Budget 2009 contained important proposals in regard to exempting packaged software from customs duty, on importation, and on excise duty, with regard to domestic supplies, to the extent that such software is purportedly chargeable to the service tax. The proposals attempted to redress the problem of potential double taxation that arises in regard to such software. Earlier articles in this column had highlighted the problem of double taxation in relation to several transactions including the service taxation of packaged software post the changes announced in the Budget 2009.
The Central Board of Excise and Customs (CBEC) has recently issued Circular (F. No. 354/189/2009-TRU dated November 04, 2009) concerning the applicability of Notification No. 80/2009-Customs in relation to the import of shrink wrapped software. Before we discuss the implications of the aforesaid circular, in order to better understand the issue, it is worthwhile to consider the manner in which packaged software was brought to tax under the excise and customs provisions. The excise and customs tariff for Heading 85 23 is in relation to several media for recording of sound or other phenomena, whether or not recorded, and Heading 85 23 80 20 is for information technology software.
It must thus be understood that both the excise and customs tariffs are applicable in regard to software resident in tangible media. This is an important point since both the tariffs extend only to excisable goods that are enumerated in the schedules thereunder and not to any other goods. The excise rate is 8 per cent on such software and the basic customs duty is exempt. Thus, both imported and indigenous software are charged to 8 per cent duty.
The Interpretative Notes to the Customs Valuation Rules also stipulate that the charges for the right to reproduce the goods in the country of importation shall not be added to the customs value. In addition, the relevant general exemption notification under the Central Excise Tariff exempts customised software on media from the duty and limits the applicability therefore to packaged or canned software which is defined to mean software developed to meet the needs of a variety of users and which is intended for sale or capable of being sold off the shelf. In contrast, the service tax provisions extend to services and not to goods. It is thus worthwhile to look at how the service tax was extended to software in general. The definition of information technology software services inter-alia extends to the following:
“Providing (this has replaced the earlier word
'Acquiring') the right to use information technology software for commercial exploitation including right to reproduce, distribute and sell the information technology software and the right to use software components for the creation of and inclusion in other information technology software products.” Consequently, the service tax extended to transfers of right to use such software.
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This would mean that if service tax were to apply in regard to providing the right to use information technology software, it would stand to reason that the tax would not apply in a situation of supply of tangible goods, which would not amount to a service at all.
It is against in this background that the government had amended the customs / excise tax laws in Budget 2009 to exempt such consideration as is attributable for the transfer of the right to use, reproduce etc. from excise / customs duties vide Notification No. 22/2009-Central Excise and Notification No. 80/2009-Customs respectively. Thus, packaged software or canned software are exempt from the above duties to the extent of the consideration paid or payable for the transfer of the right to use such software which should be for commercial exploitation including the right to reproduce, distribute and sell such software and the right to use the software components for creation of an inclusion in other information technology software products.
Coming back to the recent circular issued by the CBEC, it pertains to objections raised by the Customs Authorities in two different locations concerning the import of shrink wrapped software. In one of the locations (Mumbai), the Customs authorities had taken a view that the exemption would be available only if all the activities viz. the right to reproduce, the right to distribute, the right to sell and the right to use the software component for creation of an inclusion in other IT products were undertaken. On the other hand, in the other location (Chennai), the Customs authorities had refused to accept the split value (one value for media CVD and the other for right to use software) in a single invoice and had taken a view that CVD should be charged on the entire amount.
The Circular has provided a clarification that the objection raised by the Customs authorities in Mumbai is legally untenable as the phrase used in Notification No. 80/2009-Customs is inclusive in nature, and that the word ‘and’ is therefore to be understood as ‘or’ and hence even if one of the activities mentioned in the said inclusive portion is carried out, it would satisfy the condition of commercial exploitation making the import eligible for the benefit available under the aforesaid notification.
Further in case of imports in Chennai, the Circular has clarified that the benefit of the aforesaid exemption notification should be granted as the notification itself envisages splitting up of the value of the imported goods into one pertaining to software media and the other pertaining to the right to use, and hence there is no rationale for the department to deny the splitting up of the value unless there are reasons to believe that such splitting up has been done in order to evade payment of duty.
Indeed, the above clarification issued by the CBEC is a welcome step and would mitigate the double taxation in the domain of the federal laws to an extent, such as those between customs/excise and service tax.
The real and larger problem of double taxation of such software, to VAT as goods by the State Governments and to service tax as services by the Central government, continues to remain unresolved. It is hoped that the much awaited dual GST would resolve this long outstanding problem faced by the IT industry.
The author is Leader, Indirect Tax Practice, PricewaterhouseCoopers
E-mail: pwctls.nd@in.pwc.com