IN THE HIGH COURT OF KARNATAKA AT BENGALURU

DATED THIS THE 9TH DAY OF FEBRUARY 2015

PRESENT

THE HON’BLE MR. JUSTICE N.KUMAR AND

THE HON’BLE MR. JUSTICE B.VEERAPPA

WRIT PETITION Nos.57023 – 57070/2013 (T – RES) BETWEEN : Infosys Limited (Formerly known as Infosys Technologies Limited) Plot Nos.44 & 97-A, 3rd Cross Electronic City, Hosur Road Bangalore – 560 100 Rep. by its Principal – CAG Mr.P.Prakash. ...PETITIONER

(By Sri N. Venkataraman, Senior Counsel for Sri T.Suryanarayana, Adv.)

AND : 1. The Deputy Commissioner of

Commercial Taxes (Audit-4.4) VAT Division-4, Vanijya Therige Karyalaya-2 National Games Village Koramanagala, Bangalore-560 047

2. The Commissioner of Commercial Taxes Vanijya Therige Karyalaya Gandhinagar, Bangalore-560009

R

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3. The State of Karnataka Rep. by the Principal Secretary Finance Department Government of Karnataka Vidhana Soudha, Bangalore-560001

4. The Commissioner of Service-Tax Service-Tax Commissionerate No.16/1, S.P. Complex Lalbagh Road, Bangalore-560027

5. The Union of India Rep. by the Secretary Ministry of Finance Department of Revenue Government of India, North Block New Delhi-110001. …RESPONDENTS

(By Sri Gopal Subramaniam, Senior Adv., Sri Abhishek

Tiwari, Ms. Anusha Ramesh, Advs. for Sri K.M.Shivayogiswamy, AGA for R-1 to 3;

Sri G.Rajagopalan, Additional Solicitor General of India for Sri N.R.Bhaskar, Adv. for R-4 & 5.)

. . . .

These writ petitions are filed under Article 226 of the Constitution of India, praying to quash the impugned re-assessment order dated 23.11.2013 vide Annex-Z passed by the R1 under Section 39(1) of the KVAT Act and Section 9(2) of the CST Act for the tax periods April 2005 to March 2009 & to quash the impugned demand notice in Form VAT 180 dated 23.11.2013 vide Annex-Z1 issued by the R1 for the tax periods April 2005 to March 2009. These writ petitions coming on for orders this day, N.Kumar J., made the following:

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O R D E R The assessee has preferred these Writ Petitions

seeking for :

(a) quashing of the re-assessment order, demand notice

in Form VAT 180 and for a direction to respondents

1 to 3 to refund the amount; and

(b) for a declaration that Section 3 of the Karnataka

Value Added Tax Act, 2003 to the extent it seeks to

levy tax on pure services like implementation,

customization and other support services in respect

of software as ultra vires Articles 246 and 265 of the

Constitution of India; or

(c) in the alternative, to declare that Section 65 (105)

(zzzze) of the Finance Act, 1994, to the extent it

seeks to levy service tax on implementation,

customization and other support services, if treated

as a sale, as being ultra vires Articles 246 and 265

read with Entry 97 of List I of the Seventh Schedule

to the Constitution; and

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(d) for a direction to respondent Nos. 4 and 5 to refund

the entire service tax paid by and collected from the

petitioner and other consequential reliefs.

Though in the Writ Petition they have challenged the validity

of Section 3 of the KVAT Act as well as Section 66 read with

Section 65 (105)(zzzze) of the Finance Act, 1994, no

arguments were addressed on the constitutional validity of

the said provisions. Therefore, it is not considered.

FACTS IN BRIEF:

2. The assessee is a Company incorporated under the

provisions of the Companies Act, 1956 and is engaged in the

business of development and sale of information technology

related services like customization of software,

implementation of software, annual technical and support

services, trading/support services of third-party software

besides providing services and other related technical

consultancy and engineering services. The petitioners have

developed a software solution branded as ‘Finacle’. Finacle

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is a specialized universal banking software solution

developed and provided by the petitioner for usage in the

banking sector. Finacle software solution consists of various

modules like core banking, customer relationship

management, treasury, internet banking, mobile banking

and wealth management systems. All of the above modules

when integrated form “Finacle Universal Banking Solution’

(‘Finacle UBS’ or ‘Finacle’). From time to time, the petitioner

releases upgraded versions of the said software solution

called ‘Finacle Release’. The petitioner has an independent

and dedicated team to develop Finacle and its upgraded

releases. The said releases are developed primarily for adding

a new functionality and it typically takes one to one and a

half years for a new release to be available in the market.

