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Constitutional Aspects – Relevant Terms


Part XII of the Constitution of India contains matter related to “Finance, Property, Contracts and Suits” covering article 264 to article 300A.

Article 265 states that no tax shall be levied or collected without the authority of law and authority of law as per the observations made by the Supreme Court in the case of Kunnathat 1961 SC 552 means that tax proposed to be levied must be within the legislative competence of the legislature imposing the tax. Some other aspects:

-       The law must not be a colourble use of or a fraud upon the legislative power to tax.

-       Does not include the imposition or collection of the tax by an administrative order which is not referable to any statutary provision- Devkala Consultacny Services – AIR 1999 Kar 319,323.

-       Aspects theory requires 2 different taxable events. One event cannot have 2 aspects.


The law must also not violate the fundamental right such as article 14,19 etc.

Article 14 speaks about this being the essence of democracy. Further that orders of the executive to be informed by reason. Also that there is a presumption that actions of government are reasonable and in public interest. The burden of proof to prove otherwise would be of the citizen.

Articvle 19 states that: all citizens shall have the right to practice any profession, any occupation or to carry out any trade or business.


The Supreme Court in the case of Vijaylakshmi Rice Mills 2006 (201) ELT 329 has distinguished the works ‘tax’ and ‘fee’ and has held that tax is compulsory exaction of money for public purposes by state whereas the fee is charge for service rendered by governmental agency.



Article 366 (12) of the Indian constitution defines “goods” to include all materials, commodities, and articles

Goods are defined in an inclusive manner, it does throw the light on the expression of meaning as to what and all could be included. The definition of goods under various legislatures defines goods to include all kinds’ of movable properties with the exclusion as to actionable claims. Whereas, under customs act goods has been defined to include any property whether tangible or intangible if it has the specified characteristics. The definition could be wide ranging from one statute to the other.

Can software be regarded as goods?

The Supreme Court in the case of Tata Consultancy Services Vs State of Andhra Pradesh (2004 (178) ELT 22 (SC)), had observed that since software was capable of abstraction, consumption, use, transmission, transfer, delivery, storage, possession etc., it was included as ‘material, articles and commodities’ in definition of ‘goods’. Goods include both tangible and intangible movable properties, materials, commodities and articles and also corporeal and incorporeal materials. ‘Goods’ may be a tangible property or an intangible. It would become goods provided it has the attributes thereof having regard to (a) its utility; (b) capable of being bought and sold; and (c) capable of transmitted, transferred, delivered, stored and possessed. If a software whether customized or non-customized satisfies these attributes, the same would be goods.

Once software is goods, transfer of right to use the same for consideration should be subject matter of sales tax / VAT going by Article 366(29A) of Constitution of India

Can transfer of right to use software be regarded as service?

We understand that the substance of the agreement here involves transfer of right to use software. Presently taxation of transfer of such right is an issue under both VAT as well as service tax. While the category of ITSS introduced under service tax specifically talks about taxing of transfer of right to use software supplied electronically and software supplied for commercial exploitation, transfer of right to use goods is generally regarded to be amounting to deemed sale of goods in question and liable to VAT going by Article 366(29A) of the Constitution of India. Therefore whether a ‘deemed sale’ could also be a service is an issue which is still open. If yes then it goes against the decision of the Supreme Court in the decision of Imagic Creative 2008 (9) STR 337 where it was held that VAT and service tax are mutually exclusive.

Further, it is interesting to note the decision of the division Bench of the Madras High Court in the case of Infotech Software Dealers Association (2010-TIOL-620) wherein an important decision in the context of taxation of software has been delivered. While holding that software (packaged or customized) is goods, the Court has also upheld the validity of levy of service tax on IT software services. The Court has however left open the much debated issue as to whether a transaction in software between the re-seller and end user is a sale or service.

The copyright in software is protected and always remains the property of the creator and what is transferred is the right to use the software with copyright protection. The sale is coupled with a condition for exclusive use of the software by the customer at the exclusion of others and it gives absolute possession and control to the user of the right to use the software. When the developer does not sell the software (be it packaged or customized) as such, the transaction between with the end users cannot be a sale of software as such but only the contents of the data stored in the software, which would only amount to a service. When the goods as such are not transferred, the question of deeming sale of goods (transfer of right to use goods) does not arise and the transaction would only be a service and not a sale. On the other hand, if the software is sold through the medium of internet in downloadable form, it does not fit into the ambit of “IT software on any media”. When an access control is given through an internet medium with a user name and password and when there is no CD or other storage media for the software, it is possible to hold that it does not satisfy the requirement of being “goods” under the entry used in the Statute.

