Decided on August 24,2010



- (1.) D.MURUGESAN, J. Both the writ petitions raise an important question as to whether a software would amount to goods and if so, when it is supplied to a customer pursuant to the "End User Licence Agreement" (EULA), the transaction is liable to be treated as sale or service and whether the Parliament has the legislative competency to bring in the amended provisions of Section 65(105)(zzzze) by virtue of the powers under Entry 97 of List I of Schedule VII of the Constitution of India?
(2.) Facts put forth by the petitioner: The petitioner in both the writ petitions is Infotech Software Dealers Association (hereinafter referred to as "the ISODA), a society registered under the Societies Registration Act with its headquarters at Mumbai. It prays for a Writ of Declaration to declare Section 65(105)(zzzze) of Chapter V of Finance Act, 1994 (as amended by Finance No.2 Act of 2009) is null and void, ultra vires and unconstitutional of the provisions of Articles 245, Entries 92C and 97 of List-I, Entry 54 of List-II of Schedule VII and contrary to provisions of Articles 14, 19(1)(g), 265 and 268A of the Constitution of India in so far as the petitioner is concerned. 2.2. The ISODA has about 100 members who are all software resellers. The members of the association of companies are engaged in the business of reselling of Computer Software Products. The sale of software by the members of the association falls into three categories. They are (i) Shrink Wrap Software; (ii) Multiple User Software/Paper Licence and (iii) Internet Download. The Shrink Wrap Software is a box containing the CD/DVD, user manual and the end user licence agreement. The box is wrapped in plastic and therefore called as "Shrink Wrap Software". When a special DVD/CD is manufactured capable of being used in more than one hardware and when the same is sold along with paper licence to enable a customer/purchaser to use the DVD/CD in a specific number of hardware equipments, it is known as "Multiple User Software or Paper Licence". In case of large number of users in different locations, it may not be feasible to have paper licence DVD/CD and therefore the distributor with the authority of the software manufacturer enters into an agreement which enables the purchaser to download from the internet a fixed number of copies of the software, which transaction is known as "Internet Download". 2.3. The software is also classified into two types, namely, Canned Software and Customised Software. Canned software means a software that is designed and created for sale to more than one person and it is designed in such a way that large number of people can use it on a variety of hardware and it is also called as "Packaged Software" or "Standard Software" or "Normal Software" or "Branded Software". On the other hand, Customised Software means the software created for a single person or a specific customer to meet his specific requirement and it is also called as "Tailor-made Software" or "Specific Software". 2.4. Whenever software is sold in all the categories, they are treated as goods regardless of the nature of transaction. In such event, the goods are liable to sales tax and are liable to Value Added Tax (VAT). As the ultimate transaction is only that of sale of goods, an element of service is absent and in such circumstances, the State Government alone is competent to enact a law under Entry 54 of List II of Schedule VII. 2.5. Until 16.5.2008, the sale of canned software license was subject to 4% VAT and the contract for customised software maintenance and other technical support were subject to service tax. No service tax was levied in the case of sale of canned software license. 2.6. An amendment was brought to Section 65(105) of Chapter V of Finance Act, 1994 through Finance Act No.2 of 2009, whereby a new clause (zzzze) was introduced to Section 65(105). Sub-section (105) of Section 65 defines the expression "taxable service" and by virtue of the new provision of clause (zzzze), the information technology software is also brought under the meaning of "taxable service". That amendment was brought in by virtue of residuary power under Entry 97 of List I of Schedule VII. As the software being goods and there is no element of service when it is sold to the customers, the provisions of Section 65(105)(zzzze), particularly sub-clauses (v) and (vi) is unconstitutional, as it is beyond the legislative competence of Parliament. 2.7. The impugned provision is also liable to be struck down as being arbitrary and ultra vires of Article 14, as in the case of software, the right of possession as well as the effective control over the branded software is transferred to the purchaser, whereas under Section 65(105)(zzzze) (v) and (vi) of the Finance Act, the service tax has been levied only in relation to the supply of tangible goods without transfer of right of possession and effective control of tangible goods. The provision is also violative of Article 19(1)(g) and Article 265 of the Constitution of India. By virtue of the amendment, levy of service tax makes the sale of software totally unviable. As the measure and the value of tax have been done arbitrarily, particularly when the service element is absent, the levy of service tax on the value would be violative of Article 14 as well as Article 19(1)(g) of the Constitution of India. 2.8. By the imposition of service tax, the cost of the canned software to the end customer will increase by 13%. In case of VAT + service tax, it will increase to 25%. In case of import of software from abroad, the software becomes subject to levy of CVD+VAT+service tax. The amendment to the Finance Act would seriously prejudice the members of the association of companies who are the vast majority of computer users in the country and to bear the increase in the net cost of the software by almost 25%.
(3.) Contentions of the respondents: The amendment would fall under Entry 97 of List I of Schedule VII and the challenge to the legislative competency of Parliament is totally unsustainable. All standardised software are not like any other product or goods. There is no element of sales when it is supplied to the end user by means of EULA. Along with the Standardised Software a key (an alpha numerical code) is provided to the end user to activate the software by registering the same with the original manufacturer through the internet. Standardised Software Licence licensed and available across the shelf or downloaded from internet is not a finished product, rather updates are given by the original manufacturer (Microsoft or Symantec) to the end user for an agreed period. Updates are supplied to the end user through the internet for a period specified in the license. Once the software is registered with the original manufacturer through the internet using the key supplied by the original manufacturer, (the key is nothing but an alpha numerical code) the terms of license are agreed upon and installed for use in the specific computer. 3.2. The original manufacturer, who creates the software, only licenses the software for the private use of the end user subject to the terms and conditions. If the end user agrees to the terms and conditions, such end user is given "right to use" (install, run and get updates) the software within the limits prescribed. At no stage an end user who runs the software installed in his computer becomes absolute owner of the software. The end user cannot tamper or modify, cannot improve and cannot rectify errors in the software and the end user should not sell the software to another person for commercial exploitation. In view of the specific licensing agreement between the original manufacturer of Standardised Software, namely, Microsoft and Symantec, and the end user, it would be clear that the software is not sold, but only licensed for the limited use for which it is licensed. In other words, in trade parlance, whenever a software product is launched, the original manufacturer releases what is known as End User License Agreement and Product Use Rights. 3.3. As the Right to Use includes, among other things, the three basic components, namely, (i) right to install the software in a computer by registering the same subject to licensing terms and conditions; (ii) right to run the software and (iii) right to receive updates online through the internet if and when provided by the original manufacturer, it would not amount to absolute sale. Right to Use excludes certain rights, particularly right to modify, right to work and right to commercial exploitation. 3.4. The provisions of Section 65(105)(zzzze) uses the expression providing the right to use information technology software for commercial exploitation including right to reproduce, distribute and sell information technology software and right to use software components for the creation of and inclusion in other information technology software products and providing the right to use information technology software supplied electronically. 3.5. The canned software or packaged software is capable of being marketed and sold off the shelf in a standardised form and therefore is excisable goods. The service element is discernible clearly in the customised software which is liable for service tax. Providing 'right to use' is a service and is liable to service tax within the ambit of constitutional mandate and residual powers of taxation. In any case, each transaction should be considered individually to find out as to whether it is a sale or service and the writ petitions are premature, as no action is taken in terms of the amended provision.;

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