The Finance Act, 2008 brought some new services under the Service Tax net. One of them is Information Technology Software Service. Inclusion of a new services category — Information Technology Software Services — within the ambit of Service Tax legislation has created confusion among software firms. The levy of this new service along with other services has become effective from 16 May, 2008.Post the Notification, many feel that from 16 May, 2008, packaged software will also attract 12.36% of Service Tax. So far, packaged software attracts Value Added Tax (VAT) of 4% and 12% of excise duty.
The confusion arises as the Notification does not make a clear demarcation of whether ‘software’ is to be sold as goods and hence liable for sales tax (VAT) or considered as ‘services’ and liable for a Service Tax or both.
Packaged softwares are products that are sold off the shelf. Examples of the products that would fall under this are Microsoft, Autodesk, Adobe and several security software packages for computers. This will also include accounting software from Tally.
Normally Service Tax is payable to the Central Government when a service is offered, while VAT is applicable when a product is sold.
In case of softwares which are not sold off the shelf, the sale price includes free initial installation and implementation of the software. This includes some modifications or customisations to suit the customers, but without disturbing the basic structure of the software or its performance.
The copyright in the software is protected and always remains the property of the creator. What is sold is the right to use the software.
The sale is with a condition for exclusive use of the software by the customer at the exclusion of others. The sale gives absolute possession and control to the purchaser/user of the right to use the software.
The sale normally gives a warranty period and after the said period some annual maintenance charges are recovered for the services rendered, popularly called Annual Maintenance Contract (AMC).
At present the sale is subjected to tax under the Maharashtra Value Added Tax Act, 2002, (MVAT) and AMC is subjected to Service Tax.
The confusion is created due to the amendment in the Service Tax by the Finance Act, 2008 which has added “Information Technology Software Service” by way of sub-clause (zzzze) in Cl. 65(105) of the Finance Act, 1994, and further sub-clause (53a) in Cl. 65, defining the term “information technology software.”
The query :
Whether Service Tax is applicable to the sale of computer software ? Whether MVAT is also applicable to the same ?
Questions to be answered/verified :
To answer the query, the following crucial questions will have to be addressed :
1. Is the software ‘Goods’ and covered as a ‘Sale’ under the MVAT Act, 2002 ?
2. Is it a service chargeable to Service Tax under Cl. 65(105)(zzzze) of the Finance Act, 1994 ?
3. Whether both the MVAT and Service Tax are applicable ?
4. What is the value chargeable to Service Tax, if applicable ?
5. Facts from the sale/licence agreements.
Analysis of the questions :
1. Is the software ‘Goods’ ?
1.01 The question is very important and is relevant to decide its taxability.
The question assumes importance, because if it is ‘Goods’, it is subjected to tax under the MVAT. If it is not goods, then it may be subjected to Service Tax.
1.02 ‘Goods’ is defined in S. 2(12) under the Maharashtra Value Added Tax Act, 2002, as :
“In this Act, unless the context otherwise requires, goods means every kind of moveable property not being newspapers, actionable claims, money, stocks, shares, securities or lottery tickets and includes livestocks, growing crop, grass and trees and plants including the produce thereof including property in such goods attached to or forming part of the land which are agreed to be severed before sale or under the contract of sale.”
1.03 Under Article 366(12) of the Constitution of India,
“Goods include all materials, commodities, and articles.”
1.04 Further, Entry 39 in Schedule C to the Maharashtra Value Added Tax Act, 2002, which decides the rate of tax, describes goods under that entry as :
“Goods of intangible or incorporeal nature as may be notified, from time to time, by the State Government in the Official Gazette”; and the Notification VAT-1505/CR-114/Taxation-1, dated 1-6-2005 notifies a list of goods in which Item (5) reads :
1.05 Further, it would be worth to look to the definition of ‘Sale’ under the Maharashtra Value Added Tax Act, 2002, S. 2(24) :
“Sale means a sale of goods made within the State for cash or deferred payment or other valuable consideration, but does not include a mortgage, hypothecation, charge or pledge; and the words ‘sell’, ‘buy’ and ‘purchase’, with all their grammatical variations and cognate expression, shall be construed accordingly.
