2023 (12) TMI 311 - AT - Service Tax

Software supplied on physical medium constitutes goods not services, service tax demand on IT software invalid

Edukite Software Pvt Ltd Versus C.C.E. & S.T. -Vadodara-I

Edukite Software Pvt Ltd Versus C.C.E. & S.T. -Vadodara-I - TMI ISSUES PRESENTED AND CONSIDERED 1. Whether supply of computer software loaded on a tangible medium (CD/USB/Hard Drive) constitutes sale of goods (thereby taxable under sales tax/VAT) and not a taxable service under Service Tax law. 2. Whether an agreement for permanent transfer of intellectual property rights in software (and consideration received by way of CST against C-form) is a sale of goods and immune from Service Tax liability. 3. Whether the tax demand (including by invoking extended period of limitation) can be sustained where software was supplied on a medium and treated as goods by the supplier. ISSUE-WISE DETAILED ANALYSIS - Issue 1: Characterisation of software on a medium as sale of goods vs. service Legal framework: The determination turns on the statutory and constitutional concept of 'goods' as including movable property (tangible and intangible when put on a medium) and the tests whether an item is capable of abstraction, consumption, use, transmission, transfer, delivery, storage and possession; and on the principle that transactions which are in substance sale of goods cannot be treated as service transactions for levy of Service Tax. Precedent treatment: The Court followed and applied prior apex authority which held that software, when loaded on a physical medium (CD/floppy/USB/hard drive), becomes goods because the intellectual property is incorporated on a medium and is capable of being transmitted, transferred, delivered, stored and possessed; that both 'branded' (canned) and 'unbranded' (uncanned) software may be goods when marketed; and that a composite lump-sum charge for software delivered on media, once treated as sale and taxed as such, cannot be subsequently split to levy service tax on the same consideration (authority relied upon and followed). Interpretation and reasoning: The Court accepted that when intellectual property embodied in software is supplied on a physical medium, the transaction is of sale of goods in substance because the buyer acquires possession and control; the software and medium cannot be teased apart as the buyer pays for the intellectual content incorporated on the medium. The Court emphasized that the correct test is functional - whether the item can be abstracted, consumed, used, transmitted, stored and possessed - not mere tangibility of the underlying intellectual property. Ratio vs. Obiter: Ratio - Where software is supplied loaded on a tangible medium and the transferee is placed in possession and full control, the transaction is a sale of goods and not a service; revenue cannot impose Service Tax on the same consideration. Obiter - Remarks distinguishing branded and unbranded software in other contexts were noted but the Court expressly limited its opinion to software supplied on a medium and did not decide broader questions about unmarketed/customized software's situs or classification. Conclusions: The Court concluded that software supplied loaded on a medium attains the character of goods and is therefore not liable to Service Tax as a service. Consequently, any service tax demand premised on such characterization cannot be sustained. ISSUE-WISE DETAILED ANALYSIS - Issue 2: Effect of permanent transfer of intellectual property rights and taxation treatment Legal framework: Contracts effecting permanent transfer of intellectual property rights in software, particularly when the transfer results in delivery of software on a medium and grant of rights of use/possession to the transferee, must be examined to determine whether the transaction is a transfer of goods (sale) or a contract for services. The attributes of transfer (consensus ad idem as to identity, availability for delivery, transferee's legal right to use, exclusivity during the period) are relevant to characterising a transfer as sale of goods. Precedent treatment: The Court relied on precedents recognizing that where intellectual property is incorporated onto a medium and marketed, it constitutes a chattel/goods for sales tax/customs purposes, and that the contract cannot be artificially vivisected into sale and service components to create a service tax liability once the sale element has already been taxed. Interpretation and reasoning: The Court found that a memorandum of understanding (MOU) for sale and permanent transfer of intellectual property rights, coupled with delivery of software on a medium and payment of sales tax/CST, indicates a transaction in substance of sale of goods. The attributes of a transfer of the right to use and possession were applied to conclude that the buyer obtained legal rights akin to ownership sufficient to characterise the transaction as sale. Ratio vs. Obiter: Ratio - Permanent transfer of intellectual property embodied in software and supplied on a medium, with transfer of possession/control and taxation as sales, constitutes sale of goods and not a service. Obiter - Broader nuances of exclusive transfer rights vs. licence-only arrangements were referenced via prior authority but not expanded upon beyond the facts. Conclusions: The Court held that the MOU evidencing permanent transfer of IP rights and the commercial reality of supply on a medium resulted in characterisation as sale; Service Tax could not be levied on such transactions once treated as sale and taxed under CST/VAT. ISSUE-WISE DETAILED ANALYSIS - Issue 3: Legality of invoking extended limitation and artificial segmentation of transactions Legal framework: Revenue cannot recharacterise or vivisect a single transaction into multiple taxable events to levy tax twice on the same consideration; limitation rules and principles against double taxation apply where the substance of the transaction has been treated as sale and taxed accordingly. Precedent treatment: The Court adopted the principle from prior rulings that once a lump-sum is charged for sale of software on media and sales tax has been discharged, revenue cannot thereafter levy Service Tax on the same sale consideration on the ground that updates or other service-like elements are provided, absent separate taxable events clearly distinct in substance and consideration. Interpretation and reasoning: The Court rejected the revenue's attempt to artificially segregate the transaction into sale and service components, observing that the user was put in possession and full control of the software (deemed sale), and that the essence was one transaction of sale. Hence, extended period of limitation could not be validly invoked to recover Service Tax on the same consideration once sales tax treatment applied. Ratio vs. Obiter: Ratio - Artificial segregation of a composite transaction already taxed as sale to levy Service Tax on the same consideration is not tenable; the revenue cannot levy Service Tax in such circumstances nor rely on extended limitation to recover tax on the same taxable event. Obiter - The Court did not engage in an exhaustive limitation-law analysis but applied the principle to the facts. Conclusions: The demand based on treating the sale of software on medium as service and invoking extended limitation was unsustainable; the demand was set aside. INTERCONNECTED REASONING/CROSS-REFERENCES All three issues converge on a single factual and legal core: software embodied on a tangible medium, transferred with possession and control and taxed as sale, must be treated as sale of goods; prior apex jurisprudence on the attributes of 'goods' and the impermissibility of vivisection of transactions was applied and followed. The Court expressly followed the authoritative ratio that the intellectual property when put on media becomes goods and the transaction is within the ambit of sales taxation, thereby precluding concurrent Service Tax on the same consideration. DISPOSITION The Court set aside the impugned order and allowed the appeal, holding that the demand for Service Tax in respect of software supplied on a medium (and treated as sale) could not be sustained.