9911796707
TMI Blog2015 (9) TMI 738X X X X Extracts X X X X X X X X Extracts X X X X ..... n the alternative, to declare that Section 65 (105) (zzzze) of the Finance Act, 1994, to the extent it seeks to levy service tax on implementation, customization and other support services, if treated as a sale, as being ultra vires Articles 246 and 265 read with Entry 97 of List I of the Seventh Schedule to the Constitution; and (d) for a direction to respondent Nos. 4 and 5 to refund the entire service tax paid by and collected from the petitioner and other consequential reliefs. Though in the Writ Petition they have challenged the validity of Section 3 of the KVAT Act as well as Section 66 read with Section 65 (105)(zzzze) of the Finance Act, 1994, no arguments were addressed on the constitutional validity of the said provisions. Therefore, it is not considered. FACTS IN BRIEF: 2. The assessee is a Company incorporated under the provisions of the Companies Act, 1956 and is engaged in the business of development and sale of information technology related services like customization of software, implementation of software, annual technical and support services, trading/support services of third-party software besides providing services and other related technical consultancy a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... dent activities and cannot be clubbed together. Many a time, the customer chooses the petitioner to provide the services of implementation. In such a case, the petitioner enters into separate agreements - one for sale of Finacle and the other for provision of implementation services. Where the implementation is undertaken by the petitioner, the petitioner sets up a project implementation team comprising of both the petitioner's employees as well as customers' employees. The project implementation team ensures that Finacle is integrated into the customers' IT environment. The process of implementation does not entail development of any new software or upgradation of the existing software. 5. Apart from the above activity of development and sale of its own software and services, the petitioner also purchases and sells third-party software and provides implementation and other support services for such thirdparty software. The petitioner also provides annual technical support services which may involve some amount of transfer of property in goods. The petitioner also provides other services like training, installation, customization, online software support services, tech ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ined the books of accounts and the activities of the petitioner in detail and with particular focus on implementation services, claimed as exempt by the petitioner, and passed two orders dated 23-02-2007 under Section 38(1) of the KVAT Act for the tax periods June 2005 to March 2006 and April 2006 to December 2006 respectively. In the said orders, the ACCT (LDU) discussed in detail the implementation services provided by the petitioner and accepted that the said activity is a pure service without any element of sale or transfer of property in goods and consciously allowed the exemption claimed by the petitioner on the turnover relatable thereto. 9. It is thereafter for the first time, on 13-03-2009, the Assistant Commissioner of Commercial Taxes (Enforcement- 7), South Zone, Bangalore, visited the petitioner's place of business and thereafter issued a notice dated 17-04-2009 under Section 52 of the KVAT Act contending that the sale of Finacle by the petitioner is nothing but a sale of software license and since software licenses were inserted in Serial No.34 of the Third Schedule to the KVAT Act, with effect from 01-04-2007, the petitioner was liable to pay the higher rate of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... oftware and not sale of software licence as contended by the revenue and, therefore, the authority was wrong in levying higher rate of tax. It further held that implementation service does not involve any transfer of property in goods and, therefore, not liable to tax under the KVAT Act. The Tribunal followed its earlier judgment rendered in the case of IBM India Private Limited. At that stage, the request of the State that they should be given an opportunity to examine the implementation service agreements was acceded to and the Tribunal remanded the matter back to the assessing authority as they were passing an order of remand on the question of disallowance of input tax credit. The assessing authority was directed to examine the issue strictly in light of its earlier judgment in the case of IBM India Private Limited. Thereafter, notice came to be issued under Section 39 of the KVAT Act and Section 9(2) of the CST Act. The petitioner filed its objections to the notice. After hearing the parties, the assessing authority rejected the petitioner's claim for exemption on implementation charges on an entirely new ground that the said activity is nothing but a value addition to Fin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e of the works contract, if any, up-gradation, enhancement is done, the copyright vests with the assessee. The customer is only entitled to the right to use the said software. 