Share on Facebook

Share on Twitter

Share on LinkedIn

Share on Email

Share More

In the current high-tech era, information technology has become an indispensable part of our life. India, being an IT hub, this fast growing industry is a major source of revenue. Hence, it becomes vital to assess the taxability of proceeds generated therefrom.

Information Technology is composed of two basic components - IT services and Business Process Outsourcing (BPO), our tentative focus being IT services.

While the term ‘IT services’ may be misleading as one may interpret that only the services related to IT are included in such head, however the sale transactions related to software are also included, consequently attracting VAT. As for the ambiguity prevailing in the taxability of software under IT services, there have been many disputes emerging regarding the suitable conventions for applicability of Service tax and VAT.

Taxability of software has been an unclear issue creating a situation of double taxation. In the contemporary day, both Service tax and VAT can be levied on Software depending upon the transaction. Both the Sales Tax Authorities and Service Tax authorities have been demanding ‘tax’ on software and these unending debates have even escalated to the apex court.

Software can be split into two categories for the purpose of taxation –

Canned Software: These are commonly known as packaged software, branded software, shrink- wrap software, ready- made application software. These have features which are commonly used by most of the customers and can’t be modified. These are sold off-the-shelf to customers at retail outlets via physical media or can also be downloaded electronically. For example Tally, Norton Antivirus, Microsoft office, etc.

Un-canned or Customized Software: Customized software is specifically created for a particular customer to meet his specific needs. Such software has to be developed from scratch to furnish a new one.

Taxability under Service Tax

For the first time on 16-05-2008, Section 65(53a) was inserted vide Finance Act 2008, to define information technology software as any representation of instructions, data, sound or image, including source code and object code, recorded in a machine readable form, and capable of being manipulated or providing interactivity to a user, by means of computer or an automatic data processing machine or any other device or equipment”.

Subsequently, on 16-05-2008, the taxable service in respect of information technology software, was defined in section 65(105)(zzzze) which read as follows:

“Any service provided or to be provided to any person, by any other person in relation to information technology software including –

(i) Development of information technology software,

(ii) Study, analysis 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) Providing the right to use information technology software supplied electronically”;

However, the said section 65 ceased to apply w.e.f. 01-07-2012 vide notification 20/2012 dated 05-06-2012 with the advent of negative list regime and comprehensive approach of taxation of services, and the said section containing definitions was replaced by the then newly inserted section 65B applicable w.e.f. 01-07-2012.

Section 65B(28) defines “information technology software” as any representation of instructions, data, sound or image, including source code and object code, recorded in a machine readable form, and capable of being manipulated or providing interactivity to a user, by means of computer or an automatic data processing machine or any other device or equipment”.

Further, another section 66E was inserted w.e.f. 01-07-2012, in which clause (d) specified that “Development, design, programming, customization, adaption, upgradation, enhancement, implementation of information technology software” is a declared service and hence taxable under service tax.

Hence, under present circumstances, the taxability of software can be linked to the definition of Information Technology Services as mentioned under the ambit declared services under Section 66 E (d). The detailed description of the phrases as mentioned under clause (d) is provided below:

· Design – plan, scheme
· Programming – process of writing a computer programmes.
· Customization – modifying to meet a specific requirement
· Adaptation – change to suit, adopt
· Upgradation – raising standard, improving quality/version/features
·  Enhancement – in value, content, quality

It is evident from the above that Service Tax is levied on the development, designing, customization, upgradation etc. of IT software. Nevertheless, the question of taxability of IT software under Service tax and VAT arises in the case where the software is provided to the client without any customization, i.e. sale of packaged software.

Further, it has been seen that the sale of Software is usually conditional to the acceptance of a software license agreement which gives the buyer the ‘right to use’ the software subject to the certain terms and conditions stated in the agreement. Thus, it may be noted that on purchasing the software, the buyer becomes the “licensee” and “not the owner of the Software” itself. A buyer can use, abstract, consume, deliver, store, possess, transfer and transmit such property only in consonance with the license agreement. However, he cannot resell or exploit it commercially for his own gain or profit.

Clause (f) of section 66E, further provides that “transfer of goods by way of hiring, leasing, licensing or in any such manner without transfer of right to use such goods” constitutes declared service.

The phrase “right to use” is explained in case of BSNL & Anr. vs. U.O.I. [2006 (145) STC 0091 SC]. The question in this case arose that whether supply of SIM cards during the provision of telecom service attracted VAT or service tax. The Hon’ble Supreme Court held that for a transaction to constitute a transaction for ‘transfer of right to use the goods’, it must have the following attributes:

a) There must be goods available for delivery;

b) There must be a consensus ad idem as to the identity of the goods;

c) The transferee should have a legal right to use the goods - consequently all legal consequences of such use, including any permissions or licenses required therefor should be available to the transferee;

d) For the period during which the transferee has such legal right, it has to be to the exclusion of the transferor - this is the necessary concomitant of the plain language of the statute - viz. a “transfer of the right to use” and not merely a licence to use the goods;

e) Having transferred the right to use the goods during the period for which it is to be transferred, the owner cannot again transfer the same rights to others.