Since Finacle is a banking software solution consisting of

various modules, provision of services to the client-banks

will be dependent on their specific business requirements

and needs. Pursuant to the client-banks’ specifications,

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Finacle requires implementation to ensure that the client-

banks’ requirements are met.

3. The petitioner further submits that the

implementation activity commences after the sale of Finacle.

The implementation activity typically includes:

• Installation of Finacle already purchased by the bank

on the bank’s hardware at their premises

• Bank specific customization using Finacle parameters

and tools

• Customization of functionalities like setting up of fees,

charges etc.,

• Reports-Standard RBI & MIS reports are modified for

each bank

The process of implementation essentially involves

setting up of bank-specific modules under savings bank,

current account etc., configuring the accounts with the fees,

charges, interest and such other basic requirements, setting

up interfaces for data migration of the accounts from the old

system followed by the banks to Finacle system, testing of

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the setup environment by the bank and assessing the banks

in starting up their operations on Finacle.

4. A customer can buy Finacle from the petitioner and

thereafter has the option to engage anybody for its

implementation. Therefore, the sale of Finacle and its

implementation are two different and independent activities

and cannot be clubbed together. Many a time, the customer

chooses the petitioner to provide the services of

implementation. In such a case, the petitioner enters into

separate agreements – one for sale of Finacle and the other

for provision of implementation services. Where the

implementation is undertaken by the petitioner, the

petitioner sets up a project implementation team comprising

of both the petitioner’s employees as well as customers’

employees. The project implementation team ensures that

Finacle is integrated into the customers’ IT environment. The

process of implementation does not entail development of

any new software or upgradation of the existing software.

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5. Apart from the above activity of development and sale

of its own software and services, the petitioner also

purchases and sells third-party software and provides

implementation and other support services for such third-

party software. The petitioner also provides annual technical

support services which may involve some amount of transfer

of property in goods. The petitioner also provides other

services like training, installation, customization, online

software support services, technical consultancy and

engineering services.

6. The petitioner has been treating development and sale

of its own software like Finacle or sale of any third-party

software as a ‘sale’ and has been paying sales tax/VAT at the

applicable rates on the entire turnover relating thereto. In

respect of the turnover relating to provision of

implementation, customization or other support services,

whether of its own software or that of a third-party, the

petitioner has been treating the entire turnover as exempt

and has not paid any sales tax/VAT but has been paying

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service-tax since the time the levy of service-tax on such

transactions came into force. As regards annual technical

support services, since there is some amount of transfer of

property in goods involved, the petitioner has been declaring

and paying works contract tax. Insofar as the activity of

development and export of software, although it is a sale, the

petitioner claimed exemption of the turnover relatable

thereto as such turnover qualified as an exempt turnover

under Section 5 of the CST Act.

7. As soon as the levy of sales tax on computer software

came into force, with effect from 01-04-2001, the petitioner

made an application for clarification to the Authority for

Clarification and Advance Ruling under Section 4 of the KST

Act. They explained in the application in detail the entire

gamut of its activities and sought clarification regarding their

exigibility to sales tax and rate of tax applicable thereto. The

Authority for Clarification and Advance Ruling passed an

order dated 12-11-2002 clarifying that the sale of software

would be exigible to tax at the rate of 4% under Entry 20(v)

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of Part C of the Second Schedule to the KST Act. Further,

they clarified that the annual technical support services and

the activity of training, installation, implementation, onsite

support, customization, online software support,

parameterization etc., are not liable to tax unless it involved

any transfer of property in goods.

8. The Revenue did not raise any issue under the KST

regime and the returns filed by the petitioner declaring its

total and taxable turnovers have been accepted without any

demur. Even after coming into force of the KVAT Act, with

effect from 01-04-2005, no issue was raised by the Revenue.

In fact, the Assistant Commissioner of Commercial Taxes

(Audit-4), LDU Division, Bangalore, examined the books of

accounts and the activities of the petitioner in detail and

with particular focus on implementation services, claimed as

exempt by the petitioner, and passed two orders dated

23-02-2007 under Section 38(1) of the KVAT Act for the tax

periods June 2005 to March 2006 and April 2006 to

December 2006 respectively. In the said orders, the ACCT

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(LDU) discussed in detail the implementation services

provided by the petitioner and accepted that the said activity

is a pure service without any element of sale or transfer of

property in goods and consciously allowed the exemption

claimed by the petitioner on the turnover relatable thereto.

