Why pay Service Tax on Packaged Software - to be on the safer side?

In India, the taxation and legal system is very complicated, extremely slow and quite expensive in terms of money and time.

So, whenever there is an ambiguity on the applicability of a particular tax or law - usual advise given by Tax Consultants is - "we feel this - this and this ... - but to be on safer side pay tax" i.e., collect from the customer and pay to the government. After all - it's the poor customer who pays!!!

And bigger the company seeking the advice - bigger is the consultant i.e., all MNC's seek advice from one of the big four management consultants. Never mind what their track record is. We have seen fate of number of global consulting organizations and their customers in the last 7-8 years. Not only consultancy organizations but even their top notch MNC customers have gone out of businesses. So, much about the big consultants and their advice!!

So, it's time that we start using our brain and innate wisdom to understand the tax/legal issues on hand and devise ways to tackle the issues. Times are tough and going forward - it's going to be tougher. So, it's time that we get out of our cosy comforts and forget about being safe and start learning to take stand, devise a strategy to fight the outcome of the stand and fight out - when required.

Take the issue of double taxation that has shaken the entire Software Industry in India. It has applied a 'brake' and changed the 'gear' from 5th to the 1st gear - without pressing the clutch. Any one who knows how to drive a four wheeler would understand what's fate of such an action.

Some people think that Indian Government has done this intentionally. It's done with a intention of milking docile IT customers and IT Software Houses of their hard earned money. And Government is not in a mood to offer quick corrective action. They want as much money as possible in the government coffers - so that they can pay the farmers and arrears to government employees as per 6th Pay Commission recommendation. And you know very well why all this is done - of course, to get votes in the next election and stay in power for another five years. All this in the name of democracy. It's a shame on us that we take all this lying down.

Consider this case a little deeper to examine - what's implication of both taxes applied simultaneously on the sale of a packaged software product?

It leads a question - whether 'Service tax' and 'VAT' is to be paid on 'basic price' simultaneously or one after another. If applied simultaneously - we are thrown back by 25 years to age old system of manual book keeping because modern Accounting Packages can not handle it. If you are using modern ERP packages then you will need to hire services of costly and time-consuming ERP consultants to modify your billing system. And they will take couple of months to carry out the necessary changes to your billing and accounting system.

If you apply it one after after then question arises - which comes first? VAT or Service tax. Fortunately, there is a consensus among tax authorities that Service tax comes first because it's a Central Government tax (like Excise) and VAT comes next. So, you pay Service tax @ 12.36% on basic price and then charge VAT on the total of basic price and service tax.

So far so good. But, bigger issue to be discussed and settled is whether Service Tax is applicable on the sale of packaged software or not. This is because as per Finance Minister's budget speech and a letter written by the Service Tax Commissioner - Service Tax is applicable on tailor made software and Excise/CVD is payable on the packaged software.

So, it is time to decide whether software resellers are selling tailor-made software or packaged software. Once they are clear about this point they will be able to convince all parties viz., government, distributors and vendors - that Service tax is NOT payable on the packaged software.

In this context, if any one is having any doubt, please read clarification given by Tax Research Unit (TRU) vide D.O. F. No.334/1/2008-TRU dt.29-2-2008:

..
4.1.5 Software and upgrades of software are also supplied electronically, known as digital delivery. Taxation is to be neutral and should not depend on forms of delivery. Such supply of IT software electronically shall be covered within the scope of the proposed service.….
..
4.1.7 Following consequential amendments in other taxable services are also being made: To clarify as removal of doubts that ‘Management, maintenance or repair of properties’ includes Management, maintenance or repair of IT software [section 65(105)(zzg)]. Maintenance of packaged software (being goods) is also leviable to service tax under the said service.

Notice "taxation is to be neutral and should not depend on forms of delivery" and "packaged software (being goods)". So, when we sell packaged software supplied vide different forms of delivery viz. Shrink-wrap, OEM, Paper license or Internet download, it's all same viz. packaged software. Packaged software (being goods) - attract VAT. So, there is no Service tax.

Once we all (dealers, distributors and vendors) are clear and are all united on this issue we could take a stand as an industry and we all should collectively refuse to pay Service tax to government. If government wants Service tax then let them demand it.

Currently we all are assuming that government wants Service tax on packaged software and we are paying it. But indication is otherwise i.e., government's original intention was to levy Service tax on the Tailor-made or Customised software only. Same thing was said in the Finance Minister's speech also.

While presenting the Finance Bill 2008 he said: “I propose to increase the excise duty on packaged software from 8 per cent to 12 per cent to bring it on par with customized software which will attract a Service tax of 12 per cent.”