It was upheld that where the main intent is to render services, any supplementary supply of goods cannot change the intention of primary transaction.

Relying on the judgement of Supreme Court in the above case, read with the clause (f) of declared services, it can be established that the levy of service tax on IT software shall be applicable only when the transaction does not involve “transfer of right to use” the underlying goods.

Apart from the above, reference can also be made to the TRU letter no. D. O. F. No 334/1/2012, where in para 5.4.1 states that Sale of pre-packaged or canned software is in the nature of sale of goods and is not covered in the entry no. 4 (i.e. development, design, programming, customization, adaptation, up gradation, enhancement, implementation of information technology software) of declared services.

Para 5.4.2 of the TRU further states that, On-site development of software/customized software is covered under the category of development of information technology software, thus leviable to service tax.

Taxability under VAT

The taxability of IT Software under VAT is dependent on whether the transaction results in “transfer of right to use” of the underlying goods, i.e. transfer of possession and effective control of the underlying goods to the customer.

The development and programming of software has been specifically cited in many states for applicability of VAT. The Readers can refer the following provisions:

· Under Karnataka VAT Act 2003, Schedule VI via entry number 11, ‘Programming and providing of computer software’ is subject to VAT at 5.5%.

· Under Haryana VAT Act 2003 in ScheduleC, Entry no. 44 read with Section 7(1)(a)(iii)  ‘Telephones, cell phones (including their parts and accessories) having maximum retail price upto Rs.10000/-, tele-printer, wireless equipment and parts thereof, Digital Video Disc and Compact Disc, Information Technology products’ and IT software on any media is taxable at the rate of 5% under HSN code 85.24.

Nevertheless it is clear that Information Technology has been specifically included as ‘declared services’ in the Finance Act and has also been mentioned in several States under VAT. But whether the software has attributes of goods or is liable to service tax or both, is a matter of argument and even litigation.

This article aims to clarify the sensitive issue of double taxation of Software and the question whether software shall be liable to Service tax, VAT or both. Below are the relevant judgments that allude to this subject-


In case of Sasken Communication Technologies Ltd. v. Joint Commissioner of Commercial Taxes (Appeals)-3 Bangalore {Writ Appeal Nos. 90-113 and 118-129 of 2011 (T-RES) APRIL 15, 2011} it has been held that customized software development services qualify to be “services” and are not liable to VAT under Karnataka Value Added Tax Act, 2003.

In the said case, the Commercial Tax Officer observed that said development activity of software attracted tax under 'works contract' as per section 4(1)(c) of KVAT Act. Accordingly, show-cause notice was issued to the assessee proposing to re-assess under section 39(1) of KVAT Act for period April 2009 to March 2010. The assessee submitted that software development service provided by it will be covered under section 65(105)(zzzze) of the Finance Act, 1994. Hence, same was liable to service tax and the payment or levy of VAT on the same did not arise. The assessing authority rejected plea of the assessee and upheld the demand on the assessee along with interest and penalty. Aggrieved by the said order, the assessee preferred a writ petition before the High Court. However, the Single Judge was of the view that whether the contract in question is a service contract or not and whether if it is a works contract, it is necessary to carefully examine each agreement between the parties.

Based on a reading of the agreements, The HC observed that the contract between parties is for rendering of services in relation to development of software. Further, Intellectual property developed as a direct/ indirect result of software programming shall be considered as “works made for hire” and shall remain exclusive property of client and the Appellant shall have not ownership interest therein. Moreover, Consideration under the contract is not for cost of the project but for service rendered based on time or man hours. Also, there was no software in existence and no goods in existence as on date of signing the contract. Therefore, the contracts on hand are not for sale of software but for development of software.

Subsequently, the High Court observed that the decision in the case of Tata Consultancy Service is applicable only to packaged software and the said conclusion cannot be applied to customized software, as is the case on hand without examining the nature of activities and the contract thereof. Hence, a detailed analysis of the agreements is required to determine the dominant nature of the contract and to ascertain the intention of the parties. Further it is contended that as the Appellant is paying service tax, which is collected by the Parliament under List I of the Seventh Schedule of the Constitution of India, State Governments are not empowered to collect any tax on the same subject by covering it under List II of the Seventh Schedule of the Constitution of India.

