How to classify software maintenance

The service taxability of supply of software of all kinds has always been an area of controversy and dispute. This is primarily due to the very nature of the industry, which does not fit in very well with India’s indirect taxation system which envisages transactions with a well defined consideration for each such transaction, whether it is of supply or sale of goods. This article addresses the particular issue of taxability of maintenance of software, which has seen a fair amount of change and volatility, with exemptions and clarifications being issued and withdrawn over a period of time.

In a recent decision, in the case of M/s SAP India Pvt. Ltd. Vs Commissioner of Central Excise, Bangalore [2010-TIOL-1569], the Bangalore Bench of the Tribunal had occasion to deal with the taxability of maintenance of software. The point before the Tribunal was whether maintenance of software would be covered under the taxable category of Information Technology Software Services (ITSS), which came into effect from 16 May 2008, or under the taxable category of management, maintenance or repair services which was subject to service tax even during the period prior to the above date.

 

While deciding the matter in favour of the appellants, the Tribunal examined in detail the various services rendered by them to their customers in relation to the software that already stood installed in the computer systems of such customers. The Tribunal also examined the literature filed by the revenue to comprehend the nature of the services so rendered. The relevant extract of the definition of ERP maintenance clearly established that software maintenance was far more than merely "fixing mistakes". Reference was invited to the definition of ‘maintenance’, which included four activities that were undertaken after a software program was released for use:

 

corrective maintenance 
 

adaptive maintenance 
 

perfective maintenance or enhancement 
 

preventive maintenance or reengineering

The literature further provided that only about 20 per cent of all maintenance work was directed towards "fixing mistakes" and that the bulk of the work related to adapting existing systems to changes in their external environment, making enhancements requested by users and reengineering applications for future use. On the basis of the facts produced before it, the Tribunal concluded that after the release and implementation of an ERP software package earlier sold by it to customers, SAP provided a variety of maintenance services to such customers or licensees. These services were provided to upgrade the software or to enhance its efficiency, in order to meet the requirements of the customers. Thus, evolving technological changes resulted in execution of perfective measures to upgrade the software, which were covered by the terms "adaptive maintenance" and "perfective maintenance", mentioned in the above literature.

The Tribunal further determined that "maintenance", in the context of computer software, was an expression of wider connotation, unlike the maintenance of tangible goods such as vehicles. Further, the Tribunal held that maintenance or repair of tangible goods would not normally result in the upgradation of its value or functional capacity or bring its efficacy upto a higher level than what originally existed. However, maintenance of software could improve the deployment of such software to new functional areas and result in increased efficacy and value. Based on the above, the Tribunal clearly held that the activities undertaken by the appellants would be taxable only under the category of ITSS, with effect from 16 May 2008, under the descriptive clause "adaption, upgradation, enhancement, implementation and other similar services related to information technology software”. As a corollary, such maint-enance of software would not be liable to tax as 'manage-ment, maintenance or repair' services for any prior periods. The Tribunal referred to the decision of the Karnataka High Court in the case of Commissioner vs. Turbotech Precision Engineering Pvt Ltd (2010-TIOL-498) wherein it was held that a new taxable service covered by a specific entry under Section 65 of the Finance Act, 1994, relat-ing to taxable services, would not attract the levy of tax under any pre-existing entry or heading.

Another interesting aspect of the Tribunal decision is the distinction that has been made between computer software and IT software. The Tribunal realised that Information Technology Software Services was in relation to information technology software and that computer software and information technology software were treated differently by the legislature. In this regard, the Tribunal examined the definition of management, maintenance or repair services. The explanation to the definition provides that "goods" includes "computer software” and that "properties" includes “information technology software". Further, management, maintenance or repair was taxable in relation to:

(a) management of properties, whether immovable or not;

(b) maintenance or repair of properties , whether immovable or not; or

(c) maintenance or repair including reconditioning or restoration, or servicing of any goods, excluding a motor vehicle.

Based on the above definition and the explanation to ‘management, maintenance or repair services, the Tribunal concluded that maintenance or repair of information technology software was specifically covered under sub-clause (b) whereas maintenance or repair of computer software was specifically covered under sub-clause (c). Accordingly, it held that the legislature understands information technology software to be distinct and different from computer software. Based on this distinction, the Tribunal confir-med that any incidental advice, consultancy or assistance given by the service provider will be squarely covered under the definition of ITSS, since adaptation, upgradation, enhancement and implementation of information technology software was expressly covered thereunder.

While this judgement puts to rest any issues regarding the date from which software maintenance contracts are taxable under service tax law, it does not address a more fundamental issue. The point is that the software products industry provides upgrades, as part of typical software maintenance contracts. These are frequently sent in CDs to all licensees who have entered into annual maintenance contracts with the software provider. A supply of software in a CD is actually a sale of goods rather than a service. This leads to the challenge that a part of the work done under an annual maintenance contract (helpdesk support) is a service, and subject to service tax, and a part of the work (supply of upgrades and patches) is a sale of goods and subject to VAT.

It will be interesting to see how the forthcoming GST addresses this issue. However, until such time as the GST is introduced, the central challenge of whether a tra-nsaction is a supply of goods or a supply of services would continue to be relevant in many industries, one of which is the IT industry.

The Author is Leader Indirect Tax Practice PricewaterhouseCoopers Pvt. Ltd. Email: pwctls.nd@in.pwc.com Supported by Rahul Renavikar and Abhishek A Rastogi