Service tax on IT is blessing in disguise
Bangalore, Feb 5: The IT Sector (by IT, I mean Information Technology and not Income Tax….with the 2008-09 Budget round the corner, it is perhaps important to clarify) would seem to have been getting a lot more favorable treatment from the successive Finance Ministers, as compared to other sectors comprising the services sector.
Perhaps the FM thinks that software professionals are more important to the society than perhaps, Chartered Accountants or Architects or Engineers or Marketing Consultants or HR Consultants? What else would justify the exclusion of the software services sector from the reach of the ever expanding service tax net?
A look at the current service tax provisions and exemption notifications would clearly suggest that the Government has not been able to fully comprehend the various facets of the Software Services sector. Consider for instance, the fact that, the word 'software" has not been directly used in the statute, except in some Board Circulars and Notifications. Rather, the words 'Information Technology" have been defined to exclude software services.
The definition of 'Information Technology service" has undergone a major change with effect from May 1, 2006. Prior to May 1, 2006 it was defined as any service in relation to designing, developing or maintenance of Computer software, or Computerized data processing, or System networking, or any other service primarily in relation to operation of computer systems. After May 1, 2006, it is defined as any service in relation to designing, or developing of Computer software or System networking, or any other service primarily in relation to operation of computer systems.
It is then clear that effective May 1, 2006, computerized data processing and maintenance of computer software and system networking shall not be treated as 'Information Technology" service under BAS and would hence be liable for service tax. However, activities like designing and developing computer software and system networking are still covered under the definition of 'Information Technology service" and not taxable by virtue of exclusion from the purview of BAS.
Taxability
of
software
services
is
also
connected
to
the
definition
of
'Consulting
Engineer"s
service".
Prior
to
the
Finance
Act,
2007,
taxable
service
in
respect
of
'consulting
engineer"
meant
any
service
to
a
client,
by
a
consulting
engineer
in
relation
to
advice,
consultancy
or
technical
assistance
in
any
manner
in
one
or
more
disciplines
of
engineering;
but
not
in
the
discipline
of
computer
hardware
engineering
or
computer
software
engineering.
After enactment of the Finance Act, 2007 (with effect from June 1, 2007) the taxable service means any service to a client, by a 'consulting engineer" in relation to advice, consultancy or technical assistance in any manner in one or more disciplines of engineering including the discipline of computer hardware engineering but excluding the discipline of computer software engineering. Further, the exemption to taxable services provided by a 'consulting engineer" in relation to computer software vide Notification No. 4/99 was withdrawn with effect from September 10, 2004 making computer software related maintenance service taxable after this date.
Interestingly,
a
reference
to
software
services
is
also
noticed
in
terms
of
the
Management
Consultant"s
services.
In
terms
of
a
taxable
service
provided
in
relation
to
Enterprise
Resource
Planning
(ERP)
software
system
by
a
'management
consultant"
in
connection
with
the
management
of
any
organization
which
were
exempted
from
Sep.
10,
2004
(Notification
No.
16/2004)
to
Feb.
28,
2006
vide
Notification
No.
2/2006
are
taxable
after
Feb
28,
2006.
Frankly,
it
beats
logic
to
say
that
a
Management
Consultant
who
advises
on
ERP
related
services
should
be
exempted
from
service
tax,
as
contrasted
to
another
who
advises
on
other
software
related
services.
Luckily,
this
anomaly
has
now
been
removed.
Now,
the
reference
to
software
services
under
both
BAS
and
Consulting
Engineer"s
services
reflects
the
confusion
that
prevails
in
the
Government"s
mind.
Added to this is the confusion arising out of treatment of software products as 'goods" for purposes of levy of sales tax/ VAT. In the well known case of In case of Tata Consultancy Services v. State of Andhra Pradesh (2004-TIOL-87-SC-CT-LB), the Supreme Court, while upholding the levy of sales tax on branded software, also went on to state as follows "Thus, even unbranded software, when it is marketed/sold, may be goods. We, however, are not dealing with this aspect and express no opinion thereon because in case of unbranded software other questions like situs of contract of sale and/or whether the contract is a service contract may arise".
It
is
common
knowledge
that,
in
software
service
contracts,
there
is
delivery
or
transfer
of
right
given
to
the
client
to
use
programs
or
modules
which
are
nothing
but
unbranded
software,
per
se.
Irrespective
of
whether
these
unbranded
software
would
constitute
'goods"
for
purpose
of
levy
of
sales
tax/VAT,
there
can
be
no
doubt
that
in
all
of
these
contracts,
there
is
a
predominant
element
of
service
which
is
present
right
through.
As
the
service
tax
law
has
evolved
over
the
last
few
years,
many
components
or
facets
of
the
software
sector
have
come
to
be
taxed.
Some
of
these
are
maintenance
of
computer
software,
lending
or
deployment
of
software
personnel,
management
consultancy
services
related
to
software,
etc.
Of
course,
the
BPO
sector
is
also
subject
to
service
tax
under
Business
Auxiliary
Services
(BAS)
under
Section
65(19)
of
the
Finance
Act,
1994.
Irrespective
of
the
rationale
behind
taxing
the
BPO
sector
but
exempting
the
software
services
sector,
one
would
need
to
appreciate
that
the
dividing
line
between
the
various
segments
or
sectors
are
rather
thin.
For instance, it is very difficult to differentiate somebody who lends software professionals and one who undertakes software services projects. It would ultimately depend on the wording of the contracts and it does no good to a taxing system which allows the determination of the levy of a tax to be based on the way the underlying contract is worded.
As
contrasted
to
any
other
service
segment,
the
IT
segment
constitutes
the
largest
and
the
fastest
growing
one.
With
the
various
segments
like
BPO,
Manpower
Supply,
Software
Maintenance,
Computer
Hardware
Engineering
etc.
being
subjected
to
service
tax,
one
sees
little
justification
in
the
software
services
industry
continuing
to
be
left
out.
If the justification is in terms of the need to promote the software services sector, perhaps, there is a lot more justification in exempting the BPO segment and the Computer Hardware Engineering segment, which post much lesser margins and are in the danger of becoming uncompetitive, due to the appreciating rupee. Despite the raising rupee, as aforesaid, the software services sector continues to post high growth rates both in terms of business as well as, in terms of profitability. There is then no justification for treating the software services sector as a holy cow, in my opinion.
One last point
The levy of service tax on software services could come as a blessing in disguise. Being an exempted service, software exporters, who contribute very significantly to the size of the sector, while continuing not to pay service tax under the Export of Services Rules, 2005, will now be able to claim cenvat credit in respect of the service tax paid on input services including the service tax paid on their premises, if the software services were to be made taxable services. Levying service tax on software services might turn out to be good for the sector, after all.
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