IN THE HIGH COURT OF JUDICATURE AT MADRAS DATED: 24.08.2010 CORAM THE HONOURABLE MR.JUSTICE D.MURUGESAN AND THE HONOURABLE MR.JUSTICE M.SATHYANARAYANAN W.P.Nos.3811 & 18886 of 2009 Infotech Software Dealers Association (A society registered under the Societies Registration Act) 12, Riddhi Siddhi, C.S.Complex Dahisar East, Mumbai 400 068 rep.by its Authorised Signatory Petitioner in both the Mr.Sudarsan Ranganathan .. Writ Petitions -vs- 1. Union of India Ministry of Finance Department of Revenue Central Board of Excise and Customs rep. By its Secretary North Block, New Delhi-1 2. The Chairman Central Board of Excise and Customs Department of Revenue North Block New Delhi 110 001 3. Commissioner of Service Tax Central Board of Excise and Customs Department of Revenue Room No.23-A, North Block New Delhi-14 4. Commissioner of Service Tax 6th Floor, MHU Complex No.692, Anna Salai Respondents 1 to 4 in Nandanam, Chennai-35 .. both the Writ Petitions 5. Commissioner of Central Excise 6/7, ATD Street Race Course, Respondent No.5 in Coimbatore 641 018 .. W.P.No.3811 of 2009 Petitions under Article 226 of The Constitution of India, praying for the issue of a Writ of Declaration to declare Section 65 (105)(zzzze) of Chapter V of Finance Act, 1994 (as amended by Finance No.2 Act of 2009) as null and void and ultra vires and unconstitutional of the provisions of Articles 245, Entries 92C and https://hcservices.ecourts.gov.in/hcservices/ 97 of List-I, Entry 54 of List-II of Schedule VII and contrary to provisions of Articles 14, 19(1)(g), 265 and 268A of the Constitution of India in so far as the petitioner is concerned. For Petitioner :: Mr.Arvind P.Datar Senior Counsel for Mr.P.Giridharan For Respondents :: Mr.M.Ravindran Additional Solicitor General assisted by Mr.S.Yashwanth Additional Central Government Standing Counsel ORDER D.MURUGESAN, J. Both the writ petitions raise an important question as to whether a software would amount to goods and if so, when it is supplied to a customer pursuant to the "End User Licence Agreement" (EULA), the transaction is liable to be treated as sale or service and whether the Parliament has the legislative competency to bring in the amended provisions of Section 65(105)(zzzze) by virtue of the powers under Entry 97 of List I of Schedule VII of the Constitution of India? 2.1. Facts put forth by the petitioner: The petitioner in both the writ petitions is Infotech Software Dealers Association (hereinafter referred to as "the ISODA), a society registered under the Societies Registration Act with its headquarters at Mumbai. It prays for a Writ of Declaration to declare Section 65(105)(zzzze) of Chapter V of Finance Act, 1994 (as amended by Finance No.2 Act of 2009) is null and void, ultra vires and unconstitutional of the provisions of Articles 245, Entries 92C and 97 of List-I, Entry 54 of List-II of Schedule VII and contrary to provisions of Articles 14, 19 (1)(g), 265 and 268A of the Constitution of India in so far as the petitioner is concerned. 2.2. The ISODA has about 100 members who are all software resellers. The members of the association of companies are engaged in the business of reselling of Computer Software Products. The sale of software by the members of the association falls into three categories. They are (i) Shrink Wrap Software; (ii) Multiple User Software/Paper Licence and (iii) Internet Download. The Shrink Wrap Software is a box containing the CD/DVD, user manual and the end user licence agreement. The box is wrapped in plastic and therefore called as "Shrink Wrap Software". When a special DVD/CD is manufactured capable of being used in more than one hardware and when the same is sold along with paper licence to enable a customer/purchaser to use the DVD/CD in a specific number of hardware equipments, it is known as "Multiple User Software or Paper Licence". In case of large https://hcservices.ecourts.gov.in/hcservices/ number of users in different locations, it may not be feasible to have paper licence DVD/CD and therefore the distributor with the authority of the software manufacturer enters into an agreement which enables the purchaser to download from the internet a fixed number of copies of the software, which transaction is known as "Internet Download". 2.3. The software is also classified into two types, namely, Canned Software and Customised Software. Canned software means a software that is designed and created for sale to more than one person and it is designed in such a way that large number of people can use it on a variety of hardware and it is also called as "Packaged Software" or "Standard Software" or "Normal Software" or "Branded Software". On the other hand, Customised Software means the software created for a single person or a specific customer to meet his specific requirement and it is also called as "Tailor-made Software" or "Specific Software". 