In the last few decades, the Information Technology (“IT”) Sector has emerged as one of the most booming sectors in the global economy, and its success is partially attributable to various existing and newly developed computer software. On the financial front, this had initially opened a pandora’s box when it came to the taxation of computer-driven software products.
Earlier, the sale of non-tangible goods was exempt from the levy of Sales Tax, as only those goods which were supplied in tangible form were subject to tax liability. Similarly, due to the computer software’s non-tangible nature, such products were deemed non-taxable owing to the Sales Tax exemption on sale of non-tangible goods.
The aforementioned situation, coupled with a lack of rules and regulations, created a lot of confusion when it came to the indirect taxation of software products under the Sales Tax. Hence, other forms of tax were levied on software products.
For example, pre-packaged software attracted Value Added Tax (“VAT”) and Service Tax, whereas the manufacture of IT products was subject to Excise Duty. With the further development of the service sector in the Indian economy, the information-based service industry became a vital part of the service sector.
However, with the changing times, the erstwhile statutes for indirect taxation were rendered ineffective with regards to taxability of IT-based services, and the need for a new tax regime for taxing software products became prominent.
Accordingly, this Blog aims to illustrate the current legal position of indirect taxation on computer software in India, highlighting the significant developments after the implementation of the Goods and Services Tax (“GST”) regime.
WHAT IS A COMPUTER SOFTWARE?
Before discussing the complexity of tax implications on the computer software, it is crucial to understand the meaning of the term ‘computer software’. Computer and computer software are two separate components; while computers can exist in physical form as they have both hardware and software components, the software is invariably an intangible asset.
The Income Tax Act, 1961 (“ITA”) defines the term ‘computer software’ under Sections 9, 10A, 10B, and 80HHE of the ITA, which deals with the export of computer software and Explanation 2 of both Section 10A and 10B of the ITA define computer software for the purpose of said provisions as:
“(a) any computer program recorded on any disc, tape, perforated media or other information storage device; or
(b) any customized electronic data or any product or service of similar nature as may be notified by the Board,
Which is transmitted or exported from India to any place outside India by any means.”
The term “computer programme” is defined under Section 2(ffc) of the Copyright Act, 1957 to mean: “a set of instructions expressed in words, codes, schemes or in any other form, including a machine-readable medium, capable of causing a computer to perform a particular task or achieve a particular result.”
The term ‘software’ was also interpreted by the Supreme Court of India in the case of L.M.L. Ltd. v. Commissioner of Customs 2003 (135) ELT 703 Tri Del as “software is the set of instructions that allows physical hardware to function and perform computations in a particular manner, be it a word processor, web browser or the computer’s operating system.”
From a combined reading of the definitions provided in the ITA and the Copyright Act, 1957 and the Supreme Court’s decision, it can be inferred that the term computer software refers to a set of one or more computer programmes, recorded on a particular information storage device, which provides instructions to cause a computer to perform certain task(s) or achieve particular result(s). Computer software are recognized as intellectual property under the Copyright Act, 1957.
INDIRECT TAX IMPLICATIONS IN THE PRE-GST ERA
Before the implementation of GST in India, some states levied Sales Tax on all tangible personal property, but not intangible property. While in other states, both tangible and intangible personal property was liable for levy of Sales Tax. Additionally, in the erstwhile tax regime, most states primarily imposed a VAT of around 5% and a Service Tax of 15% on the sale of pre-packaged software.
If the software came in the form of a tangible product such as a pen-drive or hard disk, additional Excise Duty was levied along with VAT and Service Tax. The breakdown of indirect tax implications on such computer software were as follows:
- Excise Duty for the manufacture of computer software;
- VAT on the sale of computer software; and
- Service Tax for the provision of service of software, which can be downloaded multiple times.
Such irregularities in the levy of indirect taxes on software products complicated the issue and created an unclear situation for dealers of computer software.
INDIRECT TAX IMPLICATIONS IN THE POST-GST ERA
To understand the GST implications on computer software, it is vital to determine whether the supply of computer software is to be treated as supply of goods or supply of services. Previously, an ambiguity existed with regards to the treatment of such supply as goods or services based on the nature of software, i.e., tangible or intangible asset. However, within the GST Regime, the controverted position has been clarified to a significant extent by the Central Board of Indirect Taxes and Customs (“CBIC”).
