ABSTRACT

The Information Technology Sector is probably the most booming sector in the world at present. This revolution in the market is attributable to a great extent to the increasing use of computer driven softwares and other innovations in the field of intellectual property. This massive progression however, has created a myriad of complexities as far as taxation is concerned. How to tax incomes from softwares and their use has become a topic of debate both in direct as well as indirect taxes are concerned. The debate in indirect taxes is whether software is to be treated as goods or as services. The debate as regards direct taxes is a very interesting one, bordering around the concept of whether income generated from softwares is from the transfer of a copyrighted right or the transfer of a copyrighted article. The former case would mean that the income is arising out of royalties and the latter would entail income generation from business and profession. The position of law as regards the same is not a settled one whether in India or internationally. The situation is further complicated when cross border software supply takes place and the various Double Taxation Avoidance Agreements come into picture. An attempt has been made in this paper to elucidate the exact legal position of software taxation while discussing its applicability under both heads of income in different situations through the application of various case laws on the subject.

INTRODUCTION

The true wealth of todays society lies in Intellectual Property. It is possible now for any person to create value in the economy through the creation of a copyrighted article, a patentable invention or a trademark. A lot of these find expression through the form of softwares and other computer programmes which have almost attained the status of lex mercatoria[footnoteRef:1]. And as the software boom continues, the need for determining its value arises which inevitably requires the determination of what effect such softwares will have on taxes[footnoteRef:2]. Softwares and taxation have been the subject of considerable development over the past years. If there was one component of the legal fabric of intellectual property commercialization that kept the fabric in place, then it would undoubtedly be taxation[footnoteRef:3]. [1: Fabrizio Marrella and Christopher S. Yoo, Is Open Source Software the New Lex Mercatoria?, http://lsr.nellco.org/upenn/wps/papers/171. Last accessed on 17th September, 2011.] [2: Nicholas Deleault, How Intellectual Property Assets Affect Estate Taxes?, Ezine Articles 14th March, 2007] [3: Rodney D. Ryder, Intellectual Property Law- Concept to Commercialisation, Macmillan, New Delhi, 2005 at p.409 ]

WHAT IS SOFTWARE?

The first and foremost thing to consider is that a computer and a computer software are two entirely different concepts since a computer contains both software and hardware components[footnoteRef:4]. The term software does not have any uniform definition. However, it can be meant to include: [4: The definition was upheld in CCE, Pondicherry v. Acer India Ltd., 2004 (172) E.L.T. 289 (S.C.) ]

The entire set of programs, procedures and related documentation associated with a system and especially a computer system; specifically computer programs[footnoteRef:5]. [5: Merriam Webster, Merriam Webster's Collegiate Dictionary, 10th ed., Merriam Webster 1993 ]

According to Section 65 (53a) of the Finance Act, 1994, Information Technology Software means, any representation of instructions, data, sound or image, including source code and object code, recorded in a machine readable form, and capable of being manipulated or providing interactivity to a user, by means of a computer or an automatic data processing machine or any other device or equipment.

The Supreme Court of India also had the occasion to interpret the meaning of the term software.

In L.M.L. Ltd. v. Commissioner of Customs[footnoteRef:6], the Supreme Court has stated that: software is the set of instructions that allows physical hardware to function and perform computations in a particular manner, be it a word processor, web browser or the computer's operating system. [6: 2003 (153) ELT 703 Tri Del]

The US Internal Revenue Service defines computer software as:

"... all programs or routines used to cause a computer to perform a desired task or set of tasks, and the documentation required to describe and maintain those programs. Computer programs of all classes, for example, operating systems, executive systems, monitors, compilers and translators, assembly routines, and utility programs as well as application programs are included. Computer software does not include procedures which are external to computer operations, such as instructions to transcription operators and external control procedures."

It is safe to say that because of the lack of a clear definition the interpretation of Computer Software varies from Act to Act.

TYPES OF SOFTWARE FOR TAXATION PURPOSES

Softwares are of varying types because of their use in multifaceted activities. System softwares control overall operation of the computer system[footnoteRef:7]. [7: Mukesh Dhunna & J. B. Dixit, Information Technology in Business Management Sangeeta Dixit ed., Laxmi Publications, Ltd. 2010, p. 194 ]

whereas Utility softwares are useful for documenting, writing or debugging computer programs[footnoteRef:8]. Application softwares on the other hand are a task oriented or user-oriented programs that makes computers more versatile[footnoteRef:9]. [8: Ibid at p. 194-195 ] [9: Richard D. Harris, Property Taxation of Computer Software: Northeast Datacom., Inc. v. City of Wallingford, 23 Conn. L. Rev. , 1990, p. 174 ]

However for the purposes of taxation only two types of software are considered.

