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Softwares due to  its very inherent nature of intangibility & deliverability have always been a matter of grey area for tax professionals and trade. This article intends to discuss the complexities surrounding the Software Industry in regard to Service tax & VAT in a simplified yet exhaustive approach. Before we dive into deeper oceans of laws, it will be worthwhile to overview the scheme arrangement of this paper. The same is as under:-

 ST on software

Let’s Start.

A. What is a Software

As per book on Software Engineering “by Roger S. Pressman, a software is an instruction that when executed provides desired function and performances. It is stated that Software is composed of programs, data and documents. Each of these items comprises a configuration that is created as part of the software engineering process.

As per “The Law Relating to Computers and the Internet” by Mr. Rahul Matthan, a software program is essentially a series of commands issued to the hardware of the computer that enables the computer to perform in a particular manner.

B. Type of Softwares and Technology Transactions – An Ever-growing and Ever-complexifying domain

i. Software Industry has grown with epitome success. Just to reflect on this it is worthwhile to note that NASSCOM estimates revenue of $ 118 Billion for IT-BPM in FY 2014. The industry is no more just about few off the shelf products but has evolved in all forms whether it is deliverability, technicality and ready availability. Broadly there can be several transactions such as :-

• Sale of Canned/Pre-packaged Softwares

• Sale of Software by E-Delivery / Direct Download

• Sale of License to Use Software / EULA (End User License Agreement)

• Onsite / Off Site Customised Softwares & Implementation (Also called as “Bespoke Software Development”)

• Twitching / Patching of existing customer owned softwares

• Supplying Technical Staff to BPO/KPO’s viz, Java, C++ professionals, coders etc

• Training and Support Services

• Updates & Patches – PKC’s (Product Key Cards) &  WAU’s (Windows Anytime Upgrades)

• Testing

• AMC Contracts

• Cloud Sharing

• Online Database Access

• Value Added Services – Mobiles, Android Apps and others.

It may not be possible for us to discuss service tax and vat in all of the above cases but we can discuss the fundamentals to allow us to analyse of different transactions.

C. What is canned Software and Uncanned Software?    

Firstly, for the sake of simplicity, we shall define uncanned software as softwares which are not canned (Simple!!). Now, canned software means (for purpose of our discussion) a software product or solution, usually purchased from a software company, which cannot be modified or altered beyond the original functionality. Canned softwares are generally sold off the shelf and are carried within a media (viz CD/ Blu-ray etc).

The canned Software Packages are of the ownership of companies/persons, who have developed that software. The customers are licensees with permission to use or sub-licence these packages to others. The canned software programmes are programmes like Oracle, Lotus, Master Key, N-Export, Unigraphics, etc.

D. Canned Softwares are goods and Liable to Sales Tax Only (Judgement by Hon’ble SC in TCS r.w. Oracle , Gramophone, LML and others)

i. In Gramophone Co. of India Ltd. v. Collector of Customs, Calcutta, 114 ELT 770 (SC) the question which arose for determination was whether recording of audio cassettes on duplicating music system amounts to ‘manufacture’. The answer was in the affirmative. It was held that a blank audio cassette is distinct and different from a pre-recorded audio cassette and the two have different use and name. Hence the same were held as goods.

ii.  In Tata Consultancy Services v. State of Andhra Pradesh, 137 STC 620 (SC) it was held that a software programme may consist of commands which enable the computer to perform a designated task. The copyright in the programme may remain with the originator of the programme. But, the moment copies are made and marketed, they become goods. One of the major lights thrown by Hon’ble Supreme Court in the present case was that the ambit of ‘goods’ under Article 366(12) of Constitution of India includes even incorporeal and/or intangible properties. The same principle was also upheld at several instances viz, MPEB[1], H.Anraj[2], NTPC[3, MP Cement[4] etc.

In this Landmark Judgement of TCS, Hon’ble SC held that:-

“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 purposes 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 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”

iii. Hence the view is clear in terms of Canned Softwares (Packaged Softwares) that the same shall be liable to Sales tax only and that no service tax shall be liable pursuant to Section 65B(44) definition of ‘Service’ as well. The same view has been accepted even by the Service tax Department in its education guide dated 20th June, 2012 wherein it has clarified by the department that:-

“6.4.1 Would sale of pre-packaged or canned software be included in this entry?

