Service Tax on I.T. Services - Trapping the Golden Eggs

[This article appeared in “Service Tax Today” Volume 14 Part 1 Page No. 1 dt. 2-5-2008]

(Part 2 of a series of 3 Articles)

Extension of Service Tax to Information Technology Sector – Trapping the Golden Eggs- II

by CA. Pradip R Shah

e-mail: pradip_shah@vsnl.com

1.0   Encompassing all the Aspects and Stages

An interesting aspect of the proposal to levy Service Tax (ST) on software has been referring to it as Information Technology Service (ITS) rather than software. As we have seen in detailed examination of S. 65(53a) (“Service Tax Today”, Volume No. 13 Part No. 8 dt. 25-04-2008) the scope for charging tax is much more than what may appear. There are various aspects and stages of ITS. Apart from developing the know-how i.e. software lot many activities goes into pre and post development and at installation stage. The proposal encompasses all these activities. As far as aspects are concerned, other issues emerging from these activities viz. management, testing, repairs and maintenance etc. are also brought within the net of taxation by carrying out various amendments. An attempt has been made here to discuss all the aspects involved therein. The basic issue regarding ITS lending into double taxation i.e. VAT and ST has not been covered here as it requires detailed discussion and will be covered in the third article of the series.

2.0   The Budget, 2008 carries the following proposal for charging ST on ITS.

Providing of services relating to Information Technology Software

After sub-clause (zzzzd), the following sub-clauses shall be inserted, namely:—

“(zzzze) to any person, by any other person in relation to information technology software for use in the course, or furtherance, of business or commerce, including,—

(i)     development of information technology software,

(ii)    study, analysis, design and programming of information technology software,

(iii) adaptation, upgradation, enhancement, implementation and other similar services related to information technology software,

(iv)   providing advice, consultancy and assistance on matters related to information technology software, including conducting feasibility studies on implementation of a system, specifications for a database design, guidance and assistance during the startup phase of a new system, specifications to secure a database, advice on proprietary information technology software,

(v)    acquiring the right to use information technology software for commercial exploitation including right to reproduce, distribute and sell information technology software and right to use software components for the creation of and inclusion in other information technology software products,

(vi)   acquiring the right to use information technology software supplied electronically;

2.1   As usual, it is quite lengthy and complex making it difficult to comprehend. Apart from that by referring to ITS, it extends to lengthy definition given u/s 53(a). It can be better appreciated only when both are read together. Since reading it in the text form will lead to more confusion, an attempt has been made hereunder to combine both in a tabular format to get some clarity.

Dissecting the Issue

3.0   The very basis of attracting tax is that the services related to ITS should have been provided to any person, by any other person in relation to information technology software for use in the course, or furtherance, of business or commerce. Experience has shown that levying tax on the basis of end-use raises hosts of new issues particularly tax administration. It is difficult to ensure compliance with such conditions giving rise to various legal issues. Now, as we all know ITS, apart from finding application in business or commerce, is also being bought and sold for ones personal requirements as well. Two examples of it will be sufficient to explain the complexity.

Mr. X buys anti-virus software from website of a developer based in Bangalore for his desktop. He is not carrying any business and has been using the computer system for personal requirements. The software bought permits Mr. X the right to use only. He is not permitted to copy or distribute it. In terms of clause (vi) acquisition of the right to use electronically is considered as rendering of service. The issue arises whether the developer of the software based at Bangalore will be liable for ST? How does he ensure that the ITS is for business or commercial uses? In order to lessen the tax burden, Mr. X would not like to pay 12.36% ST. He may also intimate it to the vendor / developer about not using for any business or commercial purposes. The real problem will arise for the developer / vendor of ITS as he will have to satisfy the ST Department about the end-use of the ITS. How will he ensure end-use of his products other than business purposes? Even assuming that a declaration is obtained from Mr. X a question will arise for which time frame it should be applicable? Should it be forever? If so, who will ensure its implementation?

Let us take another example.

Mr. I is an investor in shares and securities. For the purpose of carrying out analysis of movement in prices over long timeframe, has purchased software developed by M/s S Ltd. Since the liability to pay ST is on M/s S Ltd. how will it ensure that Mr. I is not carrying on any business or will not use it for carrying on business of trading in shares and stock? In the next year Mr. I convert his holding in shares of various companies into stock-in-trade and use the same software for trading activities. Mr. I have also contracted with M/s S Ltd. for up-gradation and maintenance of the same software. How M/s S Ltd. will ensure its application to personal use only by Mr. I?

