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Applicability of VAT & Service Tax on Software

By CA Abhishek Malpani

4th March 2013

Applicability of VAT & Service Tax on Software

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 necessary 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
Honble 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 possess 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 customized, 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, excise duty and
the VAT.
Under the federal customs and excise law, information technology software and the related
paper license are typically exempt from customs and excise duties, other than
packaged/canned software 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
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Applicability of VAT & Service Tax on Software

By CA Abhishek Malpani

4th March 2013

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)
ii)

development, design, programming, customization, adaptation, upgradation,

enhancement, implementation of information technology software and
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 note issued by government on the
matter clarifies that every transfer of goods on lease, license 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 license to use software is a service or sale of goods, the test to be applied is
whether the grant of such a license tantamount 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.

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Bizsol
. partners in strategy

Applicability of VAT & Service Tax on Software

By CA Abhishek Malpani

4th March 2013

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.
As per guidance note issued by government, Definition of Transfer of right to use goods:
What is the meaning and scope of the phrase transfer of right to use such goods
Transfer of right to use goods is a well-recognized constitutional and legal concept. Every
transfer of goods on lease, license or hiring basis does not result in transfer of right to use
goods. Transfer of right of goods involves transfer of possession and effective control over
such goods in terms of the judgment of the Supreme Court in the case of State of Andhra
Pradesh vs RashtriyaIspat Nigam Ltd [Judgment dated 6/2/2002 in Civil Appeal no. 31 of 1991].
Transfer of custody along with permission to use or enjoy such goods, per se, does not lead to
transfer of possession and effective control. The test laid down by the Supreme Court in the
case of Bharat Sanchar Nigam Limited vs Union of India [2006(2)STR161(SC)] to determine
whether a transaction involves transfer of right to use goods, which has been followed by the
Supreme Court and various High Courts, is as follows:
There must be goods available for delivery;
There must be a consensus ad idem as to the identity of the goods;
The transferee should have legal right to use the goods consequently all legal consequences
of such use including any permissions or licenses required therefore should be available to the
transferee;

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Bizsol
. partners in strategy

Applicability of VAT & Service Tax on Software

By CA Abhishek Malpani

4th March 2013

For the period during which the transferee has such legal right, it has to be the exclusion to
the transferor this is the necessary concomitant of the plain language 91 of the statute, viz., a
transfer of the right to use and not merely a license to use the goods;
Having transferred, the owner cannot again transfer the same right to others.
Whether a transaction amounts to transfer of right or not cannot be determined with reference
to a particular word or clause in the agreement. The agreement has to be read as a whole, to
determine the nature of the transaction.
For more clear understanding, some FAQs on applicability of Vat & service tax on Software.
1. Whether Vat & service tax both are applicable for sale of software license?
Comment:
As per Sec 66E(f), purchase of license amounts to declared service. As per the definition of
Transfer of Right to use & case law of Bharat Sanchar Nigam Limited vs. Union of India
[2006(2) STR 161(SC)], when there is mere transfer of permission for the use of software
without transferring the control to transfer such license to third party then there is no transfer
of right to use & service tax will be applicable on such sale.
As per Maharashtra Vat provision, Notification VAT-1505/CR-114/Taxation-1, dated 1-6-2005
notifies a list of goods in which Item (5) reads Software Packages. As per Maharashtra state
government, sale of package software is sale of Goods & hence vat is applicable.
Central government has in Finance Act 2012 & in Guidance Note given the clarity on which type
of sale of software transaction service tax is applicable. But as per state government, on all sale
of software packages VAT is applicable even if Right to use characteristics is transferred or not.
2. Whether company can avail credit of service tax & vat paid on purchase of software license?
Comment:
Unit can avail the credit of service tax.
As per Rule 54(f) of M Vat Rules, Software packages are eligible for set off in the hands of trader
of software. So only trader of software can take the Vat credit on purchase of software.
3. What are remedies available to company in case they want to pay only service tax or vat?

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Applicability of VAT & Service Tax on Software

Bizsol

By CA Abhishek Malpani

. partners in strategy

4th March 2013

Comment:
Till now there is no specific judgment of High court & Supreme Court which gives clarity on
applicability of vat or service tax on sale of software. So company will have to go into litigation
for applicability of tax.
As companies are availing the credit of both vat & service tax, they do not go into litigation.
Summary of taxability of Information Technology Software
Category
Software

Excise Duty[ in case

Manufacture
in
India]

Custom Duty
[In case of
Imports]

Service Tax

VAT/ CST

Yes

No basic but
CVD and SAD

No

Yes

Packaged
software where
MRP not required

Excise duty on cost

of media

No basic but
CVD and SAD on
cost of media

Service Tax on
transfer
of
right to use
software

Yes

Tailor
software

No

No

Yes

Yes

No

No

Yes

Yes

No

No

Yes

NA to person
downloading
software

Packaged
Software
MRP

of

with

made

Paper License of
software and PUK
card
Software
downloaded on
internet form out
of India

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