Tinaz (132 Points)
10 June 2009Dear Friends,
Can anyone guide me on the following aspect of Service tax on software services.
Software sales are chargeable under VAT as goods, as also chargeable to service tax under Information Technology Software services. The vendor hence is charging both VAT & Service Tax. One commodity is being taxed twice. Can anyone guide on the correct treatment of taxes for such sales.
The following changes are being proposed in the Finance Bill, 2008 [refer clause 85 of the Finance Bill, 2008].
Kunal Baid
(Manager - Finance)
(24 Points)
Replied 10 June 2009
This article will help you
Hard battle for software
The issue of double taxation on software remains unresolved. The Union Budget 2009-10 did not mention it and now the political system is busy with the general elections. Nagesh M Joshi examines this issue and looks at why various industry participants are anxious about it
The timeline of Lok Sabha elections is out. Starting from April 16, 2009 (first date of Poll) to May 28, 2009 (last date of Poll Counting) the political and media fraternity of the entire nation will be interested only in one thing: election reports and analysis. It goes without saying that all other issues, no matter how pertinent they may be, will have to wait. This includes the stinging issue of double taxation faced by the domestic software industry.
ISODA, the apex body representing India’s software resellers, has taken a legal route to resolve it, but the road to resolution looks rough.
The issue
It is simple to understand but its impact is complex and far-reaching. Today every sale of a packaged software product attracts multiple taxes simultaneously: value added tax and service tax (and in some cases, excise/ CVD). As both these are indirect taxes, the end-customer has to shell out more money for the same amount of software.
Satej Revankar, Associate VP - IT, Nitco Tiles described the impact aptly saying, “Since last year, the money we have had to shell out for buying the same amount of software has gone up. This hurts, especially during a slowdown when our budgets are already tight.”
Arun Gupta, Customer Care Associate & Group CTO, Shoppers’ Stop said, “The issue of double taxation on software purchases is serious. Enterprises do not buy software in small chunks. When the cost of purchase of such large orders goes up, it adversely impacts our purchasing ability.”
Satyanarayan B, CIO & Vice President, Dimexon Diamonds gave another perspective, “It is not only about a hike in the cost of buying software. There is a huge amount of confusion in the market. No two vendors will give you the same story. Some will tell you that service tax is applicable and some will say it is not. Some will say that CVD is applicable as well. We are clueless. This uncertainty impacts our project investment decisions.”
| How is software sold? |
| To understand the issue in its totality, one must first know the various ways in which software is sold.
|
The problem
Last year’s Budget included the sale of software in ‘downloaded format’ and the ‘customized software’ under service tax leviable at the rate of 12.36%. There was no confusion till the implementation of Budget recommendations on May 16, 2008. However, from this date, the tax authorities started levying service tax even on ‘packaged software’ which, till then were regarded as a ‘good’ rather than a ‘service’.
At the root of the issue, lies the debate about classification of ‘packaged software’ as a ‘good’ or a ‘service’. In the box How is software sold? we have explained how the new government rules have started considering ‘packaged software’ as both owing to different methods of delivery present in the market today.
As we see in method 2, 5, and 6 (as shown in the box), the packaged software is regarded as a ‘good’ as well as a ‘service’. As a result, the product attracts all taxes: (Excise / CVD) + Service Tax + VAT + local taxes viz. Octroi.
To give an idea about the lethality of the impact, if a product originally priced at Rs 100, the customer in Mumbai may end up paying
Rs 197.98 for it due to taxes imposed at every level of transaction (See table: The punitive purchase). Please note, while presenting this structure, we have not rounded off the figures. If they are rounded off, the impact on customer will look worse.
There is also a new debate about what piece of software can be considered as a ‘service’ and what qualifies as a ‘good’.
Explained Paras Shah, CEO, Neoteric Infomatique, a leading national distributor, “Some applications although loaded on the client’s systems, need to access the vendor’s server resources for their effective functioning. For example, security software is useless if the definition database is not updated regularly. In other words, the software is unusable without the ‘service’ from the software vendor’s server. The government officials may take a view that such a software product should be qualified as a service rather than as a good.”
Shah goes on to state that the authorities must issue comprehensive guidelines clarifying the classification of products and the way different taxes must be levied on every sales transaction. “Only that can remove the confusion in this matter,” he said.
According to Pradeep Nair, Director - Software Group, IBM India, there also are issues on the constitutional validity of double taxation on software. As per the constitution, multiple taxes may not be levied on the same product qualifying it as good as well as service at the same time. He added, “In these tough financial times, the double taxation of software licenses is one of the major factors impacting the purchase decisions of the clients. Given the dual levy, IBM has been involved in various discussions with customers, explaining to them the tax positions taken by IBM on software licenses.”
The service tax consultant and Chartered Accountant Rajiv Luthia of RPJ & Associates pointed out the contradiction: “There is a great amount of confusion about the interpretation of tax rules with regards to information technology software. As per the VAT administrations of the state governments, packaged software is a good and therefore, leviable under VAT. However, according to Service Tax Department, it is regarded as a service. As per the Constitution the same product cannot be classified as service and good at once.”