3.1   The whole issue arises from the typical nature of ITS finding its application in the personal and business / commerce as well and its easy adaptability to either of them. Software finds its place in day-to-day life for personal use as well. Users are buying ITS related to Internet, antivirus utilities, software related to accounting, finance, investment etc It is for these reasons this is going to be the most taxing issue for the taxpayers and the ST Department equally.

3.2   Clause No. (i) to (vi) can be classified from various aspects as follow:

3.3   Pre-development Stage

(ii)           study, analysis, design …… of information technology software,

(iv)      providing advice, consultancy and assistance on matters related to information technology software, including conducting feasibility studies on implementation of a system, specifications for a database design, guidance and assistance during the startup phase of a new system, specifications to secure a database, advice on proprietary information technology software,

3.4   Development Stage

(i)          development of information technology software

(ii)         ………. programming of information technology software,

3.5   Installation Stage

(iii) adaptation, …… implementation and other similar services related to information technology software,

(iv)   providing advice, consultancy and assistance on matters related to information technology software, including conducting feasibility studies on implementation of a system, …….. guidance and assistance during the startup phase of a new system, ……..

3.6   Post-development Stage

(iii) adaptation, upgradation, enhancement, …… and other similar services related to information technology software,

(v)    acquiring the right to use information technology software for commercial exploitation including right to reproduce, distribute and sell information technology software and right to use software components for the creation of and inclusion in other information technology software products,

(vi)   acquiring the right to use information technology software supplied electronically;

3.7   As can be seen, drafting of the clauses is not on any predetermined methodology to cover all the aspects. There are clauses covering more than one aspect. In the same manner, a clause contains different services covering different aspects. Terms not applicable to a particular aspect has been deleted with the marking “….” to maintain the continuity.

Activities of Rendering the Services

4.0   Items No. 1 to 17 of the above table are clear case of rendering of the services. However, the more disturbing parts are item No. 18 to 23. Item No. 18 to 22 refers to acquisition of the right, sell etc. of IT’S A clear case of encroaching in the arena of VAT. To what extent this is within the provision of Article 366(29A)(d) of the Constitution is going to be a matter of debate. However, of all the most interesting, and unexpected item to be found is “acquiring the right to use ITS supplied electronically”. Clause (v) has taken care of acquisition of the right in an extensive manner. However, inclusion of clause (vi) shows over cautious approach to the whole issue. There appear to be a feeling somewhere in CBEC that mode of delivery may take out ITS from the purview of ST. In fact, the same clause could have been inserted as an Explanation at the end of the clause (zzzze). Its inclusion as item no. (vi) is baffling.

Contradictory Approach?

5.0   The Budget proposal carries insertion of new service called Supply of Tangible Goods without transferring Right to use the goods. Letter No. D.O. F. No.334/1/2008-TRU Dt. 29^th  February, 2008 explaining the provisions in this respect has to say as follow:

4.4 SUPPLY OF TANGIBLE GOODS FOR USE:

4.4.1 Transfer of the right to use any goods is leviable to sales tax / VAT as deemed sale of goods [Article 366(29A)(d) of the Constitution of India]. Transfer of right to use involves transfer of both possession and control of the goods to the user of the goods.

4.4.2 Excavators, wheel loaders, dump trucks, crawler carriers, compaction equipment, cranes, offshore construction vessels & barges, geo-technical vessels, tug and barge flotillas, rigs and high value machineries are supplied for use, with no legal right of possession and effective control. Transaction of allowing another person to use the goods, without giving legal right of possession and effective control, not being treated as sale of goods, is treated as service.

4.4.3 Proposal is to levy service tax on such services provided in relation to supply of tangible goods, including machinery, equipment and appliances, for use, with no legal right of possession or effective control. Supply of tangible goods for use and leviable to VAT / sales tax as deemed sale of goods, is not covered under the scope of the proposed service. Whether a transaction involves transfer of possession and control is a question of facts and is to be decided based on the terms of the contract and other material facts. This could be ascertainable from the fact whether or not VAT is payable or paid.