No. It is a settled position of law that pre-packaged or canned software which is put on a media is in the nature of goods [Supreme Court judgment in case of Tata Consultancy Services v. State of Andhra Pradesh [2004 (11) TMI 11 (SC)]. Sale of pre-packaged or canned software is, therefore, in the nature of sale of goods and is not covered in this entry.”

iv. Generally VAT on such softwares is levied at 5% in majority of states. For example, in Delhi the VAT it is 5% and in Haryana also it is 5% (plus surcharge u/s 7A additional).

E. Software Licensing and associated concepts of Transfer of Right to Use, Service tax and VAT Controversy and never ending jargon – An Analysis

i. Software Licensing and service tax / vat implications thereon still remains to be one of the most interesting subject matter for tax professionals across the country. The conflictions between judiciary, revenue and practicalities make this concept a major attention seeker amongst other issues interalia.

ii. Before we proceed there is a requirement to touch on the practicality, that a lot many software companies levy full VAT and Service tax simultaneously on sale of software license / EULA (End User License Agreement). The same may be against judicial principles of mutual exclusiveness of VAT & Service tax as laid down by Apex court in Imagic Creative Pvt. Ltd. Versus Commissioner of Commercial Taxes & Ors 2008 (9) S.T.R. 337 (S.C) but clearly suggests the ambiguity haunting the transaction. We will go deeper in the matter now.

iii. As per the definition of ‘service’ as contained in clause (44) of section 65(B) only those transactions are outside the ambit of service which constitute only a transfer of title in goods or such transfers which are deemed to be a sale within the meaning of Clause 29(A) of article 366 of the Constitution. The relevant category of deemed sale is ‘transfer of right to use goods’ contained in sub-clause (d) of clause (29A) of the Constitution.

iv. Transfer of right to use goods’ is deemed to be a sale under Article 366(29A) of the Constitution of India and transfer of goods by way of hiring, leasing, licensing or any such manner without transfer of right to use such goods is a declared service under clause (f) of section 66E.

Transfer of Right to Use – A Sub Analysis

v. The question as to what would constitute transfer of right to use goods has been sought to be answered by the Courts at various points of time.

a. One of the issues highlighted by the Hon’ble Supreme Court has been that of effective control and this should be transferred to the transferee in order to have a scenario of transfer of right to use goods. This view was followed in Rashtriya Ispat Nigam Ltd Vs State of Andhra Pradesh & Another (2002 (3) TMI 705 Supreme Court) where effective control of machinery given to contractor for use by him was held to rest with the transferor and not with the contractor consequently not resulting in transfer of right to use machinery.

b. The issue of taxability of transfer of right to use goods was also reviewed by the Supreme Court in Bharat Sanchar Nigam Ltd Vs UOI (2006 (3) TMI 1 – Supreme Court of India) in the context of telecommunication services where it held thus –

“To constitute a transaction for the transfer of the right to use the goods the transaction must have the following attributes –

• There must be goods available for delivery

• There must be a consensus ad idem as to the identity of the goods

• The transferee should have a legal right to use the goods-consequently all legal consequences of such use including any permissions or licenses required therefor should be available to the transferee

• For the period during which the transferee has such legal right, it has to be the exclusion to the transferor this is the necessary concomitant of the plain language of the statute – viz. a “transfer of the right to use” and not merely a licence to use the goods

Having transferred the right to use the goods during the period for which it is to be transferred, the owner cannot again transfer the same rights to others.”

c. This view was later on followed in G.S Lamba & Sons Vs State of Andhra Pradesh (2011 (1) TMI 1196 – Andhra Pradesh High Court), where the High Court relying on various judicial precedents with regard to the concept of transfer of right to use goods, held thus when it came to holding hiring of transit mixers for transport of RMC as an arrangement for transfer of right to use goods –

“The settled essential requirements of a transaction for transfer of the right to use goods are–

• It is not the transfer of the property in goods, but it is the right to use property in goods;