9. It is thereafter for the first time, on 13-03-2009, the

Assistant Commissioner of Commercial Taxes (Enforcement-

7), South Zone, Bangalore, visited the petitioner’s place of

business and thereafter issued a notice dated 17-04-2009

under Section 52 of the KVAT Act contending that the sale of

Finacle by the petitioner is nothing but a sale of software

license and since software licenses were inserted in Serial

No.34 of the Third Schedule to the KVAT Act, with effect

from 01-04-2007, the petitioner was liable to pay the higher

rate of tax at 12.5% from 01-04-2005 to 31-03-2007 on the

entire turnover relatable to sale of Finacle instead of 4%

KVAT and 10% CST paid by the petitioner for the period.

Later, again by a notice dated 05-06-2009, he informed the

petitioner that he has been conferred jurisdiction, by the 2nd

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respondent, to re-assess the petitioner under Section 39 of

the KVAT Act for the tax periods April 2005 to March 2009

and called upon the petitioner to produce its books of

account for the said period. Thereafter, one more notice

dated 22-09-2009 was issued under Section 39 of the KVAT

Act proposing to tax sale of software as sale of software

licenses at a higher rate of 12.5% for the tax periods April

2005 to March 2007, to treat the contract for

implementation of Finacle as a works contract involving

transfer of property in goods liable to tax at the rate of 12.5%

after giving deduction for the labour charges and to disallow

the petitioner’s claim for input tax credit to the extent of 45%

on the ground that the onsite activity of the petitioner in

terms of the agreements for development and export of

software is nothing but export of services or services

provided outside India and therefore exempt from VAT. The

petitioner submitted a detailed reply raising several

objections including the question of jurisdiction. The

authorities issued a revised proposition notice proposing to

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disallow input tax credit relatable to exports to the extent of

50% on the ground that 50% of the export turnover arises on

account of onsite activities. The petitioner submitted a reply.

Over-ruling all the objections, the authority proceeded to

pass an order raising a total demand of Rs.68,02,44,801/-

towards tax, interest and penalty. The petitioner filed an

application for rectification under Section 69 of the Act.

Accepting some of the errors pointed out by the petitioner, by

an order dated 5.12.2009, the total demand was reduced to

Rs.49,08,43,982/-. Aggrieved by the said order, the

petitioner preferred a Writ Petition before this Court in W.P.

Nos. 37456-37458 and 37649-37693/2009. The said Writ

Petitions came to be disposed of with liberty to the petitioner

to file a statutory appeal. Accordingly, the petitioner filed

appeal before the Tribunal. The Tribunal, after hearing the

parties, partly allowed the appeals filed by the petitioner. It

held that sale of Finacle is a case of sale of software and not

sale of software licence as contended by the revenue and,

therefore, the authority was wrong in levying higher rate of

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tax. It further held that implementation service does not

involve any transfer of property in goods and, therefore, not

liable to tax under the KVAT Act. The Tribunal followed its

earlier judgment rendered in the case of IBM India Private

Limited. At that stage, the request of the State that they

should be given an opportunity to examine the

implementation service agreements was acceded to and the

Tribunal remanded the matter back to the assessing

authority as they were passing an order of remand on the

question of disallowance of input tax credit. The assessing

authority was directed to examine the issue strictly in light

of its earlier judgment in the case of IBM India Private

Limited. Thereafter, notice came to be issued under Section

39 of the KVAT Act and Section 9(2) of the CST Act. The

petitioner filed its objections to the notice. After hearing the

parties, the assessing authority rejected the petitioner’s

claim for exemption on implementation charges on an

entirely new ground that the said activity is nothing but a

value addition to Finacle software and, therefore, there is a

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sale of customized Finacle software and the entire turnover

relating to sale of Finacle and its implementation is liable to

tax, as opposed to the earlier ground that the said activity

amounts to works contract. Thus, the exemption claimed by

the petitioner was rejected.

