The Hindu Business Line : Does it seem uncanny that you can tax canned software?

IN A judgment dated November 5, running to more than 14,000 words, the apex court ruled that the Andhra Pradesh Government can tax the canned software of Tata Consultancy Services (TCS). For most of us, canned stuff is what is available off the shelf, much like canned pickle or jam; the uncanny expression `canned software', however, is the opposite of custom-made software that is `uncanned', so you don't use it by deploying a can opener.

TCS was into both: in the canned segment, it was sub-licensing Oracle, Lotus and so on, while it also developed software for customers. A sales tax officer in Hyderabad felt that canned software was `goods' and so coming within the tax net. The Commissioner and, subsequently, the Tribunal too, concurred with the officer's thinking, and so the company approached the apex court.

Soli Sorabjee argued forcefully that software would not come under the definition of `goods' as in the Andhra Pradesh General Sales Tax Act, because Section 2(h) of the Act included only tangible moveable property; computer software was not tangible moveable property. He drew support from The Law Relating to Computers and the Internet by Rahul Matthan to highlight the difference:

"Though the floppy disc, the CD-ROM and the hard disc are each tangible commodities that could be bought sold and resold, the software embedded in these media are intangible and fall into a very different category."

Sorabjee drew the attention of the court to the definition of `computer program' in The Copyright Act, as "a set of instructions expressed in words, codes, schemes or in any other form, including a machine-readable medium, capable of causing a computer to perform a particular task or achieve a particular result."

Accordingly, he argued that computer program is "literary work and is intellectual property of the programmer." To substantiate the `intangible' angle, the company's counsel also cited many a case from the US courts.

Arrangement of electrons

From the taxman's side, Mr Rakesh Dwivedi quoted from a bunch of contrary decisions, again from the US, to show how software is taxable. In these cases, it had been held that when stored on magnetic tape, disc or computer chip, software is physically manifested in machine-readable form "by arranging electrons, by use of an electric current, to create either a magnetised or unmagnetised space," and "this arrangement of matter recorded on tangible medium constitutes a corporeal body."

The judgment dissects software transactions to find three program copies: an original, a duplicate, and the buyer's final copy on a memory device. While the incorporeal right to software, that is, the copyright, remains with the originator, what is sold is but a copy of the software. "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," the US courts have reasoned, said the Supreme Court, and cited an analogy:

"It has been held that when one buys a copy of a copyrighted novel in a bookstore or recording of a copyrighted song in a record store, one only acquires ownership of that particular copy of the novel or song but not the intellectual property in the novel or song."

Another parallel is in a quote from a US decision in Advent Systems Ltd vs Unisys Corporation:

"An analogy can be drawn to a compact-disc recording of an orchestral rendition. The music is produced by the artistry of musicians and in itself is not a `good', but when transferred to a laser-readable disc it becomes a readily merchantable commodity. Similarly, when a professor delivers a lecture, it is not a good, but, when transcribed as a book, it becomes a good."

There is no difference between branded and unbranded software, remarked the court. "In both cases the software can be transmitted, transferred, delivered, stored, possessed and so on. Thus even unbranded software, when it is marketed/sold, may be goods."

However, in the case of unbranded software there were other questions such as "situs of contract of sale and/or whether the contract is a service contract."

Electricity and mushrooms

In 1969, the apex court had ruled in the Madhya Pradesh Electricity Board case that electric energy is `goods' because there can be sale and purchase of the same like any other movable object. When the Revenue's counsel cited this precedent, Sorabjee countered, saying that software was intellectual incorporeal property whereas electricity was not.

However, the court pointed out: "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 concerned item 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."

Another interesting case that was lined up for support by the taxman was on whether lottery tickets are goods. Yet another was about how "technical material supplied in the form of drawings, manuals and computer disc" were goods.

TCS had taken shelter behind Winter vs Putnam on mushrooms, but that was of no help as the court said:

"It was the quality of information regarding mushrooms which was not regarded as a product even though the encyclopaedia containing the information was regarded as goods."

On the fallacy that only the media were goods, the court had this to say: "There is no scope for splitting the engineering drawing or the encyclopaedia into intellectual input on the one hand and the paper on which it is scribed on the other."

Here is an example: "Valuable paintings are worth millions. A painting or a portrait may be specially commissioned or an article may be tailor-made. This aspect is irrelevant since what is taxed is the final product as defined and it will be an absurdity to contend that the value for the purposes of duty ought to be the cost of the canvas and the oil paint even though the composite product, i.e., the painting, is worth millions."

Justice S. N. Variava said that there was no difference between a sale of a software program on a CD/floppy disc and that of music or film on a cassette/CD.

"In all such cases, the intellectual property has been incorporated on a media for purposes of transfer. Sale is not just of the media, which by itself has very little value. The software and the media cannot be split up."

Does it still seem uncanny that you can tax canned software?

Tailpiece

`To buy peace from the taxman, I went to a godman.'

`Then?'

`And the first thing he asked me was how to save tax!'

Detaxification@TheHindu.co.in

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