R IN THE HIGH COURT OF KARNATAKA AT BENGALURU DATED THIS THE9H DAY OF FEBRUARY2015PRESENT THE HON’BLE MR. JUSTICE N.KUMAR AND THE HON’BLE MR. JUSTICE B.VEERAPPA WRIT PETITION Nos.57023 – 57070/2013 (T – RES) BETWEEN : Infosys Limited (Formerly known as Infosys Technologies Limited) Plot Nos.44 & 97-A, 3rd Cross Electronic City, Hosur Road Bangalore – 560 100 Rep. by its Principal – CAG Mr.P.Prakash. ...PETITIONER (By Sri N. Venkataraman, Senior Counsel for Sri T.Suryanarayana, Adv.) AND :
1.
2. The Deputy Commissioner of Commercial Taxes (Audit-4.4) VAT Division-4, Vanijya Therige Karyalaya-2 National Games Village Koramanagala, Bangalore-560 047 The Commissioner of Commercial Taxes Vanijya Therige Karyalaya Gandhinagar, Bangalore-560009 3.
4. 5. 2 The State of Karnataka Rep. by the Principal Secretary Finance Department Government of Karnataka Vidhana Soudha, Bangalore-560001 The Commissioner of Service-Tax Service-Tax Commissionerate No.16/1, S.P. Complex Lalbagh Road, Bangalore-560027 The Union of India Rep. by the Secretary Ministry of Finance Department of Revenue Government of India, North Block New Delhi-110001. …RESPONDENTS (By Sri Gopal Subramaniam, Senior Adv., Sri Abhishek Tiwari, Ms. Anusha Ramesh, Advs. for Sri K.M.Shivayogiswamy, AGA for R-1 to 3; Sri G.Rajagopalan, Additional Solicitor General of India for Sri N.R.Bhaskar, Adv. for R-4 & 5.) . . . . These writ petitions are filed under Article 226 of the Constitution of India, praying to quash the impugned re- assessment order dated 23.11.2013 vide Annex-Z passed by the R1 under Section 39(1) of the KVAT Act and Section 9(2) of the CST Act for the tax periods April 2005 to March 2009 & to quash the impugned demand notice in Form VAT180dated 23.11.2013 vide Annex-Z1 issued by the R1 for the tax periods April 2005 to March 2009. N.Kumar J., made the following: These writ petitions coming on for orders this day, 3
ORDERThe assessee has preferred these Writ Petitions seeking for : (a) quashing of the re-assessment order, demand notice in Form VAT180and for a direction to respondents 1 to 3 to refund the amount; and (b) for a declaration that Section 3 of the Karnataka Value Added Tax Act, 2003 to the extent it seeks to levy tax on pure services like implementation, customization and other support services in respect of software as ultra vires Articles 246 and 265 of the Constitution of India; or (c) in the alternative, to declare that Section 65 (105) (zzzze) of the Finance Act, 1994, to the extent it seeks to levy service tax on implementation, customization and other support services, if treated as a sale, as being ultra vires Articles 246 and 265 read with Entry 97 of List I of the Seventh Schedule to the Constitution; and 4 (d) for a direction to respondent Nos. 4 and 5 to refund the entire service tax paid by and collected from the petitioner and other consequential reliefs. Though in the Writ Petition they have challenged the validity of Section 3 of the KVAT Act as well as Section 66 read with Section 65 (105)(zzzze) of the Finance Act, 1994, no arguments were addressed on the constitutional validity of the said provisions. Therefore, it is not considered. FACTS IN BRIEF:
2. The assessee is a Company incorporated under the provisions of the Companies Act, 1956 and is engaged in the business of development and sale of information technology related services like customization of software, implementation of software, annual technical and support services, trading/support services of third-party software besides providing services and other related technical consultancy and engineering services. The petitioners have developed a software solution branded as ‘Finacle’. Finacle 5 is a specialized universal banking software solution developed and provided by the petitioner for usage in the banking sector. Finacle software solution consists of various modules like core banking, customer relationship management, treasury, internet banking, mobile banking and wealth management systems. All of the above modules when integrated form “Finacle Universal Banking Solution’ (‘Finacle UBS’ or ‘Finacle’). From time to time, the petitioner releases upgraded versions of the said software solution called ‘Finacle Release’. The petitioner has an independent and dedicated team to develop Finacle and its upgraded releases. The said releases are developed primarily for adding a new functionality and it typically takes one to one and a half years for a new release to be available in the market. Since Finacle is a banking software solution consisting of various modules, provision of services to the client-banks will be dependent on their specific business requirements and needs. Pursuant to the client-banks’ specifications, 6 Finacle requires implementation to ensure that the client- banks’ requirements are met.
3. The petitioner further submits that the implementation activity commences after the sale of Finacle. The implementation activity typically includes: • Installation of Finacle already purchased by the bank on the bank’s hardware at their premises • Bank specific customization using Finacle parameters and tools • Customization of functionalities like setting up of fees, charges etc., • Reports-Standard RBI & MIS reports are modified for each bank The process of implementation essentially involves setting up of bank-specific modules under savings bank, current account etc., configuring the accounts with the fees, charges, interest and such other basic requirements, setting up interfaces for data migration of the accounts from the old system followed by the banks to Finacle system, testing of 7 the setup environment by the bank and assessing the banks in starting up their operations on Finacle.
4. A customer can buy Finacle from the petitioner and thereafter has the option to engage anybody for its implementation. Therefore, the sale of Finacle and its implementation are two different and independent activities and cannot be clubbed together. Many a time, the customer chooses the petitioner to provide the services of implementation. In such a case, the petitioner enters into separate agreements – one for sale of Finacle and the other for provision of implementation services. Where the implementation is undertaken by the petitioner, the petitioner sets up a project implementation team comprising of both the petitioner’s employees as well as customers’ employees. The project implementation team ensures that Finacle is integrated into the customers’ IT environment. The process of implementation does not entail development of any new software or upgradation of the existing software. 8 5. Apart from the above activity of development and sale of its own software and services, the petitioner also purchases and sells third-party software and provides implementation and other support services for such third- party software. The petitioner also provides annual technical support services which may involve some amount of transfer of property in goods. The petitioner also provides other services like training, installation, customization, online software support services, technical consultancy and engineering services.
6. The petitioner has been treating development and sale of its own software like Finacle or sale of any third-party software as a ‘sale’ and has been paying sales tax/VAT at the applicable rates on the entire turnover relating thereto. In respect of the turnover relating to provision of implementation, customization or other support services, whether of its own software or that of a third-party, the petitioner has been treating the entire turnover as exempt and has not paid any sales tax/VAT but has been paying 9 service-tax since the time the levy of service-tax on such transactions came into force. As regards annual technical support services, since there is some amount of transfer of property in goods involved, the petitioner has been declaring and paying works contract tax. Insofar as the activity of development and export of software, although it is a sale, the petitioner claimed exemption of the turnover relatable thereto as such turnover qualified as an exempt turnover under Section 5 of the CST Act.
7. As soon as the levy of sales tax on computer software came into force, with effect from 01-04-2001, the petitioner made an application for clarification to the Authority for Clarification and Advance Ruling under Section 4 of the KST Act. They explained in the application in detail the entire gamut of its activities and sought clarification regarding their exigibility to sales tax and rate of tax applicable thereto. The Authority for Clarification and Advance Ruling passed an order dated 12-11-2002 clarifying that the sale of software would be exigible to tax at the rate of 4% under Entry 20(v) 10 of Part C of the Second Schedule to the KST Act. Further, they clarified that the annual technical support services and the activity of training, installation, implementation, onsite support, customization, online software support, parameterization etc., are not liable to tax unless it involved any transfer of property in goods.
8. The Revenue did not raise any issue under the KST regime and the returns filed by the petitioner declaring its total and taxable turnovers have been accepted without any demur. Even after coming into force of the KVAT Act, with effect from 01-04-2005, no issue was raised by the Revenue. In fact, the Assistant Commissioner of Commercial Taxes (Audit-4), LDU Division, Bangalore, examined the books of accounts and the activities of the petitioner in detail and with particular focus on implementation services, claimed as exempt by the petitioner, and passed two orders dated 23-02-2007 under Section 38(1) of the KVAT Act for the tax periods June 2005 to March 2006 and April 2006 to December 2006 respectively. In the said orders, the ACCT11(LDU) discussed in detail the implementation services provided by the petitioner and accepted that the said activity is a pure service without any element of sale or transfer of property in goods and consciously allowed the exemption claimed by the petitioner on the turnover relatable thereto.