10. Challenging the aforesaid order, the petitioner has filed

these Writ Petitions. As the State had preferred an appeal

against the judgment of the Tribunal in the case of IBM India

Limited vs State of Karnataka, which is heard along with the

Writ Petition, the learned single Judge directed the High

Court Registry to post these Writ Petitions before the

Division Bench to be heard along with the connected

Revision Petitions. That is how these Writ Petitions are

listed before the High Court.

RIVAL CONTENTIONS: 11. Sri. N. Venkataraman, the learned Senior counsel for

the assessee, contends that the assessee has Proprietary

Rights over the software `Finacle’. It owns a copyright. The

said software is meant exclusively for Banks. Depending

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upon the needs and requirements of the clients, after

entering into a contract, the assessee scripts on the said

standard software programs to meet the requirements of the

client. This is what is popularly known as customization.

The software which emerges in the process of customization

is also owned by the assessee. The copyright vests in that.

This package and customized software is handed over to the

customer – Bank for their use. It is popularly known as

copyrighted Article. Under the contract, right to use this

copyrighted Article is transferred to the customer and the

transfer of this copyrighted Article takes place at the time of

delivery of the said software. The assessee has paid VAT on

the consideration for such right to use software, which is a

deemed sale under Clause 29A(d) of Article 366 of the

Constitution of India. It is a simple contract of sale of goods.

This contract of sale also includes annual technical support

(eight years). Clause 5 of this agreement includes the

annual maintenance involving both service and upgradation

or enhancement of the software. Since the contract is

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combination of both goods and services, it is in the nature of

a Works contract. Assessee has discharged VAT liability in

respect of the said goods sold under this contract in the

capacity of Works Contract. In the course of the works

contract, if any, up-gradation, enhancement is done, the

copyright vests with the assessee. The customer is only

entitled to the right to use the said software.

12. If the packaged customized software is delivered to the

customer, the customer has option of utilizing the service of

the assessee or any other person in the field for

implementation of the contract. What is required in the said

implementation is to evaluate the skill to integrate several

other softwares including finacle - the software belonging to

the assessee, the right to use of which is transferred. It is

not a pre-sale activity, it is a post-sale activity. Clause 3 of

the agreement makes this position clear. At the time of

implementation of the contract, there is no transfer of any

goods. Even in that process if any software emerges the said

software ownership vests with the customer. Therefore,

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there is no transfer of right to use as the customer owns the

said software. Therefore, it is a contract of pure service and

no sale aspect is involved in this contract. The entire

consideration received in the course of the implementation of

the contract is subjected to service tax and tax is paid.

Therefore, it was submitted that the claim of the State for

levy of VAT on this part of the contract is unsustainable. In

substance, he submits that in order to find out what is the

goods transferred when the transfer of ownership passes is

to be gathered from the terms of the contract, the way the

parties intend and understood the contract. The Courts

cannot re-write the contract or sub-contract if any to the

contract. The real test in the case of sale of goods is whether

the ownership right of the copyright or right to use the

copyright is transferred and when it is transferred. When the

assessee had not claimed any ownership over any software,

which may emerge in the process of implementation of the

contract and the ownership vests with the customer, there is

no transfer of any goods and even if it is to be treated as

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right to use software, which is a deemed sale, there is no

transfer of any goods. It is purely a service contract.

13. Per contra, Sri Gopal Subramaniam, the learned

Senior counsel appearing for the State contended that the

contract in question is neither a service contract nor a works

contract, but it is a contract for sale. Any customization of

packaged software prior to sale renders the software a goods

and the transfer of right to use that goods involves sale and

chargeable to VAT. The agreement entered into between the

parties as set out in the impugned order makes it clear that

unless the said software undergoes scripting, configuration,

screen customization, identification of product

enhancements and other processes set out in response to

the customers requirement is undertaken, the said software

is not ready to go-live. It is this process which the assessee

calls as implementation of the contract and wants to avoid

payment of VAT on the ground that service tax has been

paid. It is impracticable in law. One of the tests to be

applied to find out when exactly the goods is transferred, is

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the test of functionality or feasibility. It is only when the

goods are marketable and useable or becomes functionable it

may be said that the goods has come into existence which is

capable of transfer. He has referred to the definitions of

‘dealer’ in Section 2(12), ‘goods’ defined in Section 2(15), and

‘turnover’ mentioned in Section 2(36). According to him it is

the transactional value which has to be taken note of and all

the components of transactional value should be considered

as sale consideration and it should be subjected to tax under

VAT. In fact customization involves service. It is only after

the service is rendered, it becomes a customized product i.e.,

goods which is marketable, usable, functionable and

therefore, transferable, whereas the service rendered is

immaterial and therefore, he submits that unless the goods

are customized it is not usable and therefore, the

consideration paid for customization is subject to VAT.