12. If the packaged customized software is delivered to the customer, the customer has option of utilizing the service of the assessee or any other person in the field for implementation of the contract. What is required in the said implementation is to evaluate the skill to integrate several other softwares including finacle- the software belonging to the assessee, the right to use of which is transferred. It is not a pre-sale activity, it is a post-sale activity. Clause 3 of the agreement makes this position clear. At the time of implementation of the contract, there is no transfer of any goods. Even in that process if any software emerges the said software ownership vests with the customer. Therefore, there is no transfer of right to use as the customer owns the said software. Therefore, it is a contract of pure service and no sale aspect is involved in this contract. The entire consideration received in the course of the implementation of the contract is subjected to service tax and tax is paid. Therefor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nents of transactional value should be considered as sale consideration and it should be subjected to tax under VAT. In fact customization involves service. It is only after the service is rendered, it becomes a customized product i.e., goods which is marketable, usable, functionable and therefore, transferable, whereas the service rendered is immaterial and therefore, he submits that unless the goods are customized it is not usable and therefore, the consideration paid for customization is subject to VAT. Whether the assessee calls it as implementation of the contract or customization or improved enhancement, it is immaterial. It is the substance of the contract, which has to be taken note of and, therefore, he submits that the order passed by the Assessing Authority is in accordance with law and does not call for any interference. 14. Sri. G. Rajagopalan, the learned Senior counsel appearing for Union of India submitted that while considering what constitutes goods the definition of the 'goods', as contained in Article 366 (12) of the Constitution of India, alone is the criteria and the definition of 'goods' in the VAT Act cannot be looked into and, therefore, he ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ied upon several judgments of the Apex Court as well as this Court in support of their respective contentions. The law relating to taxability of software is now fairly well settled. 17. The Constitution Bench of the Apex Court in the case of TATA CONSULTANCY SERVICES VS. STATE OF A.P. reported in (2005) 1 SCC 308 has held as under:- "19. Thus this Court has held that the term "goods", for the purpose of sales tax, cannot be given a narrow meaning. It has been held that properties which are capable of being abstracted, consumed and used and/or transmitted, transferred, delivered, stored or possessed, etc., are "goods" for the purposes of sales tax. The submission of Mr. Sorabjee that this authority is not of any assistance as a software is different from electricity and that software is intellectual incorporeal property whereas electricity is not, cannot be accepted. In India the test to determine whether a property is "goods", for purposes of sales tax, is not whether the property is tangible or intangible or incorporeal. The test is whether the item concerned is capable of abstraction, consumption and use and whether it can be transmitted, transferred, delivered, stored, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... which customs duty could be levied. 34. The decision of Winter v. Putnam case (938 F 2nd 1033 (9th Cir 1991) is also of no help to the appellants as in that case it was the quality of information regarding mushrooms which was not regarded as a product even though the encyclopaedia containing the information was regarded as goods. Here we are not concerned with the quality of information given to the appellants. The question is whether the papers or diskettes etc. containing advice and/or information are goods for the purpose of the Customs Act. The answer, in our view, is in the affirmative. 41. Significantly Chapter 49 also includes items which have substantial intellectual value as opposed to the value of the paper on which it is put. Newspapers, periodicals, journals, dictionaries etc. are to be found in Chapter 49 wherein maps, plans and other similar items are also included, while Chapter 97 talks about original engravings. It is clear that intellectual property when put on a media would be regarded as an article on the total value of which customs duty is payable. 42. To put it differently, the legislative intent can easily be gathered by reference to the Customs Valuat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tual input. What is being taxed under the Customs Act read with the Customs Tariff Act and the Customs Valuation Rules is not the input alone but goods whose value has been enhanced by the said inputs. The final product at the time of import is either the magazine or the encyclopaedia or the engineering drawings as the case may be. There is no scope for splitting the engineering drawing or the encyclopaedia into intellectual input on the one hand and the paper on which it is scribed on the other. For example, paintings are also to be taxed. Valuable paintings are worth millions. A painting or a portrait may be specially commissioned or an article may be tailor-made. This aspect is irrelevant since what is taxed is the final product as defined and it will be an absurdity to contend that the value for the purposes of duty ought to be the cost of the canvas and the oil paint even though the composite product, i.e., the painting, is worth millions. 