9. It is thereafter for the first time, on 13-03-2009, the Assistant Commissioner of Commercial Taxes (Enforcement- 7), South Zone, Bangalore, visited the petitioner’s place of business and thereafter issued a notice dated 17-04-2009 under Section 52 of the KVAT Act contending that the sale of Finacle by the petitioner is nothing but a sale of software license and since software licenses were inserted in Serial No.34 of the Third Schedule to the KVAT Act, with effect from 01-04-2007, the petitioner was liable to pay the higher rate of tax at 12.5% from 01-04-2005 to 31-03-2007 on the entire turnover relatable to sale of Finacle instead of 4% KVAT and 10% CST paid by the petitioner for the period. Later, again by a notice dated 05-06-2009, he informed the petitioner that he has been conferred jurisdiction, by the 2nd 12 respondent, to re-assess the petitioner under Section 39 of the KVAT Act for the tax periods April 2005 to March 2009 and called upon the petitioner to produce its books of account for the said period. Thereafter, one more notice dated 22-09-2009 was issued under Section 39 of the KVAT Act proposing to tax sale of software as sale of software licenses at a higher rate of 12.5% for the tax periods April 2005 to March 2007, to treat the contract for implementation of Finacle as a works contract involving transfer of property in goods liable to tax at the rate of 12.5% after giving deduction for the labour charges and to disallow the petitioner’s claim for input tax credit to the extent of 45% on the ground that the onsite activity of the petitioner in terms of the agreements for development and export of software is nothing but export of services or services provided outside India and therefore exempt from VAT. The petitioner submitted a detailed reply raising several objections including the question of jurisdiction. The authorities issued a revised proposition notice proposing to 13 disallow input tax credit relatable to exports to the extent of 50% on the ground that 50% of the export turnover arises on account of onsite activities. The petitioner submitted a reply. Over-ruling all the objections, the authority proceeded to pass an order raising a total demand of Rs.68,02,44,801/- towards tax, interest and penalty. The petitioner filed an application for rectification under Section 69 of the Act. Accepting some of the errors pointed out by the petitioner, by an order dated 5.12.2009, the total demand was reduced to Rs.49,08,43,982/-. Aggrieved by the said order, the petitioner preferred a Writ Petition before this Court in W.P. Nos. 37456-37458 and 37649-37693/2009. The said Writ Petitions came to be disposed of with liberty to the petitioner to file a statutory appeal. Accordingly, the petitioner filed appeal before the Tribunal. The Tribunal, after hearing the parties, partly allowed the appeals filed by the petitioner. It held that sale of Finacle is a case of sale of software and not sale of software licence as contended by the revenue and, therefore, the authority was wrong in levying higher rate of 14 tax. It further held that implementation service does not involve any transfer of property in goods and, therefore, not liable to tax under the KVAT Act. The Tribunal followed its earlier judgment rendered in the case of IBM India Private Limited. At that stage, the request of the State that they should be given an opportunity to examine the implementation service agreements was acceded to and the Tribunal remanded the matter back to the assessing authority as they were passing an order of remand on the question of disallowance of input tax credit. The assessing authority was directed to examine the issue strictly in light of its earlier judgment in the case of IBM India Private Limited. Thereafter, notice came to be issued under Section 39 of the KVAT Act and Section 9(2) of the CST Act. The petitioner filed its objections to the notice. After hearing the parties, the assessing authority rejected the petitioner’s claim for exemption on implementation charges on an entirely new ground that the said activity is nothing but a value addition to Finacle software and, therefore, there is a 15 sale of customized Finacle software and the entire turnover relating to sale of Finacle and its implementation is liable to tax, as opposed to the earlier ground that the said activity amounts to works contract. Thus, the exemption claimed by the petitioner was rejected.
10. Challenging the aforesaid order, the petitioner has filed these Writ Petitions. As the State had preferred an appeal against the judgment of the Tribunal in the case of IBM India Limited vs State of Karnataka, which is heard along with the Writ Petition, the learned single Judge directed the High Court Registry to post these Writ Petitions before the Division Bench to be heard along with the connected Revision Petitions. That is how these Writ Petitions are listed before the High Court. RIVAL CONTENTIONS:
11. Sri. N. Venkataraman, the learned Senior counsel for the assessee, contends that the assessee has Proprietary Rights over the software `Finacle’. It owns a copyright. The said software is meant exclusively for Banks. Depending 16 upon the needs and requirements of the clients, after entering into a contract, the assessee scripts on the said standard software programs to meet the requirements of the client. This is what is popularly known as customization. The software which emerges in the process of customization is also owned by the assessee. The copyright vests in that. This package and customized software is handed over to the customer – Bank for their use. It is popularly known as copyrighted Article. Under the contract, right to use this copyrighted Article is transferred to the customer and the transfer of this copyrighted Article takes place at the time of delivery of the said software. The assessee has paid VAT on the consideration for such right to use software, which is a deemed sale under Clause 29A(d) of Article 366 of the Constitution of India. It is a simple contract of sale of goods. This contract of sale also includes annual technical support (eight years). Clause 5 of this agreement includes the annual maintenance involving both service and upgradation or enhancement of the software. Since the contract is 17 combination of both goods and services, it is in the nature of a Works contract. Assessee has discharged VAT liability in respect of the said goods sold under this contract in the capacity of Works Contract. In the course of the works contract, if any, up-gradation, enhancement is done, the copyright vests with the assessee. The customer is only entitled to the right to use the said software.
12. If the packaged customized software is delivered to the customer, the customer has option of utilizing the service of the assessee or any other person in the field for implementation of the contract. What is required in the said implementation is to evaluate the skill to integrate several other softwares including finacle - the software belonging to the assessee, the right to use of which is transferred. It is not a pre-sale activity, it is a post-sale activity. Clause 3 of the agreement makes this position clear. At the time of implementation of the contract, there is no transfer of any goods. Even in that process if any software emerges the said software ownership vests with the customer. Therefore, 18 there is no transfer of right to use as the customer owns the said software. Therefore, it is a contract of pure service and no sale aspect is involved in this contract. The entire consideration received in the course of the implementation of the contract is subjected to service tax and tax is paid. Therefore, it was submitted that the claim of the State for levy of VAT on this part of the contract is unsustainable. In substance, he submits that in order to find out what is the goods transferred when the transfer of ownership passes is to be gathered from the terms of the contract, the way the parties intend and understood the contract. The Courts cannot re-write the contract or sub-contract if any to the contract. The real test in the case of sale of goods is whether the ownership right of the copyright or right to use the copyright is transferred and when it is transferred. When the assessee had not claimed any ownership over any software, which may emerge in the process of implementation of the contract and the ownership vests with the customer, there is no transfer of any goods and even if it is to be treated as 19 right to use software, which is a deemed sale, there is no transfer of any goods. It is purely a service contract.
13. Per contra, Sri Gopal Subramaniam, the learned Senior counsel appearing for the State contended that the contract in question is neither a service contract nor a works contract, but it is a contract for sale. Any customization of packaged software prior to sale renders the software a goods and the transfer of right to use that goods involves sale and chargeable to VAT. The agreement entered into between the parties as set out in the impugned order makes it clear that unless the said software undergoes scripting, configuration, screen customization, identification of product enhancements and other processes set out in response to the customers requirement is undertaken, the said software is not ready to go-live. It is this process which the assessee calls as implementation of the contract and wants to avoid payment of VAT on the ground that service tax has been paid. It is impracticable in law. One of the tests to be applied to find out when exactly the goods is transferred, is 20 the test of functionality or feasibility. It is only when the goods are marketable and useable or becomes functionable it may be said that the goods has come into existence which is capable of transfer. He has referred to the definitions of ‘dealer’ in Section 2(12), ‘goods’ defined in Section 2(15), and ‘turnover’ mentioned in Section 2(36). According to him it is the transactional value which has to be taken note of and all the components of transactional value should be considered as sale consideration and it should be subjected to tax under VAT. In fact customization involves service. It is only after the service is rendered, it becomes a customized product i.e., goods which is marketable, usable, functionable and therefore, transferable, whereas the service rendered is immaterial and therefore, he submits that unless the goods are customized it is not usable and therefore, the consideration paid for customization is subject to VAT. Whether the assessee calls it as implementation of the contract or customization or improved enhancement, it is immaterial. It is the substance of the contract, which has to 21 be taken note of and, therefore, he submits that the order passed by the Assessing Authority is in accordance with law and does not call for any interference.
