March 12 2010
The taxation of software is a vexed subject in the Indian context, given that, depending on the supply methodology, software is subject to one or more of the principal indirect taxes - namely, central excise duty (applicable to the 'manufacture' of excisable goods in India), service tax (applicable to the provision of a 'taxable service'), state sales tax/value-added tax (VAT) (applicable to a 'sale' of goods in India) and customs duties (applicable to the import of goods) - due to the breadth and overlap of these levies. This update focuses on the taxation of software imports into India and issues related thereto, and outlines the changes introduced by the presentation of the Union Budget 2010-11 on February 26 2010 in this regard.
Under the Customs Act 1962, customs duties are levied on imports of goods into India. Although the definition of 'goods' in the Customs Act is set out in terms similar to the definitions in the state sales tax/VAT legislation, in respect of which the Supreme Court has held that 'goods' include intangibles, the taxation event for Customs (ie, the import) has been judicially interpreted to be complete only when the goods cross the Customs barrier and become part of the mass of goods within the country. Therefore, notwithstanding judicial decisions to the effect that software constitutes intangible goods, only an import of software in tangible form (ie, on a CD or other tangible medium) can be liable to customs duties. The following customs duties apply to software:
The duty rates are set out in the Customs and Central Excise Tariff provisions, exemptions to which can be notified by the central government from time to time.
Services in relation to IT software were brought under the ambit of service tax from May 2008; these include the provision of the right to use IT software for commercial exploitation and the provision of the right to use software supplied electronically. IT software services are said to be imported if they are provided from outside India to a person in India. The rate of service tax is 10% (since February 24 2009).
The applicability of customs duties and service tax requires separate examination for the three modes in which software import transactions usually occur:
Under the Customs Tariff, which is aligned with the Harmonized System of Nomenclature, software kits were classified under Entry 8523 80 20 (IT software), which attracted a zero rate of BCD and was exempt from SAD. The applicability of CVD depended on whether the software was customized software (ie, software developed for a specific user or client) or packaged software (ie, software designed to meet the need of a variety of users). Customized software was exempt from CVD, but packaged software attracted an 8% duty. By this rate structure, customized software effectively attracted tax as a service, whereas packaged software was taxed as goods.
Chargeability to service tax under the taxable service of IT software services led to dual taxation of packaged software under customs and service tax, as only imports of software for non-commercial use (ie, direct imports for personal use) escaped taxation under the service tax provisions.
Following representations from the IT industry, in 2009 this tax burden was alleviated by an exemption from CVD to the extent of the consideration payable for the right to use the software for commercial exploitation, by which the domain of Customs with regard to software was restricted to the value of the tangible medium on which the software was recorded. Implicitly, only the licence value attracted the charge of service tax. Although the exemption from CVD was issued with the express purpose of removal of the overlap in taxation, some customs authorities continued to insist on payment of CVD on the entire value of packaged software, rejecting the split values for the tangible medium and licence provided by importers. Fortunately, in November 2009 the Central Board of Excise and Customs issued a clarification instructing all customs authorities to accept the split into values attributed to the medium and licence by importers, unless there were reasons to believe that the split had been made with a view to evade tax.
Subject to the valuation issues that arose out of the position adopted by the customs authorities that licence fees were required to be added to the value of the medium on the basis that the licence was a condition of sale of the medium, the second mode of software imports (ie, separate imports of the medium and licence) earlier provided for a duty arbitrage over the first mode (ie, imports of complete kits), on account of the CVD exemption for licences classified under Entry 4907 00 30 (documents of title conveying the right to use IT software). This saving opportunity disappeared once the CVD exemption to the extent of consideration payable for the right to use software was notified. The third mode of software imports (ie, electronic downloads) has attracted a levy of service tax since May 2008 - other than imports by individuals for non-commercial use.
Two changes to the above scheme of taxation have been introduced, which are effective from February 27 2010. The first is that the rate of central excise duty (and therefore CVD) on IT software has been increased to 10%. The second, in sync with and as an alternative to the exemption from CVD to the extent of the consideration payable for the right to use the software (on which service tax is payable), is an exemption from the whole of the applicable service tax if the entire purchase consideration has been charged to applicable customs duties.
Although at present there is no double taxation in terms of customs duties and service tax, software imports on tangible media attract a further tax (ie, state sales tax/VAT) on further sales of the software, without an opportunity to recover the customs duties and service tax paid earlier. These multiple levies of tax will abate only upon the transition to a comprehensive goods and services tax (GST) regime. The previous target date of April 1 2010 for the transition to GST has been pushed back and, as the union finance minister said in his speech, there is an "earnest endeavour" to introduce GST from April 2011.
For further information on this topic please contact Udayan Choksi at Economic Laws Practice by telephone (+91 22 6636 7000), fax (+91 22 6636 7172) or email (email@example.com).
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