1. Shrink Wrapped Software: These kinds of software are meant for personal use of the public for day-to-day work or internal use in businesses. They are generally available off the shelf and the customer after purchasing it enters into an End User License Agreement (EULA)[footnoteRef:10] with the manufacturer of the software stating that he has obtained only a license to use the software, subject to the restrictions of the Copyright Act, 1957. The customer does not get any right to use any of the copyrights which exclusively belongs to the manufacturer. This sale of this form of software would involve a sale of a product and thus give rise to business income.[footnoteRef:11] [10: A EULA is a contract between the "licensor" and purchaser of the right to use the software. The license may define ways under which the copy can be used. EULAs in shrink wrapped softwares have been held to be enforceable in the cases of ProCD, Inc. v. Zeidenberg 86 F.3d 1447 (7th Cir., 1996) and Microsoft v. Harmony Computers, 846 F. Supp. 208 (E.D.N.Y., 1994)] [11: A.J. Majumdar, Taxation of Royalty Income from Computer Software under Income-tax Act and Double Taxation Avoidance Agreements, Taxmann, [2011] 20 CPT 126, p. 6]

2. Computer Softwares: These form of softwares are meant not only for use but also for

commercial exploitation[footnoteRef:12]. Basically manufacturers of electronic equipments like mobile phones and computers obtain the license to commercially exploit the softwares produced by another company and modify it as per the requirements of their own product. The manufacturer in this case has to pay royalty income to the owner or author of the software. [12: The Finance Bill, 2008 inserted Section 65(105)(zzzze) in the Finance Act, 1994. The Section 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.]

THE GREY AREAS UNDER THE INCOME TAX ACT, 1961

The treatment of softwares is a disputed area under the Income Tax Act, 1961. The cases under the Act are decided on the basis of individuality of facts and quite often it becomes difficult to set a precedent for the decisions involving Computer Software. Two major controversial issues arise when softwares are treated under the Act:

1. Whether income earned from softwares is in the form of royalty income or income from business and profession? 2. Whether expenditures incurred on computer softwares is in the nature of a capital expenditure or revenue expenditure?

ROYALTY INCOME OR BUSINESS INCOME : THE MAJOR CONUNDRUM

The classification of a transaction involving softwares as a sale or licensing is an issue that has perplexed revenue authorities from across the world. The issue that arises from a software transaction is whether it is a transfer of a copyrighted right or a transfer of a copyrighted article[footnoteRef:13]. In the former case, the recipient has the right to commercially exploit the software through reproduction or duplication etc. In the latter, the customer has the right to use the software only for the purposes of his own business that is end-user software.[footnoteRef:14] [13: Mihir Naniwadekar, Is Income From Software Taxable As Royalty?, ] [14: A.J. Majumdar, Taxation of Royalty Income from Computer Software under Income-tax Act and Double Taxation Avoidance Agreements, [2011] 20 CPT 126.]

No commercial exploitation is allowed for software of this kind. The former case would involve income from royalty whereas the latter would involve income from business and profession. In order to understand the clear position in India under the Act and the DTAAs it is important to have a perusal of the following key concepts.

a) Royalty in general parlance

Royalty is the income arising to the owner of a property from allowing another person to commercially exploit his property. The Blacks Law Dictionary defines royalty as compensation for the use of property, usually copyrighted material or natural resource, expressed as a percentage of receipts from using the property or as an account per unit produced Reference to royalty arising from grant of the right of user of, copyright, patent, design, trade mark or a secret formula or process, etc., found mention for the first time in OECD Model Convention of 1963. The Indian Income-tax Act, 1961 incorporated the concept in 1976[footnoteRef:15]. [15: In 1984, following the Trade Related Aspects of Intellectual Property Rights (TRIPS) resolution, computer programs were included within the ambit of the Indian Copyright Act, 1957. ]