14. Sri. G. Rajagopalan, the learned Senior counsel appearing for Union of India submitted that while considering what constitutes goods the definition of the ‘goods’, as contained in Article 366 (12) of the Constitution of India, alone is the criteria and the definition of ‘goods’ in the VAT Act cannot be looked into and, therefore, he submits that the definition of goods in the State legislation has to yield to the definition of goods in the Constitution. However, he submitted that there is no inconsistency between the two definitions. Therefore, service pure and simple cannot be read into the definition of the goods. He submitted that w.e.f.16.5.2008 service in relation to information technology software has been brought under service tax net by virtue of Section 65 (105) (zzzze). It defines information technology service which includes development, upgradation, enhancement, implementation and other similar services 22 related to software. Section 65B (44) of the Finance Act, 1994 defines the word ‘service’ which excludes any activity which constitutes merely transfer, delivery or supply of any goods which is deemed to be a sale within the meaning of clause (29A) of Article 366 of the Constitution. Section 66E provides for declared services. A declaration is found at clause (d) that development, design, programming, customization, adaptation, upgradation, enhancement, implementation of information technology software is a declared service. Once the parliament has expressly declared the aforesaid activities as a declared service the jurisdiction of the State to levy tax on such activities has been excluded. Once the implementation is included in the definition of the ‘taxable service’ in the Service Tax Act, the State legislature is not empowered to levy VAT treating it as goods and therefore, he submits that the petitioner, who has sought several reliefs by way of refund of service tax paid, is not entitled to the same. 23 15. In the light of the aforesaid facts and the rival contentions, the points that arise for our consideration in these writ petitions are as under :- (1) In the absence of transfer of a right to use a software under a contract, can it be said that the activity of implementation involves a deemed transfer of goods as contemplated under Article 366 (29A)(d) of the Constitution of India ?. (2) After supply of packaged and customized software, if any service is required to integrate the software into the system to make the software functional or usable, does it amount to pre-sale activity which is chargeable to VAT or is it a post sale activity, which is in the nature of service simplicitor?. POINT No.1:
16. The learned counsel appearing for the parties relied upon several judgments of the Apex Court as well as this Court in support of their respective contentions. The law relating to taxability of software is now fairly well settled. 24 17. The Constitution Bench of the Apex Court in the case of TATA CONSULTANCY SERVICES VS. STATE OF A.P. reported in (2005) 1 SCC308has held as under : - “19. Thus this Court has held that the term “goods”, for the purpose of sales tax, cannot be given a narrow meaning. It has been held that properties which are capable of being abstracted, consumed and used and/or transmitted, transferred, delivered, stored or possessed, etc., are “goods” for the purposes of sales tax. The submission of Mr. Sorabjee that this authority is not of any assistance as a software is different from electricity and that software is intellectual incorporeal property whereas electricity is not, cannot be accepted. In India the test to determine whether a property is “goods”, for purposes of sales tax, is not whether the property is tangible or intangible or incorporeal. The test is whether the item concerned is capable of abstraction, consumption and use and whether it can be transmitted, transferred, delivered, stored, possessed, etc. Admittedly in the case of software, both canned and uncanned, all of these are possible.” 25 Dealing with the copyright articles, it held as under : - 24. It is thus to be seen that under the Customs Act, apart from what had been specified therein, any other kind of moveable property constituted goods. This Court held as follows:
"27. According to Section 12 of the Customs Act, duty is payable on goods imported into India. The word "goods" has been defined in Section 2(22) of the Customs Act and it includes in clause (c) "baggage" and clause (e) any other kind of moveable property. It is clear from a mere reading of the said provision that any moveable article brought into India by a passenger as part of his baggage can make him liable to pay customs duty as per the Customs Tariff Act. An item which does not fall within clauses (a), (b), (c) or (d) of Section 2(22) will be regarded as coming under Section 2(22)(e). Even though the definition of the goods purports to be an inclusive one, in effect it is so worded that all tangible moveable articles will be the goods for the purposes of the Act by residuary clause (e) of Section 2(22). Whether moveable article comes as a part of a baggage, or is imported into the country by any other manner, 26 for the purpose of the Customs Act, the provision of Section 12 would be attracted. Any media whether in the form of books or computer disks or cassettes which contain information technology or ideas would necessarily be regarded as goods under the aforesaid provisions of the Customs Act. These items are moveable goods and would be covered by Section 2(22)(e) of the Customs Act. (SCC pp.609-10, para 27).
33. It is true that what the appellants had wanted was technical advice on information technology. Payment was to be made for this intangible asset. But the moment the information or advice is put on a media, whether paper or diskettes or any other thing, that what is supplied becomes a chattel. It is in respect of the drawings, designs etc. which are received that payment is made to the foreign collaborators. It is these papers or diskettes etc. containing the technological advice, which are paid for and used. The foreign collaborators part with them in lieu of money. It is, therefore, sold by them as chattel for use by the Indian importer. The drawings, designs, manuals etc. so received are goods on which customs duty could be levied. 27 34. The decision of Winter v. Putnam case (938 F2d 1033 (9th Cir 1991) is also of no help to the appellants as in that case it was the quality of information regarding mushrooms which was not regarded as a product even though the encyclopaedia containing the information was regarded as goods. Here we are not concerned with the quality of information given to the appellants. The question is whether the papers or diskettes etc. containing advice and/or information are goods for the purpose of the Customs Act. The answer, in our view, is in the affirmative.
41. Significantly Chapter 49 also includes items which have substantial intellectual value as opposed to the value of the paper on which it is put. Newspapers, periodicals, journals, dictionaries etc. are to be found in Chapter 49 wherein maps, plans and other similar items are also included, while Chapter 97 talks about original engravings. It is clear that intellectual property when put on a media would be regarded as an article on the total value of which customs duty is payable. 28 42. To put it differently, the legislative intent can easily be gathered by reference to the Customs Valuation Rules and the specific entries in the Customs Tariff Act. The value of an encyclopaedia or a dictionary or a magazine is not only the value of the paper. The value of the paper is in fact negligible as compared to the value or price of an encyclopaedia. Therefore, the intellectual input in such items greatly enhances the value of the paper and ink in the aforesaid examples. This means that the charge of a duty is on the final product, whether it be the encyclopaedia or the engineering or architectural drawings or any manual.
43. Similar would be the position in the case of a programme of any kind loaded on a disc or a floppy. For example in the case of music the value of a popular music cassette is several times more than the value of a blank cassette. However, if a pre-recorded music cassette or a popular film or a musical score is imported into India duty will necessarily have to be charged on the value of the final product. In this behalf we may note that in State Bank of India v. Collector 29 of Customs ((2000) 1 SCC727: (2000) 1 Scale
72) the Bank had, under an agreement with the foreign company, imported a computer software and manuals, the total value of which was US Dollars 4,084,475. The Bank filed an application for refund of customs duty on the ground that the basic cost of software was US Dollars 401.047. While the rest of the amount of US Dollars 3,683,428 was payable only as a licence fee for its right to use the software for the Bank countrywide. The claim for the refund of the customs duty paid on the aforesaid amount of US Dollars 3,683,428 was not accepted by this Court as in its opinion, on a correct interpretation of Section 14 read with the Rules, duty was payable on the transaction value determined therein, and as per Rule 9 in determining the transaction value there has to be added to the price actually paid or payable for the imported goods, royalties and the licence fee for which the buyer is required to pay, directly or indirectly, as a condition of sale of goods to the extent that such royalties and fees are not included in the price actually paid or payable. This clearly goes to show that when technical material is supplied whether in the form 30 of drawings or manuals the same are goods liable to customs duty on the transaction value in respect thereof.
44. It is a misconception to contend that what is being taxed is intellectual input. What is being taxed under the Customs Act read with the Customs Tariff Act and the Customs Valuation Rules is not the input alone but goods whose value has been enhanced by the said inputs. The final product at the time of import is either the magazine or the encyclopaedia or the engineering drawings as the case may be. There is no scope for splitting the engineering drawing or the encyclopaedia into intellectual input on the one hand and the paper on which it is scribed on the other. For example, paintings are also to be taxed. Valuable paintings are worth millions. A painting or a portrait may be specially commissioned or an article may be tailor-made. This aspect is irrelevant since what is taxed is the final product as defined and it will be an absurdity to contend that the value for the purposes of duty ought to be the cost of the canvas and the oil paint even though the composite product, i.e., the painting, is worth millions. 31 45. It will be appropriate to note that the Customs Valuation Rules, 1988 are framed keeping in view the GATT protocol and the WTO agreement. In fact our rules appear to be an exact copy of GATT and WTO. For the purpose of valuation under the 1988 Rules the concept of "transaction value" which was introduced was based on the aforesaid GATT protocol and WTO agreement. The shift from the concept of price of goods, as was classically understood, is clearly discernible in the new principles. Transaction value may be entirely different from the classic concept of price of goods. Full meaning has to be given to the rules and the transaction value may include many items which may not classically have been understood to be part of the sale price.
46. The concept that it is only chattel sold as chattel, which can be regarded as goods, has no role to play in the present statutory scheme as we have already observed that the word "goods" as defined under the Customs Act has an inclusive definition taking within its ambit any moveable property. The list of goods as prescribed by the law are different items 32 mentioned in various chapters under the Customs Tariff Act, 1997 or 1999. Some of these items are clearly items containing intellectual property like designs, plans, etc.
47. In the case of St Albans City and District Council v. International Computers Ltd. ((1996) 4 All ER481 Sir Ian Glidewell in relation to whether computer programme on a disc would be regarded as goods observed at p. 493 as follows :
"Suppose I buy an instruction manual on the maintenance and repair of a particular make of car. The instructions are wrong in an important respect. Anybody who follows them is likely to cause serious damage to the engine of his car. In my view, the instructions are an integral part of the manual. The manual including the instructions, whether in a book or a video cassette, would in my opinion be 'goods' within the meaning of the 1979 Act, and the defective instructions would result in a breach of the implied terms in Section 14. If this is correct, I can see no logical reason why it should not also be correct in relation to a computer disc on to which a program designed 33 and intended to instruct or enable a computer to achieve particular functions has been encoded. If the disc is sold or hired by the computer manufacturer, but the program is defective, in my opinion there would prima facie be a breach of the terms as to quality and fitness for purpose implied by the 1979 Act or the 1982 Act."