The question whether a transaction amounts to sale or service depends on the individual transaction. The terms and conditions of end user license agreement are material to determine whether there is an element of sale involved when software is delivered to the customer. Dominant nature test as prescribed in the case of Bharat Sanchar Nigam Ltd (Supreme Court) 2006 (2) S.T.R. 161 (S.C.) be applied to determine the intent of the parties and the substance of the contract.

This is an important decision in the context of software taxation and the observations of the Court are significant. The observations that there is no deemed sale (right to use) in software licensing and that electronic download of software is a service are interesting and could have far reaching consequences. While the Court has considered the terms of a specific license agreement to analyze the nature of transactions and these terms are not standard. However, the authorities for levy of tax on sale and service being different, interpretation of the terms can also vary.



According to clause 29A tax on the sale or purchase of goods includes

a.    a tax on the transfer, otherwise than in pursuance of a contact, of property in any goods for cash, deferred payment or other valuable consideration;

b.    a tax on the transfer of property in goods (whether as goods or in some other form) invoked in the execution of a works contract;

c.    a tax on the delivery of goods on hire purchase or any system of payment by instalments;

d.    a tax on the transfer of the right to use any goods for any purpose (whether or not for a specified period) for cash, deferred payment or other valuable consideration;

e.    a tax on the supply of goods by any unincorporated association or body of persons to a member thereof for cash, deferred payment or other valuable consideration;

f.      a tax on the supply, by way of or as part of any service or in any other manner whatsoever, of goods, being food or any other article for human consumption or any drink (whether or not intoxicating), where such supply or service, is for cash, deferred payment or other valuable consideration, and such transfer, delivery or supply of any goods shall be deemed to be a sale of those goods by the person making the transfer, delivery or supply and a purchase of those goods by the person to whom such transfer, delivery or supply is made;


What are goods in a sales transaction therefore remains primarily a matter of contract and intention. The seller and such purchaser would have to be ad idem [ consensus in mind] as to the subject matter of sale or purchase. The court would have to arrive at the conclusion as to what the parties had intended when they entered into a particular transaction of sale, as being the subject matter of sale or purchase. In arriving at a conclusion the court would have to approach the matter from the point of view of a reasonable person of average intelligence.


The taxability of works contract especially was a controversial issue with varying judgments by the courts. In Gannon Dunkerly 2002-TIOL-493-SC case relating to works contracts holding that the expression sale of goods as used in the legislative list would have the same meaning as used in sale of goods act 1930. It was further held that the state could not enlarge its power to levy sales tax by amending an ordinary law and giving an artificial definition to the word sale. Eventually the 46th amendment was made to insert clause 29A enabling levy of sales tax on works contract and other items. In a works contract, there is neither a contract to sell the materials used in the construction nor passing of property as movables. Therefore the state could not impose a tax on the supply of material used in such a contract by treating it as a sale.


The forty sixth amendment was made precisely with a view to empower the state to bifurcate the contract and to levy sales tax on the value of the material involved in the execution of works contract, irrespective of the fact that the value may represent a small percentage of the amount paid for the execution of the works contract. The sub-clauses of article 366(29A) serve to bring the  transactions where one or more of the essential ingredients of sale as defined in the Sale of Goods Act 1930 are absent, within the ambit of purchase and sale for the purpose of levy of sales tax. The amendment permits specific composite contracts enumerated in article 366 (29A) to be divisible contracts where the sale element could be isolated and subjected to sales tax.


Scope of Right to use goods:

Clause (29A) refers only to cases where there is a transfer of right to use goods delivered to the person concerned. It does not cover transactions which merely license a person to use goods without securing possession. Thus a unit giving sophisticated machinery to a contractor to manufacture certain products. The contractor was not at liberty to make use of the machinery, it does not dilute the possession and control of the machinery by the unit. It was also held that this would not amount to a transfer of right to use. However after the 46th amendment, the works contract which was an indivisible one, by a legal fiction was altered into a contract divisible into one for sale of goods and other for supply of labour and services. It is thus possible for the states to levy sales tax on the value of the goods involved in a works contract in the same way in which sales tax was leviable on the price of the goods and materials.