I've learnt from a customer that he had some verbal discussion with the Commissioner of Service tax. In that Service Tax Commissioner confirmed that Service tax is payable only on the tailor made software. He even said that his field staff does not have mandate for the collection of service tax on packaged software products.

BUT WE ALL ARE PAYING SERVICE TAX ON PACKAGED SOFTWARE - RATHER FOOLISHLY - TO BE ON SAFER SIDE.

WHOSE FAULT IS IT? It is time we start thinking like Legal Experts and Court Judges viz., what is the intention of government in bringing IT Software Services in Service tax net? And whether it is correct to charge two taxes on same item viz., Packaged IT Software .

Believe me, in case of doubts, even our constitution rules in favour of the tax payer and not government.

“Service tax is imposed under entry 97 of List I (in Constitution of India) which is a residual entry. Thus, if a transaction is covered in list II, it cannot get covered in entry 97 of List I. Since sales tax is covered in list II, it is doubtful if service tax can be imposed on a transaction which is entirely getting covered under List II.” - V S Datey - Tax consultant.

Then - it's time that we take a stand as a IT Software Industry and decide not to pay Service tax on packaged software.

Quality of Service provided by the Service Providers

I remember hearing an episode from my Master about quality of work done by people from India. Many years back in the British newspapers Churchill’s remark about loose wires hanging on the wall attributed to 'some indian must have done the electrical wiring' had attracted furore from Indian elite of his time. But after narrating this episode my master said “Churchill’s observation was correct. How much True it is?.” He went on to explain that we never take 'pride' in what we do.

It is quite sad that even after lapse of 50-60 years situation is very much similar. Although India has emerged as a hub of 'call centre' for the world and MNCs like Dell and others outsource their work to India - looking at quality of services offered - I'm convinced that this boom also will die the death of 'dot-com' bubble. It may not be that fast or sudden but it is written on the wall. Companies giving this outsourcing work to India will realize soon that it's not worth the saving. They better have few people on the job giving quality service than to give it out to Indian who has no concept of what service is.

This comments many seem too harsh but you can prove to yourself that it's 100% true. Just try calling any private or MNC bank in India; or any telephone company for some help; or any good insurance company. I've personally tried taking help on simple issues from ICICI Bank, CitiBank, ICICI Prudential Insurance, SBI Credit Cards, SBI online banking, BPL Mobile for Blackberry Services, Dell for Sales and Technical support, Principal of the D J Sanghvi Engineering College in Mumbai and story is alarmingly same. If you don't bang your head and/or phone and feel like pulling your hair and start curing your decision to take help from this service providers.

Believe me, Indian Government is not justified in charging us 12% Service Tax on Services that you get in India. Service tax should be on 'real services' and not on the 'harassment' in the name of service. May I suggest that Government should call it 'Harassment Tax' because in the name of service we get only a harassment.

I've to really make a great effort in remembering any incidence where I would have got a prompt, simple and correct answer from the service provider. Not that such incidents have not happened ever but they too miniscule in number (say 0.5%) .

You may reason saying I may be too demanding and that's why I'm feeling what I'm feeling. But that's not true. In fact, I'm surprised by the wondering that if I'm - a well educated - tech savvy person is getting such shabby answers from call centre employees and their supervisors; what an ordinary person on the road must be experiencing and feeling?

How is the salary that call centre executives and supervisors and manager is justified? Have you ever managed to speak to a call center's manager? I've never managed it. A call centre supervisor has got 100 tricks to ensure that you give up. Of course, I'm sure usage of such tricks would definitely lead to ulcer and/or heart attack. But, that's what they are getting paid for.

I wonder, what could be the remedy? When would we Indians start taking pride in the work that we do? When will we become disciplined? Even highly educated people are not free from these problems.

I think, it’s time that we stop accepting this non-sense without any fight. Time has come to assert our rights. It’s only we don’t tell that we ‘deserve’ better treatment that we get such treatment. Time has come when we start revolting. If we don’t – no body will.

We should stop saying that ‘who has the time’ to do all this? Agreed, most of us do not have time or energy to put this additional fights but some one will have to. If we don’t help ourselves who will help us? It’s time that we wake up to the fact that Government is not going to do anything unless we demand it forcefully. Courts are not going to help us unless we have infinite time and resources (money). Courts have ceased to a ‘pillar’ of democracy. Media is busy serving interests of ‘rich and powerful’. Who is going to serve us? No one, except ourselves.

Start hitting back whenever you are shabbily treated. Pick-up pen to write letters. Pick-up courage to speak up - without any fear. Demand and you shall get. Knock and door will be opened – Jesus said. It’s time that we take responsibility for ourselves in our own hands and stop depending upon Government, Courts and Media.