As a result of a new tax, the financially hard-pressed customers have started either postponing their purchases or reducing their order volumes. Observed Chintan Thakkar, Chief Finance Officer, Computer Associates, “The additional levy of service tax on top of the existing taxes is badly impacting their purchasing power. Many customers have withheld their purchase decisions on this account.”
The box, The root cause, throws some light on how the new definitions issued by the government have led to the confusion with respect to tax on software sales.
| The punitive purchase | ||
| Steps involved | Price in rupees | |
| Original value | 100 | |
| CVD ** | 12% | i.e. Rs 12 |
| Price after CVD | 112 | |
| Service tax | 12.36% | i.e. 13.84 |
| Landing price | 125.84 | |
| Distributor margin | 5% | i.e. Rs 6.29 |
| Distributor price | 132.13 | |
| Distributor service tax | 12.36% | i.e. Rs 16.33 |
| Price after Distributor ST | 148.46 | |
| Distributor VAT | 4% | i.e. Rs 5.94 |
| Price to the reseller | 154.4 | |
| Reseller margin | 5% | i.e. Rs 7.72 |
| Reseller price | 162.12 | |
| Reseller service tax | 12.36% | i.e. Rs 20.04 |
| Price after Reseller ST | 182.16 | |
| Reseller VAT | 4% | i.e. Rs 7.29 |
| Price after Reseller VAT | 189.45 | |
| Octroi (if applicable) | 4.50% | i.e. Rs 8.53 |
| Price to the customer | 197.98 | |
| ** If imported under section 8523 8020 of Customs Tariff Act | ||
Plight of the resellers
The problems faced by the reseller community are worse. Typically, software is imported by distributors on behalf of vendors who develop these packages. The distributors then sell these products to the resellers who then resell them to the customers. In effect, a reseller first pays the money to the distributor and later collects payment from the customer. In most cases, it’s the resellers who generate leads, ensure proper documentation, collection, and close the deals.
Till recently, few distributors delivered service tax paid software packs to the resellers. As a result, since they could not have claimed ST refund, even resellers could not add service tax component to the invoice values. However, with the new notification issued by the government, many customers started deducting 11.33 per cent as TDS (tax deducted at source) from the order values before making any payments to the reseller. Result: A net loss suffered by the resellers in the whole transaction.
To understand the situation, refer to the table Reseller’s Plight. Compare it with the table The Punitive Purchase. Instead of charging Rs 197.98 to the customer, the reseller charges Rs 139.57 and ends up earning Rs 106.51. Effective loss: Rs 21.91 or 17.06%.
Commented Sujit Mohanty, Associate VP & Director, Sonata Information Technology, “Many of our customers have postponed their purchase decisions indefinitely. Some have reduced order volumes. But even when we manage to sell, it’s a death knell for software implementation players like us. We are destined to lose money rather than earning it in every deployment.”
To fight these issues, close to a hundred software resellers have come together and formed an association, Infotech Software Dealers’ Association (ISODA). The association’s Chairman, Rajesh Kothari informed, “If you consider that ISODA members control more than 60% of the total software sale that happens in the country, you would know the scale and the gravity of the problem.”
As a remedial measure, ISODA has been speaking to various industry bodies like CII and Nasscom in addition to software vendors and distributors to ensure that the anomalies in the taxation are removed immediately.
| The root cause |
| The confusion and contention with regards to tax on sale of packaged software started when new definition of information technology software as a taxable service was added to service tax rules.
As per section 105 (zzzze), a taxable service means any service provided or to be 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, including, i. development of 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 creation of and inclusion in other information technology software products, vi. acquiring the right to use information technology software supplied electronically The above definitions squarely cover packaged software sold in the form of paper license as a service regardless whether the delivery happens through a media pack or internet download. This is happening even when the same software sale. Moreover, it is another debatable issue if the activity of development of information technology software itself is regarded as a taxable service by the authorities even when there is no direct sale of the software. In such a scenario, even the bundled or preloaded applications as under OEM licenses also become liable under service tax. |
| Resellers’ plight | ||
| Steps involved | Price in rupees | |
| Original value | 100 | |
| CVD ** | 12% | i.e. Rs 12 |
| Price after CVD | 112 | |
| Distributor margin | 5% | i.e. Rs 5.60 |
| Distributor price | 117.6 | |
| Distributor VAT | 4% | i.e. Rs 4.70 |
| Price to the reseller | 122.3 | |
| Reseller margin | 5% | i.e. Rs 6.12 |
| Reseller price | 128.42 | |
| Reseller VAT | 4% | i.e. Rs 5.14 |
| Price after Reseller VAT | 133.56 | |
| Octroi (if applicable) | 4.50% | i.e. Rs 6.01 |
| Price to the customer | 139.57 | |
| TDS | -11.33% | i.e. - Rs 15.81 |
| Payment after TDS | 123.76 | |
| Claim by Service Tax Department | 12.36% of sales value | i.e. Rs 17.25 |
| Reseller's revenue *** | 106.51 | |
| Reseller's profit *** | -21.91 | or -17.06% |
| ** If imported under section 8523 8020 of Customs Tariff Act | ||
| *** Assuming that there is no penalty imposed by the Service Tax Department | ||
| Some early developments |
| Since July last year, various customer organizations as well vendors and resellers approached the Central Board of Excise and Customs seeking clarification on the issue of double taxation. For quite some time there was no response. However, of late, the Service Tax Department has started replying to these queries.