Whether the assessee calls it as implementation of the

contract or customization or improved enhancement, it is

immaterial. It is the substance of the contract, which has to

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be taken note of and, therefore, he submits that the order

passed by the Assessing Authority is in accordance with law

and does not call for any interference.

14. Sri. G. Rajagopalan, the learned Senior counsel

appearing for Union of India submitted that while

considering what constitutes goods the definition of the

‘goods’, as contained in Article 366 (12) of the Constitution of

India, alone is the criteria and the definition of ‘goods’ in the

VAT Act cannot be looked into and, therefore, he submits

that the definition of goods in the State legislation has to

yield to the definition of goods in the Constitution. However,

he submitted that there is no inconsistency between the two

definitions. Therefore, service pure and simple cannot be

read into the definition of the goods. He submitted that

w.e.f.16.5.2008 service in relation to information technology

software has been brought under service tax net by virtue of

Section 65 (105) (zzzze). It defines information technology

service which includes development, upgradation,

enhancement, implementation and other similar services

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related to software. Section 65B (44) of the Finance Act,

1994 defines the word ‘service’ which excludes any activity

which constitutes merely transfer, delivery or supply of any

goods which is deemed to be a sale within the meaning of

clause (29A) of Article 366 of the Constitution. Section 66E

provides for declared services. A declaration is found at

clause (d) that development, design, programming,

customization, adaptation, upgradation, enhancement,

implementation of information technology software is a

declared service. Once the parliament has expressly

declared the aforesaid activities as a declared service the

jurisdiction of the State to levy tax on such activities has

been excluded. Once the implementation is included in the

definition of the ‘taxable service’ in the Service Tax Act, the

State legislature is not empowered to levy VAT treating it as

goods and therefore, he submits that the petitioner, who has

sought several reliefs by way of refund of service tax paid, is

not entitled to the same.

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15. In the light of the aforesaid facts and the rival

contentions, the points that arise for our consideration in

these writ petitions are as under :-

(1) In the absence of transfer of a right to use a

software under a contract, can it be said that the

activity of implementation involves a deemed

transfer of goods as contemplated under Article 366

(29A)(d) of the Constitution of India ?

(2) After supply of packaged and customized software,

if any service is required to integrate the software

into the system to make the software functional or

usable, does it amount to pre-sale activity which is

chargeable to VAT or is it a post sale activity, which

is in the nature of service simplicitor?

POINT No.1: 16. The learned counsel appearing for the parties relied

upon several judgments of the Apex Court as well as this

Court in support of their respective contentions. The law

relating to taxability of software is now fairly well settled.

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17. The Constitution Bench of the Apex Court in the case

of TATA CONSULTANCY SERVICES VS. STATE OF A.P.

reported in (2005) 1 SCC 308 has held as under : -

“19. Thus this Court has held that the

term “goods”, for the purpose 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.”

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Dealing with the copyright articles, it held as under : -

24. It is thus to be seen that under the

Customs Act, apart from what had been specified

therein, any other kind of moveable property

constituted goods. This Court held as follows:

"27. According to Section 12 of the Customs

Act, duty is payable on goods imported into India.

The word "goods" has been defined in Section

2(22) of the Customs Act and it includes in clause

(c) "baggage" and clause (e) any other kind of

moveable property. It is clear from a mere reading

of the said provision that any moveable article

brought into India by a passenger as part of his

baggage can make him liable to pay customs

duty as per the Customs Tariff Act. An item which

does not fall within clauses (a), (b), (c) or (d) of

Section 2(22) will be regarded as coming under

Section 2(22)(e). Even though the definition of the

goods purports to be an inclusive one, in effect it

is so worded that all tangible moveable articles

will be the goods for the purposes of the Act by

residuary clause (e) of Section 2(22). Whether

moveable article comes as a part of a baggage, or

is imported into the country by any other manner,

26

for the purpose of the Customs Act, the provision

of Section 12 would be attracted. Any media

whether in the form of books or computer disks or

cassettes which contain information technology or

ideas would necessarily be regarded as goods

under the aforesaid provisions of the Customs

Act. These items are moveable goods and would

be covered by Section 2(22)(e) of the Customs Act.