Computer software was included within the ambit of literary work in 1984, in view of the amendment made to Article 10 of the Berne Convention, 1886 for protection of Literary and Artistic Rights of Owners. The exclusive right of exploitation available with the author of a computer software includes, the right to sell or give on commercial rental or offer for sale or for commercial rental any copy of the computer software. Section 18 and Section 30 of the Copyright Act empower the author of an intellectual property to assign or license all or any of the copyrights in respect of the property to another person for an agreed period, while retaining the ownership of the intellectual property. In that case, the assignee or the licensee alone will be entitled to exercise the copyrights assigned or licensed to them for the agreed period as per the terms of the contract, and not the author of the intellectual work. The consideration which is paid by the assignee, etc., to the author of the intellectual property for such assignment is called royalty. It is thus, the passive income of the author of the intellectual property.b) Scope of royalty under the Income Tax Act, 1961

The Finance Act, 1976 introduced clauses (v), (vi) and (vii) in section 9(1) of the Income Tax Act, 1961 extending the rule of deemed accrual in India on source principles to income from interest, royalty and fees for technical services. As per Explanation 2 to Section 9(1)(vi) of the Act, royalty inter alia means:" consideration (including any lump sum consideration but excluding any consideration which would be the income of the recipient chargeable under the head Capital gains) for:(i)the transfer of all or any rights (including the granting of a license) in respect of a patent, invention, model, design, secret formula or process or trade mark or similar property;(ii)the imparting of any information concerning the working of, or the use of, a patent, invention, model, design, secret formula or process or trade mark or similar property;(iii)the use of any patent, invention, model, design, secret formula or process or trade mark or similar property;

(iv)the imparting of any information concerning technical, industrial, commercial or scientific knowledge, experience or skill;(iva)the use or right to use any industrial, commercial or scientific equipment but not including the amounts referred to in section 44BB;(v)the transfer of all or any rights (including the granting of a license) in respect of a copyright, literary, artistic or scientific work"

Even though royalty envisages payment for transfer of a right to use intellectual property, it does not include the definition of such intellectual properties that are to be included within the scope of royalty. A reference has to be made to the Indian Copyright Act for the same.

c) Softwares under the Indian Copyright Act, 1957

Section 14(b) of the Indian Copyright Act, 1957 defines the term copyright for a computer programme. It states that in the case of a computer program, a copyright means the exclusive right to do or authorize others to reproduce a particular program or issue copies of a particular program or to sell the program amongst others. It can be pointed out that when a person is merely permitted to use the subject matter of the software, it cannot be said that he has acquired the copyright for the software.Section 51 of the Copyright Act says that the infringement of a copyright occurs when a person without the license of the owner or in contravention of the license does something which he is not authorized to do under the Act. This would involve unauthorized duplication, commercial use without permission and so on. However, Section 52 (1) (aa) of the Copyright Act makes an exception to the above by providing that making copies of a computer program for the purposes described therein is not considered to be an infringement of copyright. It is of paramount importance to analyse the basic purpose of the copyright in order to arrive at taxability.

d) Taxation of softwares under the OECD Model Tax Convention

The OECD Model Tax Convention in Article 12 deals with royalty arising from transactions involving transfer of computer software. The basic principles arising out of the Article are:

a) The character of payments received in transactions involving the transfer of computer software depends on the nature of the rights that the transferee acquires under the particular arrangement regarding the use and exploitation of the program.

b) The consideration for the transfer of software would be in the form of royalty income if the payment was made to acquire the right to use the copyright in the program. However, when the copyright in the program is not exploited, it will be considered as business profits.

c) Payments made for acquisition of partial rights in the copyright (without the transferor fully alienating the copyright rights) will represent a royalty income where the consideration is for granting of rights to use the program in a manner that would without such license, constitute an infringement of copyright. Examples are reproduction of a public software incorporating the copyrighted program.

d) Payments made for rights limited to enable the user to operate the program would be classified as business income. The rights transferred in these cases are specific to the nature of the computer programs like copying of the software on the users hard drive for use within the business.

e) When the author of the software agrees to supply information or technical knowhow regarding the software like algorithms or programming techniques then payments for such services are to be classified as royalty income.

f) Payments made in consideration of obtaining the exclusive distribution rights of a particular software within a territory do not constitute royalty income. Instead they are incomes from business.

g) The ease of reproducing computer programs has resulted in distribution arrangements in which the intermediary gets the right to distribute copies of the software without the right to actually reproduce the same. This is a unique scenario which is considered to be income from business and not royalty income. The logic behind this is that distributors pay income for acquisition of copies of the software and not to exploit the copyright in the software.