45. It will be appropriate to note that the Customs Valuation Rules, 1988 are framed keeping in view the GATT protocol and the WTO agreement. In fact our rules appear to be an exact copy of GATT and WTO. For the purpose of valuation under ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ended before the Court in the United States that software referred to in the agreement between the parties was a "product" and not a "good" but intellectual property outside the ambit of the Uniform Commercial Code. In the said Code, goods were defined as "all things (including specially manufactured goods) which are moveable at the time of the identification for sale". Holding that computer software was a "good" the Court held as follows : "Computer programs are the product of an intellectual process, but once implanted in a medium they are widely distributed to computer owners. An analogy can be drawn to a compact-disc recording of an orchestral rendition. The music is produced by the artistry of musicians and in itself is not a 'good', but when transferred to a laserreadable disc it becomes a readily merchantable commodity. Similarly, when a professor delivers a lecture, it is not a good, but, when transcribed as a book, it becomes a good. That a computer program may be copyrightable as intellectual property does not alter the fact that once in the form of a floppy disc or other medium, the program is tangible, moveable and available in the marketplace. The fact that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... such software would amount to manufacture under different statues. 18. Thereafter, explaining the word 'goods' in Article 366(12) of the Constitution, the Apex Court has held as under : - "27. In our view, the term 'goods' as used in article 366 (12) of the Constitution of India and as defined under the said Act are very wide and include all types of movable properties, whether those properties be tangible or intangible. We are in complete agreement with the observations made by this Court in Associated Cement Companies Ltd. (2001) 4 SCC 593. A software programme may consist of various commands which enable the computer to perform a designated task. The copyright in that programme may remain with the originator of the programme. But the moment copies are made and marketed, it becomes goods, which are susceptible to sale tax. Even intellectual property, once it is put on to a media, whether it be in the form of books or canvas in case of painting) or computer discs or cassettes, and marketed would become "goods". We see no difference between a sale of a software programme on a CD/floppy disc from a sale of music on a cassette/CD or a sale of a film on a video cas ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... /05-06, Bangalore, dated 24-7-2006 Sub: Levy of tax on software under the KST Act, 1957 and KVAT Act, 2003-Reg. It has been brought to the notice of this office that there is confusion with regard to levy of tax on transactions relating to computer software. 2. The matter is examined and it is considered necessary that the transactions be analysed for the benefit of the dealers and developers of software and the departmental officers in expeditious assessment and recovery of tax on these transactions. (1) Software is goods for the purpose of levy of tax under the provisions of the KST Act, 1957 and the KVAT Act, 2003. The sale of transfer of property in software for consideration that would be liable to tax, could be a direct sale or a deemed sale. (2) Direct sale of software would ordinarily be that transaction in which software is sold to the purchaser in a deliverable state through an appropriate media - floppy, C.D., etc, Such direct sale may include transactions in which the software agreed to be sold is developed or programmed at the purchasers' premises and later delivered to the purchasers. It would also include transactions in which sale of software for spec ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... buyer. As pointed out earlier, such integration leading to transfer of property in software from the seller to the buyer for a consideration may happen at the seller's premises or the buyer's premises. In all such cases of deemed sale of software or transfer of property in software in the execution of a works contract (by whatever name called), the seller would be liable to claim deduction from his taxable turnover amounts towards "labour charges and other like charges" not involving any transfer of property in goods actually incurred in connection with the execution of such works contract under the provisions of Rule 6(4) of the KST Rules, 1957 and Rule 3(2) of the KVAT Rules, 2005. (4) The third kind of transactions are the ones that would not involve any transfer of property in software (either as a part of a deemed sale or as a result of other sale), but which would involve a person or a-dealer providing manpower or technical services for agreed consideration (based on man hours or such other basis) to any other dealer or any other person to program / develop software for such other person or dealer at the premises of the former or latter (the manpower provider or tec ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e media - floppy, C.D. etc., In this type of transaction, the copyright or the intellectual property relating to the software sold vest with the seller. The position would be the same even in respect of software where some modification or change is made to the software sold. The same is generally called as customization in software sector. The fact whether any such customization is done at the seller's premises or the purchaser's premises would not be of any relevance. The copyright or the intellectual property rights of such modification also vests with the seller. 