2.4. Whenever software is sold in all the categories, they are treated as goods regardless of the nature of transaction. In such event, the goods are liable to sales tax and are liable to Value Added Tax (VAT). As the ultimate transaction is only that of sale of goods, an element of service is absent and in such circumstances, the State Government alone is competent to enact a law under Entry 54 of List II of Schedule VII. 2.5. Until 16.5.2008, the sale of canned software license was subject to 4% VAT and the contract for customised software maintenance and other technical support were subject to service tax. No service tax was levied in the case of sale of canned software license. 2.6. An amendment was brought to Section 65(105) of Chapter V of Finance Act, 1994 through Finance Act No.2 of 2009, whereby a new clause (zzzze) was introduced to Section 65(105). Sub-section (105) of Section 65 defines the expression "taxable service" and by virtue of the new provision of clause (zzzze), the information technology software is also brought under the meaning of "taxable service". That amendment was brought in by virtue of residuary power under Entry 97 of List I of Schedule VII. As the software being goods and there is no element of service when it is sold to the customers, the provisions of Section 65(105)(zzzze), particularly sub-clauses (v) and (vi) is unconstitutional, as it is beyond the legislative competence of Parliament. 2.7. The impugned provision is also liable to be struck down as being arbitrary and ultra vires of Article 14, as in the case of software, the right of possession as well as the effective control over the branded software is transferred to the purchaser, whereas under Section 65(105)(zzzze) (v) and (vi) of the Finance Act, the service tax has been levied only in relation to the supply of tangible goods without transfer of right of possession and effective control of tangible goods. The provision is also violative of Article 19(1)(g) and Article 265 of the Constitution of India. By virtue of the amendment, levy of service tax makes the sale of software totally unviable. As the measure and the value of tax have https://hcservices.ecourts.gov.in/hcservices/ been done arbitrarily, particularly when the service element is absent, the levy of service tax on the value would be violative of Article 14 as well as Article 19(1)(g) of the Constitution of India. 2.8. By the imposition of service tax, the cost of the canned software to the end customer will increase by 13%. In case of VAT + service tax, it will increase to 25%. In case of import of software from abroad, the software becomes subject to levy of CVD+VAT+service tax. The amendment to the Finance Act would seriously prejudice the members of the association of companies who are the vast majority of computer users in the country and to bear the increase in the net cost of the software by almost 25%. 3.1. Contentions of the respondents: The amendment would fall under Entry 97 of List I of Schedule VII and the challenge to the legislative competency of Parliament is totally unsustainable. All standardised software are not like any other product or goods. There is no element of sales when it is supplied to the end user by means of EULA. Along with the Standardised Software a key (an alpha numerical code) is provided to the end user to activate the software by registering the same with the original manufacturer through the internet. Standardised Software Licence licensed and available across the shelf or downloaded from internet is not a finished product, rather updates are given by the original manufacturer (Microsoft or Symantec) to the end user for an agreed period. Updates are supplied to the end user through the internet for a period specified in the license. Once the software is registered with the original manufacturer through the internet using the key supplied by the original manufacturer, (the key is nothing but an alpha numerical code) the terms of license are agreed upon and installed for use in the specific computer. 3.2. The original manufacturer, who creates the software, only licenses the software for the private use of the end user subject to the terms and conditions. If the end user agrees to the terms and conditions, such end user is given "right to use" (install, run and get updates) the software within the limits prescribed. At no stage an end user who runs the software installed in his computer becomes absolute owner of the software. The end user cannot tamper or modify, cannot improve and cannot rectify errors in the software and the end user should not sell the software to another person for commercial exploitation. In view of the specific licensing agreement between the original manufacturer of Standardised Software, namely, Microsoft and Symantec, and the end user, it would be clear that the software is not sold, but only licensed for the limited use for which it is licensed. In other words, in trade parlance, whenever a software product is launched, the original manufacturer releases what is known as End User License Agreement and Product Use Rights. 