However, in spite of such elaborate provisions in the OECD Convention few questions still arise. It is to be kept in mind that where the acquisition of the software is for the personal or business use of the purchaser, the same falls outside the scope of Article 12 of the OECD Tax Convention and are to be dealt with as business income.

e) Taxation of Softwares under the DTAAs

Both OECD and UN Models for DTAAs contain the same definition of royalty, which runs as:

"The term royalties. means payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph films, any patent, trade mark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience.

Thus payments made for acquiring the right to use the product itself without allowing any right to use the copyright in the product is not covered under the DTAAs. It is to be noted that while the definition of royalty in the Income-tax Act speaks of royalty arising from transfer of all or any rights (including granting of a license) in respect of a copyright, literary, artistic or scientific work, the treaty models speak of royalty arising from grant of the use or right to use, any copyright of literary, artistic or scientific work. The position under the DTAAs is that unless the definition in the respective DTAA includes the payment for the use of the software as royalty, it cannot be characterized as royalty income as it might not entail the use of copyrights in the software at all.Generally, Article 12 of DTAAs deal with royalty income, while Article 7 of the DTAAs deal with income from business.

f) The Position under the Income Tax Act, 1961: Principles for ascertaining taxability of softwares analysed with case laws

The interpretation of the term royalty income is very dicey under the Income Tax Act, 1961. This is especially so when it comes to income from softwares. Essentially royalty accrues to the owner of a copyright as consideration for the commercial exploitation of the copyright in the software which still belongs to the owner.

In the case of ABC, In re[footnoteRef:16], it was held that the charges received by American company from an Indian company for allowing access to and use of its Central Processing Unit (CPU) at USA and Consolidated Data Network (CDN) thereby allowing the latter to use the software developed and protected by the former is income arising in India and is taxable as royalty under article 12(3)( a ) of Double Taxation Avoidance Agreement between India and USA and under Section 9(1)( vi ) of the Act. [16: [1999] 238 ITR 296/ 105 Taxman 240 (AAR) ]

In the case of Tata Consultancy Services v. State of Andhra Pradesh[footnoteRef:17] which dealt with the concept of sales tax on software, the Supreme Court made an important observation: [17: [2004] 271 ITR 401 ]

It has been held that by sale of the software programme the incorporeal right to the software is not transferred. It is held that the incorporeal right to software is the copyright which remains with the originator. What is sold is a copy of the software. It is 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.

Therefore, what is transferred is not the copyrighted right but only a copyrighted article. This decision marked the origin of the distinction between the two concepts. The distinction is relevant in the case of transactions regarding shrink wrapped software, the income accruing from which is income from business and profession.

Even though there is intellectual property nascent in every software, it cannot be said that every transfer of software involves the transfer of an intellectual property. The decision of Motorola v. DCIT[footnoteRef:18] and Lucent Technologies v ITO[footnoteRef:19] are to be considered here which clearly state that while one cannot have a copyright without a copyrighted article, one can certainly have a copyrighted article without a copyright. The Court accordingly held that the software supplied in the above cases was just a copyrighted article and not the copyrighted right and fell within the ambit of income from business under both the Act and the Indo US DTAA. [18: (2005) 96 TTJ Delhi 1 (SB) ] [19: 82 TTJ 163 ]

In the case of Dassault Systems K.K., In re[footnoteRef:20] the product was to be hosted on a server in Japan and the end user in India will electronically download the software by accessing the weblink on the system. It was held by the AAR, New Delhi that the passing of a right to use of a software for which the owner still retains a copyright is not the same as transferring rights in relation to a copyright. It is thus not in the nature of royalty income under the Treaty as well as the Act. [20: [2010] 322 ITR 125 ]

A clear position is laid down in the case of Factset Research Systems Inc. In re[footnoteRef:21]wherein a US Company supplied a database to an Indian company, containing certain financial information. It was an exclusive license as it could not be distributed by the Indian company. A fee was also paid in this regard. It was held by the AAR that if exclusive rights are granted to a software by the owner for a specified period of time for the Indian company to carry on business, it would fall within the ambit of right to use the copyright. The owners intellectual property is not affected and it cannot be considered as royalty under Section 9(1)(vi) of the Act or Article 12 of the Indo US DTAA. [21: [2009] 317 ITR 169. See also Wipro Ltd. v. ITO [2005] 94 ITD 9 Bang. ]

