Budget 2012-13 possibly provides an opportunity to resolve this longstanding problem through the proposed taxation of services.
The indirect taxation of information technology software has been a longstanding matter of debate and dispute. In particular, the challenge of double taxation has been endemic. This article highlights the recent developments in this regard which could equally pose challenges as also present opportunities to mitigate the impact of the tax.
In order to better understand these developments, it is worthwhile to briefly recapitulate the manner in which such information technology software is presently taxed. On the fundamental issue of the proper classification of such software as either ‘goods’ or ‘services’, the Hon’ble Supreme Court, in its landmark decision in Tata Consultancy Services vs state of Andhra Pradesh [(2004) 178 ELT 22 (SC)], had observed that ‘goods’ could be a tangible property or an intangible one. For anything to become ‘goods’, it had to posses the following attributes (a) it should have utility; (b) it should be capable of being bought and sold; and (c) it should be capable of being transmitted, transferred, delivered, stored and possessed. Therefore, if the software, whether or not customised, was capable of abstraction, consumption, use, transmission, transfer or delivery, it would be treated as goods. Once the software is classified as goods, it is liable to the goods taxes of customs duty, excise duty and the VAT.
Under the federal customs and excise law, information technology software and the related paper licence are typically exempt from customs and excise duties, other than packaged/canned soaftware in shrink wrapped packages, which are charged to the countervailing duty/excise duty, as the case may be. Such software is also chargeable to the state VAT. However, VAT is also levied on the licensing of IT software, as “transfer of right to use goods”, falling under the deemed sales transactions specified under Article 366(29A) of the Constitution of India.
In contrast to the above, the service tax provisions evidently extend only to ‘services’ and not to ‘goods’. Accordingly, the licensing of information technology software was first subjected to service tax with the introduction of the taxable category of “Information Technology Software Services” effective May 16, 2008. The relevant definition specifically includes within its ambit the activities of (a) providing the right to use information technology software for commercial exploitation, and; (b) providing the right to use information technology software supplied electronically. It can thus be seen that while the licensing of such IT software is liable to service tax, equally the transfer of the right to use such software is also liable to VAT, if the software satisfies all the attributes of ‘goods’, as noted in the TCS case (supra). It is this dual levy of service tax and VAT on the same transaction that has been the bane of the software industry.
Budget 2012-13 possibly provides an opportunity to resolve this longstanding problem through the proposed taxation of services based on a negative list. As a part of this new approach, the central government has also proposed the introduction of a list of ‘declared services’, which shall be taxed as services regardless of the controversies surrounding their inherent character and their taxability as either ‘goods’ or services. Two important entries in this list of declared services are i) development, design, programming, customization, adaptation, upgradation, enhancement, implementation of information technology software and ii) transfer of goods by way of hiring, leasing, licensing or any such manner without the transfer of the right to use such goods.
While the first entry clearly covers activities that would fall in the category of software services, which are surely not chargeable to VAT, the second entry would inter alia cover the activities of licensing of packaged software, which is where the challenge of double taxation lies. It is worth noting that the entry includes activities of licensing only where there is “no transfer of the right to use goods”. The draft guidance paper on the matter clarifies that every transfer of goods on lease, licence or hiring does not result in a transfer of the right to use goods and that a transfer of goods without the transfer of possession and effective control over such goods would not be a sale but a service.
The guidance paper, while explaining the scope of the taxability of the ‘transfer of right to use pre-packaged or canned software’, has also clarified that in order to determine whether providing a licence to use software is a ‘service’ or ‘sale of goods’, the test to be applied is whether the grant of such a licence tantamounts to a ‘transfer of the right to use such goods’.
It thereafter refers to the essential characteristics of a transfer of the right to use, as laid down by the Supreme Court in the case of Bharat Sanchar Nigam Limited vs Union of India [2006(2) STR 161(SC)], namely that it should be a) a transfer of the right to use to the exclusion of the transferor during the period of the transfer and b) having transferred the right the owner cannot again transfer the same right to others. If a transaction meets these two essential conditions, it will only be chargeable to the VAT and not the service tax.
Consequently, once these changes are brought into force, the levy of the service tax or the VAT on information technology software will be determined by whether there is a transfer of the right to use such technology software or whether there is a mere permission granted for the use of such software, without any transfer of control and possession thereof. This test is not an easy one to meet and the circumstances and the facts of each transaction will influence the determination of the software as either goods or services. Therein lies both the challenge, of continuing double taxation, and the opportunity, of a possible resolution of the problem due to determination of the one correct tax that is payable.
Thus, while the inclusion of information technology software as a ‘declared service’ in the negative list basis of service taxation is indeed welcome, there continues a need to satisfactorily resolve the related test of the transfer of the right to use such software, so as to resolve the problem of double taxation once & for all.