The introduction of the category of Information Technology Software Service as a taxable service category u/s 65(105)(zzzze) of Chapter V of Finance Act 1994 with effect from 16th May 2008 led to issues regarding the taxability of information technology software licensing arrangement under service tax. This was on account of two clauses in the said section dealing with provision of right to use software. While one clause dealt with provision of right to use information technology software supplied electronically, the other dealt with providing the right to use information technology software for commercial exploitation which included rights to reproduce, distribute and sell the software as well as right to use components of software for creation of and inclusion in other information technology software products.
The negative list based taxation scheme introduced with effect from 01st July 2012 included an entry in Section 66E(f) seeking to treat transfer of goods by way of hiring, leasing, licensing or in any such manner without transfer of right to use such goods as a declared service. This entry would be wide enough to cover software licensing within its ambit. Having said this it would be pertinent to see what could be taxed under service tax and what could not as transfer of right to use goods has specifically been sought to be excluded from service tax net.
The need to review this aspect assumes greater significance if we were to consider Article 366(29A)(d) of the Constitution of India as per which, a tax on sale or purchase of goods includes 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. This coupled with Article 246(3) read with entry 54 of List II of the Seventh Schedule to the Constitution of India is all the more reason why the boundaries of taxability would have to be ascertained.
The need stems from the fact that List II referred above deals with subjects falling under the domain of the State Legislature implying power to the States to levy tax on transfer of right to use goods except where the transfer falls under entry 92A of List I to the said Schedule which deals with sale or purchase in the course of inter-state trade or commerce where the power to levy tax lies with the Parliament. So while VAT/sales tax would be levied on transfer of right to use goods, service tax could be levied on an arrangement involving hiring or leasing or licensing not resulting in transfer of right to use goods. This despite the fact that Article 366(29A)(d) even extends to a scenario where the period of hiring/leasing/licensing is not specified. This would make the task of trying to identify the taxability under service tax and VAT/sales tax trickier as the demarcation between an arrangement involving transfer of right to use goods and one not involving the same could be very hazy at times.
Concept of “goods”
In trying to address this issue we would have to revisit the very concept of “goods” and “transfer of right to use” as this would enable us to appropriately classify contracts/arrangements between parties entering into a contract. If we were to refer Section 65B (25) of Chapter V of Finance Act 1994, “goods” has been defined to mean every kind of movable property other than actionable claim and money; and including securities, growing crops, grass, and things attached to or forming part of the land which are agreed to be severed before sale or under the contract of sale.
If we were to refer Article 366(12) of the Constitution of India, “goods” includes all materials, commodities and articles for the purposes of the said Constitution. If we were to refer Section 2(7) of The Sale of Goods Act 1930, “goods” means every kind of moveable property other than actionable claims and money; and includes stock and shares, growing crops, grass, and things attached to or forming part of the land which are agreed to be served before sale or under the contract of sale. In Section 2(d) of The Central Sales Tax Act 1956, ''goods'' includes all materials, articles, commodities and all other kinds of movable property, but does not include newspapers, actionable claims, stocks, shares and securities
In order to fully appreciate the scope and coverage of the term, we would have to comprehend the reference to the terms “movable”, “materials”, “commodities” and “articles”. The question to be answered here is whether the same would include intangible property or would refer to tangible property alone.
In India, going by Section 22 of the Indian Penal Code 1860, the word “movable property” is intended to include corporeal property of every description, except land and things attached to the earth or permanently fastened to anything which is attached to the earth. The term “corporeal” if one refers P Ramanatha Aiyar’s Advanced Law Lexicon, would refer to things which may be seen and touched. It denotes the nature or physical existence of a body. Consequently, corporeal property would be one which has a physical existence. As per the Law Lexicon, the term “movable” as an adjective applied to property signifies that it is capable of being moved or put out of one place into another, and therefore necessarily implies that such property has an actual locality and is susceptible of locomotion or a change of place.
It is however, in The General Clauses Act 1897 that the term “movable property” has been sought to be given wider connotation and that is meaning, property of every description, except immovable property. This would however be in the context of Central Acts and Regulations and would not in the humble opinion of the Author override the meaning in Article 366(12) even though Article 367(1) provides for the Act being used for interpretation of the Constitution. Since our Constitution refers to materials, commodities and articles, it would now be necessary for us to study these terms.