The distinction between copyrighted right and copyrighted article was elaborated on in the case of Samsung Electronics Co. Ltd. v. ITO[footnoteRef:22] wherein the assessee had acquired from a US Company, a readymade off the shelf computer program for its business. [22: [2005] 94 ITD 91; See also Sonata Information Technology Ltd. v. Addl. CIT [2006] 103 ITD 324 and Hewlett Packard (India) (P) Ltd. v. ITO [2006] 5 SOT 660 ]

However, the assessee had not purchased a copyright of the program but merely a copy of it on a CD. Thus its payments to the US Company was not in the nature of royalty under Article 12(3) of the Indo US DTAA and Section 9(1)(vi) of the Income Tax Act. In Kansai Nerolac Paints Ltd v. Addl. DIT[footnoteRef:23], under the license agreement between the assessee and a Singapore Company, the Singapore company has granted a non transferable, non exclusive license to use their software. It was held that the Singapore owner was still the absolute owner of the software and when a software is put into media like CDs or cassettes and then sold, it becomes goods and the income arising therefrom would be that from business under the India Singapore DTAA. [23: [2010] 6 taxmann.com 71; See also Infrasoft Ltd. v. Asst. DIT [2009] 28 SOT 179. ]

In the case of Velankini Mauritius Ltd. and Bydesign Solutions Inc.[footnoteRef:24] it was categorically held that sale of shrink wrapped software cannot be treated as royalty income either under the Act or under the India Mauritius DTAA. [24: IT Appeal Nos. 985 and 986 (Bang. of 2009), dated May 31st, 2010 ]

In the case of Geoquest Systems BV In re[footnoteRef:25], there was a supply of end user software with a license to use by the assessee, a Dutch Company to an Indian Company. The AAR stated that the license does not grant the assessees customers any right in the copyright of the software but merely a copyrighted article. Thus income earned by the assessee from such a licensing does not fall within the ambit of royalty income under Section 9(1)(vi) nor does it fall within the ambit of royalty income under Article 12 of the the India Netherlands DTAA. It would fall under Article 7 of the DTAA dealing with business income and in the absence of a permanent establishment in India, the same software licensing agreement cannot be taxed in India. [25: [2010] 6 taxmann.com 95 (AAR- New Delhi) ]

The Supreme Court has had the opportunity in the case of CIT v. Oracle Software India (P) Ltd.[footnoteRef:26] to hold that the process of transformation of a blank CD into CDs loaded with software by duplicating the master copy of the software constitutes a processing or manufacture of goods and hence is to be treated as business income and not royalty income. [26: [2010] 1 taxmann.com 21 (SC) ]

However, the distinction between a copyrighted right and a copyrighted article was left blurred after the landmark judgment of the ITAT, Delhi in Gracemac Corporation v. ADIT (IT)[footnoteRef:27]. In Gracemac, Microsoft Corporation entered into an agreement with its wholly owned subsidiary, Gracemac which granted it an exclusive license to manufacture and distribute MS software in accordance with the terms of the license. It was agreed that Gracemac would make no copies except as provided in the agreement, and the master-copy of the software would always be the property of Microsoft and would be returned to Microsoft on termination of the agreement. Gracemac in turn granted a non-exclusive license to Microsoft Operations (MO Singapore) to reproduce the software and distribute the same to retailers/distributors or to Microsoft subsidiaries. MO paid Gracemac royalty calculated as a percentage of the price received from the distributors. MO in turn entered into a non exclusive distribution agreement with Microsoft Regional Sales Corporation (MRSC). [27: [2010] 7 Taxmann.com 139 (Delhi - ITAT) ]

Under this, MO sold the copies to MRSC in Singapore, and MRSC further distributed the same to local distributors, who had the right to distribute the software in their respective countries. The distributor sold the products to Indian distributors, who in turn sold the same to end-users. Microsoft Corporation (the parent) and the owner of the relevant intellectual property entered into end-user license agreements (EULAs) with the end-users. Thus, the copies of the software were purchased by the end-users, who also entered into EULAs with Microsoft Corporation. The end-user was never granted any right to make additional copies for commercial use Thus, the main issue that arises from this case is whether supply of off-the-shelf software by non-resident companies to Indian distributors is taxable in the hands of the non-resident companies as royalty under Section 9(1)(vi) of the Act and under Article 12 of the India-US DTAA.

