This document is intended to discuss the Tax challenges being faced by the Software Product Industry and our Budget Recommendations to Govt. to solve them.
Here are some key areas we will be covering:
1) Software Sale treated as Royalty income
2) Curative steps towards the existing ambiguity and potential duplicity on the taxability of software as goods and / or services
3) Inadequate Rate of Abatement from the Retail Selling Price (“RSP”) to arrive at the value of packaged software/canned software, falling under Central Excise Tariff Heading 8523 80 20 of The Central Excise Tariff Act, 1985, for payment of excise duty under Section 4A of The Central Excise Act, 1944.
4) Appropriate treatment to arrive at the value of the supply of multi-license packaged software/canned software
Tax challenges being faced by the (SPI)Software Product Industry and Budget Recommendations made by iSPIRT
1 Direct Tax Issues
1.1 Issue: Software Sale treated as Royalty income (‘Copyright’ Vs
‘Copyrighted Article’) and applicability of Tax Withholding under
Section 194J of the Income Tax Act, 1961 (“the IT Act”)
The Finance Act, 2012 brought in some important amendments to the IT Act which expanded
the scope and coverage of the term “royalty”, according to which any income arising out of sale
of software amounts to a royalty income, ) irrespective of the medium through which such sales
happens. This requiring the payer to deduct TDS in the said transaction.
This has made software product business extremely difficult, especially in an era when
Internet is proliferating and economies are progressing towards a digital age. All the software
that is sold as a product to end users by the manufacturer/producer carries a license for end
use without transfer of copyright in the software. All the channel partners (distributors,
resellers, retailers, internet ecommerce sites and market places) sell the same license with the
software issued by manufacturer/producer to be finally purchased and used by an end user.
Hence, the software product and the license associated with it is tradable and sold as goods
not as a “copyright”. The incomes arising are Business Incomes as in sell of any other goods.
International practice is to treat sales of software, irrespective of the medium through which
such sales happens (On a media like CD/DVD, downloaded through internet, sold as paper
license, site license etc. or downloaded through internet) based on how the rights (Copy right)
are transferred. Such an approach termed as “Right based approach” which shall distinguish
between the natures of right transferred in consideration for the payment by payer, as follows:
(a) Transfer of a “copyright” when the payer can commercially exploit the copy right and such
transfer be treated as royalty income. The term “commercially exploit” means to exploit the
rights that would otherwise be the sole privilege of the copyright holder and that will,
without such granting of use, constitute an infringement of the copyright. And hence, the
term “commercially exploit” shall mean for payer to be able to:
i) reproduce or copy, modify or adapt the software, information or digitized goods for
further sale for profit; or
ii) prepare derivative works based on the copyrighted software program for further
sales for profit.
Transfer of a “copyrighted article” from the owner to the payer if the rights are limited to those
necessary to enable the end user payer to operate the software product, for personal
consumption or for use within his business operations. Such payment for “copyrighted article”
i.e. software product shall be treated as business income and not as royalty. A software
product as “copyrighted article” is normally traded through a channel of distributors,
resellers/retailers or may be sold using e-commerce directly by the manufacturer/producer or
by a channel partner.
In view of above, it is suggested/recommended that:
a) The ‘Explanation 4 and 5’ in Section 9(1)(vi) inserted by the Finance Act, 2012 may
please be repealed and replaced by provisions that may bring in the Right Based
approach and distinction between “Copyright” and “copyrighted Articles” for purpose
of considering income respectively as Royalty Income and Business Income .
b) Explanation may be added so that, income arising out of sale of “Copyrighted articles”
i.e. Software product, be exempted from withholding tax for following categories of
software products thereby covering distributors, resellers and end-user:
i) Shrink-wrap software;
ii) Software license (site, enterprise or network);
iii) Downloadable software; and
iv) Software bundled with hardware.
c) And accordingly Section 194J of the IT Act may please be modified to do away with the
need to deduct tax (TDS) for software product sales where the sales are for “copy
d) The relevant authority and departments may like to:
i) Define “Copyright” for said purpose of royalty income, within the IT ACT for
better clarity and removing dependency on understanding “Copyright” from
definitions in section 14 and section 52 of Indian Copy Right ACT, with the
exception that for infringement of copyright the Indian Copyright Act shall
ii) Follow an example of Singapore IT Act which is friendly with promoting a digital
economy. ( A copy attached for ready reference).
The proposed amendment to the IT ACT does not affect the revenue from direct tax, but
it greatly eases the software business.
1.2 Issue: Delay in refunds (easing access to working capital)
The delay in grant of TDS refunds has had adverse impact as it has resulted in blocking valuable
and expensive working capital leading to operational and financial difficulties, besides inhibiting
growth. It is recommended that a robust process and a mechanism for rectification application
be put in place to speed up the process of refund of TDS.
A mechanism to implement a time bound plan may solve the issue and provide high relief to
SME segment software product companies.
2 Indirect Tax
2.1 Issue: Curative steps towards the existing ambiguity and potential
duplicity on the taxability of software as goods and / or services
It is pertinent to note that among others, software products are sold through a multi -tier trade
channel consisting of small dealers, having small turnovers, and trades in software and
hardware. Often, the distribution network and channel partners for off the shelf packaged
software, as well as hardware, are the same.
Jurisprudence has held “packaged or canned software” as tradable and as “goods” for the
purposes of VAT / sales tax (as has been held in Tata Consultancy Services v. State of Andhra
Pradesh 271 ITR 401 SC).
“Information Technology software” has been recognized as “goods” and classified under the
Indian Central Excise Tariff under Tariff Heading 8523 80 20 in the First Schedule to the Central
Excise Tariff Act, 1985.