Definition under the Tax laws:

It is pertinent to note that the definition of sale under sales tax or the VAT laws is different from that of the definition as defined under the Central Excise law. Under the central excise law, sale & purchase has been defined to mean any transfer of possession of goods by one person to another in the ordinary course of trade or business for cash or deferred payment or other valuable consideration. The definition as provided under the CE law is to be used for the service tax law by virtue of sec 65(121)

The distinguishing factor between the definition under the CE law and the VAT laws are that the transfer of possession is sufficient whereas under the VAT laws, transfer of property in goods is required.



Part XI of the Constitution deals with relationship between the union and the states. This portion provides for distribution of legislative powers between parliament and state legislatures. The manner in which the powers have been distributed are specifically set out in Schedule VII of the Constitution. Article 246 specifies the manner in which parliament and state legislatures can exercise their respective powers.

Article 245 provides for the following:

      i.        Parliament may make laws for the whole or any part of the territory of India and the legislature of a state may make laws for the whole or any part of the state

     ii.        No law made by the parliament shall be deemed to be invalid on the ground that it would have extra territorial operation.

Further article 246 governs the subject matter of the laws made by the parliament and by the legislature of states. The matters are listed in the seventh schedule to the Constitution. The seventh schedule is classified into three lists:

a.    List I: This list enumerates the matters in which the parliament has an exclusive right to make laws

b.    List II: This list enumerates the matters in respect of which the legislature of any state has an exclusive right to make laws.

c.    List III: This list enumerates the matters in respect of both the parliament and subject to list I, legislature of any state, have powers to make laws.


The entry 84 of List I as required in the present context provides for levy of duties of excise on tobacco and other goods manufactured or produced in India except:

a.    Alcoholic liquors for human consumption;

b.    Opium, Indian hemp and other narcotic drugs and narcotics.


Article 270 mentions that all taxes and duties referred to in the union list, except the duties and taxes referred to in article 268, 268A and 269 respectively, surcharge on taxes and duties referred to in article 271 and any cess levied for specific purpose under any law made by the parliament shall be levied and collected by the government of India and shall be distributed between the union and the state in the manner provided.


Retrospective operation of laws:

The legislature has the plenary power to pass laws retrospectively. But the retrospective effect given to an act does not make the act a thing done in the exercise of judicial power. The legislature can interfere with the vested rights of persons in a retrospective legislation but this does not mean that it is adjudicating between the parties. Every retrospective amendment or change will affect vested rights. But the legislative power can be challenged only if the retrospective law is violative of article 14 or article 20(1).

The factors which are generally considered relevant in answering are (i) the context in which retrospectivity was contemplated (ii) the period of such retrospectivity and (iii) the degree of any unforeseen or unforeseeable financial burden imposed for the past period. The Supreme Court reiterated the power of the legislature to retrospectively impose a tax or levy, provided the same is not arbitrary


Clarificatory Amendments – Retrospective:

An amendment which is clarificatory in nature will generally be retrospective. It was held that the legislature can make a declarative enactment to set aside what is a judicial error in an interpretation of a statute and can make the meaning of a provision clear; it can also explicit state what was already implicit.

Service Tax:

The levy of service tax was initially under the residuary powers conferred to the Union by entry 97 which provides for - any other matter not enumerated in list II or list III including any tax not mentioned in either of those lists to the Seventh Schedule to the Constitution of India. Later entry 92C was introduced specifically to cover ‘Taxes on Services’, this however has not been made effective. The constitutional aspects can be better appreciated by referring to the decisions rendered by the Supreme Court. Some of which are discussed below

Observations made by the Supreme Court in the case of TN Kalyana Mandapam Association [2004 (167) E.L.T. 3 (S.C.)]:


A tax on services rendered by mandap-keepers and outdoor caterers is in pith and substance, a tax on services and not a tax on sale of goods or on hire purchase activities. Section 65 clause 41 sub-clause (p) of the Finance Act, 1994, defines the taxable service (which is the subject matter of levy of service tax) as any service provided to a customer by a mandap-keeper in relation to use of a mandap in any manner including the facilities provided to a customer in relation to such use also the services, if any, rendered as a caterer. The nature and character of this service tax is evident from the fact that the transaction between a mandap-keeper and his customer is definitely not in the nature of a sale of hire purchase of goods. It is essentially that of providing a service. In fact, as pointed out earlier, the manner of service provided assumes predominance over the providing of food in such situations which is a definite indicator of the supremacy of the service aspect. The legislature in its wisdom noticed the said supremacy and identified the same as a potential region to collect indirect taxes. Moreover, it has been a well established judicial principle that so long as the legislation is in substance, on a matter assigned to a legislature enacting that statute, it must be held valid in its entirety even though it may trench upon matters beyond its competence. Incidental encroachment does not invalidate such a statute on the grounds that it is beyond the competence of the legislature (Prafulla Kumar v. Bank of Commerce). Article 246(1) of the Constitution specifies that the Parliament has exclusive powers to make laws with respect to any of the matters enumerated in List I in the Seventh Schedule to the Constitution. As per Article 246(3), the State Government has exclusive powers to make laws with respect to matters enumerated in List II (State List). In respect of matters enumerated in List III (Concurrent List) both Parliament and State Government have powers to make laws. The service tax is made by Parliament under the above residuary powers – Entry 97.

