The Hindu Business Line : A bug in software service

SOFTWARE development has always been a priority area for the Centre. For the past several years, it has granted tax sops for software-related services. At present, work relating to software development enjoys service tax exemption.

This exemption was first granted through Notification No. 4/99-ST of February 28, 1999, under the category of `Consulting Engineer', which provided for exemption for services `in relation to computer software' provided by a consulting engineer.

Even while Notification 4/99 was in force, the Government granted exemption for `Information technology services' under business auxiliary services (introduced with effect from July 1, 2003).

On October 7, 2005, the Central Board of Excise and Customs (CBEC) issued Circular Number 81/2005 clarifying that based on the recent sales tax decision of the Supreme Court in the Tata Consultancy Services (TCS) case, services relating to maintenance of software would be subject to service tax. This circular is bound to be controversial, as the intention of the Government is not to levy tax on this activity and also because the legal position in the TCS case is different.

As this circular is based entirely on the apex court decision in the TCS case, it would be of relevance to look at the decision. The issue of whether branded software can be termed `goods' first came up before the Andhra Pradesh High Court in Tata Consultancy Services vs State of Andhra Pradesh (1997 105 STC 421) in 1996. The court examined various aspects and ruled that that branded software is `goods' and liable to sales tax.

The court did not decide the issue of whether unbranded software could be called `goods' even as it observed that unbranded software may perhaps be outside the ambit of `goods'. However, following this decision, unbranded software has been interpreted as not being `goods'. Most of the States introduced a separate entry for branded software in their respective sales tax legislation. Thus, branded software came into the sales tax net.

However, TCS took the matter on appeal to the Supreme Court in Tata Consultancy Services vs State of Andhra Pradesh. The apex court rendered a landmark decision on November 5, 2004, upholding the AP High Court ruling that branded software is `goods'.

More significantly, the Supreme Court also observed that unbranded software may be goods subject to certain other conditions being fulfilled.

During the course of delivering the judgment, the apex court observed that there was no distinction between branded and unbranded software and that the their characteristics were similar. However, after recording all of these points, the court specifically and categorically observed that the issue of whether unbranded software could be called `goods' was not before the court and that the issue has been left open. The relevant portion of the apex court's observation is as follows:

"However, we find no error in the High Court holding that branded software is goods. In both cases, the software is capable of being abstracted, consumed and used. In both cases the software can be transmitted, transferred, delivered, stored, possessed, etc. Thus even unbranded software, when it is marketed/sold, may be goods. We, however, are not dealing with this aspect and express no opinion thereon because in case of unbranded software other questions like situs of contract of sale and/or whether the contract is a service contract may arise."

Now, the issue is whether this Supreme Court pronouncement can be taken to mean that unbranded software is goods. It may be noted from the apex court's observations that unbranded software can be called goods only if certain conditions are fulfilled.

However, the CBEC Circular has presumed that in developing unbranded/customised software, the supplier develops the software and thereafter transfers the software so developed in a media and the media is taken to the customer's premises for loading in their system. On the basis of this wrong presumption, the circular goes on to conclude that unbranded software is goods.

Inasmuch as the Supreme Court had not held unconditionally that unbranded software would be goods, any decision based on these observations would not be in consonance with the apex court decision.

Also, it is a well-settled legal position that the views expressed by the Department through circulars cannot override the provisions contained in an Act. In this regard, a look at the definition of `Business auxiliary service' would be appropriate.

The relevant portion of the definition under Section 65 (19) of the Finance Act, 1944, reads thus:

`(19) "Business auxiliary service" means any service in relation to,... but does not include any information technology service...

"Explanation. — For the removal of doubts, it is hereby declared that for the purposes of this clause, (b) (a)... "information technology service" means any service in relation to designing, developing or maintaining of computer software, or computerised data processing or system networking, or any other service primarily in relation to operation of computer systems."

On a plain reading of this definition, it may be noted that the activity of `maintaining of computer software' would fall under the term `Information technology services' and the definition of `Business auxiliary service' excludes `Information technology services'.

Thus, any service relating to maintenance of computer software would clearly be out of the purview of service tax. If an activity is excluded from the coverage of tax under a particular taxable service through the Act, it is not open to the Department to tax the same under another category by issuing a circular.

Inasmuch as the circular goes beyond the provisions of the Act, it is in contravention of the legal principles. Of late, there have been a number of instances where the Department has issued circulars/clarifications in haste only to withdraw them in leisure.

This could be yet another instance where the Government would come out with another circular to clear the controversy.

(The author is a Chennai-based advocate)

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