For the purpose of this clause :
(b) (iv) the 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.”
1.06 It can be seen that ‘goods’ has been defined under all the relevant acts very widely and includes the right to use any goods which can be sold.
1.07 There have been many instances where the courts of law had occasions to examine whether the software is goods. Although with some limitations, but the most relevant on the subject was the case of :
(i) Tata Consultancy Services v. State of A.P., (2004) 271 ITR 401 (SC)
This is a landmark judgment of the Supreme Court of India, on the definition of ‘Goods.’ A detailed discussion on the same throws light on the term in the correct perspective.
1.08 Tata Consultancy Services (TCS) provides consultancy services including computer consultancy services. They prepare and load on customers’ computers custom-made software and also sell ready-made computer software packages off the shelf. The readymade software is also known as canned software.
The assessing officer, first appellate authority and the Sales Tax Tribunal Andhra Pradesh held that canned softwares are goods and sales tax is leviable on their sale.
TCS filed a tax revision case to the Hon. Andhra Pradesh High Court, which was dismissed.
The appellant preferred an appeal before the Supreme Court and the question raised in the appeal was whether canned software sold by the appellant can be termed to be ‘goods’.
The appellant submitted that the term ‘goods’ in S. 2(h) of the Andhra Pradesh General Sales Tax Act only includes tangible moveable property, and the words ‘all material articles and commodities’ also cover only tangible moveable property, and computer software is not tangible moveable property.
The appellant further submitted that the definition of ‘computer’ and ‘computer programme’ in the Copyright Act, 1957 shows that a computer programme falls within the definition of Literary Work and is intellectual property of the programmer.
The appellant also submitted that computer software is nothing but a set of commands, on the basis of which the computer may be directed to perform the desired function.
It was further contended by the appellant that software is unlike a book or a painting. When the customer purchases a book or a painting, what he gets is the final product itself and in the case of software the consumer does not get any final product, but all that he gets is a set of commands which enable his computer to function.
It was further argued that having regard to its nature and inherent characteristic, software is intangible property which cannot fall within the definition of the term ‘goods’ in S. 2(h) of the Andhra Pradesh General Sales Tax Act.
The Supreme Court did not agree with these arguments and held as under :
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”.
This judgment more or less has defined the test to decide what is 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”.
1.09 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 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 :
“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 being transmitted, transferred, delivered, stored and possessed. If a software whether customised or non-customised satisfies these attributes, the same would be goods.”
This makes it clear that whether the software is a customised one or otherwise, it would be goods.
1.10 Further in the latest judgment of — Infosys Technologies Ltd. v. Special Commr. of Commercial Taxes, (2008) 17 VST 256 (Mad.), while deciding the question “whether customised or non-customised software satisfies the test of the ‘goods’ and is ‘goods’ for sales tax ?”, following the Supreme Court judgment in Bharat Sanchar Nigam Ltd. v. Union of India, (2006) 145 STC 91, it was held that goods may be a tangible property or an intangible one, it would be goods provided it has the attributes having regard to (a) its utility, (b) capable of being bought and sold; and (c) capable of being transmitted, transferred, delivered, stored and possessed.
If a software, whether customised or non-customised, satisfies these attributes the same would be goods.
2.0 Is it a service chargeable to Service Tax under Cl. 65(105) (zzzze) of the Finance Act, 1994 ?
2.01 The services provided under the Information Technology Software Service head on or after 16-5-2008 have been made taxable.
2.02 The statutory definition in S. 65(53a) of the Finance Act, 1994 is :
‘information technology software’ means any representation of instruction, data, sound or image, including source code and object code, recorded in machine readable form, and capable of being manipulated or providing interactively to a user, by means of a computer or an automatic data processing machine or any other device or equipment.