48. ……… In Advent Systems Ltd. v. Unisys Corpn. (925 F2 670 (3d Cir 1991)) it was contended before the Court in the United States that software referred to in the agreement between the parties was a "product" and not a "good" but intellectual property outside the ambit of the Uniform Commercial Code. In the said Code, goods were defined as "all things (including specially manufactured goods) which are moveable at the time of the identification for sale". Holding that computer software was a "good" the Court held as follows :
"Computer programs are the product of an intellectual process, but once implanted in a medium they are widely distributed to computer owners. An analogy can be drawn to a compact-disc recording of an orchestral rendition. The music is produced by the 34 artistry of musicians and in itself is not a 'good', but when transferred to a laser- readable disc it becomes a readily merchantable commodity. Similarly, when a professor delivers a lecture, it is not a good, but, when transcribed as a book, it becomes a good. That a computer program may be copyrightable as intellectual property does not alter the fact that once in the form of a floppy disc or other medium, the program is tangible, moveable and available in the marketplace. The fact that some programs may be tailored for specific purposes need not alter their status as 'goods' because the Code definition includes “specially manufactured goods”.
49. We are in agreement with the aforesaid observations and hold that the value of the goods imported would depend upon the quality of the same and would be represented by the in respect of the goods transaction value imported."
25. It is to be noted that this authority is directly dealing with the question in issue. Even 35 though the definition of the term "goods" in the Customs Act is not as wide or exhaustive as the definition of the term "goods" in the said Act, it has still been held that the intellectual property when it is put on a media becomes goods. Mr. Sorabjee submitted that whilst referring to the case of St. Albans City and District Council vs. International Computers Ltd. [1996 (4) All E R481 this Court missed the express finding of that Court to the effect "clearly, a disk is within this definition. Equally clearly, a program, of itself, is not". Mr. Sorabjee submitted that the English case clearly holds that software programes are not goods. He further submitted that the observations of this Court in Associated Cements Case (Supra) are in the context of valuation of imported goods and must therefore not be taken into consideration whilst deciding whether software is intangible, incorporeal intellectual property. We are unable to accept this submission of Mr. Sorabjee. The observations have been made not just in the context of valuation but to decide whether the items imported were "goods". Question of valuation would come only if the 36 items imported were "goods" on which custom duty could be levied.
26. In the case of Commissioner of Central Excise, Pondicherry vs. M/s Acer India Ltd., reported in JT2004(8) SC53 this Court has considered in detail what a software programme is. After so considering, it has been held that a computer and operative software are different marketable commodities. This Judgment would also have been against the arguments canvassed by Mr. Sorabjee but for the fact that this Court has itself clarified as follows:
"85[86].. We, however, place on record that we have not applied our mind as regard the larger question as to whether the informations contained in a software would be tangible personal property or not or whether preparation of such software would amount to manufacture under different statues.
18. Thereafter, explaining the word ‘goods’ in Article 366(12) of the Constitution, the Apex Court has held as under : - 37 “27. In our view, the term ‘goods’ as used in article 366 (12) of the Constitution of India and as defined under the said Act are very wide and include all types of movable properties, whether those properties be tangible or intangible. We are in complete agreement with the observations made by this Court in Associated Cement Companies Ltd. (2001) 4 SCC593 A software programme may consist of various commands which enable the computer to perform a designated task. The copyright in that programme may remain with the originator of the programme. But the moment copies are made and marketed, it becomes goods, which are susceptible to sale tax. Even intellectual property, once it is put on to a media, whether it be in the form of books or canvas in case of painting) or computer discs or cassettes, and marketed would become “goods”. We see no difference between a sale of a software programme on a CD/floppy disc from a sale of music on a cassette/CD or a sale of a film on a video cassette/CD. In all such cases, the intellectual property has been incorporated on a media which by itself has very little value. The 38 software and the media cannot be split up. What the buyer purchases and pays for is not the disc or the CD. As in the case of paintings or books or music or films the buyer purchases and pay for is not the disc or the CD. As in the case of paintings or books or music or films the buyer is purchasing the intellectual property and not the media, i.e., the paper or cassette or disc or CD. Thus a transaction sale of computer software is clearly a sale of “goods” within the meaning of the term as defined in the said Act. The term “all materials, articles and commodities” includes both tangible and intangible/incorporeal property which is capable of abstraction, consumption and use and which can be transmitted, transferred, delivered, stored, possessed, etc. The software programmes have all these attributes” 19. From the aforesaid decision it is clear that intellectual property once it is put on to a media, whether it be in the form of books or canvas (in case of painting) or computer discs or cassettes, and marketed would become “goods”. Intellectual property has been incorporated on a media for the purpose of transfer. Sale is not just of the media which 39 by itself has very little value. The software and the media cannot be split up. What the buyer purchases and pays for is not the disc or the CD, he is purchasing the intellectual property which is embedded in the media. Thus a transaction involving sale of computer software is clearly a sale of goods within the meaning of the terms as defined even under the VAT Act. The term “all materials, articles and commodities includes both tangible intellectual property and intangible property which is capable of abstraction, consumption and use and which can be transmitted, transferred, delivered, stored, possessed etc. The software programmes have all these attributes.
20. After the aforesaid judgment of the Apex Court, the Commissioner of Commercial Taxes issued the Circular No.17/2006-07 dated 24.7.2006 which deals with levy of tax on software under the KST Act, 1957 and KVAT Act, 2003. The said circular is issued for the benefit of the dealers and developers of software and the departmental officers because of the confusion created. It reads as under:- 40 CIRCULAR NO.17/06-07 No.KSA.CR.76/05-06, Bangalore, dated 24-7-2006 Sub: Levy of tax on software under the KST Act, 1957 and KVAT Act, 2003-Reg. It has been brought to the notice of this office that there is confusion with regard to levy of tax on transactions relating to computer software.
2. The matter is examined and it is considered necessary that the transactions be analysed for the benefit of the dealers and developers of software and the departmental officers in expeditious assessment and recovery of tax on these transactions. (1) Software is goods for the purpose of levy of tax under the provisions of the KST Act, 1957 and the KVAT Act, 2003. The sale of transfer of property in software for consideration that would be liable to tax, could be a direct sale or a deemed sale. (2) Direct sale of software would ordinarily be that transaction in which software is sold to the purchaser in a deliverable state 41 through an appropriate media – floppy, C.D., etc, Such direct sale may include transactions in which the software agreed to be sold is developed or programmed at the purchasers’ premises and later delivered to the purchasers. It would also include transactions in which sale of software for specific task that may go as a part of another software in use by the purchaser. Even after any such sale (direct sale), as per the trade practice, in many cases the copyright or the intellectual property right relating to the software sold may still vest with the seller. However, this would not affect the nature of the transaction from being a sale for the purposes of the KST Act or the KVAT Act. As in the transactions relating to any other goods, even in respect of software, there could be some modification or change that would be made in the software sold. Whether any charges collected by the seller towards such modification or change, generally called as customization in software sector, is a post sale or pre-sale expenditure would depend on the agreement/contract between the seller and the buyer, and on the actual conduct of the parties concerned as indicated by the relevant 42 documents and books of account. The fact whether any such customization is done at the seller’s premises or the purchaser’s premises would not be of any relevance to determine this aspect. Similarly, whether such charges were collected in lump sum or on the basis of man hours spent for such development would not by itself be of any relevance to determine this aspect. (3) Deemed sale or transfer of property in software in the execution of a works contract would ordinarily be that transaction pursuant to a contract, in which a ready software or the one which is developed/ programmed as per the specifications of the purchaser would be delivered /supplied to the purchaser by being loaded to the purchasers equipment or any other similar device and the relevant agreement /contract / order envisages payment of charges for such service rendered by the seller. As pointed out in the earlier para, where such service rendered is a pre-sale service making the transaction a direct sale or is a post-sale service would depend on the agreement/contract between the seller and the buyer, and on the actual conduct of the parties concerned as indicated by the relevant 43 documents and books of account. Such deemed sale may also include a transaction in which the seller integrates his software with a software belonging to the purchaser either as a part of a contract for maintaining, repairing, upgrading or improving software or any device embedded with software entered into between the seller and the buyer. As pointed out earlier, such integration leading to transfer of property in software from the seller to the buyer for a consideration may happen at the seller’s premises or the buyer’s premises. In all such cases of deemed sale of software or transfer of property in software in the execution of a works contract (by whatever name called), the seller would be liable to claim deduction from his taxable turnover amounts towards “labour charges and other like charges” not involving any transfer of property in goods actually incurred in connection with the execution of such works contract under the provisions of Rule 6(4) of the KST Rules, 1957 and Rule 3(2) of the KVAT Rules, 2005. (4) The third kind of transactions are the ones that would not involve any transfer of property in software (either as a part of a deemed 44 sale or as a result of other sale), but which would involve a person or a-dealer providing manpower or technical services for agreed consideration (based on man hours or such other basis) to any other dealer or any other person to program / develop software for such other person or dealer at the premises of the former or latter (the manpower provider or technical service provider could be a dealer engaged in selling of software or other goods apart from providing manpower/ technical services and similarly the person procuring such manpower/services could be a dealer engaged in selling software or other goods apart from being in business which does not involve sale of goods). In such transactions, the software so developed/ programmed would be the property of the latter and the former would not have any ownership over such software developed/ programmed. Such transactions of providing manpower/ services of technical personnel may also be for the purpose of implementing, deploying, testing, maintaining, repairing, upgrading or improving software but without involving any transfer of property in software in the execution of the contract for the 45 work of providing manpower or providing or performing services. The charges collected (whether called as labour charges, consultant charges, etc.,) by the manpower or service provider in such transactions would not be turnover for the purpose of the KST Act, 1957 and the KVAT Act, 2003. However, whether a transaction is a works contract involving transfer of property in goods or is a mere service or labour contract would depend on the agreement/ contract between the parties, and on the actual conduct of the parties concerned as indicated by the relevant documents and books of account.
