Software taxation : simply confusing?

As the IT industry grapples with the impact and implications of the
newly-introduced software taxation structure, we bring you the viewpoints of
various players that stand to get affected by the changes. Will the seemingly
simple solution to industry's tax problems create further din? Most feel its a
game of wait 'n' watch...

The Finance Minister simplified the tax structure of software by waiving off
excise duty, but did not offer clarity on whether either VAT and service tax or
either of them have to be charged, creating more confusion amongst software
distributors and resellers.

In the Union Budget of 2009-10, the government announced exemption from
excise duty for packaged software. This change in the budget structure ensured
that both excise duty and Countervailing Duty (CVD) is exempted from packaged
software and will instead attract service tax on the licensed portion.

However, instead of simplifying, the announcement has further complicated the
taxation structure of software. Now software distributors and dealers in the
market are unclear whether or not they should charge value added tax (VAT) and
service tax on the domestic transactions of the packaged software.

Situation so far

The confusion that is currently prevailing is that software resellers have
been charging excise duty and Central Sales Tax (CST) on the import of the
software, VAT on its sale and service tax on the implementation of software. The
exemption of excise duty on packaged software and the simultaneous application
of Special Addition Tax (SAT) have left dealers flummoxed.

Now they are confused as to whether they should continue with the existing
tax structure of charging these three different tiers of tax, or stop charging
the excise duty on license fee or charge only the service tax!

The core reason for this lack of clarity is that packaged software is
imported as goods and is liable to VAT during domestic transactions. Now with
the waving of excise duty and levying of SAD it enters the category of services.
The confusion is largely about the continuity of VAT at domestic purchase since
VAT is subject to goods only and not on services.

Wait 'n' watch

Elaborating on the issue, Alok Gupta, CEO, Softmart Solutions said, “The new
system is creating lot of confusion as to whether software resellers should
charge VAT or not.”

“When packaged software is categorized under services, it should also be exempted from VAT, which is paid for products. But there is no clarity on it”
	Alok Gupta Softmart Solutions
“The taxation structure of software would become clearer only when the billing of new stock starts. Till then partners are charging VAT as they were doing before”
	Hemant Chabria Chabria Infotech
“We are consulting our tax advisors on the potential interpretation of the proposals made in the 2009-10 budget speech and its impact on taxation of software licenses”
	K Jaishankar MD, Ingram Micro
“The government has announced service tax on packaged software on the license side but has not clarified if the four percent special addition duty will continue or not”
	Vinnie Mehta Executive Director MAIT

“We are still not clear what tax structure should we follow. There is no
clarification from the government. We had requested National Association of
Software Companies (NASSCOM) to offer clarity on the matter and the software
body has assured that it will have a dialogue with the government and will seek
more information,” said Mukesh Gupta from New Delhi's Digitronics Infosolution.
Till this clarification comes through, dealers are charging tax according to
their convenience or their interpretation of the law. But they do know at the
back of their minds that in the absence of right information about the taxation
they might have to pay heavy penalty in the future.

Onus on importers

Nitin Aggarwal from New Delhi's Trifin Information Technology pointed out
that there is also no clear communication on how the new inventory of software
would be taxed. “We are still selling the old inventory and have not billed any
new product since the government made its announcement during the Budget. Due to
lack of clear communication, we are not receiving new stock and even the
distributors have not imported so far. Things will be clear only once the
distributors import the fresh lot and sell it to the partners with clear
indication of tax structure,” he said.

Ashutosh from New Delhi's Future Soft Solution mentioned, “As of now we are
following the same taxation structure but the decision has to be taken by the
distributors. It depends on how the distributors are billing the products.”
Currently, his company is billing products on the same model that was being
followed earlier, while waiting for a decision to be taken by importers.

Currently, resellers are charging four percent of VAT and 10 percent of CVD.
The Government has waived off the excise duty but has exposed the software to
services and hence they have become liable to service tax. Now the products that
are imported as goods are classified under service tax.

Needless to say, this wait-and-watch situation is affecting the resellers who
are handling customers. This is because they are the ones who have to answer to
the numerous queries posed by their clientele. “Resellers are accountable to
their customers but right now we don't have much say in this,” Ashutosh
lamented.

