| Software can broadly be categorised as 'packaged software' and 'customised software'. Packaged software is a mass-market product, typically available in shrink-wrapped, packaged form off the shelf in retail outlets. Customised software is tailored to the specific requirements of the customers for whom it is created. The Budget has inserted a new sub-clause (zzzze) in Section 65 (105) of the Finance Act in order to levy service tax on development of information technology software, thus bringing customised software on par with packaged software, in terms of taxation "" packaged software is chargeable to excise duty at the same rate of 12 per cent. The newly introduced definition is with regard to Information Technology Software Services. These have been exhaustively defined to inter alia include all activities in relation to conceptualising, planning, designing, advice, consultancy, development and implementation of software. |
| There are some concerns with regard to certain parts of definition and these will be taken up in subsequent analyses. The new development is, by and large, a positive step for the IT industry, and, in particular, for exporters of IT services as they would now be able to recoup their input service and excise taxes. |
| However, the extension of the service tax to customised software opens up interesting issues in relation to the State Value Added Tax (VAT). Certain States have classified software development as either 'goods' or as 'works contracts' under local VAT legislations. The States were apparently encouraged by the decision of the Supreme Court in the case of Tata Consultancy Services, where it had held that 'software on media' would be goods, as it met the requirements of abstraction, consumption, transmission, transfer, delivery, storage and possession etc., all of which were essential for a property to qualify as 'goods'. Although the Court did not make any specific observations on 'un-branded' or 'customised software', it implied that 'customised software' also met these requirements and would be subject to levy of VAT, as goods. However, with the classification of software development as a service, under service tax law, a new meaning has been assigned to the activity of software development. This has led to uncertainty as to which tax ought to apply on software development "" the goods tax in the form of VAT or the service tax. |
| It may also be noted that under the central excise and customs tariffs, software on media is classified as goods. Thus, both customised and packed software, if on media, will be classified as goods. It is true that customised software on media is exempt from duty at present but it does qualify as goods. Thus, by implication, only customised software that is not on media can be charged to service tax, as services. The point however is whether customised software, even if not on media, continues to be goods. |
| In this regard, the OECD Model Tax Convention Commentary states, that a transaction resulting in the acquisition of property should be understood to include a transaction where a digital product, whether provided on a tangible medium or in the form of a digital signal, is acquired by a customer'. Further, the Commentary states that, 'if one party engages another party to create an item of property that the first party will own from the moment of its creation, then no property will have been acquired by the first party from the other and the transaction should be characterised as the provision of services'. In the case of customised software, the originally developed software is arguably owned by the developer and not by the receiver of such software prior to transmission, and the consideration is towards the software and not towards the intellectual skills employed by the software developer. This is, of course, a purely factual point and there could be transactions where the consideration is indeed for services alone, based on a consideration of the underlying facts. |
| It is thus seen that the challenge is in relation to the taxation of customisation of software and its transmission to the client as digitalised content sent electronically. It appears now that in terms of the new provisions in service tax law, this transaction would be treated as services and charged to service tax. The States, which have proceeded to tax these transactions to VAT, will now need to assess whether they would continue to tax such transactions, as goods. What is clear in law is that the developer of customised software can only be required to pay either VAT or service tax, not both, as per the decision of the Supreme Court in the BSNL case. |
| The question is as to what is the appropriate tax to be charged in this regard. The problem is that both the State VAT authorities as well as the Central Government seem to independently deem the activity of software development as either goods or services, without incorporating provisions invoking a factual test. This real threat of double taxation of the activity of customised software development and electronic transmission needs to be immediately addressed. It will be even more interesting to see what will be the appropriate tax treatment of this activity under the dual GST regime that will likely be in force in 2010. |
| The author is Leader, Indirect Tax Practices PwC. |
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