S. Jaikumar & G. Natarajan, Advocates, Swamy Associates

“IT” is no more soft.

(S. Jaikumar & G. Natarajan, Advocates, swamy associates)

The levy of service tax on various software related services, with effect from 10.05.2008, has thrown out many issues as to the applicability of this levy, vis-à-vis the levy of duty of excise and customs. In this article an attempt has been made to reap a holistic understanding of the issue.

Excise Duty.

Chapter heading 8523 of the first schedule to the Central Excise Tariff Act, 2005 reads as

Discs, tapes, solid-state non-volatile storage devices, “smart cards” and other media for the recording of sound or of other phenomena, whether or not recorded, including matrices and masters production of discs, but excluding products of chapter 37.

A cruise through the bewildering single/double/triple dashes under the tariff entry would reveal that the above chapter heading has been broadly sub-divided into, (a) Magnetic media, (b) Optical media, (c) Semi-conductor media. Under semi conductor media, chapter heading 8523 80 20 reads as “information technology software”. The term “information technology software” is also explained in the Supplementary Note as

For the purposes of heading 8523, “Information Technology Software” means any representation of instructions, data, sound or image, including source code and object code, recorded in a machine readable form, and capable of being manipulated or providing interactivity to a user, by means of an automatic data processing machine”.

It may be observed that, software by itself is an intangible property and it cannot be considered as “goods”. But, when software is stored in a medium, it acquires the characteristics of “goods” and also find a place in the Central Excise Tariff. It has also been held so by the Hon’ble Apex Court in Tata Consultancy Services Vs State of A.P. 2004 (178) ELT 22 SC.

As per the Central Excise Tariff, such software attracts a duty of excise @ 12 %. But customized software is exempted from payment of duty of excise, vide S.No. 27 of Notification 6/2006 Dated 01.03.2006, which reads as below: (1) (2) (3) (4) (5) “27. 8523 (a) Any customized Nil - software (that is to say, any custom designed software, developed for a specific user or client), other than packaged software or canned software (b) Packaged Software 12% -”;

Explanation. – The expression “packaged software or canned software” means a software developed to meet the needs of variety of users, and which is intended for sale or capable of being sold, off the shelf.

As per Chapter note 10 of Chapter 85, for the purposes of heading 8523 “recording” of sound or other phenomena shall amount to manufacture. As such, copying of software from one storage medium to another storage medium or multiplication thereof into number of storage mediums, would amount to manufacture and if the same is done in relation to any “packaged software” duty of excise has to be paid.

In this connection, it may be noted that it is a common commercial practice to trade in software through online. In other words, if a person wants do purchase a software, he may do so, by visiting the web site, where such software is offered for sale and purchase the same. Upon such purchase, the said software would be loaded into the system. This process of downloading the software through electronic mode and storing the same, can be considered as “manufacture”, thereby strictly attracting the duty of excise. But, in the absence of “removal” of such software, i.e. removal the medium in which such software is stored, or due to the availability of the exemption notification 67/95 (wherever the said download of software has been done in or in relation to manufacture of dutiable excisable goods), or may be due to the SSI exemption availability, there would not be any duty liability in case of such online downloading of software. Service Tax.

In the budget 2008, various software related activities have been brought within the ambit of levy of service tax. While doing so, the Hon’ble Finance Minister has observed in para 156 of his Budget speech,

55 per cent of the GDP is contributed by the services 156. sector, which is a growing sector that must contribute its legitimate share to the exchequer. I propose to bring under the service tax net four services. They are:-

(i) asset management service provided under ULIP, to bring it on par with asset management service provided under mutual funds;

(ii) services provided by stock/commodity exchanges and clearing houses;

(iii) right to use goods, in cases where VAT is not payable; and

(iv) customised software, to bring it on par with packaged software and other IT services.

It is also relevant to refer to the clarifications contained in the CBEC’s letter D.O.F. No. 334/1/2008 TRU Dated 29.02.2008

4.1 Information Technology Software Service :

4.1.1 Information Technology (IT) software service includes, -

• Development (study, analysis, design and programming) of software.

• Adaptation, up-gradation, enhancement, implementation and other similar services in relation to IT software.

