The Hindu Business Line : When milk mixes with water, won't software merge in hardware?

THE ACER India case that was decided by the Supreme Court on September 24 was about a simple dispute: When you load software onto a computer, does it become part of the hardware? If that sounds like a powerful Zen question, you are not alone; the Excise Department was in a similar predicament.

The more it saw the fully loaded hard disks of Acer's computers, the more it felt that the company should be paying Excise Duty on the full value of hardware, as enhanced by the software put in.

Earlier, the Bangalore tribunal had relied on a 1997 decision of the Supreme Court in PSI Data Systems and held that no Excise Duty was payable on software so loaded. However, in February 2004, a Division Bench of the apex court had doubted the correctness of the PSI decision, and said: "The computer would otherwise be a dead box, if software, without which the computer cannot work, is not purchased... It appears to us that the price of such software is thus includable in the value for purposes of excise duty." Thus, the Department's case against Acer landed up at a larger Bench of the apex court for remedy.

Justices N. Santosh Hegde, S. B. Sinha and Tarun Chatterjee heard the case, even as Mr A. Subba Rao argued for the Department, and Mr V. Lakshmikumaran, for Acer. The company used to load `operational software' on orders received from customers.

For computing Excise Duty, Acer deducted the value of operational software from the total value of the computer supplied to the customers. Excise officials objected, saying that duty was payable on the entire value of the computer, including the value of operational software.

In 2002, the Department demanded the differential duty of about Rs 1 crore, saying the loading of software in the factory came "within the mischief of `transaction value' of the computer in terms of Section 4 of the Central Excise Act, 1944 with effect from April 1, 2000, having regard to the expressions `by reason of sale' or `in connection with the sale' as contained in the definition thereof."

Mr Rao contended that operational software "implanted in hardware" became part thereof. The company was preloading software on computer before clearing the same from the factory, and so Excise Duty would be payable on the entire value thereof, he said. On the other side, Mr Lakshmikumaran submitted that software "implanted on specific orders placed by customers" retained "the characteristics of software", and would not lose such identity "only because the information contained therein together with the right to use the same" got implanted in the computer itself.

Duty was leviable under different headings for hardware and software, he pointed out. For software, duty is nil, and so "the assessee was entitled to claim deduction of the value thereof from the total value of the computer", he reasoned.

To solve the case, the court referred to dictionaries for the meaning of terms such as application program, firmware, operating system and so on. The judgment also refers to `flash memory chip' and `the Electrically Erasable Programmable Read Only Memory (EEPROM)' on which `Basic Input Output Software is etched'.

"As is the general practice in the computer industry, the value of the firmware etched on to the EEPROM is always included in the assessable value of the computers," the court observed.

Customers can purchase the operational software separately and do the loading themselves. However, "while construing a taxing statute, the existing market practice may also be taken into consideration." The court said that the statue should be interpreted in a user-friendly manner so as not to lead to wide-scale evasion of duty.

"If any other interpretation is made, the same would encourage the manufacturers to sell the operational computer separately as a result of which the buyers may have to incur extra charges. The customers, thus, may not be able to get the benefit of the information contained in the operational computer loaded in the factory. Furthermore, it may encourage in loading of pirated software in the computer."

Section 3 of the Central Excise Act is the charging provision, said the court. Accordingly, duty "shall be levied on all excisable goods". Section 4 speaks of transaction value, where the expressions `by reason of', and `in connection with the sale' have been used. But "a machinery provision contained in Section 4 and that too the explanation contained therein by way of definition of `transaction value' can neither override the charging provision nor by reason thereof a `goods' which is not excisable would become an excisable one only because one is fitted into the other, unless the context otherwise requires," ruled the court.

Again, "it must be borne in mind that Central Excise Duty cannot be equated with sales tax. They have different connotations and apply in different situations." Thus, `goods' that are not excisable, if transplanted into something which is excisable would not together make the same excisable goods "so as to make the assessee liable to pay excise duty on the combined value of both". This struck at the Department's contention.

Towards the end, the judgment mentions that accessories of a machine promote the convenience and better utilisation of the machine but nevertheless they are not machine itself. Computer and software are distinct and separate. "Although a computer may not be capable of effective functioning unless loaded with software, the same would not tantamount to bringing them within the purview of the part of the computer." Operational software does not lose its value and is still marketable as a separate commodity, said the court. "A licence to use the information contained in a software can be given irrespective of the fact as to whether they are loaded in the computer or not."

The judges said that the order did not consider "the larger question as to whether information contained in a software would be tangible personal property or not, or whether preparation of such software would amount to manufacture under different statutes."

An Excise decision that belongs to the new economy, one may say. The Department's logic may yet find an application in what a milkman does when passing off a diluted product to his customers.

Tailpiece

"I paid sales tax for worms in the packed chocolate!"

"Oh, I got an Excise Duty demand for viruses that went from my factory computer!"

Detaxification@TheHindu.co.in

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