2.03 S. 65(105) (zzzze) of the Finance Act, 1994, inserted, defines taxable service as :
“any service provided or to be provided to any person, by any other person in relation to information technology software for use in the course, or furtherance, of business or commerce, including :
(i) development of information technology software,
(ii) study, analysis, design and programming of information technology software,
(iii) adaptation, upgradation, enhancement, implementation and other similar services related to information technology software,
(iv) Providing advice, consultancy and assistance on matter related to information technology software, including conducting feasibility studies on implementation of a system, specifications for a database design, guidance and assistance during the startup phase of a new system, specification to secure a database, advice on proprietary information technology software,
(v) Acquiring the right to use information technology software for commercial exploitation including right to reproduce, distribute and sell information technology software and right to use software components for the creation of an inclusion in other information technology software products,
(vi) Acquiring the right to use information technology software supplied electronically.
On a plain reading of the scope, apparently Sale of Software seems to be covered under the charge of Service Tax.
2.04 The Circular/Letter D. O. F. No. 334/1/2008-TRU, dated 29-2-2008, 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 case also.
This is because the Supreme Court also has held the right to use as goods.
It is obvious that the test to decide any transaction as a sale as is accepted in taxing statutes, is 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.
2.05 The further test for checking about the applicability of Service Tax is to check whether MVAT is payable or paid.
It is obvious from the clarification by the Department itself that transfer of right to use any goods is subjected to VAT and where VAT is payable or paid, the service is not covered under the scope of Service Tax.
2.06 This is a very important point as it relates to a clarification per Constitution.
2.07 Further, Service Tax since its inception has never been intended to be levied on Sale of Goods and the same principle has throughout been followed consistently by the Department. The reason is obviously related to the Constitutional power of the Union Government to levy tax on an item covered under Article 246 read with List II — State List — to Schedule VII to the Constitution of India. This is more particularly explained in the following paras 3.00 to 3.14.
2.08 The mutual exclusivity of taxes which has been reflected in Article 246(1) of the Constitution means that taxing entries must be construed so as to maintain exclusivity.
(i) Gujarat Ambuja Cements Ltd. v. UOI, (2005) 4 SCC 214, (para 23)
2.09 Presumption that a Legislature is acting within its competence :
In constructing an enactment of a Legislature with limited competence, the Court must presume that the Legislature in question knows its limits and that it is only legislating for those who are actually within its jurisdiction.
(i) State of Bihar v. Charusila Dasi, 1959 S.C. 1002
(ii) P. N. Krishna Lal v. Govt. of Kerala, (1995) Supp.(2) SCC 18 (Para 8)
(iii) Anant Prasad Laxminiwas Genriwal v. State of A.P., 1963 S.C. 853.
In all the amendments that may take place, the Legislature has to remain in the framework defined by the Constitution.
Service Tax is never intended to, nor can it, be levied on subjects which are enumerated in List-II i.e., a State List.
Hence, even if wordings are drafted to suggest some different meanings, it cannot travel beyond the framework.
The Courts have laid down the principles of interpretations and while deciding matters like this the test called ‘pith and substance’ has to be applied ignoring the apparent words.
2.10 The State Legislature has legislative competence to treat a particular sale or purchase as the first sale or purchase.
(i) Food Corporation of India v. State of Kerala, (1997)
(ii) Arjun Flour Mills v. State of Orissa, (1998) 8 SCC 89 (Para 1).
2.11 Whenever the question of legislative competence arises, the issue must be solved by applying the rule of pith and substance whether that legislation falls within any of the entries in List-II. If it does, no further question arises and article 246 cannot be brought in to yet hold that the State Legislature is not competent to enact the law.