• Article 366(29A)(d) read with the latter part of clause (29A) which uses the words, “and such transfer, delivery or supply. . .” would show that the tax is not on the delivery of the goods used, but on the transfer of the right to use goods regardless of when or whether the goods are delivered for use subject to the condition that the goods should be in existence for use;

• In the transaction for the transfer of the right to use goods, delivery of goods is not a condition precedent, but the delivery of goods may be one of the elements of the transaction;

• The effective or general control does not mean always physical control and, even if the manner, method, modalities and the time of the use of goods is decided by the lessee or the customer, it would be under the effective or general control over the goods; and

• The approvals, concessions, licences and permits in relation to goods would also be available to the user of goods, even if such licences or permits are in the name of owner (transferor) of the goods; and

During the period of contract exclusive right to use goods along with permits, licences, etc., vests in the lessee.”

d. In State Bank of India and Others Versus State of Andhra Pradesh [1988] 70 STC 215 (AP) it was held that the transaction does not involve the right to use goods as possession of the lockers is not transferred to the hirer even though the contents of the locker would be in the possession of the hirer.

e. In Ahuja Goods Agency vs State of UP motor vehicles [(1997) 106 STC 540] it was held that no transfer of right to use goods takes place in hiring out of vehicles where it is the responsibility of the owner to abide by all the laws relating to motor vehicles as as effective control and possession is not transferred.

f. Two of the requirements for transfer of right to use goods as confirmed by the Courts have been that of exclusivity of transfer in such a way that the same goods cannot be transferred to others as well as the point of effective control over the goods. While this would work in case of tangible property, we would have issues in applying the same principles to intangible property like for instance trademarks or software.

g. When the issue was referred to the High Court, it held the transfer of right to use intangible property as not being liable to VAT where the transfer is not on exclusive basis.  In Malabar Gold Private Limited Vs CTO Kozhikode & Others 2013 (32) S.T.R. 3 (Ker) , the two Member Bench overruled the earlier verdict of the Single Member Bench to hold the view that allowing a franchisee to use trademark for retailing of gold on non-exclusive basis where the franchisor could have additional franchisees, did not amount to transfer of right to use goods.

h. A similar view was also held by the Madras High Court in Infotech Software Dealers’ Association Vs UOI & Others [2010] 34 VST 133 (Mad) where the Court held that an EULA (End User License Agreement) for allowing another to use software which is copyrighted would not necessarily result in transfer of right to use goods as the software itself is not transferred and what is allowed is the right to use the data stored in the software.

“On a careful reading of the above, we are of the considered view that when a transaction takes place between the members of ISODA with its customers, it is not the sale of the software as such, but only the contents of the data stored in the software which would amount to only service. To bring the deemed sale under Article 366(29A)(d) of the Constitution of India, there must be a transfer of right to use any goods and when the goods as such is not transferred, the question of deeming sale of goods does not arise and in that sense, the transaction would be only a service and not a sale. {Para 31}”

vi. Further, the service tax department clarifies that the natured transaction is not goods (where there is no transfer of right to use) and hence liable to pure service tax only. In its education guide released 20th June, 2012 at the juncture of introduction of Negative list it has been clarified that :-

a. A license to use software which does not involve the transfer of ‘right to use’ (To identify this would not be a simple task and it is this which is reason for most ambiguities in this transaction!!) would neither be a transfer of title in goods nor a deemed sale of goods. Such an activity would fall in the ambit of definition of ‘service’ and also in the declared service category specified in clause (f) of section 66E.

b. Therefore, if a pre-packaged or canned software is not sold but is transferred under a license to use such software, the terms and conditions of the license to use such software would have to be seen to come to the conclusion as to whether the license to use packaged software involves transfer of ‘right to use’ such software in the sense the phrase has been used in sub-clause (d) of article 366(29A) of the Constitution.

c. Whether the license to use software is in the paper form or in electronic form makes no material difference to the transaction.

d. However, the manner in which software is transferred makes material difference to the nature of transaction. If the software is put on the media like computer disks or even embedded on a computer before the sale the same would be treated as goods. If software or any programme contained is delivered online or is down loaded on the internet the same would not be treated as goods as software as the judgment of the Supreme Court in Tata Consultancy Service case is applicable only in case the pre-packaged software is put on a media before sale.