(SCC pp.609-10, para 27).

33. It is true that what the appellants had

wanted was technical advice on information

technology. Payment was to be made for this

intangible asset. But the moment the information

or advice is put on a media, whether paper or

diskettes or any other thing, that what is supplied

becomes a chattel. It is in respect of the drawings,

designs etc. which are received that payment is

made to the foreign collaborators. It is these

papers or diskettes etc. containing the

technological advice, which are paid for and

used. The foreign collaborators part with them in

lieu of money. It is, therefore, sold by them as

chattel for use by the Indian importer. The

drawings, designs, manuals etc. so received are

goods on which customs duty could be levied.

27

34. The decision of Winter v. Putnam case

(938 F 2nd 1033 (9th Cir 1991) is also of no help to

the appellants as in that case 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. Here we are not concerned

with the quality of information given to the

appellants. The question is whether the papers or

diskettes etc. containing advice and/or

information are goods for the purpose of the

Customs Act. The answer, in our view, is in the

affirmative.

41. Significantly Chapter 49 also

includes items which have substantial intellectual

value as opposed to the value of the paper on

which it is put. Newspapers, periodicals, journals,

dictionaries etc. are to be found in Chapter 49

wherein maps, plans and other similar items are

also included, while Chapter 97 talks about

original engravings. It is clear that intellectual

property when put on a media would be regarded

as an article on the total value of which customs

duty is payable.

28

42. To put it differently, the legislative

intent can easily be gathered by reference to the

Customs Valuation Rules and the specific entries

in the Customs Tariff Act. The value of an

encyclopaedia or a dictionary or a magazine is

not only the value of the paper. The value of the

paper is in fact negligible as compared to the

value or price of an encyclopaedia. Therefore, the

intellectual input in such items greatly enhances

the value of the paper and ink in the aforesaid

examples. This means that the charge of a duty is

on the final product, whether it be the

encyclopaedia or the engineering or architectural

drawings or any manual.

43. Similar would be the position in the

case of a programme of any kind loaded on a disc

or a floppy. For example in the case of music the

value of a popular music cassette is several times

more than the value of a blank cassette.

However, if a pre-recorded music cassette or a

popular film or a musical score is imported into

India duty will necessarily have to be charged on

the value of the final product. In this behalf we

may note that in State Bank of India v. Collector

29

of Customs ((2000) 1 SCC 727 : (2000) 1 Scale 72)

the Bank had, under an agreement with the

foreign company, imported a computer software

and manuals, the total value of which was US

Dollars 4,084,475. The Bank filed an application

for refund of customs duty on the ground that the

basic cost of software was US Dollars 401.047.

While the rest of the amount of US Dollars

3,683,428 was payable only as a licence fee for

its right to use the software for the Bank

countrywide. The claim for the refund of the

customs duty paid on the aforesaid amount of US

Dollars 3,683,428 was not accepted by this Court

as in its opinion, on a correct interpretation of

Section 14 read with the Rules, duty was payable

on the transaction value determined therein, and

as per Rule 9 in determining the transaction value

there has to be added to the price actually paid or

payable for the imported goods, royalties and the

licence fee for which the buyer is required to pay,

directly or indirectly, as a condition of sale of

goods to the extent that such royalties and fees

are not included in the price actually paid or

payable. This clearly goes to show that when

technical material is supplied whether in the form

30

of drawings or manuals the same are goods liable

to customs duty on the transaction value in

respect thereof.

44. It is a misconception to contend that

what is being taxed is intellectual input. What is

being taxed under the Customs Act read with the

Customs Tariff Act and the Customs Valuation

Rules is not the input alone but goods whose

value has been enhanced by the said inputs. The

final product at the time of import is either the

magazine or the encyclopaedia or the engineering

drawings as the case may be. 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. For example, paintings are also to be taxed.

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.

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45. It will be appropriate to note that the

Customs Valuation Rules, 1988 are framed

keeping in view the GATT protocol and the WTO

agreement. In fact our rules appear to be an exact

copy of GATT and WTO. For the purpose of

valuation under the 1988 Rules the concept of

"transaction value" which was introduced was

based on the aforesaid GATT protocol and WTO

agreement. The shift from the concept of price of

goods, as was classically understood, is clearly

discernible in the new principles. Transaction

value may be entirely different from the classic

concept of price of goods. Full meaning has to be

given to the rules and the transaction value may

include many items which may not classically

have been understood to be part of the sale price.