(i) State of A.P. v. McDowell & Co., (1996) 3 SCC 709 (para 7)
2.12 Doctrine of pith and substance
This doctrine means that if an enactment substantially falls within the powers expressly conferred by the Constitution upon the Legislature which enacted it, it cannot be held to be invalid, merely because it incidentally encroaches on matters assigned to another Legislature.
(i) Bharat Hydro Power Corpn. Ltd. v. State of Assam, (2004) 2 SCC 553-561 (para 18)
The doctrine of pith and substance is sometimes invoked to find out the nature and content of the legislation. However, when there is an irreconcilable conflict between the two legislations, the Central legislation shall prevail. However, every attempt would be made to reconcile the conflict.
(i) Special Reference No. 1 of 2001. In re, (2004) 4 SCC 489, 499-500 (para 15)
The express words employed in an entry necessarily include incidental and ancillary matters so as to make the legislation effective.
(i) Hindustan Lever v. State of Maharashtra, (2004) 9 SCC 438, 457-58 (para 34)
The Court is required to ascertain the true nature and character of the enactment with reference to the legislative power. It must examine the whole enactment, its object, scope and effect of its provision. If on such adjudication, it is found that the enactment falls substantially on a matter assigned to the State Legislature, the enactment must be held valid even though the nomenclature of the enactment shows that it is beyond the legislative competence of the State Legislature. When a levy is challenged, its validity has to be adjudged with reference to the competency of the State Legislature to enact such a law and real nature and character of the levy, its pith and substance is to be found out and adjudged with reference to the competency of the Legislature.
(i) State of Karnataka v. Drive-in-Enterprises, (2001) 4 SCC 60, 63-64 (para 6)
If by applying the rule of pith and substance, the legislation falls within any of the entries of List II, the State Legislature’s competence cannot be questioned on the ground that the field is covered by the Union List.
(i) State of Rajasthan v. Vulan Medical & General Store, (2001) 4 SCC 642, 652-53 (para 11)
In other words, when a law is impugned as ultra vires, what has to be ascertained is the true character of the legislation. If on such examination it is found that the legislation is in substance one on a matter assigned to the Legislature, then it must be held to be valid in its entirety, even though it might incidentally trench on matters which are beyond its competence.
(i) Krishna A. S. v. State of Madras, AIR 1957 SC;
(ii) Kantian Devon Produce & Co. s. State of Kerala, (1972) 2 SCC 218;
(iii) P. N. Krishna Lal v. Govt. of Kerala, 1995 Supp (2) SCC 187 (para 8 and 9).
In a situation of overlapping, the rule of pith and substance has to be applied to determine to which entry a given piece of legislation relates. Thereafter, any incidental trenching on the field reserved to the other Legislature is of no consequence.
(i) Goodricke Group Ltd. v. State of W.B., 1995 Supp (1) SCC 707 (para 12)
(ii) ITC Ltd. v. A P M C, (2002) 9 SCC 232 (para 182)
(iii) E. V. Chinnaiah v. State of A.P., (2005) I SCC 394, 413 (para 29)
It is the function and power of the court to interpret an enactment and to say to which entry an enactment relates. The opinion of the Govt. in this behalf is but an opinion and not more.
(i) Goodricke Group Ltd. v. State of W.B., 1995 Supp (1) SCC 707 (para 37)
In order to examine the true character of the enactment, one must have regard to the enactment as a whole to its objects and to the scope and effect of the provisions. It would be quite an erroneous approach to the question to view such a statute not as an organic whole, but as a mere collection of sections, then disintegrate it into parts, examine under what heads of legislation those parts would severally fall and by that process determine what portions thereof are intra vires and what are not.
(i) Bharat Hydro Power Corpn. Ltd. v. State of Assam, (2004) 2 SCC 553, 561 (para 18)
2.13 It is obvious from the discussion above that the doctrine of pith and substance has to be applied while interpreting the situation like the one in the present case.