Further, “packaged or canned software” is also acknowledged as a “packaged commodity” for
the purposes of the Legal Metrology Act, 2009, read with the Rules framed there under. On the
basis of the same, the manufacture of such is generally subject to Central Excise valuation on an
MRP/Retail sales Price (RSP) basis in terms of Section 4A of the Central Excise Act, 1944.
Software supplied digitally is interpreted as a service – this is in some-what contradiction to the
fact that the basic operational character, marketability and commercial value of the software in
question remains unchanged, whether it is supplied “over the counter” in a shop, or supplied
The existing service tax laws need to be amended to exclude any form of electronic delivery of
packaged software through telecommunication networks from coverage under service tax, by
way of amendment to the Mega Notification No. 25/2012 dated June 6, 2012 which provides
exemption from service tax. The exemption to be provided by insertion of a new clause to
Notification No. 25/2012, which could read as follows: “Packaged software delivered online or
down loaded on the internet”
Alternatively, an explanation could be inserted under Section 66 E of the Finance Act, 1994 that
the development of software covered under sub-clause (d) is “only in relation to customized
software and any packaged software delivered online or down loaded on the internet is
specifically excluded from the provisions of Section 66 E and should not be chargeable to
Additionally, the “Taxation of Services: An Education Guide” dated June 20, 2012 issued by the Central
Board of Excise & Customs would need to be amended. Specifically, clause 6.4.4 needs to be amended to
exclude the following portions of clause 6.4.4:
“However, the manner in which software is transferred makes material difference to the nature
of transaction. If the software is put on the media like computer disks or even embedded on a
computer before the sale the same would be treated as goods. If software or any programme
contained is delivered online or is down loaded on the internet the same would not be treated as
goods as software as the judgment of the Supreme Court in Tata Consultancy Service case is
applicable only in case the pre-packaged software is put on a media before sale.
Delivery of content online would also not amount to a transaction in goods as the content has
not been put on a media before sale. Delivery of content online for consideration would,
therefore, amount to provision of service.”
Further, the following language may be inserted at the end of the Supplementary Note in the Chapter
Notes of Chapter 85 of Schedule I of the Central Excise Tariff, “Packaged software delivered online or
down loaded on the internet is also included in the meaning of “Information Technology Software” f or
the purposes of heading 8523”.
These amendments will boost the trade in Software and also help in furthering the cause
of Digital economy as Small Indian Software Product companies can then rely on
ecommerce penetrate markets deeper. Hence, these measures are going to reform the
software trade, improve the revenue and trade and easy administration.
2.2 Inadequate Rate of Abatement from the Retail Selling Price (“RSP”)
to arrive at the value of packaged software/canned software, falling
under Central Excise Tariff Heading 8523 80 20 of The Central
Excise Tariff Act, 1985, for payment of excise duty under Section 4A
of The Central Excise Act, 1944.
Serial No 93A of Not. No. No 49/2008-CE (NT) dated December 24, 2008 (as amended) provides
for valuation under Section 4A of the Central Excise Act, and a specific abatement of 15% from
the RSP to arrive at the value of packaged software or canned software falling under Central
Excise Tariff Heading 8523 80 20 for payment of Central Excise Duty.
It may be noted that the abatement was fixed when the rate of Central Excise Duty was 10%,
which has now been increased to 12% (excluding applicable cesses)
It is the industries plea that the abatement of 15% is inadequate and does not take into account
the incidence of taxes on the product – VAT/CST rates ranging from 5.5% to 6.6%, Octroi/Entry
Tax/LBT in the State of Maharashtra, increase of Central Excise Duty from 10% ad valorem to
12% ad valorem (and proportionate increase applicable cesses).
The taxes on the product itsel;f amount to approx. 22% of the RSP apart from the other costs
on channel sales that are built to arrive at RSP and the notified abatement of 15% is not
Serial No. 93A in Not. No. 49/2008 (NT) dated December 24, 2008 is required to be amended to
increase the abatement from the existing 15% to 35%.
This amendment shall immensely help the SME Software Product Companies.
2.3 Appropriate treatment to arrive at the value of the supply of multi-license
packaged software/canned software, falling under Central
Excise Tariff Heading 8523 80 20 of The Central Excise Tariff Act,
1985, for payment of excise duty under Section 4A of The Central
Excise Act, 1944.
The case of multi-license supplies vis-à-vis the provisions of Section 4A of the Central Excise Act
read with Serial No 93A of Not. No. No 49/2008-CE (NT) dated December 24, 2008 (as
amended) is not appropriately represented in the context of volume discounts. The same may
also be argued to be out of sync with the general and broadly accepted principles under Central
Excise laws for extending and treatment of commercial discounts in the context of Central
The following replacement may be considered for the Explanation in Serial No 93A of Not. No.
No 49/2008-CE (NT) dated December 24, 2008 (as amended):
“Explanation. –For the purposes of this notification, “packaged software or canned software”
means a software developed to meet the needs of variety of users, and which is intended for
sale or capable of being sold of the shelf. However, this would not include multi license
supplies of packaged or canned software, which would be assessed on the basis of transaction
value as per and subject to the provisions of Section 4 of the Central Excise Act, 1944”.
Alternatively, Serial No. 93B may be inserted as follows:
Description of goods Abatement as a
retail sale price
(1) (2) (3) (4)
93B 8523 80 20 Multiple license supply of packaged
software or canned software
Explanation. -The meaning of
"packaged software or canned
software" for the purposes of this entry
would be the same outlined above in
S. No. 93A.
Note 1 - an appropriate rebate percentage would need to be