The term “material” in this context could be seen to relate to or consist of matter corporeal; not spiritual; physical; substantial as opposed to formal. As a noun, it is the substance or matter of which anything is made. The term commodity could be seen to mean an article of trade, a movable article of value; something that is bought and sold (U.S. v. Sischo, D.C. Wash., 262 F. 1001, 1005) as referred to in Tata Consultancy Services Vs State of Andhra Pradesh (2004 (11) TMI 11 – Supreme Court). The term “article” in the context of a lease would indicate movable chattels (per ERLE C.J. Garton vs Gregory, 31, LJQB 302).
The view that the term “goods” could include movable and tangible property alone and not immovable and intangible property would get credence if we were to follow the principle of contemporaneous exposition i.e. interpreting statute or any other document by referring to the exposition it has received from contemporary authority as confirmed by the Supreme Court in Desh Bandhu Gupta & Co Vs Delhi Stock Exchange Association Ltd. (1979 (2) TMI 175 Supreme Court of India). If we follow this view, the question of taxing intangible property as goods would not arise. However, in India, the Courts over the years have brought even intangible property within the definition of “goods”.
These verdicts have been based on the concept of “property” which is very wide and would include both corporeal and incorporeal assets ignoring the usage of the said word with the word “movable” as well as the concept of “movable property” as per Salmond on Jurisprudence. In Salmond’s Jurisprudence, as confirmed by the Supreme Court in Vikas Sales Corporation & Another Vs Commissioner of Commercial Taxes & Another (1996 (5) TMI 363 – Supreme Court of India) the expression "movable property" has been stated to include corporeal as well as incorporeal property. Debts, contracts and other choses-in-action are said to be chattels, no less than furniture or stock- in-trade. Similarly, patents, copyrights and other rights in rem which are not rights over land are also included within the meaning of movable property.
So, while in Madhya Pradesh Electricity Board Vs CST Madhya Pradesh (1968 (11) TMI 85 – Supreme Court of India), electric energy was held to be goods on the grounds that the same could be transmitted, transferred, delivered, stored, possessed, etc., in the same way as any other movable property, in H. Anraj Versus Government of Tamil Nadu & Shri Dipak Dhar and Others Versus The State of West Bengal and Another (1985 (10) TMI 258 – Supreme Court of India) the entitlement to a right to participate in a draw was held to be goods. In Vikas Sales Corporation case referred above, transfer of import license called REP license/EXIM scrip to another was held to constitute a sale of goods.
In Tata Consultancy Services Vs State of Andhra Pradesh (2004 (11) TMI 11 – Supreme Court of India), while acknowledging difference of opinion in US Courts over the issue of regarding software as goods, reliance was placed on verdict in Advent Systems Ltd. v. Unisys Corpn. [925 F 2d 670 (3d Cir 1991)] followed in Colonial Life Insurance Co. v. Electronic Data Systems Corp., 817 F. Suppl. 235 to hold that branded software sold goods and that the term "all materials, articles and commodities" includes both tangible and intangible/incorporeal property which is capable of abstraction, consumption and use and which can be transmitted, transferred, delivered, stored, possessed etc. and that the software programmes have all these attributes. The Court also held the view that there was no distinction between unbranded and branded software in this regard though it refused to discuss taxability issues concerning unbranded software.
The issue regarding treatment to be given to unbranded software came up before the Madras High Court in M/s Infosys Technologies Ltd Vs The Special Commissioner & Commissioner of Commercial Taxes (2008 (7) TMI 266 – Madras High Court) where the High Court reiterated the view that software whether customised or non-customised would be “goods” as long as they have the required attributes i.e. a) utility; (b) capable of being bought and sold; and (c) capable of being transmitted, transferred, delivered, stored and possessed.
Transfer of right to use
The question as to what would constitute transfer of right to use goods has been sought to be answered by the Courts at various points of time. One of the issues highlighted by the Honorable Supreme Court has been that of effective control and this should be transferred to the transferee in order to have a scenario of transfer of right to use goods. This view was followed in Rashtriya Ispat Nigam Ltd Vs State of Andhra Pradesh & Another (2002 (3) TMI 705 Supreme Court) where effective control of machinery given to contractor for use by him was held to rest with the transferor and not with the contractor consequently not resulting in transfer of right to use machinery.
