In India, multiple indirect taxes are levied on software transactions, including excise, customs, value added tax (VAT) and service tax. Excise is charged on the event of manufacture, customs on the import of goods into India, VAT on the sale of goods, and service tax on the provision of notified services.
Given that the definition of goods is not common across the indirect tax categories and that goods and services are not defined in mutually exclusive terms, software taxation in India has some peculiarities and overlaps, particularly because software is intangible.
Software is listed in the excise and customs tariffs (both of which are aligned to the Harmonized System of Nomenclature) as “information technology software” under chapter heading 8523, which covers discs, tapes and other recording media, whether or not recorded.
For domestic software manufacturers, excise taxation is based on recordings made on tangible media, which is considered a manufacturing activity. The tariff does not differentiate between packaged software (designed to meet the needs of a variety of users and intended for, or capable of, off-the-shelf sale) and customized software (custom-designed software developed for specific users); however customized software was exempted in 2006. Packaged software is taxed at 8% while customized software continues to be exempt.
Customs duties in India comprise basic customs duty (BCD), additional customs duty in lieu of excise duty levied on domestic products (CVD) and additional customs duty in lieu of sales tax/VAT (SAD). Software is exempt from BCD and SAD. However, CVD is levied on packaged software at 8% while customized software is exempt as under excise.
In respect of the software licences which are imported independently of the medium, chapter 49 of the customs tariff (which covers printed books, newspapers, pictures and other products of the printing industry) contains a specific entry for “documents of title conveying the right to use information technology software”, i.e. the software licence, for which the tariff rate is nil. Despite the separate entry, customs authorities are attempting to include the licence fee in the value of the medium on their perception that the licence is a condition of sale of the software, and therefore forms part of the tax base.
VAT is leviable on sales of software at 4%. Consideration paid for the transfer of the right to use software is also subject to VAT, either by forming part of the assessable value of the software or as a separate deemed sale under VAT law.
From May 2008, a levy of service tax was introduced on transactions relating to software under the taxing entry of “information technology software services” which was defined to cover (i) the development of customized software, (ii) the transfer of the right to use software (both packaged and customized) for commercial exploitation (including the right to reproduce, distribute and sell the software and the right to use software components for the creation of and inclusion in other information technology software products) and (iii) downloads of software in electronic form.
The introduction of service tax on software brought about double taxation under excise and customs (CVD), on the one hand, and service tax on the other, on account of the “right to use” element. After complaints from the IT industry about the burden of double taxation, an attempt was made to resolve the issue in July 2009 by enacting a partial exemption from excise and CVD on the licence fee for packaged software. This exemption was subject to two conditions: (i) the transfer of right to use must be for commercial exploitation, and (ii) the assessee has to register with the service tax authorities.
However, implementation issues arose in October 2009 when, despite the exemption, some customs authorities continued to insist on payments of CVD for the entire consideration of packaged software (including the licence fee) after rejecting the split values provided by importers. As a result, thousands of rupees worth of consignments of Microsoft’s latest operating system, Windows 7, for example, were held up at customs for over 10 days after the product had been launched.
In some cases, authorities also denied software consignments an exemption where the licence did not include the rights to reproduce, distribute and sell the software.
In order to resolve these difficulties, a clarification was issued in November 2009 instructing authorities to accept the split values provided by assessees for the physical media and the licence and to collect CVD only on the former, unless the values were split so as to evade duty. It was also clarified that it would suffice if one of the rights required in the first condition for the exemption was covered under a software licence.
Today, the unresolved overlap that remains is between VAT and service tax on the right to use software components, the cost of which is compounded by the lack of fungibility of credit between VAT (a state levy) and service tax (a federal levy). Businesses charge both VAT and service tax to their customers. This overlap in the definitions of goods and services must be addressed on the transition to the goods and services tax regime.
Rohan Shah is the managing partner and Divya Jeswant is a lawyer at full-service law firm Economic Laws Practice. The firm is headquartered in Mumbai, and has offices in New Delhi, Pune and Ahmedabad.
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