Cover story of Service tax on Software

Taxable services need precise descripttion

States demand sales tax/VAT and the Centre wants service tax on the same transaction and on the same consideration.

THE LAW providing for a levy of service tax apparently seeks to tax services received and consumed outside India. (This was substantiated in the earlier part of this article in these columns on January 16.) In other words, an Indian law seeks to tax services that have no nexus whatsoever to Indian territory.

Some examples of services provided for Indian parties by a non-resident outside India and consumed outside India are:

Indian company appointing an agent for sales promotion in the U.K.

Indian company engaging a management consultant in the U.S.

Branch in New York engaging an architect for constructing a building in Cincinatti.

Construction company engaging an engineer in China for work at a Chinese site.

Branch in Germany booking air tickets through an agent in Germany for employee travel to London.

Project office director stationed in France getting his car serviced in France.

Banking services availed in a foreign country.

Liaison office in Japan engaging security services.

IT company in India enrolling all its senior managers working in the U.S. at a fitness centre in that country.

Pre-shipment inspection carried out by foreign agencies prior to import into India.

The list is endless. What is adding insult to the injury is a requirement that the service receiver register himself under the category of service provided by the service provider. In other words, the IT company, which enrolls its executives in a fitness centre in the U.S. will have to register itself under the category of `Health Club and Fitness Centre Services'.

The moot question therefore is whether an Indian law can impose tax on a transaction between two parties completely outside India when there is no nexus to India.

The Privy Council in the case of Wallace Vs. CIT (16 ITR 240) has held that where there is sufficient territorial connection or nexus between the person sought to be charged and the country seeking to tax him, the tax can extend to that person in respect of his foreign income.

The Supreme Court in the case of Hoechst Vs. State of Bihar (154 ITR 64) has held that the connection must be a real one and the liability sought to be imposed must be pertinent to that connection.

The Supreme Court in the case of Electronics Corporation Vs. CIT (183 ITR 43) has held that unless nexus exists, Parliament has no competence to make law. Article 245(1) empowers Parliament to enact laws for the whole or any part of the territory of India. The provocation for the law must be found within India itself. Such a law may have extra territorial operation in order to observe the object and that object must be related to something in India

Software maintenance

The Board vide Circular dated October 7, 2005 has clarified that service in relation to maintenance or repair or servicing of software attracts service tax under the category of maintenance or repair.

It has clarified that the circular is being issued taking into account the Supreme Court judgment in the case of Tata Consultancy Services Vs. State of Andhra Pradesh. In fact, the Supreme Court in the case of Tata Consultancy Services (2004) 178 ELT 22, at Para 26 has observed as under:

"Thus, even unbranded software, when it is marketed or sold may be goods. We however are not dealing with this aspect and express no opinion thereof because in the case of unbranded software other questions like situs of contract of sale and/or whether the contract is a service contract may arise."

A reading of this para would show that the Supreme Court did not give any specific finding on the taxability of unbranded software or the nature of unbranded software since it was not an issue before the Court and there are other questions that would arise in respect of unbranded software. However, the Board has concluded that the Supreme Court has held that even unbranded software is `goods'.

Further, the Circular appears to be in conflict with the provisions of the Statute. "Software maintenance" has been given a special treatment and is considered an Information Technology service and expressly excluded from the ambit of business auxiliary services.

The Explanation to Section 65(19) reads as under:

"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.

Parliament in its wisdom has excluded information technology services from the family of business auxiliary services and has also defined information technology services.

Classification of services

Section 65A of the Finance Act, 1994 deals with classification of services and the first rule of classification is that a specific descripttion should be preferred to a general descripttion. Accordingly, information technology service is a specific descripttion for maintenance of software or repair of software and the appropriate category would be Business Auxiliary Services and the exclusionary benefit set out in 65(19) is squarely applicable. The circular has created a lot of confusion in the IT industry.

Viewed from another angle, maintenance of a software will also mean development of new modules or layers, which are given out to the customer as patches.

IPR — sale or service ?

There is a service tax on intellectual property service. Intellectual property service in terms of Section 65(55b) of the Finance Act, 1994 means (a) transferring temporarily; or (b) permitting the use or enjoyment of intellectual property right.

Intellectual Property Right as per Section 65(55a) means any right to intangible property, namely, trademarks, designs, patents, or any other similar intangible property, under any law for the time being in force but does not include copyright.

Therefore, where a person is allowed to use an intellectual property right for consideration, the said transaction attracts service tax. The same transaction and the same consideration attracts sales tax or VAT.

The Madras High Court in the case of A.V. Meiyappan (1967) 20 STC 115 has held that copyright is in the nature of incorporeal movable property and hence goods. The Supreme Court in the case of H.Anraj Vs. Govt of Tamilnadu (1986) 61 STC 165 has held that lottery tickets are goods liable to sales tax.

The Supreme Court in the case of Vikas Sales Corporation (1996) 102 STC 107 has held that the expression property has been uniformly understood in an expansive manner and signifies things and rights considered as having money value.

The Madras High Court in the case of SPS Jayam (137 STC 117) has held that royalty for allowing use of trademark attracts sales tax. Entry-46, Part-B of the First Schedule to the TNGST Act covers "Patents, trademark, import licenses, exim scrips, export permits or license or quota and other goods of incorporeal or intangible character."

The industry is in a quandary since the States demand sales tax / VAT and the Centre demands service tax on the same transaction and on the same consideration.

When something is considered as goods and taxed as goods by the State in exercise of the powers available under Entry-54, State list, Seventh Schedule to the Constitution of India, the question is whether the same can be taxed as a service by the Centre in exercise of residual powers available under Entry-97 of the Union List. Views can emerge only after seeing the decision of the Supreme Court in a batch of cases involving telecom service providers, which was heard recently.