3.3. As the Right to Use includes, among other things, the three basic components, namely, (i) right to install the software in a computer by registering the same subject to licensing terms and conditions; (ii) right to run the software and (iii) right to receive updates online through the internet if and when provided by the original manufacturer, it would not amount to absolute sale. Right to https://hcservices.ecourts.gov.in/hcservices/ Use excludes certain rights, particularly right to modify, right to work and right to commercial exploitation. 3.4. The provisions of Section 65(105)(zzzze) uses the expression providing the right to use information technology software for commercial exploitation including right to reproduce, distribute and sell information technology software and right to use software components for the creation of and inclusion in other information technology software products and providing the right to use information technology software supplied electronically. 3.5. The canned software or packaged software is capable of being marketed and sold off the shelf in a standardised form and therefore is excisable goods. The service element is discernible clearly in the customised software which is liable for service tax. Providing 'right to use' is a service and is liable to service tax within the ambit of constitutional mandate and residual powers of taxation. In any case, each transaction should be considered individually to find out as to whether it is a sale or service and the writ petitions are premature, as no action is taken in terms of the amended provision. 4. We have heard Mr.Arvind P.Datar, learned senior counsel for the petitioner and Mr.M.Ravindran, learned Additional Solicitor General of India for the respondents. 5. The provisions of Section 65(105)(zzzze) reads as under:- "Section 65: In this chapter, unless the context otherwise requires,-- (105) "taxable service" means any service provided or to be provided- (zzzze) to any person, by any other person in relation to information technology software for use in the course, or furtherance, of business or commerce, including-- (i) development of information technology software, (ii) study, analysis, design and programming of information technology software, (iii) adaptation, upgradation, enhancement, implementation and other similar services related to information technology software, (iv) providing advice, consultancy and assistance on matters related to information technology software, including conducting feasibility studies on implementation of a system, specifications for a database design, guidance and assistance during the startup phase of a new system, specifications to secure a https://hcservices.ecourts.gov.in/hcservices/ database, advice on proprietary information technology software. (v) acquiring the right to use information technology software for commercial exploitation including right to reproduce, distribute and sell information technology software and right to use software components for the creation of and inclusion in other information technology software products. (vi) acquiring the right to use information technology software supplied electronically." 6. Amendment Act No.2 of 2009 to the Finance Act, 1994: List I of Schedule VII contains certain specific entries, where the Parliament would be competent to enact law for imposition of taxes. Some of the entries are Entry Nos.82, 85, 86, 89, 90, 92 as stood when the Constitution was framed and brought in. By the Constitution (Sixth Amendment) Act, 1956, Entry 92-A was introduced with effect from 11.6.56, which confers power on the Parliament to enact law in respect of taxes on the sale or purchase of goods other than newspapers, where such sale or purchase takes place in the course of inter-State trade or commerce. By the Constitution (Forty-Sixth Amendment) Act, 1982, taxes on the consignment of goods (whether the consignment is to the person making it or to any other person), where such consignment takes place in the course of inter-State trade or commerce was introduced with effect from 2.2.83. By the Constitution (Eighty-eighth Amendment) Act, 2003, Entry 92-C was introduced for taxes on services. Though the Amendment Bill was passed in both the Houses of Parliament, it was not given effect to. Entry 97 is a residual entry, which empowers the Parliament to enact law in respect of any other matter not enumerated in List II or List III including any tax not mentioned in any of those lists. 