The CBIC vide its Frequently Asked Questions (“FAQs”) dated 15.12.2018 answered the question put forth in Q. 17 “Whether supply of software would be treated as supply of goods or supply of services under GST law?” as:
“Development, design, programming, customization, adaptation, upgradation, enhancement, implementation of information technology software shall be treated as supply of services as listed in Sl. No. 5(2)(d) of Schedule – II of the GST law.”
The CBIC also clarified the position with regards to the treatment of computer software in its Sectoral FAQs on IT and IT-enabled services and stated that:
“In terms of Schedule II of the CGST Act 2017, development, design, programming, customization, adaptation, upgradation, enhancement, implementation of information technology software and temporary transfer or permitting the use or enjoyment of any intellectual property right are treated as services.
But, if a pre-developed or pre-designed software is supplied in any medium/storage (commonly bought off-the-shelf) or made available through encryption keys, the same is treated as a supply of goods classifiable under heading 8523.”
Going by the aforesaid FAQs published by the CBIC with regards to computer software, the current position under the Central Goods and Services Tax Act, 2017 (“CGST Act”) is that the supply of computer software is to be generally treated as the supply of services, but when such computer software is purchased off-the-shelf through any medium/storage or made available via encryption keys, it qualifies as a supply of goods.
The supply of computer software as either goods or service attracts GST at the rate of 18%, and such suppliers are entitled to avail Input Tax Credit (“ITC”), subject to the conditions prescribed under Section 16 of the CGST Act.
GST IMPLICATIONS ON ONLINE PURCHASE OF COMPUTER SOFTWARE
Computer software that has been purchased or procured online has always been a subject of debate with regards to its treatment as a supply of goods or supply of services. Procuring a generic computer software online, which may be purchased off-the-shelf as well, is a supply of goods under GST. However, procurement of a specific computer software online, customized as per the requirements of the customer and made available to that customer only shall be treated as supply of services.
When a customized computer software is purchased from an international seller, such a supply falls under the category of Online Information and Database Access or Retrieval Services (“OIDAR”) as provided by Section 2(17) of the Integrated Goods and Services Act, 2017 (“IGST Act”).
The delivery of OIDAR services is mediated by IT over the internet or an electronic network, and their nature renders such supply essentially automated with minimal human intervention. Ensuring the absence of IT in such supply is impossible and it is inclusive of various electronic services.
When OIDAR services are acquired by Indian residents from international sellers, the Indian recipient is required to pay GST on such services on reverse charge basis, pursuant to Sr. No. 1 of Notification No. 10/2017 – Integrated Tax (Rate) dated 28.06.2017. Resultantly, the recipient shall discharge the IGST liability on acquiring OIDAR services at the rate of 18%, as provided by Notification No. 08/2017 – Integrated Tax (Rate) dated 28.06.2017.
The recipient is entitled to avail ITC on the IGST paid for acquiring such OIDAR services, if the OIDAR service is used in the course or furtherance of the recipient’s business.
GST IMPLICATIONS ON EXPORT OF COMPUTER SOFTWARE
The supply of computer software abroad by Indian parties is a major source of revenue in India, as India has emerged as a worldwide leader in the production and supply of computer software. Within India, export of goods and services are zero-rated and do not attract GST liability. Similarly, any input taxes paid for the final supply which is to be exported are refunded to the taxpayer.
Resultantly, the supply of computer software outside India as export is zero-rated and does not attract any liability under the CGST Act, irrespective of the supply being treated as goods or services. Such suppliers are also entitled to claim the refund of input tax paid prior to the export of computer software.
With the introduction of GST and rising uniformity in the indirect taxation structure of India, the complexities and irregularities prevalent in the erstwhile regime for taxation of computer software have been largely alleviated. The CBIC has clarified through multiple FAQs that the supply of computer software is to be treated as services, with the exception of its treatment as supply of goods when it is supplied through a medium/storage or through encryption keys.
Under the GST regime, the levy of GST or IGST at the rate of 18% on the supply of computer software is likely to benefit the IT Industry as it has eliminated the additional levy of concurrent indirect taxes on select software, as was the case in previous legislation.
With the implementation of GST and the standardized treatment of supply of computer software under the GST regime, the situation is slowly but steadily stabilizing in India. This bodes well for transnational software transactions and the emergence of India as a strong market player in international software markets.
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