Tell me what is a “Packaged Software” license?

Is it a purchase of “Goods”, “Service” or a “Royalty Payment"?

The idea of “duality” has deep roots not only in Indian Philosophy - where God is supposed be ‘dvaita’ as well as ‘advaita’; but such duality is in modern science also.

In Science, debate over the nature of ‘light’ and ‘matter’ is dating back to the 1600s, when various scientists proposed competing theories of ‘light’. It was through the work of Albert Einstein and many others that current scientific theory holds that all ‘particles’ also have a ‘wave’ nature. That is, 'light' has a dual nature i.e., it is a 'wave' as well as a 'particle'. When light hits a photosensitive material it generates electricity due to its particle nature.

Our Government – which seems to have no equal any where in any other country – have discovered another duality – in fact a new ‘tri-ality’ (for want to better expression let’s say this) about ‘Packaged Software’. It has found that “Packaged Software” is three different things depending upon how you look at it. If you look at it from the view of State level taxes - it’s a ‘goods’. If you look at it from Indirect Taxes point of view - it’s a “Service”. And if you look at it from Direct Taxes (Income Tax) point of view - it’s a “Royalty” payment made to the software developer.

You will say – so what? After all, in India we have more than 5500 laws and more than 100 taxes. We are paying so many taxes. And double taxation is not new.

Of course theoretically Double taxation should not be there and could be corrected. But, for that, once it is there, one need to make a writ petition in the High Court or Supreme Court OR approach some political party for the correction in the law/act. Another alternative is, if you are able to put-up with it, pay double tax. After all, it is not paid from the reseller's pocket. It's the customer who is paying then what’s the big issue?

Let’s look closely to understand this.

If you look at it from State’s point of view (for the purpose of “Value Added Tax” or “Sales Tax”) - Packaged Software License is a “goods” – without any doubt. There are number of court cases and it’s a well settled legal view that “Packaged Software” license is a “goods” and it attracts 4% VAT. It is fine up to this point.

But, if you look at it from the Centre’s point of view (for the purpose of “Service Tax”) Packaged Software License is a “Information Technology Service” (IT Service). Government woke up to this reality as late as in February 2008 and introduced a new service in the list of taxable services during the 2008 budget. With effect from 15-5-2008 all IT Services became taxable under Service tax net.

So, all companies involved in the business of selling Packaged Software Licenses started charging “Service tax” at 12.36% (inclusive of 3% Education Cess). And then to give its due to the 'State' – they are charging “Value Added Tax” at 4% on the total of License Fee and Service tax.

Everybody thought - that’s it. We can manage it i.e., customer will understand somehow that if ‘duality’ is there in ‘Religion’ and ‘Science’ - so it’s not difficult to accept that it could be there in Government taxes also. More or less, most of the customers came to accept the fact that they have to pay double tax - although it’s against the principal of double taxation.

Of course, we have heard that there are some software stalwarts like a large Software Company from Tata Group, which refuses to accept such dual nature of Software because they deal with Software licenses day-in day-out; and who would know it better? So, we understand that they have stopped purchasing Packaged Software products with double tax!! Of course, one may ask - how would they manage without purchasing any packaged software? Simple, they use open source software or they would develop it in-house. After all they have all the resources!!!

Any way, that’s besides the point. There is another twist to the story. In other words, plot thickens now. Don’t underline our Government's ability to create situations which would put even Hollywood film stories to shame!

Story goes like this – Software dealers started billing dual tax to customers in the routine manner (after fixing their Invoicing software, of course) – thinking that that’s it. But when they got payment for the packaged software licenses from the customer, they got a rude shock. They got cheque of only 89% of the Invoice amount from the Customer. Upon inquiry they found that customer had deducted 11.33% as TDS (Tax Deducted at Source aka Income tax) from the payment.

You would say ‘big deal’ - the dealers would pay that much tax less while making advance tax payment. Theoretically yes, but practically no. Why?

A typical software reseller makes about 2 to 4% gross margin on the sale of the packaged software license. So, he purchases it at say Rs.96, sells it a say Rs.100 – considering the best margin case. He bills it to customer at Rs.117 (100 + 12.36%ST +4%VAT). And customer pays him Rs.104 after deducting Rs.13 towards TDS. Reseller pays Rs.17 to Government towards Service tax and VAT – so reseller is left with Rs.87 in his hand. So, net – net he has lost Rs.9 per 96 i.e., he lost 9% from his cash flow. So, tell me after how many such transactions he would be left with no cash flow? You need to be ‘panchvi pass’ to answer this simple question.