22. In the case of deemed sale or transfer of property in software in the execution of a works contract, the seller would be liable to claim deduction from his taxable turnover amounts towards labour charges and other like charges not involving any transfer of property in goods actually incurred in connection with the execution of such works contract. In this case also, the copyright or the intellectual property right in the goods vest with the seller and what the purchaser gets is the right to use such copyright or the intellectual property. 23. However, the third kind of transactions are the ones that would ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o service tax. 26. In the case of Annual Technical Support (ATS), if the agreement of the contract includes the annual maintenance involving both service and issuing upgraded or enhanced software, then such a contract is a combination of both goods and service. The contract is in the nature of works contract. VAT is liable to be paid on the goods part and service tax is to be paid on the labour aspect. In upgradation and enhancement, the copyright is owned by the developer of software and what is transferred to the customer is the right to use. 27. In the case of implementation of customized software, where the copyright of the customized software is with the software developer, the implementation process is a pure service rendition and does not involve any transfer of property. If any source coding or scripting is done during the process of implementation, the ownership or copyright or any proprietary right would not vest with the software developer. It works purely as a hired labour. The ownership vests at all point of time with the employer who had issued the assignment. In those circumstances, since there is no transfer of ownership or the licence to use the software (deemed ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ilable." 31. It also states the various aspects involved in the customization activities of the 'Finacle' product. They can be broadly classified as under:- a. Reports (formatting to the data) b. Scripting (Functional customization) c. Configuration (parameters) d. ONS customization (Screens) e. Identification of product enhancements 32. After the customization is over and the finacle software which meets the requirement of the customer is sold, starts the implementation phase. The said implementation phase includes (a) Training (b) Requirement Study (c) Transfer of data. 33. Therefore, a case study was made in the case of UCO Bank project and it is stated as under:- "2) Once the 'RFP' is evaluated and approved the software product 'F' is directly billed to end customer against tax invoice and VAT collection 3) Customization/improvement: After ascertaining the available standardized feature in the 'Finacle' program, it is then worked out to see the extent of customization/scripting required in the tender/WO's floated using the tools & utilities in Finacle Software. 4) If the extent of deviation from the standard feature is larg ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n find out how the parties have given effect to the terms of the contract. 36. In this background, we have to find out the nature of the transaction in the instant case. We have already examined above the contract with UCO Bank and noticed how implementation is not part of the said contract. The implementation agreement was with M/s Hewlett Packard India Sale (P) Limited. Now, let us examine the contract entered into by the assessee with Federal Bank, which was also examined by the Assessing Authority in the impugned order. Annexure I is the software which is licensed to the customer. The said Annexure-I reads as under:- "Annexure I - "Software" 1.1 Licensing Terms & Fees Sl. No. Product/Modules Licensing Terms License Fees in INR ATS Fee in INR 1 Finacle Core Banking Solution with Retail Corporate Trade Finance Reporting tools Sign Cap Central FAB Connect 24 Branch FAB for 20 branches Branch License for 600 branches in India 6,80,00,000/- 12% of the license fee Branch is defined as a service outlet (SOL). The total number of branches will be arrived by counting the SOLs in the Finacle core banking solution. All the 600 licenses mentioned above to be proc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e other than those specified in this Agreement. Subject to the Bank paying the required license fee and observing all terms of the Agreement, INFOSYS grants to the BANK a non exclusive, perpetual, non transferable, limited license to use the Software. 39. Therefore, from the aforesaid clause it is clear at all times, the assessee has retained copyright and several proprietary rights in software and what is transferred is a non-exclusive, perpetual, non- transferable limited license to use the software. 