Distributor's call

Though most national distributors have not yet started fresh billing of
packaged software, they too pose a question mark on the tax structure to be
followed. To seek clarity from the government, they are taking legal recourse.

When asked to give a status on the tax structure they are following, national
distributors Redington India and Ingram Micro India declined to give any update
as the matter is being handled by legal experts or it is still being analyzed.

PS Neogi, President-IT Division, Redington India commented, “We regret that
our legal team has advised us not to offer any views/comments on software
taxation matters as it is a very complex legal issue.”

On the other hand, Iris Computers is levying CVD and VAT on the OEM products
of Microsoft. Som Arya from Iris Computers stated, “The confusion is there
because of different forms of software. We are importing software in media form
that includes CDs and we pay royalties to Microsoft. Therefore, we pay custom
duty on the cost of the media and the royalties. The total cost of the software
in domestic market includes the price of the software, custom duty and other
duties like SAD. For us, whatever duty we are paying at the custom clearance at
the time of the import, and other charges, that include freight charges and
service charges, are included in the cost.”

Following a precedent

The software tax structure has always been confusing in India. There are
various factors that are involved in taxation of packaged software. Firstly,
there is the software and the license part of it. Earlier, customized software
and its license part did not attract any custom duty.

Packaged software attracted a CVD of eight percent while the license did not
attract any CVD. Then, there is software that can be downloaded on the Internet
that attracts service tax, which is central taxation. This aside, there is
software sold in a state that attracts VAT.

There have been several means and ways of delivering software. One can
download it from the Internet or get the master software through import and one
may also replicate them locally, and then give it to a third party. Once it gets
replicated, it is subject to excise duty.

There have been issues on the valuation process of software. An importer has
to pay royalty to the owner of the software. Another issue that now crops up is
whether royalty should be included in the cost of software or not.

Finding solutions

In order to clarify the confusion with the government, the Manufacturers
Association of Information Technology (MAIT), an apex body representing India's
IT hardware, held a meeting with the Ministry of Finance. “The government has
said that the value of the software is the license part of it, as software as a
vertical is largely a service oriented sector. Hence the right to use valued
portion will be taxed.

Service tax was introduced on software transactions during the Union Budget
2008-09. The new tax structure covered the transactions related to packaged
software as well that was counted as a material subject to excise duty and VAT.

The Infotech Software Dealers Association (ISODA), an association of the
software reseller community of the IT industry has been active in bringing
clarity in the situation and has taken the legal route for the same. The
association filed a writ petition in Chennai High Court and the case has not
been debated yet as the government has not responded and has requested for some
time, at the time this article was going to press.

ISODA's answer

ISODA has challenged the government of India seeking clarification in the
matter relating to grounds on which service tax can be charged on products that
are already subjected to VAT, which is implied only on the transactions of
goods.

“We are seeking clarification from government because software is available
in different forms and the new tax structure is creating confusion. Once the
issue is debated in court, the judge will pass the order which will solve the
matter. The status quo remains and there is no clarity on whether to charge
service tax or both VAT and service tax,” said Harinder Salwan, Secretary of
ISODA.

Salwan further elaborated that according to the government inter­pretation if
the software comes in a box only then excise duty or CVD is applicable on it,
followed by VAT. But, if it is a

paper license then only service tax (no excise duty or CVD) will be applicable
on the same.

Salwan pointed that while for Corel and Adobe, software dealers are still
charging both the service tax and VAT, for Microsoft  Operating License
Products (MOLP), the CVD is being paid by the distributors and only VAT is being
applied. ISODA has made several representations at CII and FICCI since the issue
first came into light on May 16, 2008. The association had sought clarity on the
definition of packaged software and taxation that is applicable on it. In
addition, the body also demanded abolition of CVD, a demand that has been
announced in the budget but has added to more confusion now.

According to Excise/Customs classi­fications, there are more than one
classifications of Software Product. For example, “Packaged or Canned Software”
comes under custom's heading: 8524 40 11 and is liable to attract CVD; while
“Paper license of Software” comes under custom's heading: 4907 00 30 and is
liable to attract NIL Customs duty. So, the same item namely Computer Software
is falling under two classifications depending upon whether it comes as a
Packaged Product or Paper License.

Added Salwan, “The govern­ment is now trying to say that all retail boxes
will retain CVD as no transfer of right is involved and when the same comes in
the form of a paper license in the name of customer it will be liable to service
tax and no CVD and hence it becomes a service.”

