TaxTMI 
TaxTMI 
2011 (4) TMI 566
X X X X Extracts X X X X
X X X X Extracts X X X X
....einafter referred to as 'the CST Act' for short). The assessee has been filing its VAT returns in Form VAT 100 in LVO - 045 regularly. The assessee is also registered under Section 69 of Chapter-V of the Finance Act, 1994 (hereinafter referred to as the 'Act') for the purpose of payment of service tax and has been paying service tax on its service turnover from the date of applicability. The place of business of the assessee was visited by the Commercial Tax Officer for the purpose of inspection on 8-6-2010. Subsequently the case was assigned for audit. The assessee produced all its books. The Commercial Tax Officer audited the books of account for the period from 2009-10, Subsequently a notice was issued under sections 39(1), 72(2) and 36 of KVAT Act. On 9-8-2010 in the course of verification of the monthly returns it was observed that the assessee has provided software development and claimed exemption on exports. In support of his case he had filed copies of invoices and the purchase orders for verification. In the course of verification it was found that in addition to export of software the assessee has also rendered services to one M/s. Alcatel-Lucent Technolo....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... in the work. Obviously the assessee cannot sell what it does not own. Hence there cannot be any transfer of property in goods. They contended that the assessee provides only services under the agreement and the service is solely related to information Technology software services. The assessee never owns at any point of time any intellectual Property or inventions or discoveries or new developments made during the course of the performance of the agreements. All the Intellectual Property or Inventions or discoveries or new developments are the exclusive property of the customer at all times. The assessee has contracted under the agreement to render services as per the specifications of the customer and hence did not have ownership of any software developed under the agreements. Their case squarely falls within the circumstances described in Part-(4) of the Circular No. 17/2006/07 issued by the Commissioner of Commercial Taxes. They have extracted the Circular. Therefore they sought for dropping of the proceedings. 4. However on consideration of the aforesaid material the assessing authority in the impugned order has held that whether the assessee Company is a software developme....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... goods. As is clear from the terms of the agreement entered into between the parties there is no sale of any goods or deemed sale. The reliance placed by the assessing authority on the balance sheet to contend that in execution of the contract, as the assessee has purchased the software and the said software is without any substance. Though in the balance sheet the software purchase is shown, the said software is used as a tool by the assessee in executing the contract and the said tools are not transferred. The agreement and the other material on record clearly shows the assessee has rendered its services to find a solution to the problem of the customer and even before the said solution is found, the assessee has given up his right in the copyright or the proprietary right in such goods, which may emerge as a final product and therefore seen from any angle there is no element of sale of goods which attracts sales tax. Therefore he submits that, the order of assessing authority levying sales tax is ex facie illegal, one without jurisdiction and liable to be set aside. 7. Per contra, the learned Government Advocate supporting the impugned order contended that software is now hel....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... a readily merchantable commodity. Similarly, when a professor delivers a lecture, it is not goods, but, when transcribed as a book, it becomes goods. That a computer program may be copyrightable as intellectual property does not alter the tact that once in the form of a floppy disc or other medium, the program is tangible, movable and available in the market place. The fact that some programs may be tailored for specific purposes need not alter their status as "goods" because the definition includes "specially manufactured goods". Thereafter, at para 24, they proceeded to hold as under : "In our view, the terms "goods" as used in article 366(12) of the Constitution of India and as defined, under the said Act are very wide and include all types of movable properties, whether those properties be tangible or intangible. A software programme may consist of various commands which enable the computer to perform a designated task. The copyright in that programme may remain with the originator of the programme. But the moment copies are made and marketed, it becomes goods, which are susceptible to sales tax. Even intellectual property, once it is put on to a media, whether it he in ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ther the contract is a service contract" or "contract of sale is also involved", may arise. That is precisely the question that has to be decided in these cases. Therefore, the said judgment do not come in the way of this Court going into the said question, as the Supreme Court has not expressed their opinion on the said issue. Therefore, the field is open. 13. In order to justify the imposition of value added tax, the revenue contends that it is a composite contract, a works contract. There is an element of service and transfer of goods, consequently a deemed sale. 14. The word 'works contract' has been defined under the Karnataka Value Added Tax Act, 2003 as under: "Works contract" includes any agreement for carrying out for cash, deferred payment or other valuable consideration, the building, construction, manufacture, processing, fabrication, erection, installation, fitting out, improvement, modification, repair or commissioning of any movable or immovable property," 15. The revenue contends, works contract includes an agreement for improvement. In other words, their case is, the assessee has purchased software from the market. Then the said software is impr....