e. Delivery of content online would also not amount to a transaction in goods as the content has not been put on a media before sale. Delivery of content online for consideration would, therefore, amount to provision of service.

vii. Further, the above views are affirmed by AAR (Service Tax) in its Ruling No. AAR/ ST/ 04/2013 in case of M/s Microsoft Corporation (India) Private Ltd dated 2nd September , 2013.

viii. In authors view, due to the prevailing non clarity in terms of which contract would result in transfer of right to use goods or not in the context of software licensing is fundamental reason of confusion for the trade and thus a lot of players are forced to levy VAT & Service tax simultaneously on account of being prudent. Trade, readers and all stakeholders are required to conduct a thorough due diligence of the nature of software/software transaction to understand the Indirect tax implication. To understand the transaction one needs to be thoroughly equipped with various tax criterions. {Discussed in Detail in Clause ‘F’ below)

F. Various Tax Criterions in Software Industry

To Understand the software transactions taxability in terms of Service tax and VAT one needs to thoroughly equipped with the various tax criterions as detailed hereunder:-

i. Dominant Motive – The intention of entering into a transaction is important and critical while arriving at the tax implication. Recent SIM Card decision on Idea Cellular by SC observes that SIM card is part of the service and consequently no VAT should be chargeable.

ii. Aspect Theory – The Apex court in the case of Imagic Creative (supra) has observed that where VAT is applicable service tax should not be levied. That they are mutually exclusive.

iii. Vivisectable Contracts – Lump sum contracts where bifurcation between different activities does not exist may not be artificially vivisectable. Courts have ruled that as far as works contracts or supply of food contracts are considered it is possible to do so as Article 366(29A) specifically provides for the same. For the transactions which are not covered under deemed sale concept, vivisection is not a available options.

iv. Transfer of License – It is issue where there is a lack of judicial clarity. Till the same is provided by our courts, the clients are to be advised with suitable course of action and ensuring readily available scheme of planning and documentation.

v. Situs/Point of sale – Under VAT one needs to follow the goods. However in case of intangible goods how can one do that? The location of the server, place of contract licensee, dealer of software etc may also lead to some amount of uncertainty.

vi. Mode of delivery – When programs are on media and sold- shrink wrapped etc then there is no doubt that it is goods. However when the same is downloaded how we know from where it has started, where it is delivered. The importance of this criterion is even hinted by the service tax department in its education guide.

G. Other Contracts –  A Brief VAT & Service Tax Overview (11 Pointers)

1. Onsite Development of Software – Liable to Service Tax

2. Advice, consultancy and assistance on matters relating to information technology software – Liable to Service tax

3. Where client specific software is developed for the client in such a way that the intellectual property developed belongs to the client/customer (just like a job-work) from the very beginning without the creator retaining any ownership rights over the same, the arrangement would be one of service and not sale of goods. The same has been confirmed under Sasken Communication Technologies Ltd Vs Joint Commissioner of Commercial Taxes,Bangalore (2011 (4) TMI 566 – Karnataka High Court)

4. AMC Contract – Discussed separately under clause ‘H’.

5. Sale of License – Liable to Service tax if no transfer of right to use while liable for sales tax if transfer for right to use under deemed sale concept. Largely would depend on case to case basis.

6. Customised (Bespoke) Software Developed and Implemented:-  Liable to both Sales tax and Service tax.  In this context, one important ruling can be discussed here. The ruling is by foreign court i.e. in case of Levob Verzekeringen BV and OV Bank NV v. Secretary of State for Finance, Netherlands [2012] 22 174 (ECJ)  wherein it was held that

Supply of basic software along with subsequent customisation thereof to meet requirements of customer and training to his employees under a single contract is a single indivisible supply of service and whole of the receipts are liable to service tax on Dominant nature test.

7. Manpower Supply :- Liable to Service tax

8. Updates and Upgrades: – To be treated status quo with implications in case of software.

9. Cloud Sharing :- Liable to Service tax

10. Online database Sharing :- Liable to Service tax

11. Value added services: – Liable to Service tax like subscription for pro-chat, premium services etc. If charges for transfer the same shall be liable to VAT.