7. The contention of Mr.Arvind P.Datar, learned senior counsel for the petitioner is that in view of the specific Entry 54 of List II, which empowers the State Legislature alone to enact law on taxes on the sale or purchase of goods other than newspapers subject to the provisions of Entry 92-A of the list, the amendment to the Finance Act made pursuant to the residual Entry 97 would be outside the competency of Parliament. In the event the nature of transaction is sale, the States are legislatively competent to levy sales tax on the transaction under Entry 54 of List II of Schedule VII of the Constitution. Entry 97 of List I would not be applicable if the transaction is covered by Entry 54 of List II. In that sense, the Parliament lacks competency to bring in the amendment. Mr.Datar, would further submit that inasmuch as the software is goods and the nature of transaction is nothing but a sale, the State alone has the legislative competence. In support of the proposition that the software is goods, he would rely upon the judgment of the Apex Court in Tata Consultancy Services v. State of Andhra Pradesh, (2005) 1 SCC 308. He would also submit that while considering the transaction, the dominant intention of the transaction would be the relevant test to determine as to whether such transaction is a sale or service. In support of the said submission, he would rely upon the judgment of https://hcservices.ecourts.gov.in/hcservices/ the Apex Court in Bharat Sanchar Nigam Ltd., v. Union of India and others, (2006) 3 SCC 1. 8. We have carefully considered the rival contentions and the submissions of the respective learned senior counsel for the petitioner and the learned Additional Solicitor General for the respondents. The basic question is as to whether the provisions of Section 65(105)(zzzze) of Chapter V of the Finance Act, 1994 (as amended by Finance No.2 Act of 2009) is within the legislative competency of the Parliament? We may also point out that so far no action has been initiated against any of the members of the petitioner-Association pursuant to the above provision. Nevertheless, as Mr.Datar, learned senior counsel had insisted the consideration of the challenge in the larger interest, we propose to discuss the rival contentions as to the validity of the provision. 9. As far as the legislative competency to make enactments in respect of the transaction which involves a sale is concerned, the State would be competent under Entry 54 of List II of Schedule VII and in such event, the Parliament may not have the legislative competency to enact law on those subjects. In respect of a transaction which is considered to be a service, no specific entry is prescribed under List I enabling the Parliament to enact law. As Entry 92-C has not yet been given effect to, the power of Parliament could be traced to the residual entry, namely, Entry 97. 10. While considering the issue in question, two incidental questions would arise, namely, whether a software is goods and if so, whether in all case of transactions, it would amount to sale or in some transactions it could be considered to be a service. 11. The provisions of sub-section (105) of Section 65 relate to taxable service. It speaks of service provided or to be provided and it does not speak of any service provider, namely, the goods as such. In terms of the provisions of clause (zzzze), any service provided or to be provided to any person or by any other person in relation to information technology software for use in the course or furtherance of business or commerce including certain specific transactions enumerated therein could be brought under taxable service. A reading of the said section does not relate to the goods as such, but the tax to be levied only on the service already provided or the service that can be provided even at a later point of time by the re-seller. When the legislature used the expression as to the meaning of taxable service only in relation to the service provided or to be provided, that meaning cannot be extended to hold that it would mean the service provider as well. The application of the said provision must be decided depending upon the individual transaction. The only test, probably the relevant test for the Court to apply and consider is whether the impugned provision can be brought under Entry 97 of List I of Schedule VII. Inasmuch as that entry being a residuary entry and it relates to taxable service, the Parliament would certainly have the legislative competency. In this context, we may also refer to the judgment of the Apex Court in Tamil Nadu Kalyana Mandapam Association v. Union of India and others, (2004) 5 SCC 632, wherein https://hcservices.ecourts.gov.in/hcservices/ it has been held that in the absence of any entry under List II, the Parliament would be empowered to make the law for service tax under the residuary powers in terms of Entry 97 of List I of Schedule VII. 12. Article 366(12) of the Constitution of India defines the expression "goods", which include all materials, commodities and articles. It is an inclusive definition. 