3. All the concerned may note and follow the above points made in all applicable cases. It is once again emphasized that the classifications as made above regarding the transactions relating to development or programming of software into those which are liable to tax under the provisions of the KST Act, 1957, or the KVAT Act, 2003 are only illustrative to guide the officers in this regard and would apply only to such cases in which the facts that are relevant for this purpose are more or less similar. All the relevant facts and material in each case would have to be examined by the 46 authorities concerned in the light of any binding judicial pronouncements and action should be taken as per the provisions of the KST Act, 1957 or the KVAT Act, 2003 and the rules made thereunder to assess and recover tax due”.
21. The aforesaid circular recognizes three types of transactions. Firstly, direct sale of software in which software is sold to the purchaser in a deliverable state through an appropriate media – floppy, C.D. etc., In this type of transaction, the copyright or the intellectual property relating to the software sold vest with the seller. The position would be the same even in respect of software where some modification or change is made to the software sold. The same is generally called as customization in software sector. The fact whether any such customization is done at the seller’s premises or the purchaser’s premises would not be of any relevance. The copyright or the intellectual property rights of such modification also vests with the seller. 47 22. In the case of deemed sale or transfer of property in software in the execution of a works contract, the seller would be liable to claim deduction from his taxable turnover amounts towards labour charges and other like charges not involving any transfer of property in goods actually incurred in connection with the execution of such works contract. In this case also, the copyright or the intellectual property right in the goods vest with the seller and what the purchaser gets is the right to use such copyright or the intellectual property.
23. However, the third kind of transactions are the ones that would not involve any transfer of property in software either as sale or as a part of a deemed sale. This type of transaction involves a person or a dealer providing manpower or technical services for agreed consideration. In such transactions, the software so developed/programmed would be the property of the purchaser and the seller would not have any ownership over such software developed/programmed. Such transactions of providing manpower/services of technical personnel may also be for 48 the purpose of implementing, deploying, testing, maintaining, repairing, upgrading or improving software but without involving any transfer of property in software in the execution of the contract for the work of providing manpower or providing or performing services. Therefore, the department recognizes that the contract for implementation does not involve any transfer of property.
24. The packaged, readymade, off the shelf software are pure goods liable only to VAT. The customized software or tailor made software for an individual customer, similar to packaged software, where the copyright owned software is put on the media and delivered by way of transfer of right to use, will also be goods and is liable to VAT. In the case of customized software, the customized portion is embedded to the original software so as to become the customized software, the copyright of the entire software including the customized portion is exclusively owned by the developer of the software. Therefore, in both packaged and customized software, where copyright is held by the developer of 49 software and the copyrighted article alone is handed over to the customer as a transfer of right to use goods, the software is goods and liable to VAT alone.
25. However, in the case of customized software, it is possible for an entity to work on a hired contract basis rendering pure service and get delivered fully developed software for a specified customer with future contracts for upgradation and enhancement. In such a situation too, the software emerges. However, the copyright in such software belongs to the customer, as it is developed, and the developer of the software does not retain any copyright in such software. In such a situation, since there is no transfer of property in goods and what is provided is only a pure service, there can be no liability to VAT. The consideration in such cases is liable only to service tax. In the case of Annual Technical Support (ATS), if the 26. agreement of the contract includes the annual maintenance involving both service and issuing upgraded or enhanced 50 software, then such a contract is a combination of both goods and service. The contract is in the nature of works contract. VAT is liable to be paid on the goods part and service tax is to be paid on the labour aspect. In upgradation and enhancement, the copyright is owned by the developer of software and what is transferred to the customer is the right to use. In the case of implementation of customized software, 27. where the copyright of the customized software is with the software developer, the implementation process is a pure service rendition and does not involve any transfer of property. If any source coding or scripting is done during the process of implementation, the ownership or copyright or any proprietary right would not vest with the software developer. It works purely as a hired labour. The ownership vests at all point of time with the employer who had issued the assignment. In those circumstances, since there is no transfer of ownership or the licence to use the software (deemed sale), it is a pure service contract. There is no sale 51 of goods. It is a case of rendering service and is liable to service tax only.
28. It is not in dispute in this case that the ‘finacle’ software owned by the assessee is goods. As is clear from the material on record as this software package by itself is not useful to the customer, he approaches the assessee for customization of the said software to meet their requirements.
29. In the proceedings dated 12.09.2007 recorded by the Assistant Commissioner of Commercial Tax, it is stated as under:- The company was visited mainly to understand the pre-sale and post-sale activities of software product ‘Finacle’ developed by the company, such as “identification of the clients/response to the tenders floated by clients, preliminary understanding of the requirements of the clients, extent of the features inbuilt in ‘Finacle’ matching the requirements of the customers sale of ‘Finacle’, adoption of ‘Finacle’ as per the 52 requirement of the customer needs i.e., customization of the standard product to meet the required version of the customer to continue his regular nature of work and implementation of the software, training the staff, data transfer, warranty maintenance and to discuss and understand the process of development, customization and implementation of the ‘Finacle’ programme developed, by M/s. Infosys.” 30. Therefore, from the aforesaid passage it is clear there is a process of development, customization and implementation of the ‘Finacle’ programme. Speaking about customization it is stated as under :- “1. Response to customers requirements – Request for proposal (RFP). A functional request for proposal is prepared in which the requirements of the clients are classified as * Standard feature - If the customer requirements are already built in, then it is treated as standard feature. * Customization – Customer requirements are available in Finacle software in some form, but 53 requires customization to match the clients’ requirements. * Enhancement - Customer requirements are not there in the software and also cannot be customized but may be made available in the next version of the software * Alternative available - Customer requirements may be met alternative feature with all the relevant information. * Unavailable – Totally not available.” 31. It also states the various aspects involved in the customization activities of the ‘Finacle’ product. They can be broadly classified as under :- a. Reports (formatting to the data) b. Scripting (Functional customization) c. Configuration (parameters) d. ONS customization (Screens) e. Identification of product enhancements 32. After the customization is over and the finacle software which meets the requirement of the customer is sold, starts the implementation phase. The said implementation phase 54 includes (a) Training (b) Requirement Study (c) Transfer of data.
33. Therefore, a case study was made in the case of UCO Bank project and it is stated as under:- “2) Once the ‘RFP’ is evaluated and approved the software product ‘F’ is directly billed to end customer against tax invoice and VAT collection
3) Customization/improvement: After ascertaining the available standardized feature in the ‘Finacle’ program, it is then worked out to see the extent of customization/scripting required in the tender/WO’s floated using the tools & utilities in Finacle Software.
4) If the extent of deviation from the standard feature is large then the process of improvement of the software program is undertaken in the higher version or undertaken as patches.
5) Signing off: After the successful implementation and effective functioning of the software program ‘Finacle’, it is then closed by signing off.” 55 34. It is to be noticed here that the authorities were dealing with the case of UCO Bank. In the UCO Bank project the assessee has sold the customized finacle software to UCO Bank. M/s. Hewlett Packard India Sales (P) Ltd, who is a systems integrator i.e., the person who is responsible for implementation, was engaged by UCO Bank for the purpose of implementation of the said software purchased. Therefore, under the said contract, out of the total consideration payable for customization and implementation, assessee was paid the consideration for grant of license to use the customized finacle software and M/s. Hewlett Packard India Sales (P) Ltd., was paid the implementation charges. The client UCO Bank did not pay any amount to the assessee towards implementation. This only shows that the implementation can be done by a third party also and not necessarily the assessee who is the owner of the software. But, incidentally, M/s. Hewlett Packard India Sales (P) Ltd., entered into a sub-contract with the assessee for the UCO Bank project. Ex.G which gives the price and payment sets 56 out the implementation cost for Finacle core banking solution (for first 5 branches in the PILOT phase) at Rs.6,05,00,000/-. It makes clear that the remaining 20 branches will be rolled out and supported by HP and then it sets out the charges payable to the assessee at different rates for different activity per person per day.