H. AMC Contracts – VAT & Service Tax (Whether Rule 2A of Service Tax Determination of Value Rules,2006 can be applied)

i. As per the present practice among the software companies they charge both service tax and VAT on composite value of the AMC (for reasons and ambiguities discussed above) by treating the AMC contract as a works contract where both elements of service and sale of goods are involved. Under Section 4 of Delhi VAT the item rate on material transferred pursuant to Works contract is rigid 12.5%. Hence in such a case VAT shall be levied on (100 – 20% – Deemed Service portion under Rule 3, DVAT) * 12.5% i.e. 10% effective rate.

(Note:- Delhi VAT Department in its determination order No: 258/ CDVAT/ 2010/ 22 pursuant to Section 84 has clarified that VAT is applicable on basic price of Softwares/Software license excluding Service Tax.)

ii. Since it is made liable to service tax and paid as works contract in VAT, companies are discharging their service tax liabilities also under works contract service valued and taxed as per notification no 24/2012 ST providing New Rule 2A where service tax is calculated on 70 % of the contract value, resulting in effective rate of 8.65% of the value.

iii. The above practice of charging service tax might be unacceptable to service tax department for the reason being that the Service Tax authorities have considered the Software licenses through electronic mode as purely a service (discussed in detail in earlier paras). The same analogy is to be applied for license to use upgrades / updation covered under description of declared services under Section 66 E(f) of the Finance Act. Thus it can be concluded from the service tax purview that any license to use a software and license to use upgrade of such software are to be classified as a service. The annual maintenance Contracts should be considered as pure service contracts where no supply of goods is involved.

iv. It is worthwhile to note that how a dealer discharges his liability under VAT shall have no impact on liability on account of service tax.

I. Place of Provision – Why a Very Important Concept for Software Industry

Since majorly the software industry is engaged in exports and the charge of service tax as governed by Section 66B is purely dependent on where the services are rendered hence the concept of place of providing the services gains force in understanding the service tax implications. We will discuss in detail under the export of services so as to how this concept of POPS is that very essential.

J. Export of Software & Software Services/Licenses – A Service Tax Perspective

i. Section 66B of The Act reads:

“There shall be levied a tax (hereinafter referred to as the service tax) at the rate of twelve per cent on the value of all services, other than those services specified in the negative list, provided or agreed to be provided in the taxable territory by one person to another and collected in such manner as may be prescribed”

ii. Rule 3 of ‘Place of Provision of Services Rules, 2012’ reads:

“The place of provision of a service shall be the location of the recipient of service:

Provided that in case the location of the service receiver is not available in the ordinary course of business, the place of provision shall be the location of the provider of service.”

iii. Reading Section 65B and Rule 3 together, it becomes evident that Service Tax is not leviable on export of software because the recipient of service is located in non-taxable territory.

iv. Hence, export of Software is not exempted from Service Tax because it does not appear in the List of Negative Services. Service Tax shall be levied or not is decided on case to case basis depending upon the location of service recipients. If the service recipient is located outside India, Service Tax is not leviable.

v. Caution: – There can be exceptions to the above simplified analysis and the readers are required to consider every case on merit basis. I will discuss two exceptions as an example :-

a. Online Database Access Service :- Say, Company X Ltd in India allows a US Customer to access its data and charges Rs 1,00,000/- as one time consideration. Now in this case as per rule 9(b) the place of provision of service (under Online Database access service) shall be place of location of service provider and hence in such cases it shall not be deemed as rendered outside taxable territory and shall be liable to Service tax unless exempted explicitly.

b. Performance Based Service:- Under Rule 4 of POPS, where the services provided in respect of goods that are required to be made physically available by the recipient of service to the provider of service, or to a person acting on behalf of the provider of service, in order to provide the service the POPS shall be location where the services are actually performed and shall not be dependent on location of service recipient.