13. Article 366(29A)(a) deals with a tax on the transfer, otherwise than in pursuance of a contract, of property in any goods for cash, deferred payment or other valuable consideration. On the other hand, Article 366(29A)(d) deals with a tax on the transfer of the right to use any goods for any purpose (whether or not for a specified period) for cash, deferred payment or other valuable consideration. The question as to whether the software is goods or not came up for consideration before the Apex Court in the decision in Tata Consultancy Services case (supra). In that case, the Apex Court was considering the provisions of the Andhra Pradesh General Sales Tax Act, 1957. Section 2(h) of the said Act defines "goods" as meaning, all kinds of movable property other than actionable claims, stocks, shares and securities and including all materials, articles and commodities including the goods involved in works contract etc. Section 2(n) of that Act defines a sale with all its grammatical variations and cognate expressions as meaning, every transfer of the property in goods, whether as such goods or in any other form in pursuance of a contract or otherwise by one person to another in the course of trade or business, for cash, or for deferred payment, or for any other valuable consideration etc. The Apex Court referred to the judgments of the American Courts in the cases of Commerce Union Bank v. Tidwell 538 S.W.2d 405; State of Alabama v. Central Computer Services, Inc.349 So.2d 1156; First National Bank of Fort Worth v. Bob Bullock, 584 S.W.2d 548; First National Bank of Springfield v. Deptt. of Revenue, 421 NE2d 175; Compuserve, Inc. v. Lindley 535 N.E. 2D 360 and Northeast Datacom, Inc. v. City of Wallingford, 563 A2d 688 holding that “computer software” is intangible personal property. The Apex Court also considered many other judgments of the American Courts in South Central Bell Telephone Co. v. Sidney J. Barthelemy, 643 So.2d 1240; Comptroller of the Treasury v. Equitable Trust Co., 464 A.2d 248; Chittenden Trust Co. v. Commr. of Taxes, 465 A.2d 1100; University Computing Co. v. Commissioner of Revenue for the State of Tennessee, 677 S.W.2d 445 and Hasbro Industries, Inc. v. John H. Norberg, Tax Administrator, 487 A.2d 124 taking a different view. In the above cases, it was held that when stored on magnetic tape, disc or computer chip, the software or set of instructions is physically manifested in machine-readable form by arranging electrons, by use of an electric current, to create either a magnetised or unmagnetised space. It was also held in those cases that by sale of the software program the incorporeal right to the software is not transferred since the copyright of the incorporeal right to software remains with the originator and what is sold is a copy of the software. It was further held that the original copyright version is not the one which operates the computer of the customer but the physical copy of that software which has been transferred to the buyer. Having referred to the above judgments, the Apex Court in paragraph-19 held as follows:- https://hcservices.ecourts.gov.in/hcservices/ "19.Thus this Court has held that the term “goods”, for the purposes of sales tax, cannot be given a narrow meaning. It has been held that properties which are capable of being abstracted, consumed and used and/or transmitted, transferred, delivered, stored or possessed, etc. are “goods” for the purposes of sales tax. The submission of Mr Sorabjee that this authority is not of any assistance as a software is different from electricity and that software is intellectual incorporeal property whereas electricity is not, cannot be accepted. In India the test to determine whether a property is “goods”, for purposes of sales tax, is not whether the property is tangible or intangible or incorporeal. The test is whether the item concerned is capable of abstraction, consumption and use and whether it can be transmitted, transferred, delivered, stored, possessed, etc. Admittedly in the case of software, both canned and uncanned, all of these are possible." 15. While considering the expression "goods" as used in Article 366(12) of the Constitution of India, the Apex Court has further observed as follows: "27. In our view, the term “goods” as used in Article 366(12) of the Constitution and as defined under the said Act is very wide and includes all types of movable properties, whether those properties be tangible or intangible. We are in complete agreement with the observations made by this Court in Associated Cement Companies Ltd. (supra). A software program may consist of various commands which enable the computer to perform a designated task. The copyright in that program may remain with the originator of the program. But the moment copies are made and marketed, it becomes goods, which are susceptible to