As no entry is found in List 2 and List 3 of the Schedule, which could cover the tax levied, the question of Parliament lacking legislative competence to do so would not arise.


Observations of the Supreme Court in the case of All India Federation of Tax Practitioners [2007 (7) S.T.R. 625 (S.C.)]

Entry 60 of List II refers to taxes on professions and is on individual person/firm or company. A chartered accountant or cost accountant obtains a license or privilege from competent body to practice. On that privilege the State is competent to levy a tax under Entry 60. It cannot be read to include every activity undertaken by chartered accountant/cost accountant/architect for consideration. Service tax is on each activity undertaken by chartered accountant/cost accountant/architect. For each transaction or contract, chartered accountant renders professional based services and for each contract tax is levied under Finance Act, 1994. Tax cannot be levied without service being provided whereas professional tax is a tax on status. Professional tax has nothing to do with commercial activities undertaken. Chartered Accountant has to pay professional tax till he remains in the profession. Tax on services is a different subject as compared to taxes on professions, trades, callings, etc. Entry 60 of List II and Entry 92C/97 of List I operate in different spheres.

The distinction between the group of general entries and the group of taxing entries to the Lists in the Seventh Schedule has also been highlighted in the case of Southern Pharmaceuticals & Chemicals v. State of Kerala reported in (1981) 4 SCC 391 in which this Court took the view that enactment of the Medicinal Act, 1955 by Parliament under Entry 84 List I does not prevent the State Legislature from making a law under Entry 8 List II as Entry 8 was a general entry whereas Entry 84 List I was a taxing entry

As stated above, every Entry in the Lists has to be given a schematic interpretation. As stated above, Constitutional law is about concepts and principles. Some of these principles have evolved out of judicial decisions. The said test is also applicable to taxation laws. That is the reason why the Entries in the Lists have been divided into two Groups, one dealing with general subjects and other dealing with taxation. The entries dealing with taxation are distinct entries vis-a-vis the general entries. It is for this reason that the doctrine of pith and substance has an important role to play while deciding the scope of each of the entries in the three Lists in the Seventh Schedule to the Constitution. This doctrine of pith and substance flows from the words in Article 246(1), quoted above, namely, “with respect to any of the matters enumerated in List I”. The bottom line of the said doctrine is to look at the legislation as a whole and if it has a substantial connection with the Entry, the matter may be taken to be legislation on the topic. That is why due weightage should be given to the words “with respect to” in Article 246 as it brings in the doctrine of “pith and substance” for understanding the scope of legislative powers. Competence to legislate flows from Articles 245, 246 and the other Articles in Part XI. Legislation like Finance Act can be supported on the basis of a number of Entries. In the present case, we are concerned with the Constitutional status of the levy, namely, service tax. The nomenclature of a levy is not conclusive for deciding its true character and nature. For deciding the true character and nature of a particular levy, with reference to the legislative competence, the court has to look into the pith and substance of the legislation. The powers of Parliament and State Legislatures are subject to Constitutional limitations. Tax laws are governed by Part XII and Part XIII. Article 265 takes in Article 245 when it says that the tax shall be levied by the authority of law. To repeat, various entries in the Seventh Schedule show that the power to levy tax is treated as a distinct matter for the purpose of legislative competence. This is the underlying principle to differentiate between the two Groups of entries, namely, general entries and taxing entries. We are of the view that taxes on services are a different subject as compared to taxes on professions, trades, callings etc. Therefore, Entry 60 of List II and Entry 92C/97 of List I operate in different spheres.


This article focuses on some aspects of the constitution which maybe relevant to better appreciation of the various laws applicable to the IT & ITES sector.

By Madhukar N Hiregange FCA

Published by

Madhukar N Hiregange
(Chartered Accountant)
Category Service Tax   Report

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