35. The material on record shows that the assessee enters into several types of contracts. One type of contract involves contract of supply of customized products, contract of implementation and contract for ATS. An example is the assessee’s contract with Federal Bank which is also part of the records. The 2nd type of contract is only contract of supply of customized products and ATS contract, without contract of implementation. An example of such contract is the assessee’s contract with UCO Bank, which was discussed above. Therefore, in order to find out what the intention of the parties the entire contract is to be read as a whole. Terms have to be looked into and then only we can 57 find out how the parties have given effect to the terms of the contract.
36. In this background, we have to find out the nature of the transaction in the instant case. We have already examined above the contract with UCO Bank and noticed how implementation is not part of the said contract. The implementation agreement was with M/s Hewlett Packard India Sale (P) Limited. Now, let us examine the contract entered into by the assessee with Federal Bank, which was also examined by the Assessing Authority in the impugned order. Annexure I is the software which is licensed to the customer. The said Annexure-I reads as under :- “Annexure I – “Software” 1.1 _________________________________________________________________ Licensing Terms & Fees Sl. Product/Modules Licensing Terms License Fees ATS Fee No.in INR in INR1 Finacle Core Branch License 6,80,00,000/- 12% of Banking Solution for 600 branches the license with Retail Corporate in India fee Trade Finance Reporting tools Sign 58 Cap Central FAB Connect 24 Branch FAB for 20 branches _________________________________________________________________ Branch is defined as a service outlet (SOL). The total number of branches will be arrived by counting the SOLs in the Finacle core banking solution. All the 600 licenses mentioned above to be procured within 12 months from the date of UAT sign off. For additional branch license beyond the first 600 branches, the license fee for Finacle Core Banking Solution shall be Rs.1,10,000/- per branch and to be procured in lots of 10 branches. Notwithstanding anything contained to the contrary in the Agreement, the license has been granted to Federal Bank and its branches in India and shall not be assigned or transferred to any other entity. However, in the event of corporate actions including but not limited to merger or acquisition the Parties shall in good faith mutually agree and discuss the terms and conditions of extending the license to merged or acquired entity. 1.2 • • 59 ATS Terms & Fee: ATS will commence from the date of first branch GO LIVE Bank and INFOSYS may mutually renew ATS by signing an Addendum to this Agreement. Such renewal will be charged @ 12% for each ATS period of 12 months, for the license granted under this Agreement. This amount has to be paid in full in advance at the beginning of each renewal period. ATS Fee specified above is valid for 3 years from the Effective Date of this Agreement and is subject to review thereafter. • In the event of ATS not being renewed for Software and/or Third Party Software. INFOSYS has no obligation to extend any ongoing product support either through helpdesk or through product Upgrades, Maintenance Releases etc. to BANK as stated under the Agreement.” 37. Annexure-I to the agreement shows the assessee sold Finacle Core Banking Solution with Retail, Corporate, Trade Finance, Reporting tools, Sign cap, Central FAB, Connect 24 and Branch FAB for 20 branches. What they sold was 600 branch licenses aggregating to Rs.6,80,00,000/-. Therefore, 60 no implementation charges is involved in the contract for supply of software with Federal Bank also.
38. Annexure – I does not include the implementation. Annexure-I makes it clear that ATS will commence from the date of the first branch GO-LIVE. It is in this context Article 2 speaks about title. Article 2 of the agreement which deals with TITLE makes it clear that INFOSYS and Third Party Vendors shall at all times retain all title, copyright, and other proprietary rights in Software and Third Party Software respectively, any Enhancements, upgrades, maintenance releases etc. thereto and translations thereof and Bank does not acquire any rights in the same other than those specified in this Agreement. Subject to the Bank paying the required license fee and observing all terms of the Agreement, INFOSYS grants to the BANK a non exclusive, perpetual, non transferable, limited license to use the Software.
39. Therefore, from the aforesaid clause it is clear at all times, the assessee has retained copyright and several 61 proprietary rights in software and what is transferred is a non-exclusive, perpetual, non- transferable limited license to use the software.
40. The material on record discloses that finacle software, which is owned by the assessee as a packaged software, is a software before customization. The authorities call it as a software with standard features, where the customer requirements are already built in. In other words, these software, which is available on the shelf, is a copyrighted article. It is also known as a branded software. As is clear from the impugned order though the customer requirements are available in finacle software in some form it requires customization to match the clients’ requirements. It is for this purpose RFP is entered into, where the customer gives his requirements. It is only if the assessee is able to meet the said requirements then he enters into a contract prescribing consideration for such customization. Once, for the purpose of customization, scripting is done, which is otherwise known as source code or code writing, the software 62 which comes into existence, which would satisfy the requirement of the client, is also owned by the assessee. However, that software is embedded in the package software/standard software of the assessee. Once this customization takes place it becomes an un-branded software i.e., Customized copyright article in the form of finacle. When that software is transferred to the customer, what is transferred is the right to use the software. The copyright continues to vest with the assessee. Article 2 of the agreement makes this position clear. In other words, there is no transfer of copyright. However, there is transfer of right to use the software embedded in that product. By virtue of Article 366 (29A)(d) the right to use that software is deemed sale and is subjected to VAT.
41. As is clear from the impugned order at the time of evaluating the RFP there exists a standard feature or a packaged software. After knowing the requirement of the customer, the customization is done to meet the requirements of the customer. Therefore, in the agreement 63 where they have defined the word “Software”, it is a customized software. As per the definition, ‘software’ means the object code of INFOSYS proprietary software and documentation such as user guides and any other documentation provided from time in conjunction with Software, for which Non- Exclusive License in accordance with the terms of the agreement is granted by INFOSYS to BANK, as listed in Annexure I and any Addendums thereto signed by both the parties, and the intellectual property rights for which are owned by Infosys.
42. Clause 5 of the agreement speaks about the “technical support”. It provides that the scope of technical support includes : A. HelpDesk Technical assistance on Software and if agreed, on Third Party Software through Telephone/Facsimile/E-mail for Problem solving and trouble shooting, Rectification of any bugs reported B. Upgrades and Maintenance releases of Software and if agreed, Third Party Software, 43. 64 excluding separately Priced/optional products or modules for which BANK has not purchased any rights. “Upgrades” have been defined to mean subsequent improved versions and releases of Software or Third Party Software as the case may be, which may be provided in accordance with the terms mutually agreed to between the parties, and which are generally made available to customers covered under ATS at no additional charge. Upgrades may include Software Trouble Reports (STR) fixed and Software Enhancements incorporated.
44. It also provides certain exclusions: “Any on-site support, whether for Software or Third party Software will be outside the scope of this clause. Any such onsite support will be charged extra to BANK at the prevailing INFOSYS onsite support rates. It is also made clear all Customizations and Developed Software are outside the scope of ATS and shall be maintained by Bank.” 65 45. Therefore, the copyrights in the enhancements, upgrades, maintenance and releases vests with the assessee and the same is not transferred to the customer and what is transferred is only the right to use. Therefore, the said right to use these enhancements, upgrades, maintenance and releases also constitutes goods and is liable to VAT. The record shows that the assessee has paid VAT on these enhancement and upgrades. Therefore, it is clear ATS is a works contract. It is a contract to permit right to use enhancements, upgrades, maintenance and releases as well as annual technical support services as it was indivisible by virtue of 46th amendment which falls under Clause (b) of Article 366 (29A).
46. Implementation is also set out in Annexure-IV under the heading ‘services’. It reads as under :- “Definitions 1.1 “Pilot is defined as Finacle Core Banking solution going live in 15 branches 66 1.2 “Going Live” “Going Live” shall mean BANK start using the licensed Software at “Pilot” to offer Banking services to its customers. 1.3 “Parameterisation” “Parameterisation” shall mean capturing and defining as parameters in Software. BANK’s banking business requirements and environment like the chart of Accounts. Business rules, products and schemes and rules for handling exceptional conditions by INFOSYS and BANK based on information provided by BANK. Under Parameterisation, Software is configured using standard parameters available in Software. ‘Customisation’ as defined in the Agreement is outside the scope of Parameterisation. 1.4. “Parameterisation Sign-off” “Parameterization Sign-off” shall mean sign-off between BANK and INFOSYS upon completion by INFOSYS of the parameterization of licensed Software. This sign-off shall be completed prior to Going Live with licensed Software 2. Scope of Pilot Implementation: Pilot Implementation services included under the scope of this Agreement are specified below. 67 INFOSYS will be responsible for: • Project management of the pilot project • Initial systems study to understand BANK’s requirements • Core Team Education for a team of up to 25 members of BANK’s core team • Installation of Software at the Data Centre • The pilot implementation phase shall be deemed to be complete when Software shall Go Live in Data Centre and 15 number of branches. BANK will be responsible for: • Job Cards and Process Manuals preparation. • Providing inputs for Parameterization. • Data extraction from the current system. • Systems Integration Testing (SIT) and Simulation Run. INFOSYS will assist in the same. • End user training • Infrastructure readiness • Program management 3. Core Team Education Scope of Core Team Education:
68. • Training for the BANK’s Core Team on the licensed Software as per Annexure1 • Core team education will be done for 1 batch. • Size of the batch shall not be more than 25 people. • The Training will be conducted at INFOSYS facilities in Bangalore • During core team training at Bangalore, traveling, lodging and boarding expenses of BANK officials will have to be borne by BANK.