Further, as mentioned in KVAT entry 11 of VI schedule, {referred above} if it has to be treated as a works contract, it should involve an agreement to provide service and to sell goods, wherein the service aspect could be taxed by the Parliament and the goods aspect could be taxed by the State legislature. The said aspects needs to be ascertainable based on the terms of the composite contract and if such aspects are not ascertainable, the true nature and character of the contract needs to be determined for the purpose of applying the correct tax.

Also, in order to constitute a transaction of sale, there should be an agreement relating to goods to be conveyed by transferring the title in such goods. Moreover it is necessary that the agreement and the sale should relate to the same subject matter.

Customized software to fall under the category of goods, must undergo 2 tests:

Marketability - the concept of marketability needs to be analysed, i.e. whether the customised software can be sold in the market as such. In other words, whether it is capable of being bought and sold freely in the market.

Capable of transmission-- It should satisfy the test of abstraction, transmission transfer, delivery, storage and possession, etc.

As the contract towards development of customized software does not contain two aspects (i.e. whether there exists sale of goods and rendering of service), it would not qualify to be a works contract. Therefore it shall be imperative to determine the dominant intention of the parties, whereby the contract should determine that the essential ingredient is the agreement to sell movables for a price and property passing therein pursuant to the agreement or not.

Further, it is held that in software transactions, in case the software is ready for providing to customer and IP rests with the seller, the same is goods, whether branded or unbranded as the seller merely needs to transfer the goods in this case. On the other hand, if the Assessee does not have any ready-made software, there are no goods in existence and the agreement is not towards transfer of software, but to develop the software and the same is taxable under service tax.

Based on the observation of the said case, the High Court held as follows:

The contract for development of software in question are not works contract, but contract for service simplicitor and hence not liable to VAT.

The software developed by the Appellant always lies with the customer and does not qualify to be deemed sale under Article 366(29A)(b) of the Constitution.

A bird’s eye view of the other landmark judgements explaining the applicability of Service tax or VAT has been provided below for your kind perusal:

Case Name


Tata Consultancy Services vs. State of A.P [(2004) 271 ITR 401 SC]

The landmark judgment of TCS held that, software,whether customized or not shall be categorized as “goods”, only if it has the following characteristics:

(a) Utility;

(b) Capable of being bought and sold; and

(c) Capable of being transmitted, transferred, delivered, stored and possessed.

A software programme consists 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 when the copies are made and sold in the market, it becomes goods, and hence liable to VAT.

The software is an indispensable part of media and it is not possible to separate the two. It is important to note that, the consideration that the buyer pays is for the software and not for the hardware in which the software is embedded. Thus sale of computer software is clearly sale of goods within the meaning of Sales Tax Act. Further, it is to be noted that branded or packaged software, which is capable of abstraction, consumption, use, transmission, transfer or delivery, it would be treated as goods, when such software is marketed or sold. Thus, once the software is classified as goods, it is liable to the goods taxes of customs, excise duty and VAT.

Infosys Technologies Ltd. vs. Commissioner of Commercial Taxes, Chennai [2009 (233) ELT 56 (Mad)]

The landmark judgment of TCS case was upheld and it observed that whether the software is customized or non-customized, the same will be considered as goods and liable to sales tax. Hence it is immaterial whether the software is canned or un-canned, it would still be liable to sales tax/VAT.

Infotech Software Dealer Association V UOI, {(2010) 29 STT 132 Madras}

The main concern raised here was:

1. Whether software is goods?

2.  If so, whether in all transaction, it would amount to sale or it is likely to be a service.

In the said it case it was contemplated that it is crucial to comprehend the actual transaction and all transactions are not necessarily sale. Whether a particular transaction falls under the category of good or service is a matter of debate.

It was sustained that it depends upon the end user license agreement with ultimate customer of software, that whether particular transaction is sale of goods or provision of service. Anexamination of a sample ‘End User Licence Agreement’ (EULA) will clarify the dominant intention of the parties that whether the developer keeps the copyright of each software with himself.

However, in case the software is sold through internet in the form of downloadable from site, it does not fit in to ambit of ‘IT software on any media’ and when only user name and password is provided rather than the CD, it cannot be classified as goods.

CIT v Oracle Software India Ltd 2010 ELT 161 [SC]

It has been upheld that transforming blank CD into software loaded disc is ‘manufacture’ and hence possess the essential characteristics of goods.

State Bank of India and Others Versus State of Andhra Pradesh [1988] 70 STC 215 (AP)

It was held that the transaction does not involve the right to use goods as possession of the lockers is not transferred to the hirer even though the contents of the locker would be in the possession of the hirer. The same is clearly mentioned in Clause 3 of “agreement for hiring locker” which states that the hirer shall have no right of property in the locker but only an exclusive right of thereof and access thereto. Further, the lockers cannot be considered as “goods” within the meaning of section 2(h) of the act. The eligibility to tax would depend upon the question whether there is any transfer of right to use any goods. It is thus contended that if safe deposit lockers are not “goods”, then no liability of tax arises.