The Court in this case did not follow the distinction between a copyrighted right and a copyrighted article. It put forward the logic that the distinction largely evolved out of the OECD Model Tax Convention which should not be considered a safe guide to interpreting the provisions of the Income Tax Act[footnoteRef:28] although the Income Tax Act does not specifically define the term copyrighted article. The Bench then referred to the EULA entered into between Microsoft Corp and the end-user, according to which, Microsoft products have been licensed and not sold. The Tribunal stated that conditions of End User Licence Agreement itself prove that the software is licensed and not sold. This fact is further buttressed by the wordings of clause 19 of EULA which states thatthe product is protected by copyright and other intellectual property laws and treaties. Microsoft or its suppliers own the title, copyright, and other intellectual property rights in the product. The product is licensed and not sold. [28: CIT v. P.V. Kulandagan Chettiar (2004) 137 Taxman 460 (SC) ]

If the distinction had been followed, the Bench could have come to the conclusion that the payment made by the users was in respect of the copyrighted article, while the EULA is typically entered into for protection of the copyright. However, the Bench pointed out that in such a scenario the terms of the EULA would have been disregarded altogether.

The Court was of the opinion that the three assessees in the case, Gracemac, MO and MRSC were blowing hot and cold at the same time by asserting that the software sold did not contain any copyrighted rights and was just a copyrighted article and at the same time saying that an unauthorized exploitation of the software would be an infringement of copyrights. Where there is no copyright there cannot be an infringement of the same. Thus the Court disregarded all the precedents and cases on similar points by itself and other ITAT Benches by coming to a unique conclusion that sale of shrink wrapped software involves transfer of copyrighted rights and the income from the same is to be taxed under Section 9(1) (vi) of the Income Tax Act or Article 12 of the Indo US DTAA, whichever is more suitable to the assessee.

This case is a departure from the position prevailing in India and is more of an exception to the rule as was clearly demonstrated in later decisions of various ITAT Benches which held that income from the sale of shrink wrapped software is to be considered as business income because of transfer of a copyrighted article.

CAPITAL OR REVENUE EXPENDITURE: THE PERPLEXING DOUBT

The position regarding whether expenditure on software is to be considered to be of a revenue or a capital nature is still unclear. The procedure as regards treatment of capital and revenue expenditure under the Income Tax Act, 1961 is clearly envisaged in Section 37 of the Act. It says that:"Any expenditure (not being expenditure of the nature described in sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee) laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head Profits and gains of business or profession".

The landmark case on the point in India, that of Empire Jute Co. Ltd. v. CIT[footnoteRef:29] has laid down the test of enduring benefit stating that expenditure made for the purpose of securing a benefit which will endure for a long time to the business is that of a capital nature and not to be included for tax purposes. [29: [1980] 124 ITR 1/3 Taxman 69; ]

However, it is not a foolproof method of judging expenditure as has been categorically stated by Lord Radcliffe in Commissioner of Taxes v. Nchanga Consolidated Copper Mines Ltd.[footnoteRef:30]. He says: [30: [1965] 58 ITR 241 (PC) ]

" it would be misleading to suppose that in all cases, securing a benefit for the business would be, prima facie , capital expenditure so long as the benefit is not so transitory as to have no endurance at all. There may be cases where expenditure, even if incurred for obtaining advantage of enduring benefit, may, nonetheless, be on revenue account and the test of enduring benefit may break down. It is not every advantage of enduring nature acquired by an assessee that brings the case within the principle laid down in this test.

What is material to consider is the nature of the advantage in a commercial sense and it is only where the advantage is in the capital field that the expenditure would be disallowable on an application of this test. If the advantage consists merely in facilitating the assessees trading operations or enabling the management and conduct of the assessees business to be carried on more efficiently or more profitably while leaving the fixed capital untouched, the expenditure would be on revenue account, even though the advantage may endure for an indefinite future".