X X X X Extracts X X X X
X X X X Extracts X X X X
....bsp; ** &n....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... ** (e) "Services" shall mean software development and other services that the Vendor will provide to Motorola pursuant to this Agreement and the Work Orders. (f) Statement of Work shall mean a document (which may be entitled "Statement of Work" or "Scope of Work" or the like) that has been prepared by Motorola and mutually agreed in writing between the Parties, in relation to a specific requirement and provided to the Vendor that describes the Services required pursuant to a Work Order. The Statement of Work may include, among others, the following: ♦ Specifications ♦ Deliverables and....
X X X X Extracts X X X X
X X X X Extracts X X X X
....bsp; ** &....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... Statement of Work, the Vendor shall provide, at its expense, all of the facilities, personnel, equipment, software, services and other resources necessary to provide the Services, including all basic systems (hardware/software/networking equipment/connectivity, etc) required for development of any Software or performance of any Services requested by Motorola. MOTOROLA and the Vendor may identify in detail the hardware, software and infrastructure requirements for project execution in applicable Work Order and/or Statement of Work. The Vendor shall not implement any action or decision regarding such resources that would have an adverse impact on the Services (including, without limitation, changes in equipment software and systems configurations), service level specifications, the amounts payable to the Vendor under any Work Order or other Motorola, costs and expenses, without Motorola's prior written, consent, which consent may be withheld in Motorola's sole discretion. ** &nb....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... the Vendor shall accept or reject the Work order in writing and if accepted return a legible copy of the accepted Work Order to MOTOROLA, Provided, however, that if a Work Order fails to provide all required, ordering information or incorrectly states prices or other material information, relative to the Work Order, the Vendor may reject the Work Order by promptly submitting written notice of rejection to MOTOROLA stating in detail the reasons for rejection and the modifications necessary to make the Work Order acceptable to the Vendor. The Vendor shall make no changes, amendments, modifications, additions or deletions to a Work Order without the prior written consent of MOTOROLA. Acceptance of a Work order shall bind the Vendor to comply with the terms and conditions set forth in such Work Order, including delivery dates, time schedules, amounts and other ordering information shown on the Work Order and other supplemental provisions contained therein. 12.3 The effective date of a Work Order shall be the date on which it is accepted, by the Vendor, which has to be either on or after the date the Work Order is released by Motorola. 12.4 Each Work order shall incorporate by re....
X X X X Extracts X X X X
X X X X Extracts X X X X
....p; ** 16. Invoices and Payment 16.1 As compensation for the Services, MOTOROLA shall pay Vendor the fees specified in the relevant Work Order and/or Statement of Work. Vendor, in connection with the Services to be performed hereunder, may incur travel expenses at the request of MOTOROLA. All necessary, reasonable and actual travel expenses of Vendor incurred for such travel shall be reimbursed by MOTOROLA, provided that Vendor has obtained MOTOROLA'S prior written approval before incurring any such expenses, and MOTOROLA receives from Vendor an itemized list of all expenses incurred, including the paid receipts therefor, which are to be reimbursed in accordance with the above. No additional costs of any kind may be incurred without the prior written consent of MOTOROLA Vendor shall submit, invoices to MOTOROLA's authorized representative upon completion of and acceptance by MOTOROLA of each, phase of the project as set forth in the relevant Work Order and/or Statement of Work. As specified in each Statement of Work, the parties will agree wheth....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... **  ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....; ** 27. Risk Management Specific Risks related to project execution: The Vendor shall prepare a detailed Risk Plan document, assessing all risks associated with the given project under a Work Order and address each one of the identified Risks. MOTOROLA will approve all actions planned for the Risk management. The Vendor will be responsible for defining the schedules for periodic back up of program and documentation data. This backup plan would include adequate measures to protect development work from hazards like fire, theft and natural calamities to minimize damages. ** &nb....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ROLA all right, title and interest in and to such inventions, discoveries, or ideas, and all patent applications, patents and copyright thereon. 36.2 All Developed Software and all work product and all worldwide Intellectual Property rights in and to the foregoing shall be owned by Motorola. 36.3 Both source code and object code versions of any Developed Software shall be included as deliverables to Motorola. 36.4 The Vendor acknowledges that all deliverables shall be considered "works made for hire", and Motorola will have all right title and interest, including worldwide ownership of all Intellectual Property rights, in and to each deliverable and all copies made from it. If any such deliverable is not considered a work-made for-hire for any reason, the Vendor hereby irrevocably assigns, transfers and conveys, and will cause all Vendor agents and employees to assign, transfer and convey, to Motorola without further consideration all of its and their right, title and interest in and to such Deliverable, including all worldwide Intellectual Property rights in such materials. The Vendor acknowledges that Motorola and the successors and assigns of Motorola will have the righ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....rable" shall mean all materials, in whatever form, generated or resulting from, the Development, including but not limited to the software program, modules or any part thereof, source code (including comments and procedural code such as job control language and scripts to control compilation and installation) and /or object code, enhancements, applications as well as any other materials, media and documentation which shall be prepared, written and/or developed by the Developer for Nokia under this Agreement and/or Project Order. "Development" shall mean any development and/or consultancy work as well as other services to be supplied by the Developer, including but not limited to, the development programming, or modification of existing or new software or systems or any part thereof, as well as any services, applications, enhancements, documentation, materials, or other Deliverables as defined herein, which Developer performs or is obliged to perform for Nokia or on behalf of Nokia under a Project Order. "Development Price" shall mean the aggregate price payable by Nokia to the Developer for the Development and the deliverable provided by the Developer to Nokia a separate Proj....