Recently, a software implementation company (name withheld on request) approached the Commissioner of Service Tax, Bangalore questioning whether service tax would be applicable on purchase of Microsoft’s products under Open License Policy (wherein small quantities also enjoy special pricing of the vendor) which are CVD-paid. In its letter—Express Computer has a copy—the company informs that these products were already CVD-paid as they were classified under 8523 8020 of Customs Tariff Act. The letter goes on to mention: “... 5. When we buy these licenses from these importers, they do not charge any Service tax. They charge VAT on the sale of paper license. Further, they also specify the amount of customs duty paid in the bill... 8. With the introduction of service tax on information technology software, we would like to know whether the sale of MOLP will be liable for service tax in our hand? We further state that our distributor is not charging any service tax on the same as it has been considered as “goods” by the customs and hence appropriate duty of customs has already been paid. Further, when we resell the same, we will also be charging VAT on the full value of MOLP. 9. We understand that if VAT is paid on the whole value of the goods, there should not be any service tax on the very same amount...” In its reply the Office of the Commissioner of Service Tax, Bangalore (EC has a copy) states: “... It may please be noted that Software License Fee is taxable under category of “Information Technology Software Service” with effect from 05/08. As per the definition of the said service, among other things, the same includes — Acquiring the right to use: i. IT software for commercial exploitation including right to reproduce, distribute, and sell It is seen from your letter that License Fee is paid to access/ copy and use the software and hence, the activity is to be treated as service. Both, your distributor as well as your company are liable to pay the service tax on Licenses Fee charged and at the time of import also the service tax liability is on the Recipient of Service...” The letter is signed by Dr. P Ravindra Babu, Joint Commissioner (Tech). Express Computer also learnt that in some cases, the service tax authorities have also started serving notices for non-payment of service tax to some reseller and distributor organizations. |
Role of industry participants
In its statement to Express Computer, Microsoft mentioned “Till recently, packaged software was treated only as a good, and taxed accordingly (subject to excise duty and VAT). The introduction of taxable service category called “IT Software Services” with effect from May 16, 2008 has created some ambiguities on tax structure applicable for packaged software which can amount to its double taxation. We and the IT industry at large continue to provide our inputs and engage with the Government directly, and through industry forums such as Nasscom, to seek further clarity.”
Symantec too issued a similar statement. It said, “The entire double taxation issue goes against the grain of single instance taxation policies and we feel it stems from different interpretations of the same thing. As a result, not only does this impact financially, but also from a process perspective, lot of time is being spent by customer, partners and distributors on this issue. It would be really good for the industry to get this behind us and the government needs to bring clarity and transparency in this aspect.”
Observed S Krishnan Thyagarajan, Managing Director, Quest Software India, “There continues to be a lot of confusion in the market with regards to interpretation of tax rules even today. Some entities are bringing in packaged software by paying CVD while some others are not paying it. There is also confusion about whether TDS is deductible or not. All this is only leading to reduced sales for software companies and losses for resellers.”
The software reseller body, ISODA has now initiated a legal battle to resolve this issue in its favor. It has filed a case against the Service Tax Department in Madras High Court and submitted all the necessary documents to the Court. The Court has now asked the Service Tax Department under Central Board of Customs and Excise to present its defense in front of the Court.
Earlier, ISODA formed a Task Force to intensify its educational and lobbying efforts to get rid of double taxation. According to a source from a top Indian software company, Nasscom had forwarded its recommendations to the Finance Ministry but failed to get any response from the government.
As it appears, it is a long road ahead for the entire domestic software industry. Till then, all the stakeholders, especially the customers and resellers will have to shell out more money in every software transaction.
Madhukar N Hiregange
(Chartered Accountant)
(39034 Points)
Replied 11 June 2009
The matter has been created by the deifntion given to ITSS services made liable to tax from May 2008.
The entry goes against the decision of the SC in TCS case where they clearly laid down that s/w is good and therefore the question of charging VAT is beyond doubt.In my opinion the ST on the same transaction should not be attracted.
However disputes in this reagrd are expected. It would have been ideal that the definition of ITSS was modified. Hopefully in this budget.
GSTR 9 and 9C for FY 23-24 as amended by Notification 12/2024 dated 10th July 2024(with recording)
CAclubindia