3.0 Whether both the MVAT and Service Tax are applicable?
3.01 The issue is already clarified by the Department itself as mentioned in Point No. 2.04 above that, where VAT/Sales Tax is payable or paid, the service will be beyond the scope of Service Tax.
This is a very important point as it relates to a Constitutional clarification. Various courts have clarified this point in many cases.
3.02 The reason for this is the Constitution of India gives powers to the Parliament and to the Legislatures of the States to charge tax on various things/subjects.
Article 246 enumerates the powers and Lists I, II and III in Schedule VII to the Constitution enumerate various matters. List I is a Union List, List II is a State List and List III is a Concurrent List.
We are at present concerned with List-I and List-II.
3.03 In List-I
For Service Tax there is a specific Entry 92C — Taxes on Services — inserted by 95th Amendment Bill, 2003 (to be called 88th Amendment Act, 2003) and passed by Lok Sabha on 6-5-2003 and Rajya Sabha on 5-5-2003.
But this has not been made yet effective.
Entry-97 is a residuary entry and presently Service Tax is covered by this. This reads as :
97. Any other matter not enumerated in List II or List III including any tax not mentioned in either of those Lists.
3.04 In List-II — State List
Entry 54 reads :
Taxes on the sale or purchase of goods other than newspapers, subject to the provisions of Entry 92A of List I.
(92A in List-I, is for taxes on Sale or Purchase in the interstate trade.)
3.05 Sale of Goods is a State subject and goods which are subjected to State Sales Tax/VAT cannot be subjected to Union tax — i.e., Service Tax in the present case.
There have been many instances where both the Union and the State claim the taxes. There are instances of transactions of multiple taxing events. In all such questions as to whether both the taxes are applicable to the same event, various courts of law including the Supreme Court, have clarified that there cannot be a double taxation on the same thing. This is evident from the following decided cases on the subject.
3.06 Held in International Tourist Corporation v. State of Haryana, AIR 1981 SC 774; (1981) 2 SCC 319 — that :
Before exclusive legislative competence can be claimed for Parliament by resort to the residuary power, legislative incompetence of the State Legislature must be clearly established. Entry 97 itself is specific in that a matter can be brought under that Entry only if it is not enumerated in List II or List III and in the case of a tax, if it is not mentioned in either of those lists.
3.07 In State of West Bengal v. Kesoram Industries Ltd., 266 ITR 721 (SC 5-Member Constitution Bench 4 v. 1 judgment), it was held that :
Measure of tax is not determinative of its essential character. The same transaction may involve two or more taxable events in its different aspects. Merely because the aspects overlap, such overlapping does not detract from the distinctiveness of the aspects. Two aspects of the same transaction can be utilised by two Legislatures for two levies which may be taxes or fees.
3.08 It was held in — Builders’ Association of India v. UOI, 73 STC 370 (SC 5-Member Constitution Bench) that :
After the 46th Amendment, works contract which was indivisible one is by a legal fiction altered into one for sale of goods and the other for supply of labour and services. After 46th Amendment, it has become possible for States to levy tax on value of goods involved in a works contract in the way in which sales tax was leviable on the price of goods and materials supplied in a building contract which had been entered into two distinct and separate parts. (Really, in the observation ‘an indivisible works contract, is by a legal fiction altered into one for sale of goods and the other for supply of labour and services’, the second part is obiter, since the 46th Amendment does not provide that other part will be deemed for supply of labour and services).
Article 366(29A) provides for ‘deemed sale of goods’ and not ‘deemed provision of service’.
3.09 In Godfrey Philips India Ltd. v. State of UP, 139 STC 537 (SC 5-Member Constitution Bench), it was observed as follows :
The Indian Constitution is unique in that it contains an exhaustive enumeration and division of legislative powers of taxation between the Centre and the States. This mutual exclusivity is reflected in Article 246(1).
3.10 In Kerala Agro Machinery Corpn. v. CCE, (2007) (CESTAT), a strong prima facie view is expressed that when sales tax is paid on a transaction, service tax will not be payable.