Further, the hiring charges of banks are not exclusively for the use of lockers. They are composite charges to cover various services associated with the lockers. Hence, it is not possible to identify the sum charged for the transfer of right to use the lockers alone and therefore, no tax can be levied.

Authority for advance rulings, CE, C & ST Microsoft Corporation (India)(P) Ltd. Re:

(2013) 37taxmann.com315(AAR)

It has been held that transfer of software on media meant for off-the-shelf purchases is sale of goods, not liable to service tax however, the electronic download/licensing of software amounts to service and liable to service tax.

Steag Encotec India [2009-TIOL-1776-CESTAT-MUM]

In Mumbai CESTAT, it was held that to qualify a software as a custom designed software, it has to be developed from the scratch, so that a new software product should emerge as per the requirement of the client. If software is just modified from already existing established software packages / modules, it will not qualify as a custom designed software. Further, a custom designed software is taxable under service tax laws.

Recently, the High Court of Karnataka has delivered a landmark judgement in the case of, Finance Department of Karnataka Department vs IBM India Private Limited, STRP No. 215/2011 dated 18th September 2015, wherein the following aspects in respect of sale and development of customized software has been held with regard to their taxability:

1. The packaged, readymade, off the shelf software are pure goods liable only to VAT.

2.  The customized software or tailor made software for an individual customer, similar to packaged software, where the copyright owned software is put on the media and delivered by way of transfer of right to use, will also be goods and is liable to VAT. In the case of customized software, the customized portion is embedded to the original software so as to become the customized software, the copyright of the entire software including the customized portion is exclusively owned by the developer of the software. Therefore, in a customized software, where copyright is held by the developer of software and the copyrighted article alone is handed over to the customer as a transfer of right to use goods, the software is goods and liable to VAT alone.

3.  In certain cases of customized software, it is possible for an entity to work on a hired contract basis rendering pure service and get delivered fully developed software for a specified customer with future contracts for upgradation and enhancement. In such a situation too, the software emerges. However, the copyright in such software belongs to the customer, as it is developed, and the developer of the software does not retain any copyright in such software. In such a situation, since there is no transfer of property in goods and what is provided is only a pure service, there can be no liability to VAT. The consideration in such cases is liable only to service tax.

4.  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.

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 sale), it is a pure service contract. There is no sale of goods. It is a case of rendering service and is liable to service tax only.

Based on the decisions of the above case laws, it can be established that it is uncertain to resolve to one answer for the applicability of Service Tax, VAT or both on Software. Nonetheless, we can close the argument in following points –

1. Software has essential characteristics of Goods and thus packaged/non-customized software and customized software are taxable to sales tax.

2. Developing of software is subject to service tax as it is specifically mentioned in the Finance Act.

3. When the goods are transferred without transferring the right to use it would attract Service Tax, however, if the right to use is also transferred along with the goods, the same will be recognized as deemed sale and leviable to VAT.

4. Software, when downloaded from the Internet cannot be classified as goods. Subsequently, service tax shall be levied on the same.

S. No.

Nature of Transaction

VAT/Service Tax


Packaged/Canned Software



Customised Software:

a)      Onsite development/customization (IPR vest with client)

b)      Otherwise

Service Tax



Sale of license

a)      If right to use is transferred

b)      Otherwise


Service Tax


Sale of software- e-delivery

Service Tax

Even after such clarification, taxability of software is still a litigative matter. The contradictory laws of VAT and Service tax have created ambiguity regarding this issue.

However, after the influx of Goods and Service Tax (GST), both the laws of VAT and Service Tax will be subsumed and the need for bifurcation may not be necessary since every transaction will be dealt both by State and Central Government. Thus, it is likely that the hitch of double taxation will be resolved.

CS Priyanka Gupta

APRA Associates (VAT Team)


·         Case law of IBM India Private Limited, STRP No. 215/2011 dated 18th September 2015

·         Tata Consultancy Services vs. State of A.P [(2004) 271 ITR 401 SC]

·         Infosys Technologies Ltd. vs. Commissioner of Commercial Taxes, Chennai [2009 (233) ELT 56 (Mad)]

·         Sasken Communication Technologies Ltd. v. Joint Commissioner of Commercial Taxes (Appeals)-3 Bangalore {Writ Appeal Nos. 90-113 and 118-129 of 2011 (T-RES) APRIL 15, 2011}


Published by

CS Priyanka Gupta
(Deputy Manager)
Category VAT   Report

2 Likes   48 Shares   15162 Views



Popular Articles

Follow taxation Exam20 Book Book

CCI Articles

submit article

Stay updated with latest Articles!