46. The concept that it is only chattel sold

as chattel, which can be regarded as goods, has

no role to play in the present statutory scheme as

we have already observed that the word "goods"

as defined under the Customs Act has an

inclusive definition taking within its ambit any

moveable property. The list of goods as

prescribed by the law are different items

32

mentioned in various chapters under the Customs

Tariff Act, 1997 or 1999. Some of these items are

clearly items containing intellectual property like

designs, plans, etc.

47. In the case of St Albans City and

District Council v. International Computers Ltd.

((1996) 4 All ER 481) Sir Ian Glidewell in relation

to whether computer programme on a disc would

be regarded as goods observed at p. 493 as

follows :

"Suppose I buy an instruction manual on the

maintenance and repair of a particular make of

car. The instructions are wrong in an important

respect. Anybody who follows them is likely to

cause serious damage to the engine of his car. In

my view, the instructions are an integral part of

the manual. The manual including the

instructions, whether in a book or a video

cassette, would in my opinion be 'goods' within

the meaning of the 1979 Act, and the defective

instructions would result in a breach of the

implied terms in Section 14.

If this is correct, I can see no logical reason why it

should not also be correct in relation to a

computer disc on to which a program designed

33

and intended to instruct or enable a computer to

achieve particular functions has been encoded. If

the disc is sold or hired by the computer

manufacturer, but the program is defective, in my

opinion there would prima facie be a breach of

the terms as to quality and fitness for purpose

implied by the 1979 Act or the 1982 Act."

48. ……… In Advent Systems Ltd. v.

Unisys Corpn. (925 F 2d 670 (3d Cir 1991)) it was

contended before the Court in the United States

that software referred to in the agreement

between the parties was a "product" and not a

"good" but intellectual property outside the ambit

of the Uniform Commercial Code. In the said

Code, goods were defined as "all things (including

specially manufactured goods) which are

moveable at the time of the identification for sale".

Holding that computer software was a "good" the

Court held as follows :

"Computer programs are the product of an

intellectual process, but once implanted in a

medium they are widely distributed to

computer owners. An analogy can be drawn to

a compact-disc recording of an orchestral

rendition. The music is produced by the

34

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.

That a computer program may be

copyrightable as intellectual property does not

alter the fact that once in the form of a floppy

disc or other medium, the program is tangible,

moveable and available in the marketplace.

The fact that some programs may be tailored

for specific purposes need not alter their status

as 'goods' because the Code definition

includes “specially manufactured goods”.

49. We are in agreement with the aforesaid

observations and hold that the value of the goods

imported would depend upon the quality of the

same and would be represented by the

transaction value in respect of the goods

imported."

25. It is to be noted that this authority is

directly dealing with the question in issue. Even

35

though the definition of the term "goods" in the

Customs Act is not as wide or exhaustive as the

definition of the term "goods" in the said Act, it

has still been held that the intellectual property

when it is put on a media becomes goods. Mr.

Sorabjee submitted that whilst referring to the

case of St. Albans City and District Council vs.

International Computers Ltd. [1996 (4) All E R

481] this Court missed the express finding of that

Court to the effect "clearly, a disk is within this

definition. Equally clearly, a program, of itself, is

not". Mr. Sorabjee submitted that the English case

clearly holds that software programes are not

goods. He further submitted that the observations

of this Court in Associated Cements Case (Supra)

are in the context of valuation of imported goods

and must therefore not be taken into

consideration whilst deciding whether software is

intangible, incorporeal intellectual property. We

are unable to accept this submission of Mr.

Sorabjee. The observations have been made not

just in the context of valuation but to decide

whether the items imported were "goods".

Question of valuation would come only if the

36

items imported were "goods" on which custom

duty could be levied.

26. In the case of Commissioner of

Central Excise, Pondicherry vs. M/s Acer India

Ltd., reported in JT 2004 (8) SC 53, this Court has

considered in detail what a software programme

is. After so considering, it has been held that a

computer and operative software are different

marketable commodities. This Judgment would

also have been against the arguments canvassed

by Mr. Sorabjee but for the fact that this Court

has itself clarified as follows:

"85[86]. We, however, place on record that we

have not applied our mind as regard the larger

question as to whether the informations

contained in a software would be tangible

personal property or not or whether

preparation of such software would amount to

manufacture under different statues.