40. The material on record discloses that finacle software, which is owned by the assessee as a packaged software, is a software before customization. The authorities call it as a software with standard features, where the customer requirements are already built in. In other words, these software, which is available on the shelf, is a copyrighted article. It is also known as a branded software. As is clear from the impugned order though the customer requirements are available in finacle software in some form it requires customization to match the clients' requirements. It is for this purpose RFP is entered into, where the customer gives his requirements. It is only if the asses ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o mean subsequent improved versions and releases of Software or Third Party Software as the case may be, which may be provided in accordance with the terms mutually agreed to between the parties, and which are generally made available to customers covered under ATS at no additional charge. Upgrades may include Software Trouble Reports (STR) fixed and Software Enhancements incorporated. 44. It also provides certain exclusions: "Any on-site support, whether for Software or Third party Software will be outside the scope of this clause. Any such onsite support will be charged extra to BANK at the prevailing INFOSYS onsite support rates. It is also made clear all Customizations and Developed Software are outside the scope of ATS and shall be maintained by Bank." 45. Therefore, the copyrights in the enhancements, upgrades, maintenance and releases vests with the assessee and the same is not transferred to the customer and what is transferred is only the right to use. Therefore, the said right to use these enhancements, upgrades, maintenance and releases also constitutes goods and is liable to VAT. The record shows that the assessee has paid VAT on these enhancement and upgrades. Ther ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e as per Annexure1 * Core team education will be done for 1 batch. * Size of the batch shall not be more than 25 people. * The Training will be conducted at INFOSYS facilities in Bangalore * During core team training at Bangalore, traveling, lodging and boarding expenses of BANK officials will have to be borne by BANK. 4. PILOT IMPLEMENTATION FEES * Pilot Implementation Fess for Finacle Core Banking will be INR 220,00,000/- (two crores and twenty lakhs only). This cost is inclusive of 2500 man days of customization efforts. Infosys will provide the capacity planning recommendation for the hardware for Finacle core banking solution. * Core Team Education Fee for Finacle Core Banking Solution for the modules licensed is INR 30,00,000/- (thirty lakhs only). This training fee includes the charges for two executive appreciation programme and one audit training. * All applicable taxes shall be charged extra to BANK 5. Professional Services Rates Professional services outside the scope of the agreed implementation can be availed by the BANK as per INFOSYS Professional Services charges mentioned below : Role Classification Charges in INR Implementation /post 8,000/- p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Bangalore, during core team training at Bangalore, traveling, lodging and boarding expenses of the bank officials will have to be borne by the Bank. Then Article-4 specifies the fees payable for pilot implementation. Then Article-5 speaks about professional Services Rates. In none of these provisions, there is a mention of any software coming into existence which will be made use of in the implementation process. On the contrary, it is specifically stated that before pilot implementation programme commences, there should be installation of software. Therefore, the implementation of programme starts only after the installation of software which is the goods which is transferred under the agreement i.e., the customized copyrighted article 'finacle' of the assessee. The nature of the services rendered is in the nature of imparting training to the bank officials who will have to operate the system and the fees for implementation is based on 2500 man days and professional service rates is collected on the basis of Rs. 8,000/- per person per day. Similarly Rs. 10,000/- per person per day; Rs. 15,000/- per person per day. Therefore, the professional charges are paid for the servic ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... value which includes implementation charges. Without implementation the software is not capable of being marketed or saleable. 49. In fact, today, on behalf of the State, a statement is filed showing the turnover declared by the assessee in respect of the local sale of finacle and CST sale of finacle. A reading of the aforesaid statement shows in April 2005 the total value of local sale of finacle software is Rs. 2,61,93,743/-. No consideration is received for customization. Similarly in the case of CST sale of finacle. 50. According to the State, customization includes implementation. Therefore it is contended that without customization without implementation, the software is not complete saleable, useable and functional. However, when we look at the aforesaid table, assessee has sold software without the same to the extent of Rs. 2,61,93,743/-, If that is so, the argument that without the implementation the finacle product is not saleable is without any merit. Equally, the argument that implementation is a pre-sale activity and not a post sale activity, is also not acceptable. 