Decoding Finance Bill 2012

Venkatraman N, CFO, Sonata Software Ltd
Budget 2012, Software, and Irony!

The Software Industry has been having a torrid time due to haziness in taxation laws around Software.  The myriad of litigation is proof enough.  Many of my colleagues watched Budget 2012 with great expectation as they were expecting some relief from the Finance Minister.  However, post the budget most of them came back and said that there was nothing much for the Industry and it was status quo.  Time was to suggest that all of us had missed the ‘detail’ and the devil was indeed there.  Post the budget we have now heard many experts talk about the various retrospective amendments, clarifications that have been made in the Income-Tax Act, the manner in which service tax has now moved to a ‘negative list’ based of taxation etc.  I thought of highlighting a few changes which will affect the Software Industry especially those companies which ‘trade in software’ i.e. buy and sell ‘shrink wrapped software products’ in India.
Companies who traded in shrink wrapped software products have for long been either importing from outside India or buying these products locally in India and then selling them to their customers in India.  These trading companies in the case of imports, imported shrink wrapped boxes through customs and paid appropriate custom duties thereon and when sourced locally they paid taxes local taxes such as Sales Tax, VAT etc. as charged by the supplier.  Subsequently, when selling the products to its customers these trading companies charged appropriate taxes such as Sales Tax, Octroi, or VAT as the case may be.  As you will notice, the entire industry was clearly under the belief and understanding the they were buying and selling ‘goods’ as defined under law.
The Income-Tax officials at some point in early 2001 woke up and made demands on these companies on the pretext that the payments made by them to their suppliers of shrink wrapped products was in the form ‘Royalty’ as defined under the Indian-Income Tax Act and so was duty bound to have deducted tax on these payments.  They pursued the line of argument that this was not in the nature of purchase of goods and the understanding of the Industry was wrong.  This was clearly a case of the department waking up after the ‘proverbial horse had bolted’.  The companies had already made payments for their purchase and there was no way they could now go back and ‘deduct taxes on their payments in the past’.  The liability for missed deduction was thus for the companies to bear.  The trading companies picked up the debate with the department it became a raging dispute.  To ensure that the liability did not continue to build up, most of the companies started deducting taxes on payments commencing 2002.  As regards cases for the previous years, multiple decisions of the Tribunals and High Courts held in favor of the companies and said that payments for purchase of shrink wrapped software was not in the nature of royalty whereas a couple of decisions held against that view as well.  The question is now finally pending before the Honorable Supreme Court.
Now, in the Budget 2012 the Government has inserted certain clarifications to Section 9 of the Income-Tax Act stating that right from 1976 they have believed that payment for import of shrink wrapped software was ‘Royalty’.  Effectively they answered the question pending before the Supreme Court in their own favor and with retrospective effect.
The same Ministry of Finance which made the above amendment through its Tax Research Unit has issued a circular covering amendments made it in Budget 2012 to the Service Tax Act covering the taxation of shrink wrapped software.  Reproduction of Clause 5.4.4 from the aforementioned circular reads as:
It is a settled position of law that prepackaged software or canned software or shrink wrapped software is goods. (Supreme Court judgment in case of Tata Consultancy Services vs. State of Andhra Pradesh [2002(178) ELT 22(SC) refers]. To determine whether providing license to use a software is a service or sale of goods it would need to be seen whether the license to use packaged software tantamount to ‘transfer of right to use goods’. ‘Transfer of right to use goods’ is deemed to be a sale under Article 366(29A) of the Constitution of India…..”
In simple terms, the Tax Research Unit has clarified that sale of ‘shrink wrapped software’ is sale of ‘goods’ as ruled by the Supreme Court and hence no ‘Service Tax’ is applicable from a date to be notified.
The irony cannot be more glaring.  The Finance Ministry believes with retrospective effect from 1976 that ‘payment for shrink wrapped software is ‘Royalty’ under the Income-Tax Act even while the question is pending before the Honorable Supreme Court and the same Finance Ministry supported by its Tax Research Unit holds that Shrink Wrapped Software is ‘goods’ and takes guidance from a ruling of the Honorable Supreme Court to support its view!
When the Law makers, the Ministry and the Government are so confused think of the plight of the tax -payer.  When a debate starts between the tax-payer and the Government it clearly looks like that the latter has an undue advantage, and this is not a debate between equals.  I think the need of the hour is certainty, clarity and clarifications which are prospective and not retrospective.
In the next part I will cover an amendment which is positive in nature and sets right a draconian provision in the Income-Tax Act.