3.11 In the Shorter Constitution of India, Dr. Durga Das Basu, while commenting on Union’s and State’s powers and Entries in Schedule VII :
Scope of legislative (fiscal) power under Schedule VII — at Page 1693 of 14th edition 2009, — stated that :
There can be no overlapping in the field of taxation. A tax if specifically provided for under one legislative entry, effectively narrows the fields of taxation available under other related entries. It is also natural when considering the ambit of an express power in relation to an unspecified residuary power, to give a broad interpretation to the former at the expense of the latter.
(i) Godfrey Phillips India Ltd., v. State of U.P., (2005) 2 SCC 515, 544-45 (Para 59); AIR 2005 SC 1103.
3.12 Further on commenting on – Scope of the residuary power — at Page 2367 of 14th edition 2009 — it is stated that :
(3) Where the competition is between an Entry in list II and Entry 97 in list I, the latter cannot be so expansively interpreted as to whittle down the power of the State Legislature.
International Tourist Corpn. v. State of Haryana, AIR 1981 SC 774 (Para 7) 1981 (2) SCR 364
On the other hand, the Entry in the State list must be given a broad and plentiful interpretation.
International Tourist Corpn. v. State of Haryana, AIR 1981 SC 774 (Para 7) 1981 (2) SCR 364
(5) Being aware of the dangers of allowing the residuary powers of Parliament under Entry 97 of List I of the Seventh Schedule to swamp the legislative entries in the State List, the Supreme Court interpreted Entry 54 of List II, together with Art.366 (29A) of the Constitution, without whittling down the interpretation by referring to the residuary provision.
Bharat Sanchar Nigam Ltd. v. Union of India, (2006) 3 SCC 1, 40 (Para 82).
3.13 It is held 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)
4.0 What is value chargeable to Service Tax, if applicable ?
4.01 S. 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.
4.02 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)
4.03 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.
4.04 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.
4.05 The discussion in Builders’ Association of India v. UOI, 73 STC 370 (SC 5-Member Constitution Bench) is also relevant and is given in Point No. 3.08 above.
4.06 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.
In para 46 it observed that :
“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.
5.0 Facts from the Software Sale Agreement :
5.01 The software seller normally enters into an agreement with the buyer and various terms and conditions are specified and executed by the buyer and the seller.
5.02 The Terms of Agreement normally grant a licence to use the software and the vendor thereby grants to the buyer a licence to use the said product or licensed material.
5.03 Further, there are clauses which enumerate free services provided like :
Installation of product and it normally states that- the vendor undertakes to provide on-site training of the software only to the specified staff of the buyer.
The vendor also normally carries out some modifications or customisation and also takes up
— Pre-installation. Requirement/GAP analysis study, conducted by vendor.
— Data migration from all earlier software.
— Pre- and post-installation system audits.
All the above come as an inbuilt and inseparable part of the product and necessarily required with the software and are free of cost/charge for the same. The price paid is for the licence/right to use the software.
In many cases e.g., in case of a Tally software, installation is done by the representative of the vendor and other stages i.e., migration of the data and system audit, etc. are done and carried out by the buyer at his own cost. Even if the same is arranged by the vendor, the cost is paid for the buyer to a third party and nothing is paid to the vendor.
6.0 Conclusion :
Considering all the relevant facts, and the law as discussed hereinabove, and relying and based on the same as mentioned above, we reach the conclusion that :
6.01 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.
6.02 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, Entry C-39 of Schedules to the MVAT Act, 2002 and consequently MVAT is chargeable on sale price of the same. 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.
6.03 The items mentioned in Point No. 5.03 may be covered and subjected to Service Tax, 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 (para 4.06) the dominant intention of parties is to buy and sell. Hence, the sale price cannot be disintegrated for the purpose of Service Tax.
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, as this is not permitted under the Constitution of India.
Author/s : Anilkumar Shah, Chartered Accountant