4. PILOT IMPLEMENTATION FEES • Pilot Implementation Fess for Finacle Core Banking will be INR22000,000/- (two crores and twenty lakhs only). This cost is inclusive of 2500 man days of customization efforts. Infosys will provide the capacity planning recommendation for the hardware for Finacle core banking solution. • Core Team Education Fee for Finacle Core Banking Solution for the modules licensed is INR3000,000/- (thirty lakhs only). This training fee includes the charges for two executive appreciation programme and one audit training. 69 • All applicable taxes shall be charged extra to BANK5 Professional Services Rates Professional services outside the scope of the agreed implementation can be availed by the BANK as per INFOSYS Professional Services charges mentioned below : Role Classification Charges in INR Implementation /post 8,000/- per person Implementation/customization per day Services of software engineer Implementation/post 10,000/- per person Implementation/customization per day Services of project leader Implementation/post 15,000/- per person Implementation/customization per day services of project manager /Application consultant Training (core team) EAP40000/- per instructor day Database tuning 25,000/- per person per Day Note:
70. • “Person Day” is defined as Eight hours per day or part thereof. • All services required by BANK, beyond the scope of the services defined under Clause 1 to 4 of this Annexure either during or after Pilot Implementation will be charged to BANK at mutually agreed rates. • These professional services rates are exclusive of travel • Travelling expenses (return economy class airfare from the point of origination), hotel room charges at actuals and local conveyance will be charged extra to the BANK in case of cities other than Bangalore and all onsite services beyond the pilot phase implementation. The boarding and other expenses will be charged for the total duration of the INFOSYS Engineer/Consulant/Project Manager’s stay at the Bank’s site including non-working days during that stay.
3. Detailed scope of work for the services to be provided by Infosys shall be detailed out in a statement of work which shall be agreed between the parties.
4. Termination 71 Following termination of the Agreement or this Annexure by either Party, BANK shall pay to INFOSYS charges for all Services provided to the BANK up to the date of termination.” 47. Therefore, all the required responsibilities of the assessee is clearly set out. It includes Project management of the pilot project, initial systems study to understand Bank’s requirements, core team education for a team of up to 25 members of bank’s core team and installation of software at the Data Centre. The pilot implementation phase shall be deemed to be complete when software shall Go Live in Data Centre and 15 number of branches. Article 3 deals with Core Team Education which includes training for the bank’s core team on the licensed software as per Annexure-I, core team education will be done for one batch, size of the batch shall not be more than 25 people, training will be conducted at INFOSYS facilities in Bangalore, during core team training at Bangalore, traveling, lodging and boarding expenses of the bank officials will have to be borne by the Bank. Then Article-4 specifies the fees payable for pilot 72 implementation. Then Article-5 speaks about professional Services Rates. In none of these provisions, there is a mention of any software coming into existence which will be made use of in the implementation process. On the contrary, it is specifically stated that before pilot implementation programme commences, there should be installation of software. Therefore, the implementation of programme starts only after the installation of software which is the goods which is transferred under the agreement i.e., the customized copyrighted article ‘finacle’ of the assessee. The nature of the services rendered is in the nature of imparting training to the bank officials who will have to operate the system and the fees for implementation is based on 2500 man days and professional service rates is collected on the basis of Rs.8,000/- per person per day. Similarly Rs.10,000/- per person per day; Rs.15,000/- per person per day. Therefore, the professional charges are paid for the services rendered. In the entire scheme of the services, there is no whisper of any software coming into 73 existence without which the implementation cannot be completed. In fact the word ‘Going Live’ gives an indication that the bank starts using the licensed software at ‘Pilot’ to offer banking services to its customers. The word ‘Pilot’ is also defined as Finacle Core Banking Solutions going live in 15 branches. Similarly the word ‘Parameterisation’ means capturing and defining as parameters in software, Bank’s banking business requirements and environment like the chart of accounts, business rules, products and schemes and rules for handling exceptional conditions by INFOSYS and Bank based on information provided by the Bank. Under Parameterisation, software is configured using standard parameters available in software. In other words, it is an integration of several systems which are available in the software to make the bank to use the software. It is made clear that the ‘Customization’ as defined in the agreement is outside the scope of parameterization. In other words, in the process of integration and making the system workable, if it becomes necessary to script/write a code, it would be client 74 specific and it also amounts to customization. But this customization which is defined under the agreement means modifications done outside the source code of software or the third party software using the customization or extensibility infrastructure provided by software or third party software which are outside the scope of software and the right to re- use and/or incorporate into software or third party software such customizations is retained by the assessee but the ownership of the said software vests with the customer. Therefore, it is clear, in substance implementation means the customized software is integrated into several other systems so that the bank can start using the licensed software. In the process, there is no transfer of any goods or right to use any goods, what is rendered is service and therefore, the said consideration paid as service charges is not subjected to VAT but subjected to service tax. POINT No.2:- 48. The argument is that implementation is a part of customization. Without the software being implemented it is 75 not saleable, useable, functional and therefore VAT is payable on the transactional value which includes implementation charges. Without implementation the software is not capable of being marketed or saleable. In fact, today, on behalf of the State, a statement is 49. filed showing the turnover declared by the assessee in respect of the local sale of finacle and CST sale of finacle. A reading of the aforesaid statement shows in April 2005 the total value of local sale of finacle software is Rs.2,61,93,743/-. No consideration is received for customization. Similarly in the case of CST sale of finacle.
50. According to the State, customization includes implementation. Therefore it is contended that without customization without implementation, the software is not complete saleable, useable and functional. However, when we look at the aforesaid table, assessee has sold software without the same to the extent of Rs.2,61,93,743/-, If that is so, the argument that without the implementation the 76 finacle product is not saleable is without any merit. Equally, the argument that implementation is a pre-sale activity and not a post sale activity, is also not acceptable.
51. In the impugned order, the Assessing Authority proceeds on the basis that the assessee customizes the software built by it and after carrying out the implementation, delivery is made to the customer. Though billing is made earlier at the time of delivery and handing over of the customized software, it clearly points out that the customization receipts are pre-sale expenditures and the said charges so collected in the guise of services is includable in the taxable turnover. The said customized software sold remains the copyright of the assessee and could not be altered or modified without the permission of the assessee. Mere raising an invoice depicting sale of software will not change the nature of property delivered i.e., customized finacle software. Further, the assessee will continue to hold its control over the said delivered software, even after the billing date. So, when the assessee is having 77 control over the said goods even at the stage of usage by the client, it is wrong to say that, he has no authority over the software sold, immediately after the billing is made. After referring to several clauses in the agreement, it was held that the assessee though issues tax invoice for the sale of finacle software, only customized finacle software is delivered to the client and hence, the splitting up of a single activity into divisible activity i.e., one for sale and the other for service/customization is not correct and, therefore, proceeded to hold that the implementation of the project is a pre-sale process and it is subjected to VAT. The aforesaid factual finding recorded is contrary to the material on record.
52. The understanding of the authorities is that the assessee has developed a software viz., ‘Finacle software’ which is a basic software relating to banking activities and is the copyright holder for the same. Whenever customer namely a bank approaches the assessee to develop software for their business activities, the assessee will take steps to develop the said software as per the requirement of the 78 customers. In this activity, the assessee will make changes to the finacle software held by it by customizing the same to the requirement of the customers and will deliver the improved/modified version of the finacle software to them. Here, what is transferred is the software with all modifications as per the request and the proposal made by the customers. This implementation process is nothing but value addition to the finacle software, but the dealer while declaring the turnover, splits the said transaction into two parts namely, sale part and service part. This act of the dealer in splitting the contract as one for sale and the other for implementation of finacle software, thereby claiming exemption on the latter part is not correct because in almost all the instances, what is supplied by the assessee to the customers is the software as per the requirements and the amount received towards the whole process of customization has to be considered as the amount received for the supply of customized finacle software. 79 53. From the aforesaid findings, it is clear that the Assessing Authority is of the view that the customization is equivalent to implementation. During customization when scripting or code writing is done in order to make the standard or package software useful to the client, the consideration paid for customization constitutes the consideration for transfer of goods. The said aspect is not disputed by the assessee.
