India’s indirect tax regulations have generally struggled to define clear taxing principles for the technology sector, especially when intangibles are involved. The law deals with buying or selling of the “simplicitor” of hardware quite easily. This is the same as the case of pure services transaction.

However, when it comes to transactions that involve a lease or license, or use in the course of provision of services, regulations have been fairly complex to implement. Tax implications have several nuances, which may be contract- and conduct-driven and lead to challenges relating to the existence of an alternative set of interpretations of facts, and therefore, a different set of implications.

Moreover, there have been differing views expressed by courts and legislature, which has led to fractured tax outcomes.

Let us take the case of software to begin with. Software transactions can be of packaged or off-the-shelf products or customized offerings. Typically, based on judicial pronouncements, off-the-shelf software is treated as goods and is therefore liable to local sales tax levied by state governments.

However, it is interesting to note that when off-the-shelf software is sold, what is provided is a license to use it (and not the software itself). In other words, what is being allowed is the limited right to use the product and does not have the features of a “sale.”

Need for this debate arises due to the fact that state governments treat such software licenses as sale of goods and seek to levy local sales tax on these. The Central Government treats software that is provided electronically as a service and seeks to levy service tax on it. (This is the most popular mode of provision in terms of value.)

The debate in relation to taxation of software has taken centrestage since 2006. As such, granting of the right to use software was always being considered by state governments as supply of goods liable to VAT. This was affirmed by the Supreme Court in the Tata Consultancy services (TCS) case. Excise duty (ED) and countervailing duty (CVD) was introduced in 2006. Thereby, both excise duty and VAT were imposed on software.

It was argued that in concept, taxation of software became comparable to any other product that attracted ED on manufacture and then VAT on sale (with no cross credits).

However, the real debate on software taxation was triggered by the introduction of service tax (ST) on “information technology software services” (ITSS) in 2008.

This threw up a host of questions from validity to scope of coverage and protest due to resultant double taxation, since software licenses could now be “goods” under VAT and “services” under ST at the same time. Moreover, unlike in the case of works contracts, the same value was subjected to dual taxes. (In principle, only the services portion is liable to ST in the case of works contracts, with VAT applying on the goods portion). This double tax regime resulted in various representations being made to the Finance Ministry and led to the introduction (in July 2009) of exemption from customs and ED on royalties paid on the right to use packaged software supplied for commercial use, e.g., reproduction, distribution, sale or further development. However, problems relating to dual taxation continued.

To address these concerns, Budget 2010 introduced conditional exemptions from CVD and ED on import or manufacture of packaged software if ST was paid on supply of software packages (and vice versa).

This was further refined in December 2010 and in Budget 2011.

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