize or make a distinction between tangible property and intangible property. ‘Goods’ may be a tangible property or an intangible one.

• · In view of the settled law, it must be held that software is ‘goods’ as defined in Article 366(12) of the Constitution of India.
• · The copyright in the software transaction is protected and always remains the property of the creator and what is sold is the right to use the software. When the sale is with a condition for exclusive use of the software by the customer at the exclusion of others, it gives absolute possession and control to the user of the right to use the software.
• · When a taxing statute is considered with reference to the legislative competency, the nature of transaction and the dominant intention on such transaction would be relevant.
• · If the software is sold through the medium of internet as downloadable, it does not fit into the ambit of “IT software of any media”. In that event, it is possible to hold that when an access control is given through an internet medium with a username and password and when there is no CD or other storage media for the item, it does not satisfy the requirement of being ‘goods’.
• · In respect of a transaction which is considered to be a service, no specific entry is prescribed under List I enabling the Parliament to enact law. Entry 97 is a residual entry which empowers the Parliament to enact law in respect of any other matter not enumerated in List II or List III including any tax not mentioned in any of those lists.

Conclusions :-The writ petitions were dismissed with the following conclusion:

• · Software is ‘goods’ as defined in Article 366(12) of the Constitution of India.
• · The transaction may not amount to a sale in all cases and it may vary depending upon the End User License Agreement. The transaction between the members of ISODA with its customers is not of the sale of the software as such, but only the contents of data stored in the software which would amount to only service.
• · The Parliament has the legislative competency to bring in enactments to include certain services provided or to be provided in terms of Information Technology Software for use in the course or furtherance of business or commerce to mean a taxable service, in terms of the residuary Entry 97 of List I of Schedule VII. The challenge to the amended provision cannot be accepted so long as the residuary power is available. The question as to whether a transaction would amount to sale or service depends upon the individual transaction and on that ground, the vires of a provision cannot be questioned.