• Provision of advice and assistance on matters related to IT software, including :

 Conducting feasibility studies on the implementation of a system,  Providing specifications for a database design,  Providing guidance and assistance during the start-up phase of a new system,  Providing specifications to secure a database, o Providing advice on proprietary IT software.

• Acquiring the right to use,-

IT software for commercial exploitation including right to reproduce, distribute and sell, Software components for the creation of and inclusion in other IT software products,

IT software supplied electronically.

4.1.2 Software consists of carrier medium such as CD, Floppy and coded data. Softwares are categorized as “normal software” and “specific software”. Normalised software is mass market product generally available in packaged form off the shelf in retail outlets. Specific software is tailored to the specific requirement of the customer and is known as customized software.

4.1.3 Packaged software sold off the shelf, being treated as goods, is leviable to excise duty @ 8%. In this budget, it has been increased from 8% to 12% vide notification No. 12/2008-C.E., dated 1-3-2008. Number of IT services and IT enabled services (ITeS) are already leviable to service tax under various taxable services:

• Consulting engineer’s service - advice, consultancy or technical assistance in the discipline of hardware engineering [Section 65(105) (g)].

• Management or business consultant’s service - procurement and management of information technology resources [Section 65(65)].

• Management, maintenance or repair service - maintenance of software, both packaged and customized and hardware [Section 65(64)].

• Banking and other financial services - ‘provision and transfer of information and data processing’ [Section 65(12)].

• Business support service - various outsourced IT and IT enabled services [Section 65(105)(zzzq)].

• Business auxiliary service - services provided on behalf of the client such as call centres [Section 65(19)].

4.1.4 IT software services provided for use in business or commerce are covered under the scope of the proposed service. Said services provided for use, other than in business or commerce, such as services provided to individuals for personal use, continue to be outside the scope of service tax levy. Service tax paid shall be available as input credit under Cenvat credit Scheme.

4.1.5 Software and upgrades of software are also supplied electronically, known as digital delivery. Taxation is to be neutral and should not depend on forms of delivery. Such supply of IT software electronically shall be covered within the scope of the proposed service. 4.1.6 With the proposed levy on IT software services, information technology related services will get covered comprehensively.

4.1.7 Following consequential amendments in other taxable services are also being made:

• At present, ‘Information technology service’ is specifically excluded from the scope of Business auxiliary service [Section 65(105)(zzb)]. Consequent on the proposed IT software service, information technology services get covered comprehensively for the purpose of levy of service tax and, therefore, specific exclusion of ‘Information technology service’ under Business auxiliary service is being deleted.

• To include ‘testing and analysis of IT software’ services under Technical testing and analysis service [Section 65(105)(zzh)].

• To include ‘Certification of IT software’ services under Technical inspection and certification service [Section 65(105)(zzi)].

• To clarify as removal of doubts that ‘Management, maintenance or repair of properties’ includes Management, maintenance or repair of IT software [Section 65(105)(zzg)]. Maintenance of packaged software (being goods) is also leviable to service tax under the said service.

• Services provided in relation to advice, consultancy and assistance on matters related to IT software shall be leviable to service tax under the IT software service. Consulting engineer’s service [Section 65(105) (g)] in the discipline of computer hardware engineering is leviable to service tax whereas consulting engineer’s service in the discipline of computer software engineering is not leviable to service tax by way of specific exclusion. Specific exclusion of ‘consultancy in the discipline of computer software engineering’ from the scope of ‘consulting engineer’s service’ is not necessary and, therefore, being deleted.

• To clarify that a consultancy service, covering both hardware and software consultancy, shall be classifiable under ‘Consulting engineer’s service’.

From the above, it may be observed that the intention of the Government is to levy service tax only in respect of “customized software”. It may be noted that customization of software is a service activity. Once such customized software is copied into a medium, it becomes goods and thanks to Notification 6/2008, supra, the excise duty payable thereon is exempted. Even though, the service rendered would ultimately result in the emergence of “goods”, the service part of it would attract the levy of service tax.

Now, let us turn our attention to the relevant definitions under the Finance Act, 1994.

Section 65 (53a) ibid defines “information technology software” as ‘ information technology software’ to mean any representation of instructions, data sound or image, including source code and object code, recorded in a machine readable form, and capable of being manipulated or providing interactivity to a user, by means of a computer or an automatic data processing machine or any other device or equipment.