51. In the impugned order, the Assessing Authority proceeds on the basis that the assessee customize ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e, but the dealer while declaring the turnover, splits the said transaction into two parts namely, sale part and service part. This act of the dealer in splitting the contract as one for sale and the other for implementation of finacle software, thereby claiming exemption on the latter part is not correct because in almost all the instances, what is supplied by the assessee to the customers is the software as per the requirements and the amount received towards the whole process of customization has to be considered as the amount received for the supply of customized finacle software. 53. From the aforesaid findings, it is clear that the Assessing Authority is of the view that the customization is equivalent to implementation. During customization when scripting or code writing is done in order to make the standard or package software useful to the client, the consideration paid for customization constitutes the consideration for transfer of goods. The said aspect is not disputed by the assessee. 54. What the assessee contends is that the assessee has the packaged software 'Finacle' a banking solution. If the said software cannot be used as such by the banks, then they ma ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ect sale or is a post-sale service would depend on the agreement/contract between the seller and the buyer, and on the actual conduct of the parties concerned as indicated by the relevant documents and books of account. 56. Therefore, in the instant case, as is clear from the invoice at Annexure-1, the price paid is for the customized Finacle software. The Annual Technical Support commences from the date of first branch GO LIVE. ATS fees specified is valid for 3 years from the effective date of the agreement and is subject to review thereafter. The contract also includes pilot implementation fees which is calculated for 2500 man days of customized efforts. Separate fee is also charged for core team education fee. This training fee includes the charges for two executive appreciation programme and one audit training. Professional services outside the scope of the agreed implementation can also be availed by the customer as per the assessee's professional services mentioned in the agreement. It is stated that, before pilot implementation programme commences, there should be installation of software. Therefore, the implementation of programme starts only after the installation of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ce in relation to information technology software have been brought under the service tax net by virtue of Section 65 (105) (zzzze). Section 65 (105) (zzzze) of the Finance Act, 1994 defines information technology services which includes adaptation, upgradation, enhancement, implementation and other similar services related to information software. Subsequently, the word 'service' is defined under Section 65B(44) of the Finance Act, 1994 which has come into effect from 1.7.2012 which excludes any activity which constitutes merely such transfer, delivery or supply of any goods which is deemed to be a sale within the meaning of clause (29A) of Article 366 of the Constitution. Once implementation is included in the definition of taxable service under the Service Tax Act, the State Legislature has no power to levy VAT treating it as involving transfer of property in goods or otherwise. Section 66E provides for 'declared services'. One such declaration is found at clause (d), i.e., development, design, programming, customization, adaptation, upgradation, enhancement, implementation of information technology software. Therefore, once the Parliament has expressly declared ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cordingly, it is hereby set aside. 61. In the instant case, the assessee has paid VAT for the customized software. In fact the assessment orders passed earlier recognized this fact, accept it and confirm the transaction. No VAT is levied in respect of this part of the consideration meant for implementation. In those assessment orders, they categorically refer to the fact that implementation is a post sale activity. 62. In view of the fact that relief is granted to the assessee on interpretation of the constitutional and statutory provisions, it is not necessary for us to go into the constitutional validity of the provisions which are impugned. Probably that is the reason why even the Counsel for the petitioner stressed on interpretation and if his argument is accepted, it is not necessary to go into the question of vires on the constitutional law. 63. In so far as the other aspects which are involved in the impugned order is concerned, they are to be agitated by the assessee in a regular appeal under statute and that cannot be decided by the High Court. Therefore, if the assessee were to prefer a separate appeal within 30 days from the date of receipt of a copy of this order, th ..... X X X X Extracts X X X X X X X X Extracts X X X X
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