54. What the assessee contends is that the assessee has the packaged software ‘Finacle’ a banking solution. If the said software cannot be used as such by the banks, then they make known their requirements to be incorporated in the said packaged software either by way of modifications, additions and so as to make it customer specific, which is called as customization. What is sold by the assessee to the bank is the customized software and not the packaged software. It is clear from the invoice that for the consideration received for this customized software, the assessee has paid VAT because the assessee has copyright 80 not only in the packaged software but also in the customized software and what is transferred to the bank is only the right to use the said software which is a deemed sale. After this customized software is installed in the premises of the bank, before bank starts using it, the process of integration with other systems has to be carried out. It is for that purpose a separate contract called service contract is entered into. The terms of the said contract as set out above involves only rendering service and rendering training to the employees of the bank, so that the installed software starts functioning. The terms of the agreement makes it clear that it is not obligatory for the bank/customer to have the services rendered only by the assessee as a part of contract of sale or a condition of sale. It is open to the customers to have the services rendered by any other competent agency. Therefore, the Assessing Authority has misconstrued this implementation to that of customization of the software and erred in holding that the customization involves transfer of 81 goods and the assessee cannot avoid payment of VAT by describing the same as implementation.
55. Whether any charges collected by the seller towards such modification or change, generally called as customization in software sector, is a post sale or pre-sale expenditure would depend on the agreement/contract between the seller and the buyer, and on the actual conduct of the parties concerned as indicated by the relevant documents and books of account. The fact whether any such customization is done at the seller’s premises or the purchaser’s premises would not be of any relevance to determine this aspect. Similarly, whether such charges were collected in lump sum or on the basis of man hours spent for such development would not by itself be of any relevance to determine this aspect. Whether service rendered is a pre-sale service making the transaction a direct sale or is a post-sale service would depend on the agreement/contract between the seller and the buyer, and on the actual conduct of the 82 parties concerned as indicated by the relevant documents and books of account.
56. Therefore, in the instant case, as is clear from the invoice at Annexure-1, the price paid is for the customized Finacle software. The Annual Technical Support commences from the date of first branch GO LIVE. ATS fees specified is valid for 3 years from the effective date of the agreement and is subject to review thereafter. The contract also includes pilot implementation fees which is calculated for 2500 man days of customized efforts. Separate fee is also charged for core team education fee. This training fee includes the charges for two executive appreciation programme and one audit training. Professional services outside the scope of the agreed implementation can also be availed by the customer as per the assessee’s professional services mentioned in the agreement. It is stated that, before pilot implementation programme commences, there should be installation of software. Therefore, the implementation of programme 83 starts only after the installation of software which is the goods which is transferred under the agreement i.e., the customized copyrighted article ‘finacle’ of the assessee. As only after the supply of packaged and customized software, service is required to integrate the system to make the software functional or useable under the contract if that function is also entrusted to the assessee, the assessee renders services for implementation of the project. It is in the nature of post sale activity. As there is no transfer of any goods at the time of implementation of the project, there is no direct sale or deemed sale. It is in the nature of service simplicitor. Therefore, irrespective of the timing of the contract and the payment of the money as consideration of the contract, even if it includes consideration for implementation of the project, the said payment is for post sale activity and it is for service to be rendered to integrate the system and implement the project. No VAT is required to be paid on this aspect. 84 57. Though there is one composite contract, it is in different parts – one part deals with the contract of sale of customized software and another deals with the services to be rendered for implementation. Yet another agreement speaks about the technical service which is in the nature of a works contract. The assessee has paid VAT on the contract for sale of customized software. The assessee has also paid VAT in respect of the goods aspect in the works contract. Whereas the service contract does not involve sale of goods nor it is exclusively a contract for sale of goods but on the contrary it is an exclusive contract for rendering service.
58. That apart ‘goods’ has been defined under the Constitution at Article 366(12). The State legislature has defined ‘goods’ in the VAT Act at Section 2(15). While dealing with the levy of tax it is the definition given in the Constitution which has to be taken note of and whatever may be the definition in the State legislation, it has to yield to the definition in the Constitution and, therefore, any 85 attempt on the part of the State to bring the transaction in question under the definition of the goods as defined in the VAT Act has to be ignored. Even as per the definition under the VAT Act, there is no difference and a service pure and simple cannot be read into the definition of goods. With effect from 16.5.2008 service in relation to information technology software have been brought under the service tax net by virtue of Section 65 (105) (zzzze). Section 65 (105) (zzzze) of the Finance Act, 1994 defines information technology services which includes adaptation, upgradation, enhancement, implementation and other similar services related to information software. Subsequently, the word ‘service’ is defined under Section 65B(44) of the Finance Act, 1994 which has come into effect from 1.7.2012 which excludes any activity which constitutes merely such transfer, delivery or supply of any goods which is deemed to be a sale within the meaning of clause (29A) of Article 366 of the Constitution. Once implementation is included in the definition of taxable service under the Service Tax Act, the 86 State Legislature has no power to levy VAT treating it as involving transfer of property in goods or otherwise. Section 66E provides for ‘declared services’. One such declaration is found at clause (d), i.e., development, design, programming, customization, adaptation, upgradation, enhancement, implementation of information technology software. Therefore, once the Parliament has expressly declared the aforesaid activities as a declared service, the jurisdiction of the State to levy tax on such activity stands excluded. Therefore, seen from any angle, the case of the State that the implementation of information technology software is a pre- sale activity and, therefore, constitutes sale is without any substance.
59. In fact this Court had an occasion to consider a somewhat similar situation in the case of Sasken Communication Technologies Limited –vs- Joint Commissioner of Commercial Taxes, Bangalore (Appeals)-3 Bangalore reported in (2012) 55 VST89(Karn.). After considering 87 numerous judgments of the Apex Court on the point, this court, at para-35 held as under: “Therefore, computer programming and providing of computer software involves two aspects, one falling within the power of the Parliament and the other falling within the power of the State Legislature to enact the law, the law so enacted cannot be found fault with. When the programming and providing of computer software is treated as works contract, as the works contract necessarily involves an agreement to render service and an agreement for sale of goods, service aspect could be taxed by the Parliament and the sale of goods aspect could be taxed by the State Legislature. But, this distinctiveness of two transactions is to be ascertainable from the terms of the composite contract. If such an intention is not discernible from the terms of the contract then we have to find out what is the pith and substance of the contract or in other words what is the true nature and character of the contract. If on an examination of the contract as a whole, it is not possible to discern that the contract involves sale of goods but is essentially an agreement to render 60. 88 service, neither the concept of a works contract nor the concept of aspect theory is attracted.” In view of the aforesaid legal position well enunciated, the contract for implementation, which is nothing but a service contract, is not liable to VAT. In view of the provisions contained in the Finance Act, 1994, ‘contract’ for implementation specifically falls within the definition of service and is taxed, as such, under the said law. The same activity cannot be taxed under VAT, as rightly contended by the learned Counsel for Union of India. In that view of the matter, the order passed by the Assessing Authority is unsustainable. Accordingly, it is hereby set aside. In the instant case, the assessee has paid VAT for the 61. customized software. In fact the assessment orders passed earlier recognized this fact, accept it and confirm the transaction. No VAT is levied in respect of this part of the consideration meant for implementation. In those assessment orders, they categorically refer to the fact that implementation is a post sale activity. 89 In view of the fact that relief is granted to the assessee 62. on interpretation of the constitutional and statutory provisions, it is not necessary for us to go into the constitutional validity of the provisions which are impugned. Probably that is the reason why even the Counsel for the petitioner stressed on interpretation and if his argument is accepted, it is not necessary to go into the question of vires on the constitutional law.
63. In so far as the other aspects which are involved in the impugned order is concerned, they are to be agitated by the assessee in a regular appeal under statute and that cannot be decided by the High Court. Therefore, if the assessee were to prefer a separate appeal within 30 days from the date of receipt of a copy of this order, the Appellate Authority shall decide those issues by entertaining the appeal on merits without going into the question of limitation. 90 64. For the aforesaid reasons, we pass the following: i) ii) iii)
ORDERWrit petitions are allowed; The impugned order in so far as levying of VAT on the assumption that the implementation is nothing but customization of the software is hereby set aside; As the assessee has already paid VAT for customized software, it is not liable to pay any VAT for implementation which happens after the installation of the customized software in the premises of the assessee. iv) In view of the fact that the impugned order is set aside and the petitioner has succeeded in these petitions, the amounts deposited by virtue of the order directing the petitioner to deposit the amounts in terms of the interim order, is ordered to be refunded to the petitioner. v) The petitioner is at liberty to file a regular appeal under statute, on the other issues not dealt with in these Writ Petitions, within 30 days from the 91 date of receipt of a copy of this order and, if the petitioner does so, the Appellate Authority shall decide those issues on merits without going into the question of limitation. vi) No costs. Sd/- JUDGE Sd/- JUDGE ckl/ksp/ng/nsu/-