The taxable service has been defined under clause (zzzze) of Section 65(105) as any service rendered 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:-

Development (study, analysis, design and programming) of software.

 Adaptation, up-gradation, enhancement, implementation and other similar services in relation to IT software.  Provision of advice and assistance on matters related to IT software, including: o Conducting feasibility studies on the implementation of a system, o Providing specifications for a database design, o Providing guidance and assistance during the start-up phase of anew system, o Providing specifications to secure a database, o Providing advice on proprietary IT software.

 Acquiring the right to use,- o IT software for commercial exploitation including right to reproduce, distribute and sell, o Software components for the creation of and inclusion in other IT software products, o IT software supplied electronically.

From the above, it may be observed that the definition is an “inclusive one” and any service in relation to information technology software for use in the course, or furtherance, of business or commerce, would be a taxable service. It may be in the form of grant of licence to use the software, development of a new software, upgradation and the like, providing advices and services in relation to acquiring the right to use (may be assisting in sourcing the licence).

In case of packaged software sold off the shelf, there is an excise duty liability. It may be observed that by purchase of such packaged software, the purchaser only gets the licence to use the said software, with attendant restrictions on copying, multiplication, etc. So, the purchase of packaged software also involves, acquiring the right to use the software. As the main part of the definition of taxable service reads as any service rendered to any person, by any other person in relation to information technology software for use in the course, or furtherance, of business or commerce, the developer / seller of the packaged software, can be said to be rendering the service of granting the right to use the software and service tax would also attract on such activity, apart from the excise duty liability on such packaged software. Unlike the levies of sales tax and service tax, which are mutually exclusive, there is nothing to preclude the levy of excise duty in lieu of levy of service tax or vice-versa. So, there is a possibility that purchase of packaged software may attract both excise duty and service tax. But, under the VAT legislation, such packaged software is treated as goods and sales tax demanded on the entire value. Hence, by virtue of Notification 12/2003 ST, the entire value can be ascribed to the sale and there is no need to pay any service tax, in case of sale / purchase of packaged software!

Customs.

No basic customs duty is leviable on import of software. If the packaged software is imported in the form of any storage media, CVD would be payable @ 12 % plus Education Cess. If any customized software is imported in the form of any storage media, there would be no customs duties at all. If any software is imported through online, in the absence of any medium, the same cannot be considered as import of goods and hence no customs duties would be payable.

The above views can also be tabulated as below, in respect of various activities:

S.No. Activity Liability to Excise duty / Service Tax 1 Development and sale of packaged software ED @ 12 % plus Education (Eg. Sale of Excus CDs by M/s Centax Cess. No Service Tax. Publications) 2 Development of a new software for a specific ED : Nil. Service Tax under client, according to his requirements. Information Technology Service @ 12 % plus Education CESS. 3 Grant of License to use software. ED : Nil. Service Tax under Information Technology Service @ 12 % plus Education CESS. 4 Upgradation, Implementation, Adaptation, ED : Nil. Service Tax under etc. of software Information Technology Service @ 12 % plus Education CESS. 5 Maintenance of software Service tax under Maintenance & Repair service @ 12 % plus Education Cess. 6 Facilitating the acquisition of right to use any ED : Nil. Service Tax under software Information Technology Service @ 12 % plus Education CESS. 7 After getting a customized software, ED @ 12 % plus Education multiplying it in CDs and sale as packaged Cess on subsequent sale of sogftware. such software. No Service Tax. But, service tax would be charged by the software developer who develops the customized software, which can be availed as Cenvat credit. 8 Import of packaged software in CD. BCD : Nil. CVD 12 % Plus Education CESS. Service Tax : NIL. Addl Customs duty is also exempted vide S.No. 60 of Notification 20/2006 Cus, unless the software is imported in floppy discs or cartridge tapes. 9 Import of customized software in CD. No customs duties at all. Service Tax under Information Technology Service @ 12 % plus Education CESS on reverse charge basis. 10 Import of packaged software through online No customs duties at all. Service Tax : Nil. 11. Import of customized software through online No Customs duties at all. Service Tax under Information Technology Service @ 12 % plus Education CESS on reverse charge basis.