X X X X Extracts X X X X
X X X X Extracts X X X X
....sks under a Project Order, such personnel shall at all times be deemed to be the employees of the Developer and under no circumstances shall relationship of employer and employee be deemed to arise between Nokia and the Developer's personnel. The Developer warrants that such personnel are subject to the supervision of the Developer, notwithstanding the obligation of such personnel to comply with any regulations or requirements of Nokia. 3.8 The Developer is responsible for fulfilment of any and all obligations and tasks as an employer that are provided for by any applicable laws or regulations. This includes but it is not restricted to liability to fulfil and take care of all work permit issues, company and individual tax liabilities as well as social security and pension contributions. The Developer's employees shall be properly insured in accordance with any applicable laws and regulations. Nokia shall in no way be responsible for insuring the employees of the Developer. The Developer shall upon request of Nokia provide Nokia at any time during the term of this Agreement with proof of fulfilment of above mentioned employer's obligations." 18. The assessing....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ies of the company have been specified in this sentence. It is a solution provider in the meaning assigned by the software companies. It accelerates product development life cycles, connotes nothing else but development of software. The company profile obtained by the Senior Manager, narrates as under: Sasken offers a unique combination of research and development consultancy, wireless software products and software services, and works with Network OEMs, Semiconductor Vendors, Terminal Device OEMs and Operators across the world. Global fortune 500 and Tier 1 companies in these segments are part of Sasken's customer profile, Sasken offers a suite of outsourcing service offerings - new product development, test services, porting services and sustenance and support-for Data Network Equipment vendors and Management Software Vendors. Committed to innovation, Sasken works with customers to held them get to market ahead of the competition, and stay focused on new product development and manufacturing. With deep understanding of the communications industry, access to current and emerging technologies, mature development processes, global resources and a proven track record, Sa....
X X X X Extracts X X X X
X X X X Extracts X X X X
....bove residuary powers. Once the Parliament has made a law dealing with this aspect of service by virtue of the residuary power conferred on them by the Constitution. Article 248 comes into operation. It declares that Parliament has exclusive power to make any law with respect to any matter not enumerated in Concurrent List of the State Laws. Such power shall include the power to make laws, imposing tax not mentioned in either of these lists. Therefore, in fact once the Parliament makes a law, it excludes the other Legislatures to make a law in respect of which the Parliament has made law. 22. Article 254 deals with the inconsistency between the laws made by Parliament and laws made by the Legislatures of the States which reads as under:- "(1) If any provision of a law made by the Legislature of a State is repugnant to any provision of a law made by the Parliament which Parliament is competent: to enact, or to any provision of an existing law with respect to one of the matters enumerated in the Concurrent List, then, subject to the provisions of Clause(2), the law made by the Parliament whether passed before or after the law made by the Legislature of such State, or. as the ca....