In the case of Business Information Processing Services v. Asstt. CIT[footnoteRef:31], it was held that the expenses on development of computer software are revenue in nature. This is because, software used by assessee is not of any enduring benefit, as assessee has to change this software within a short span of time, Sometimes they are of no use at all because they become outdated because of change of system and change of technology. [31: [2000] 73 ITD 304 (Jp.) ]

However, in the case of CIT v. Arawali Constructions Co. (P.) Ltd[footnoteRef:32]., it was held that, expenditure on acquisition of software and payment, if made for outright acquisition of computer software which is to be used in data analysis for mining operations of the assessee, the expenditure was to be treated as a capital expenditure. [32: [2003] 259 ITR 30/[2002] 124 Taxman 146 (Raj.) ]

There are two distinct schools of thought that arise here. The first considers softwares as technical know-how that has to be purchased by the user of computer to make effective use of the machine. Softwares are used in a computer which is a capital asset. Since the computer cannot function at all without softwares hence software is also to be considered as a capital expenditure[footnoteRef:33]. The converse argument is that softwares need to be constantly updated so that no software package wears the requisite degree of durability to qualify as an enduring capital asset. The software is a raw material which by no stretch of argument can be considered as a capital asset[footnoteRef:34]. [33: CIT v. Elecon Engg. Co. Ltd. [1987] 166 ITR 66 (SC); CIT v. Premier Automobiles Ltd. [1994] 206 ITR 1; Shriram Refrigeration Industries Ltd. v. CIT [1981] 127 ITR 746 ] [34: Alembic Chemical Works Co. Ltd. v. CIT [1989] 177 ITR 377/ 43 Taxman 312 (SC); CIT v. Western India State Motors [1993] ]

Although the position is not settled, the Courts are more reluctant to consider softwares as capital expenditure rather than revenue expenditure. However, the Legislature had a different intention altogether. Until the assessment year 2002-03, only computer hardware was classified under Appendix-I (III)(2B) for depreciation at 60 per cent. Only from the assessment year 2003-04 onwards, computer software is also included along with the computer for providing depreciation at the rate of 60 per cent under Appendix-I (III)(5). Thus the intention of the Legislature is to treat computer software as a revenue expenditure till the assessment year 2002-03 and capital expenditure which carries a depreciation of 60 per cent from the assessment year 2003-04 onwards.

CONCLUSION

Softwares are an intriguing subject of study under the Income Tax Act and the debate still continues to rage as to whether they contain copyrights of the intellectual property owner or whether they are Just articles which give rise to business income. There is a fine dividing line between the two and they often get blurred. It has to be ascertained on the facts of individual cases as to whether the payment made is for the purpose of obtaining the copyright or just for the copyrighted article. The Finance Act, 2010, applicable with retrospective effect says that taxes on royalty income or fees for technical services arising under Section 9(1)(vi) of the Income Tax Act, 1961 for sale of copyrights of the software will have to be paid by a non-resident irrespective of whether a non-resident has a business connection in India or has rendered services in India. Thus non-resident companies try to escape this wide net of royalty income by not licensing the copyrights to their softwares so that it comes under the head of income from business. As per the Act, if there is no permanent establishment of the non-resident in India then it cannot be taxed under the head of business income. The Courts to address this very conundrum have evolved the test of copyrighted right versus copyrighted article which is sound in nature and is a fair estimation of taxation laws in India.

The dilemma regarding capital and revenue nature of software transactions is not a settled position but looking at the nature of the software and the benefit which it may give to the business a reasonable classification can be made. All in all, the nature of the right acquired by the end user is where the Income Tax Authorities have to look at. The taxation law as regards softwares in India is slowly but surely reaching a settled position which augurs well for transnational software deals.

A scheme of direct payment combined with minor cost pricing would make the procedure more clear which would inevitably lead to better resource allocation. Any IP tax policy should be in such a manner as to encourage IP creation and innovation to create wealth. The Government also needs to develop a mechanism whereby IP assets are valued. By focusing on pricing IP assets by companies, it would ensure better compliance with taxation requirements. Many other benefits would also result as a consequence of valuation of IP assets. IP assessment would also help in the determination of the initial cost foundation of IP for the reason of capital gains and for the purpose of payment of stamp duty. There is also the need to evolve a mechanism for the purpose of calculating the transfer price in cross-border IP deals. The number of inter-corporate transactions is rising by the day and so is their complexity. This makes compliance with a variety of supplies even more arduous. It is against this backdrop that the Transfer Pricing Regulations applicable in India need to be consonant with the global scenario. In the view of growing importance of intellectual property in the industrial growth the Government should think upon such a comprehensive law for taxation on the IP transactions that shall promote the creation and accumulation of IP and that shall add impetus to economic growth.

SUGGESTIONS

The Information Technology Software should not as such be brought within the tax net but instead it should be such Information Technology Software Services i.e. sale, purchase, development, supply, etc. should be within the purview of service tax instead services rendered in relation to such software may be within the purview of service tax such as installation charges of software, update charges, maintenance charges, repair charges.