Now, lets us come on major discussion i.e. Rule 6A of Service Tax Rules, 1994

Rule 6A of ‘Service Tax (Second Amendment) Rules, 2012’ defines the phrase ‘Export of Service’ as below:

(1) The provision of any service provided or agreed to be provided shall be treated as export of service when,-

(a) the provider of service is located in the taxable territory ,

(b) the recipient of service is located outside India,

(c) the service is not a service specified in the section 66D of the Act,

(d) the place of provision of the service is outside India,

(e) the payment for such service has been received by the provider of service in convertible foreign exchange, and

(f) the provider of service and  recipient of service  are not merely establishments of a distinct person in accordance with  item (b) of Explanation 2 of clause (44) of section 65B of the Act.

(2) Where any service is exported, the Central Government may, by notification, grant rebate of service tax or duty paid on input services or inputs, as the case may be, used in providing such service and the rebate shall be allowed subject to such safeguards, conditions and limitations, as may be specified, by the Central Government, by notification.

Two Important Points here

• Firstly, It is important to note that there is no ambiguity on the fact that once the services are rendered outside India there is no charge and hence no service tax shall be applicable. But the story does not stop here…!!. What about the Cenvat that the Exporter has incurred. To get the benefits on the Inputs/Inputs service cenvat under Rule 2(e) (Exempted Service) r.w. Rule 5 (refund to exporter) r.w. Rule 6 (which caters to cenvat attributable to exempted service) of Cenvat Credit Rules, 2004 such service must test all the parameters as laid down in Rule 6A of STR, 1994.

• Secondly, It is myth with many that Rule 6A, Service Tax Rules, 1994 has been redundant because of Section 66B. It is not the case. Rule 6A, STR, 1994 is fundamentally to govern the benefits of Cenvat Credit to the exporter and stands effective in all terms.

Before parting…

The above discussion clearly demonstrates the multi-faceted Indirect taxation of the Industry and why analysing the implications of VAT / Service tax can some-times be a very tedious affair. There is urgent need of a white paper from the Industry Associations to be represented to the law makers which can provide more defining and clear cut laws for such complex transactions.

I invite the views of esteemed readership for constructive discussion.

[1] Commissioner of Sales Tax, Madhya Pradesh, Indore v. Madhya Pradesh Electricity Board, Jabalpur (1969) 1 SCC 200

[2] H. Anraj v. Government of Tamil Nadu, reported in (1986) 1 SCC 414

[3] State of A. P. v. National Thermal Power Corpn. Ltd. & Ors. reported in (2002) 5 SCC 203

[4] M. P. Cement Manufacturers’ Association v. State of M. P. & Ors., reported in (2004) 2 SCC 249

Read Other Articles from CA Ankit Gulgulia (Jain)

About the Author:

CA Ankit Gulgulia (Jain) –Author is practicing Chartered Accountant in New Delhi and specialising in Indirect Taxes, Corporate Laws and Transfer Pricing. He can be reached at

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CA Ankit Gulgulia (Jain) is Celebrated Chartered Accountant practicing since 2010. He is Founder of Ankit Gulgulia & Associates, Chartered Accountants serving Clients PAN India and Across the Globe. He is Fellow Member of Institute of Chartered Accountants of India, Certified IFRS & Busin View Full Profile

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  1. ProductDevExperts All says:

    I have a pvt limited company. I just received a first contract for building software for a US startup company. I bill them on Time and money for developing the software. Do I need to charge them any service tax or VAT in the bill?

  2. sheelu says:


    Its a remarkable article helpful for beginners mostly.

    Our company an LLP, is planning a model with a firm to develop a software for them but allowing its access on cloud platform only. Not selling the software. What kind of taxes we will be liable to the govt?

    Between the party and us, should it be a renewable contract which will effect tds liability liability on us?

    any other tax implications too, please can you advice?

    Thanks in advance.

  3. Niranjani says:

    A very detailed analysis and quite educative and thought provoking.. it is evident that the author has expert knowledge in the subject discussed.

    Thanks for sharing the same as it has cleared many a doubt!!

  4. CA. Bhavesh Savla says:

    Excellent article. Just to follow up, there has been, as far as I recall, no case so far, on cloud based services. However, the Honourable Madras High Court, in its ISODA judgment mentioned above has also made an observation on the same.
    The relevant words are:

    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’ or the entry used in the statute.

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April 2024