GST on Supply of Software in the light of the Supreme Court ruling in income tax

Software and Hardware are expressions that permeate this Computer age. The word software is often used in contrast to hardware and denotes a set of instructions or programs used to operate computers and execute specific tasks. This is how the Internet defines Software and fairly conveys the meaning. Supply of software in the context of GST law poses primarily issues of classification as either goods or services. Rules for determining the place of supply, time of supply, etc., differ for both goods and services and therefore the determination is critical. This article seeks to delve into this seemingly two-headed hydra and also on the impact of the recent Supreme Court ruling in the context of income tax.

Software through the eyes of GST Law:-

To understand the nature of this beast, it is rather appropriate to understand products that share the features. Software is intangible but can be transferred and transmitted like electricity. It is capable of being stored in CDs and transmitted like technical knowhow or any other knowledge that can be stored in books. The Supreme Court even before the advent of computers had ruled that electricity falls within the meaning of “goods” and should be taxed accordingly. Technical knowhow such as designs and drawings when imported in CDs are treated as goods and subject to Customs duty. Therefore, it is safe to conclude that supply of software can at times be characterised as supply of goods and attract tax as such. But most of the times, software is licensed for use for a particular period and/or the licensee is bestowed with only restricted right to use the software. Hence it can also exhibit features of supply of service.

Now let us see what the GST law explicitly pronounces. It states that the following shall be treated as supply of service:-

(a) Temporary transfer or permitting the right to use or enjoyment of intellectual property right;

(b) Developing design programming customisation, adaptation, upgradation, enhancement, implementation of Information Technology Software

(c) Transfer of the right to use any goods for any purpose for cash or deferred payment or other valuable consideration

From the above it is clear that the following types of supply of software shall be treated as supply of service:-

(1) License granted to use software for a specific period which will be classifiable under 997331 as licensing services for the right to use computer software and databases.

(2) Software provided through Cloud as SAAS (Software as a Service) model. The classification in this situation will be a question of fact and need to be ascertained considering all the relevant aspects. GST law groups certain software related services as OIDAR or online information and database access or retrieval services where the services are delivered through the medium of information technology either through internet or an electronic network and the services are essentially automated and requires minimal human intervention. Provision of e-books, movie, music etc., through the internet usually falls within this class. The taxpayer need to be aware of this classification as well while deciding on classification for Cloud based services.

(3) Customisation, upgradation, enhancement and similar such services undertaken on standalone basis for computer software would be classified as supply of service. However, when these services are incidental to the delivery of software then the supply will be dependent on the nature of primary supply. A completely tailor made or customised software would probably be a supply of goods. However, it can also be considered as supply of service in terms of 5(2(d) of Schedule II of the Central GST Law.

The GST law clarifies the above. However there are circumstances where it confounds the taxpayer. There are two separate rate notifications for goods and services. Both the notifications talks about permanent transfer of intellectual property rights in computer software and provides applicable GST rates. Similarly, there is specific service code given for software downloads which may give the impression to the taxpayer that all software downloads would be classified as supply of service. The GST Council has tried to reduce the burden on the taxpayer by aligning the tax rates for both supply of computer software when treated as goods and as services. However, the allied issues relating to Place of Supply, Time of Supply, treatment as import or export etc., are left to the mercy of interpretations.

Then, where should the taxpayer go. The situation may not be as confusing as there are some judicial interpretations of yesteryears that can guide the taxpayer. The Supreme Court had in the case of TCS ruled that supply of shrink wrapped or canned software or packaged software as supply of goods. The crux of this ruling though given in the context of erstwhile indirect tax laws still holds afield or good under GST Law. Hence software sold in the form of packaged stuff through the medium of CDs will be supply of goods. This will be classified under HSN 8523 80 20.

Supreme Court on applicability of withholding tax provision on import of Software:-

The last type of supply of software is through limited end user license popularly known as EULA. These are at times concluded by click of a button on the internet by the user. The tax authorities have advised the taxpayers to understand the nature of supply from the terms of the EULA before classifying them as supply of goods or services. Many a time such software is imported from Non-resident suppliers either by the end users or by distributors who in turn sell them to the end users. This has always been borne of contention between taxpayer and income tax authorities. Tax authorities considered payments made by resident users and distributors for such software imports as Royalty and cast withholding tax obligations on the taxpayer while the taxpayer have invariably argued that this was mere purchase of goods without any licensing rights to use the software. The issue has finally been laid to rest by the Supreme Court.

The Hon’ble Court has used the analogy of buying books and ruled that in all these situations it was mere purchase of goods and no withholding tax obligations arose. It may be noted that the meaning of royalty was expanded in the Income Tax Law in 2012 and it currently covers transfer of all or any right to use a computer software (including granting of license) irrespective of the medium through which the right is transferred. In this context, it would be appropriate for the taxpayer to treat the same as royalty and withhold appropriate taxes except where it is sold as packaged software with complete transfer of ownership rights.

Now let us see the implication of the above ruling in the context of GST law. A distributor or end user importing packaged computer software will be actually treating it as supply of goods going by the above ruling or more appropriately import of goods. In the case of import of goods, Customs duty and IGST are collected through the medium of Bill of Entry at the port of import. Where software is stored in CDs etc and imported through a port, then Customs duty has to pay on such import. However the end user or distributors will not be able to meet this requirement where import is effected through other modes and therefore the mechanism to pay tax fails. Hence an honest taxpayer will be constrained to treat the transaction as import of service under the GST law and pay the GST through the medium of reverse charge.

Another vexatious issue arises in the case of distributors who import software and sell to end users and the software supplier “delivers” the software to the end user instead of distributor delivering the software. If the supply is construed as supply of goods assuming they conform to the norms explained in this article, then the relationship between the distributor and the software provider can be viewed as one of agent and principal in the context of supply of goods. The GST Law states that where an agent supplies or receives any taxable goods on behalf of his principal, such agent and his principal shall, jointly and severally, be liable to pay the tax on such goods. Further the GST rule on valuation gets attracted for the supply from the principal to the agent. The valuation rules can muddy the waters further if the margin assigned to the distributor is more than 10% as it says the consideration for the supply shall be either open market price or 90% of the price charged by the distributor to the end user. This would open up a can of worms for the numerous software distributors in this country as many may stop deducting withholding income tax treating it as import of goods. The Supreme Court is very emphatic that distributors do not get any right to use the software but a limited right to resell the software even if the form of EULA uses the word license.

In the realm of income tax law prior to this Supreme Court ruling CBDT had clarified that if tax was deducted by treating as royalty at the time of import by the importer-distributor then no further TDS would be deductible further down in the value chain. This clarification would become irrelevant post the ruling of the Supreme Court and end-user in India would be required to deduct TDS on payments made to distributors for purchase of license. This is anticipated to adversely impact the working capital of the distributors.

GST Law will be entering the fifth year in the next few months and it is better to be late than never for CBIC to come out with a circular clarifying the issues relating to supply of software. Software industry has contributed immensely to the nation’s economic growth and her tax kitty and the exchequer certainly owe a duty to help the sector by bringing out a comprehensive circular clarifying the issues plaguing the sector under the GST law.