[Emphasis supplied]

5.1   The very first sentence recognises the right of the State Government in respect of taxability of the Transfer of the right to use any goods to sales tax / VAT as deemed sale of goods [Article 366(29A)(d) of the Constitution of India]. If that is the case, why is it that different treatment meted out to ITS? Why is it proposed to levy ST on acquisition of the right to acquire ITS? By its own admission CBEC states that “Supply of tangible goods for use and leviable to VAT / sales tax as deemed sale of goods, is not covered under the scope of the proposed service.”  If it so for all the tangible goods why not for ITS? How and in what respect they are different?

5.2   Contradiction can be seen in respect of another item as well. It is also proposed to insert the following clause:

‘Explanation.— For the removal of doubts, it is hereby declared that for the purposes of this clause,—

(a) “goods” includes computer software;

(b) “properties” includes information technology software

If for the purpose of Management, Maintenance and Repair Services computer software is goods and properties why should it not be extended to its logical end viz. applying the provisions relating deemed sales for right to use the goods?

Ancillary Amendments:

6.0   Explanation to management, maintenance or repair services has been amended. After the amendment it will read as follow”

(64)       “management, maintenance or repair” means any service provided by—

      (i)       any person under a contract or an agreement; or

      (ii)      a manufacturer or any person authorised by him, in relation to,—

          (a)      management of properties, whether immovable or not;

(b)      maintenance or repair of properties, whether immovable or not; or

(c)      maintenance or repair including reconditioning or restoration, or servicing of any goods, excluding a motor vehicle;

Explanation: For the removal of doubts it is hereby declared that for the purposes of this clause

a)         “goods” includes computer software

b)         “properties” includes ITS

Mark here the wordings computer software has been treated as “goods” while ITS has been treated as “properties”. However, the term computer software has not been defined. Secondly, unlike in the case of ITS there is no reference to use of the software in business / commerce. Does it mean that services like maintenance, repairs etc. to the software for personal use will be subject to ST?

Consulting Engineer Service

7.0   Clause relating Consulting Engineering Service is also proposed to be replace by a new clause. It reads as follow:

(105)      “taxable service” means any service provided or to be provided,—

 “(g) to any person, by a consulting engineer in relation to advice, consultancy or technical assistance in any manner in one or more disciplines of engineering including the discipline of computer hardware engineering.

Explanation.— For the purposes of this sub-clause, it is hereby declared that services provided by a consulting engineer in relation to advice, consultancy or technical assistance in the disciplines of both computer hardware engineering and computer software engineering shall also be classifiable under this sub-clause.”

One can appreciate the reference to advice etc. with respect to computer hardware engineering. However, reference to computer software engineering is perplexing. Is S65(105)(zzzze) not wide enough to cover the same? Was there any need to duplicate it?

Secondly, reference is to “computer software” without defining the same. As we have seen, definition of S. 65(53a) of ITS is much wider. What logic there can be using the term which has not been defined and not using the one which has been defined?

Technical Testing & Analysis

8.0   Amendment is proposed in Technical Testing and Analysis Service also by inserting the words ITS. After the amendment the said clause will read as follow:

(106)      “technical testing and analysis” means any service in relation to physical, chemical, biological or any other scientific testing or analysis of goods or material or information technology software or any immovable property, but does not include any testing or analysis service provided in relation to human beings or animals.

With the proliferation of application of software in various applications, it has assumed critical status. It has therefore become necessary to ensure that the final product is error free. Many software professionals have specialized in this area and started rendering exclusive services in the field of testing of software. Such services will be covered under this clause.

Technical Inspection & Certification

9.0   Services relating to Technical Inspection and Certification are proposed to be amended by inserting the word ITS. After the amendment it will read as follow:

(108)      “technical inspection and certification” means inspection or examination of goods or process or material or information technology software or any immovable property to certify that such goods or process or material or information technology software or immovable property qualifies or maintains the specified standards, including functionality or utility or quality or safety or any other characteristic or parameters, but does not include any service in relation to inspection and certification of pollution levels;

Conclusion:

10.0 The main source of inconsistency is that the Government has not relied on coherent policies or rationales in their approach to software taxation. Rather, it has been construed and classified in the manner most advantageous to its own coffer. The result is a hotch-potch of incongruous standards for tax treatment.

(To be concluded)