Even in Draft representation paper on Goods and Service tax to be made to the Government of India by ICAI-Indirect tax committee, the Committee suggested that, We suggest that only packaged softwares (off the shelf) which are sold in form of CDs, licenses should be considered as goods. Further supply of Customized software should be considered as Service and not as goods. Software downloaded through internet should be regarded as service.

Only by applying the above principle, confusion can be avoided and coordination can be brought among the operation of these two taxes on a larger front. Further, by this way only breach of constitution can be avoided as the Parliament cannot make laws within Entry 97 of List I, upon a subject which already finds mention in List II of the Constitution of India, 1950.

Similarly, this principle can also apply in relation to other taxes like Customs duty, Excise duty, Octroi duty, etc. since now it will be tax on service rendered and not the software itself. Thus it can be said that this Taxing the Service Principle, can set to rest many controversies which surrounds the taxability of software and has led to a severe confusion within the minds of taxpayers as well as the charging authorities due the multiple layers of taxes existing at all the three levels.

Goods and Service Tax (GST) is considered to be one of the most important tax reforms in India. A dual system of GST is being proposed in wherein Central Goods and Service Tax (CGST) and State Goods and Service Tax(SGST) will be levied on the taxable value of different transactions. This implementation of GST in India will help in reducing the confusion, in the minds of the taxpayers, as numerous taxes shall get reduced to just one or two taxes.

Furthermore, the bonafides of the taxpayers should be seen while levying numerous tax on the same transaction, since when he is read to pay the tax on the transaction he should not be burdened with variety of taxes and at the same time it should be made crystal clear to him what taxes are to be paid on such a transaction, under what authority and at what rate.

BIBLIOGRAPHY

ARTICLES

Anil Kumar Shah, Whether Service Tax is applicable to the sale of computer software?, Tax Guru, December 8, 2009, available at http://taxguru.in/service-

tax/whether-service-tax-is-applicable-to-the-sale-of-computer-software.html

Christine E. Reinhard, Tangible or intangible--is that the question? Conflict in the

Texas tax classification system of computer software, 29 STMLJ 871, 888 (1998)

Dinesh Kumar Agarwal, Service Tax : The Information Technology conundrum, Tax India Online, March 7, 2008, available at

http://www.taxindiaonline.com/RC2/inside2.php3?filename=bnews_detail.php3&new

sid=6974

Nagesh M. Joshi, Hard battle for software, Express Computer, April 06, 2009,

available at http://www.expresscomputeronline.com/20090406/market02.shtml

Richard D. Harris, Property Taxation of Computer Software: Northeast Datacom.,

Inc. v. City of Wallingford, 23 Conn. L. Rev. 161-62, 166 (1990)

S. Sivakumar, Service tax on customised software - Madras HC delivers a punch!,

TaxIndiaOnline,November4,2008,availableat

http://www.taxindiaonline.com/RC2/inside2.php3?filename=bnews_detail.php3&new

BOOKS

2 JOHN C. HEALY & MICHAEL S. SCHADEWALD, 2009 MULTISTATE CORPORATE TAX

GUIDE II-257 (1st ed., CCH 2008)

DAVID BAINBRIDGE, SOFTWARE LICENSING 6 (2nd ed., Universal Law Publishing Co.

Pvt. Ltd. 2007)

J. B. DIXIT, COMPUTER FUNDAMENTALS AND PROGRAMMING 167 (1st ed., Laxmi

Publications, Ltd. 2010)

JOSEPH MIGGA KIZZA, ETHICAL AND SOCIAL ISSUES IN THE INFORMATION AGE 178 (4th

ed., Springer 2010)

MUKESH DHUNNA & J. B. DIXIT, INFORMATION TECHNOLOGY IN BUSINESS

MANAGEMENT 194 (Sangeeta Dixit ed., Laxmi Publications, Ltd. 2010)

WEBSITIES

http://www.businessdictionary.com/definition/shrinkwrapped-software.html

http://www.cbec.gov.in/customs/cst-0809/chap-85.pdf

http://www.indiainbusiness.nic.in/know-india/states/karnataka.htm

http://www.servicetax.gov.in/st-actmainpg.htm

Software Supply versus Software Service, available at

http://www.dateyvs.com/software.htm

Technology Innovation Management & Entrepreneurship Information Service, available at http://www.techno-preneur.net/business-ecosystem/cgovt/goa/goa-

Incentives.htm