Hey boss - don’t be ‘संतुष्ट’ (यार, SRK overtakes me sometimes) with 2 to 4% margin – ask customer to pay 9+4 i.e., 13% margin. Hey, that’s an unlucky number. OK let’s earn 15% gross margin. After all – reseller also needs to make money sometimes. Isn’t it? So, overnight price of Packaged Software license went northwards by 15%. Of course, this increase was over and above the 13% extra that customer shelled out towards Service tax and VAT on Service tax. So, in July 2008 all Packaged Software licenses became dearer by 28%.

End of story? नही यार. Plot thickens now. Some software distributors figured that if they paid 12% CVD (aka Customs Duty) while importing the Packaged Software license then suddenly “IT Software” turned from “Service” to “Goods”. So, when 12% CVD is paid - only 4% VAT would be payable; and no service tax! Wow, it meant that no TDS also. Great solution! After all, Indians are good at finding solutions. We are giving software solutions to the whole of USA and many countries in the world then why not for India. Isn’t it?

So far, before this happened, packaged software license was imported in to India by payment of ‘nil’ customs duty. Whether software was imported as a “paper license” or “software download from Internet” it did not matter. And this was more-or-less in line with GOI ‘s commitment to WTO in 1996 that by 1st June 2000 India will reduce customs duty to zero for 94 IT related items; and other IT items would have zero duty by 1st January 2005. Of course, one anomaly existed viz., if you imported packaged software license in a ‘shrink-wrap’ box then you paid 12% Customs duty. But considering the yearly volume and value of import under category - which is about 2 to 3% of the total packaged software license import – most people ignored this anomaly.

So, at least for some time – software resellers thought that by payment of 12% CVD problem of Service tax and TDS got resolved. But no, our Service tax people are smart. They are not going to give up that easily. Text of the law is in their favour. They have every right to ask each reseller to pay up “Service tax” because they have already tasted the ‘blood’ in this few months. So, software reseller community is keeping it’s fingers (and blood vessels therein) crossed. They are hoping against all hope that Service tax people will be content with revenue they have raked in so far in this 2 months.

But matter is not over yet. In January 2008 news stories had appeared in press that Microsoft was asked to make payment of about 700 to 800 Crore rupees towards Income tax. Also, in July 2008 a Supreme court judgment - in a case involving software imported by Airport Authority of India from a US supplier – it was held that Income-tax was payable by the US supplier in India because payment to them towards software license purchase by AAI was in the nature of ‘royalty’ payment. This was in spite of the wordings of the license agreement, which stated categorically that it was ‘a grant of license to use the software’. If one reads the Microsoft case judgement – it also seems to say the same thing i.e., payment received by Microsoft – although it was through a well-laid distribution network – was in fact an income towards ‘royalty’ payment; and not a ‘business profit’.

So, what does this view from “Income tax” mean to software resellers? It means that customers will keep deducting TDS from their invoices because customers are making payment towards royalty. So last I have heard is that all software resellers are queuing up outside the Income-Tax (TDS) department to apply for the Certificate under Section 197(1) (See Rule 28AA) relating to deduction of tax i.e., lower TDS.

Also, it was heard that price of all ‘downloaded’ software went upwards by another 10 to 20% depending upon from which country the software was procured. Why this? This is to pay the ‘withholding tax’ (aka Income Tax or TDS) to be paid to the Government towards income tax on the profit made by the non-resident supplier in India. This income tax on the profits made by the non-resident supplier seems to be payable by the ‘importer’. Of course, if the non-resident supplier agrees and if India has DTAA (Double Tax Avoidance Agreement) with that supplier’s country then importer may deduct TDS from the payment. But if importer is unlucky – which most likely the case – then importer will have to pay this tax from his own pocket.

Can it become more complex than this? We bet it can – but only in India. We still have our friendly politicians and bureaucrats who can make it still complex. They are capable of inventing ‘fourth’ nature of “Computer Software” licenses - apart from ‘goods’, ‘service’ and ‘royalty’!!!!

But those who are engaged in the business of software license reselling in India have got fad up of all this tax non-sense. Although they are merely 200 to 250 in number (all over India) they have got together and formed an association called "ISODA" - Indian Software Dealers Association. They have already initiated many steps to protect their interest. More on it can be found at http://www.isoda.in

p.s., one question is still unanswered. When a customer purchases ‘Computer Software License’ – how will this payment be classified as? Will it be a revenue expense, royality payment or a fee towards a professional service?

Don’t break your head. Just put this question in the next year’s Chartered Accountant’s (CA) exam. We have heard that only 2% candidates "pass" the final CA exam. But if this question is included in the exam then no one will pass next year’s CA exam. You bet.

Long live India and it’s harried citizens.