ET reports that the software industry has witnessed a 40 % drop in sales as a result of recently introduced taxation provisions. After the decision of the Supreme Court in Tata Consultancy Services v. State of Andhra Pradesh, (2005) 1 SCC 308, the sale of ‘branded’ software like Microsoft products has been subject to the sales tax/VAT regime, on the theory that when software is stored on a physical medium such as a CD, it satisfies the definition of ‘goods’ found in various sales tax laws. The other major form of software is ‘bespoke’ or ‘unbranded’ software, which is software specifically designed for one customer or corporation. In Tata Consultancy Services, the Supreme Court declined to determine this issue, and left it open, observing that although bespoke software is also goods, a transaction involving its use may well be a composite service contract and therefore outside the sales tax regime.
Over the last five years or so, the complex tax regime has resulted in several questions as to the overlapping of sales and service tax. Traditionally, sales tax was levied only on a transaction that satisfied three conditions – objective existence of ‘goods’, intention to transfer title in those goods, and actual transfer of title (State of Madras v. Gannon Dunkerley, AIR 1958 SC 560). This meant that State Governments could not levy sales tax on several ‘composite’ transactions, such as a works contract or a hire-purchase contract. Dissatisfied with this state of affairs, the 46th constitutional amendment was passed, which altered the definition of “tax on goods”, and specifically listed seven composite transactions as subject to sales tax. One of these is the “transfer of right to use goods”. This greatly expanded the range of transactions to which sales tax applied, and started to overlap with service tax and other legislations. Concomitantly, the Central Government expanded the range of transactions to which service tax applied, with each Finance Act adding a host of transactions to the list of taxable items.
Software is one area where there has been a head on collision. In the 2008 Budget, the Finance Minister added s. 65(105)(zzzze) to the Finance Act, which states that a service provided to any person in relation to information technology software for use in the course or in furtherance of business or commerce is a taxable service. The provision goes on to list specific items such as the acquisition of the right to use information technology which satisfy this definition and are consequently subject to the sales tax regime.
ET reports that the result is so-called ‘double’ taxation of branded software products – service tax when there is a download, and VAT when it is sold on a CD. This has evidently caused software prices to rise by 16 %. It is reported that CBEC is examining this issue, but that an amendment will not be possible until elections are completed.
This issue has not been settled in India, except for the decision in Tata Consultancy Services, which does not directly address the point. In England, the Court of Appeal held that a transaction where software is supplied on a physical medium such as a computer disk is a sale (St Albans City and District Council v. International Computers, [1997] FSR 251). In America, the position is not as clear, and there has been disagreement on whether it is subject to even sales tax. Some Circuit Courts have held that it is, while others have held that it is not, and no decision of the Supreme Court has addressed this point. A comprehensive account of this conflict is found in Yeh, 22 Berkeley Tech. L.J. 355 (2007).
With no clarity on the Indian position, it appears that the software industry will have to pay both service tax and VAT for the foreseeable future, with adverse consequences for consumers, developers. There is also the likelihood, as ET reports, of another increase in piracy rates as a result of the rise in costs.