Vendors' Stand

Distributors and importers are confused and are trying to get to the depth
of the matter under the supervision of tax and legal experts. Software resellers
are waiting in the aisles for clarity on the issue. The local trade bodies are
taking proactive measures to get the matter resolved and the apex IT association
is conducting dialogues with the government body. Amidst this, what are the
vendors, the ones who create the most important piece of this jigsaw puzzle,
doing? What actions are they taking to clarify the issue?

In legal terms, taxation is done at the place of transaction and
manufacturers who are located out of the geographical boundary don't play much
advantageous role in getting the matter solved.

However, are vendors supporting resellers who are exposed to the queries of
end customers for different products and brands?

Are they taking steps to get transparency in the matter? Are they discussing
the issue with national distributors who are importing their products into the
domestic market?

As of now, no vendors have been seen getting involved in the matter or taking
any action. Partners say that they have not seen or heard software giant
Microsoft playing an active role in getting clarification in the matter. Rajeev
Mittal, Group Director, Small and Mid Market Solutions and partners, Microsoft
commented that taxation issue is not a Microsoft issue but is rather a
government's right and it affects the entire software industry. “The software
taxation change that was announced in the budget is not impacting Microsoft but
the software industry as a whole. The changes that were announced from
perspective of resellers and distributors were an issue of interpretation. One
took some time to understand their legal aspects and what they really mean.
There were few segments in the software that demanded more clarification and in
between that period business got stalled for a while. Nasscom has been seeking
clarity from the government,” he said.

 Most software vendors preferred to remain silent on the issue stating that
since they are not present in the country directly, they cannot do much about
the taxation structure. Because of this distributors have stopped billing any
fresh goods and the business has been going at a slow pace. Resellers are
sitting with their orders in hand since there is no clarity on the issue.

Few vendors agreed that though they cannot play a big role in sorting out the
matter since it is more relevant for the distributors, they are providing
support to their channel. Ajay Verma Director-Channels & Alliances, Symantec
India mentioned that his company is still examining the situation as the issue
is not about CVD exemption alone but there are certain changes in service tax
also.

“We are still working on it and seeking clarification from the Government on
how and on what basis the software has to be taxed. It is correct that this
matter is more of a concern for distributors. But being a vendor it is
fundamentally required for us to seek clarification and solve the issue as our
distributors and resellers are involved in the whole matter and we are making
effort to give support to them,” he added. Amit Nath, Country Manager, Trend
Micro stated, “We are still trying to understand and are seeking clarity from
the government on issues like how the government categorizes the goods and the
service. What would happen to the products that are already there in the market
and are yet to be sold? We are hoping that government clarifies the situation as
early as possible so that the dealers face lesser inconvenience.” He further
added that though this is more of a problem for the distributors, vendors need
to seek clarification on the subject so that they can have a clear understanding
along with the channel partners. Vendors need to make a clear statement for the
sake of the dealer community.

 Krishnan Thyagarajan, MD, Quest Software India commented, “In case of Quest
we deliver our software through the 'Download' route. This attracts service tax
as well as VAT which our channel pays and CVD is not immediately relevant to our
channel partners.”

Software resellers feel that vendors can play a considerable role in
clarifying the matter and simplifying the issue. They can put their product
under stringent category of product or a service and then government can apply
taxes accordingly.

A reseller mentioned that a vendor can play 80 percent of the role in getting
clarity in such issues and the remainder 20 percent should be done by
distributors who can communicate with the government.

A legal expert, on the condition of anonymity, shared that according to the
Microsoft's end user license agreement; sale of software is subjected to code
155 of Washington's Law that describes that the sale of software is liable for
sales tax. This implies that Microsoft is treating the software as goods and not
as service. Therefore, the same module should be followed wherever Microsoft
products are being sold and in India also, it should be considered as goods and
not as a service.

The government has been busy in the budget for the last few months and now
the IT industry is seeking clarification from them as to which tax structure
they are likely to implement. It should be well-clarified and well-defined so as
to prevent any confusion at the point of purchase.

Till such time, partners are stuck with trying to contrive their own
definitions of the law and praying that they do not get picked on at a future
date for tax evasion.

Amrita Tejasvi

amritat@cybermedia.co.in