X X X X Extracts X X X X
X X X X Extracts X X X X
....in other information technology software products, (vi) providing the right to use information technology software supplied electronically. 24. Admittedly, the entries regarding service does not find a place either in List-II or List-III. The Parliament, has the competence to pass a legislation in respect of the same including imposing of tax. It is in furtherance of such a power conferred under Article 248 read with Entry 97 of List-1 the said service has been inserted in the Finance Act, 1994. 25. The Karnataka Value Added Tax Act, 2003 is enacted by the State Legislature by virtue of Entry No. 54 in List II of Schedule VII which reads as under: - "54. Taxes on the sale or purchase of goods other than newspapers, subject to the provisions of Entry 92A of List I." 26. The word "goods" is defined under the Constitution of India at Article 366(12) as under: "Goods includes all materials, commodities, and articles." 27. In the Karnataka Value Added Tax Act, 2003, Section 2 (15) defines the term "Goods" as under:- "Goods" means all kinds of movable property (other than newspaper, actionable claims, stocks and shares and securities) and includes livestock, all m....
X X X X Extracts X X X X
X X X X Extracts X X X X
....rovider. When it provides for service, it is assessable to a tax known as service tax. Such tax is leviable by reason of a parliamentary statute. In the matter of interpretation of a taxing statute, as also other statutes where the applicability of Article 246 of the Constitution of India, read with the Seventh Schedule thereof is in question, the Court may have to take recourse to various theories including "aspect theory" as was noticed by this Court in Federation of Hotel & Restaurant Assn. of India v. Union of India. [1989] 3 SCC 634. 29. If the submission of Mr. Hegde is accepted in its entirety, whereas on the one hand, the Central Government would be deprived of obtaining any tax whatsoever under the Finance Act, 1994, it is possible to arrive at a conclusion that no tax at all would be payable as the tax has been held to be an indivisible one. A distinction must be borne in mind between an indivisible contract and a composite contract If in a contract, an element to provide service is contained, the purport and object for which the Constitution has to be amended and Clause (29-A) had to be inserted in Article 366, must be kept in mind. 30. We have noticed hereinbefore....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ters in this list or in that list. It is popularly known as 'pith and substance'. The law 'with respect to, a subject might incidentally 'affect' another subject in some way; but that is not the same thing as the law being on the latter subject. There might be overlapping; but the overlapping must be in law. The same transaction may involve two or more taxable events in its different aspects. But the fact that there is an overlapping does not detract from the distinctiveness of the aspects. The true nature and character of the legislation must be determined with reference to a question of the power of the Legislature. The consequences and effect of the legislation are not the same thing as the legislative subject-matter. What matters is the nature and character of the legislation and not its ultimate economic results that matters. 31. Therefore, if computer programming and providing of computer software involves two aspects, one falling within the power of the Parliament and the other falling within the power of the State Legislature to enact the law, the law so enacted cannot be found fault with. When the programming and providing of computer software is tre....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ate Legislature as well as the Parliament can make law. Sub-clause (b) of clause (29-A) of Article 366 specifically deals with works contract. It reads thus: "366. Definitions "(29A) Tax on the sale or purchase of goods includes- (a) ** ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....rpretation that words of legal import occurring in a statute should be construed in their legal sense is that those words have, in law, acquired a definite and precise sense, and that, accordingly, the Legislature must be taken to have intended that, they should be understood in that sense. Therefore while interpreting an expression used in a legal sense, we have only to ascertain the precise connotation which it possess in law. In India, to constitute a transaction of sale there should be an agreement, express or implied, relating to goods to be conveyed by passing on title in those goods. It is the essence of this concept that both the agreement and the sale should relate to the same subject-matter. Where the goods delivered under the contract are not the goods contracted for, the purchaser has a right to reject them, or to accept them and claim damages for breach of condition. Therefore, in law, there cannot be an agreement relating to one kind of property and sale of different property. On the other hand there must be a definite agreement between the parties for the sale of the very 'goods' in which eventually property passes. To sum up, the expression "sale of goods" i....
X X X X Extracts X X X X
X X X X Extracts X X X X
....rt in the case of Bharat Sanchar Nigam Ltd. v. Union of India [2006] 3 STT 245 dealing with deemed sale has stated as under: "43. All the clauses of article 366(29A) serve to bring transactions where one or more of the essential ingredients of a sale as defined in the Sale of Goods Act, 1930 are absent, within the ambit of purchases and sales for the purposes of levy of sales tax. To this extent only is the principle enunciated in Gannon Dunkerly Limited. The amendment especially allows specific composite contracts, viz., works contracts [(clause(b)), hire purchase contracts (clause(c)), catering contracts (clause(f)) by legal fiction to be divisible contracts where the sale element could be isolated and be subjected to sales tax where the sale element could be isolated and be subjected to sales tax. 44. Gannon Dunkerley survived the 46th Constitutional Amendment in two respects. First with regard to the definition of "sale" for the purposes of the Constitution in general and for the purposes of entry 54 of List II in particular except to the extent that the clauses in Article 366 (29A) operate. By introducing separate categories of "deemed sales", the meaning of the word "go....