The issue of taxability of transfer of right to use goods was also reviewed by the Supreme Court in Bharat Sanchar Nigam Ltd Vs UOI (2006 (3) TMI 1 – Supreme Court of India) in the context of telecommunication services where it held thus –
“To constitute a transaction for the transfer of the right to use the goods the transaction must have the following attributes –
i. There must be goods available for delivery
ii. There must be a consensus ad idem as to the identity of the goods
iii. 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
iv. For the period during which the transferee has such legal right, it has to be the exclusion to 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
v. 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.”
This view was later on followed in G.S Lamba & Sons Vs State of Andhra Pradesh (2011 (1) TMI 1196 - Andhra Pradesh High Court), where the High Court relying on various judicial precedents with regard to the concept of transfer of right to use goods, held thus when it came to holding hiring of transit mixers for transport of RMC as an arrangement for transfer of right to use goods –
“The settled essential requirements of a transaction for transfer of the right to use goods are–
- It is not the transfer of the property in goods, but it is the right to use property in goods;
- Article 366(29A)(d) read with the latter part of clause (29A) which uses the words, "and such transfer, delivery or supply. . ." would show that the tax is not on the delivery of the goods used, but on the transfer of the right to use goods regardless of when or whether the goods are delivered for use subject to the condition that the goods should be in existence for use;
- In the transaction for the transfer of the right to use goods, delivery of goods is not a condition precedent, but the delivery of goods may be one of the elements of the transaction;
- The effective or general control does not mean always physical control and, even if the manner, method, modalities and the time of the use of goods is decided by the lessee or the customer, it would be under the effective or general control over the goods; and
- The approvals, concessions, licences and permits in relation to goods would also be available to the user of goods, even if such licences or permits are in the name of owner (transferor) of the goods; and
- During the period of contract exclusive right to use goods along with permits, licences, etc., vests in the lessee.”
Two of the requirements for transfer of right to use goods as confirmed by the Courts have been that of exclusivity of transfer in such a way that the same goods cannot be transferred to others as well as the point of effective control over the goods. While this would work in case of tangible property, we would have issues in applying the same principles to intangible property like for instance trademarks or software. When the issue was referred to the High Court, it held the transfer of right to use intangible property as not being liable to VAT where the transfer is not on exclusive basis. In Malabar Gold Private Limited Vs CTO Kozhikode & Others (2013 (7) TMI 101 - Kerala High Court), the two Member Bench overruled the earlier verdict of the Single Member Bench to hold the view that allowing a franchisee to use trademark for retailing of gold on non-exclusive basis where the franchisor could have additional franchisees, did not amount to transfer of right to use goods.
A similar view was also held by the Madras High Court in Infotech Software Dealers’ Association Vs UOI & Others (2010 (8) TMI 13 - Madras High Court) where the Court held that an EULA (End User License Agreement) for allowing another to use software which is copyrighted would not necessarily result in transfer of right to use goods as the software itself is not transferred and what is allowed is the right to use the data stored in the software.
Readers may note that the arrangement discussed above is different from one where customised software is developed for a client. Where developmental activities are involved, and client specific software is developed for the client in such a way that the intellectual property developed belongs to the client/customer from the very beginning without the creator retaining any ownership rights over the same, the arrangement would be one of service and not sale of goods as confirmed by the Karnataka high Court in Sasken Communication Technologies Ltd Vs Joint Commissioner of Commercial Taxes (Appeals-3) Bangalore (2011 (4) TMI 566 – Karnataka High Court).
The issue as to whether a contract would result in transfer of right to use goods or not in the context of software licensing is expected to continue for such time till the matter is clarified at the highest levels of the Judiciary. Readers are advised to exercise caution in trying to determine liability either under service tax or VAT as the same would to a large extent depend on the terms of the contract with clients which would help one in determining the true nature of activities involved and the stage/point of transfer of ownership if any for classifying the said contract.
CA Srikantha Rao T
Tags Service Tax