X X X X Extracts X X X X
X X X X Extracts X X X X
....C), namely, if there is an instrument of contract which may be composite in form in any case other than the exceptions in Article 366(29A), unless the transaction in truth represents two distinct and separate contracts and is discernible as such, then the State would not have the power to separate the agreement to sell from the agreement to render service, and impose tax on the sale. The test therefore for composite contracts oilier than, those mentioned in Article 366(29A) continues to be - did the parties have in mind or intend separate rights arising out of the sale of goods. If there was no such intention there is no sale even if the contract could be disintegrated. The test for deciding whether a contract falls into one category or the other is as to what is "the substance of the contract". We will for the want of a better phrase, call this the dominant nature test. **  ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....at no one denies the legislative competence of States to levy sales tax on sales provided that the necessary concomitants of a sale are present in the transaction and the sale is distinctly discernible in the transaction. ** ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....necessary to look into the terms of the contract carefully to ascertain the true intent and nature of the contract, what is the nature of activity, what the parties intended, what is agreed upon and what is the consideration paid. Nature of Contract 39. From the aforesaid Clauses; it is abundantly clear that the parties have entered into an agreement whereby the assessee renders service to the client for development of software, i.e., for software development and other services. Pursuant to the agreement and the work orders, the service shall be performed by the assessee. Services must be requested by issue of a valid work order together with a statement of work. As compensation for the service rendered to the customer, the fees specified in the relevant work order or in the statement of work is payable and billing is done on a time and material basis or on a fixed price on a monthly basis. Pricing for time and material projects shall be fixed at a rate setforth in Annexure-A to the agreement. 40. The assessee agrees, that all patentable and unpatentable, inventions, discoveries and ideas which are made or conceived as a direct or indirect result of the programming or othe....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ials media and documentation which shall be prepared, written and or developed by the developer for the client under this agreement and/or Project Order. If the customer agrees to provide any hardware, software and other deliverables that may be required to carry out the development and provide the deliverables he may do so. Otherwise the assessee has to make or provide all those hardware and software to develop the deliverables and the final product. No doubt at the end of the day, this software which is developed is embedded on the material object and only then the customer can make use of the same. The software so developed even before it is embedded on the material object or after it is embedded on a material object exclusively belongs to the customer. In the entire contract there is nothing to indicate that the assessee after developing the software has to embed the same on a material object and then deliver the same to the customer so as to have title to the project which is developed. The title to the project/software to be developed lies with the customer even before the assessee starts rendering service. 43. In the agreement or from any other material on record, there i....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ods in existence. The agreement is not for transfer of software. The agreement is for development of software. Even before the software comes into existence, the assessee has given up all the rights and claims of the software to be developed and has expressly agreed that such a software which may come into existence in the end of the contract period is the absolute property of the customer. The customer is at liberty to deal with that software in the manner he wants without further reference to the assessee. The consideration paid is not for transfer of any goods. The consideration paid is calculated in terms of time such as man days, man hours and man months. As on the dale of entering into the contract, both the parties are not clear how much time the contract would ultimately take and when the end product, i.e., the software is produced. 46. Intellectual property comprises of all those things which emanate from the exercise of the human brain, such as ideas, inventions, poems, designs, etc. The word 'property' comes from the Latin word proprius, which means "ones own". Intellectual property means, the legal rights which may be asserted in respect of a product of human....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ictory notions. The acquirer of an intellectual property right can derive no financial benefit from it except by using it commercially. He will gain advantage only by making a product and selling it or by charging others who wish to exploit his intellect. When he offers his services or intellect to an employer, he is not selling any intellectual property as none exists on the date of contract of employment. The employer gets a right to exploit the intellect, according to his needs and requirements and he pays for the services rendered. He is not purchasing any intellectual property for the purpose of exploiting the same, as none exists on the date of contract of employment. When an employer hires technicians and pays them salary, a relationship of employer and employee comes into existence. The employer may utilise the services of the technicians for his personal use. He may also lend their services to others, who are in need of them. He may also employ them in the job he has undertaken to execute. In all these cases the technicians are rendering their service by applying their intellect. They are paid for the services rendered. In consideration of the remuneration received they ar....