18. Thereafter, explaining the word ‘goods’ in Article

366(12) of the Constitution, the Apex Court has held as

under : -

37

“27. In our view, the term ‘goods’ as used in

article 366 (12) of the Constitution of India and as

defined under the said Act are very wide and

include 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. (2001) 4 SCC 593. A software

programme may consist of various commands

which enable the computer to perform a

designated task. The copyright in that

programme may remain with the originator of the

programme. But the moment copies are made

and marketed, it becomes goods, which are

susceptible to sale tax. Even intellectual

property, once it is put on to a media, whether it

be in the form of books or canvas in case of

painting) or computer discs or cassettes, and

marketed would become “goods”. We see no

difference between a sale of a software

programme on a CD/floppy disc from a sale of

music on a cassette/CD or a sale of a film on a

video cassette/CD. In all such cases, the

intellectual property has been incorporated on a

media which by itself has very little value. The

38

software and the media cannot be split up. What

the buyer purchases and pays for is not the disc

or the CD. As in the case of paintings or books or

music or films the buyer purchases and pay for is

not the disc or the CD. As in the case of paintings

or books or music or films the buyer is purchasing

the intellectual property and not the media, i.e.,

the paper or cassette or disc or CD. Thus a

transaction sale of computer software is clearly a

sale of “goods” within the meaning of the term as

defined in the said Act. The term “all materials,

articles and commodities” includes both tangible

and intangible/incorporeal property which is

capable of abstraction, consumption and use and

which can be transmitted, transferred, delivered,

stored, possessed, etc. The software programmes

have all these attributes”

19. From the aforesaid decision it is clear that intellectual

property once it is put on to a media, whether it be in the

form of books or canvas (in case of painting) or computer

discs or cassettes, and marketed would become “goods”.

Intellectual property has been incorporated on a media for

the purpose of transfer. Sale is not just of the media which

39

by itself has very little value. The software and the media

cannot be split up. What the buyer purchases and pays for

is not the disc or the CD, he is purchasing the intellectual

property which is embedded in the media. Thus a

transaction involving sale of computer software is clearly a

sale of goods within the meaning of the terms as defined

even under the VAT Act. The term “all materials, articles

and commodities includes both tangible intellectual property

and intangible property which is capable of abstraction,

consumption and use and which can be transmitted,

transferred, delivered, stored, possessed etc. The software

programmes have all these attributes.

20. After the aforesaid judgment of the Apex Court, the

Commissioner of Commercial Taxes issued the Circular

No.17/2006-07 dated 24.7.2006 which deals with levy of tax

on software under the KST Act, 1957 and KVAT Act, 2003.

The said circular is issued for the benefit of the dealers and

developers of software and the departmental officers because

of the confusion created. It reads as under:-

40

CIRCULAR NO.17/06-07

No.KSA.CR.76/05-06, Bangalore, dated

24-7-2006

Sub: Levy of tax on software under the KST Act,

1957 and KVAT Act, 2003-Reg.

It has been brought to the notice of this

office that there is confusion with regard to levy of

tax on transactions relating to computer software.

2. The matter is examined and it is

considered necessary that the transactions be

analysed for the benefit of the dealers and

developers of software and the departmental

officers in expeditious assessment and recovery

of tax on these transactions.

(1) Software is goods for the purpose of

levy of tax under the provisions of the KST Act,

1957 and the KVAT Act, 2003. The sale of

transfer of property in software for consideration

that would be liable to tax, could be a direct sale

or a deemed sale.

(2) Direct sale of software would

ordinarily be that transaction in which software

is sold to the purchaser in a deliverable state

41

through an appropriate media – floppy, C.D., etc,

Such direct sale may include transactions in

which the software agreed to be sold is developed

or programmed at the purchasers’ premises and

later delivered to the purchasers. It would also

include transactions in which sale of software for

specific task that may go as a part of another

software in use by the purchaser. Even after any

such sale (direct sale), as per the trade practice,

in many cases the copyright or the intellectual

property right relating to the software sold may

still vest with the seller. However, this would not

affect the nature of the transaction from being a

sale for the purposes of the KST Act or the KVAT

Act. As in the transactions relating to any other

goods, even in respect of software, there could be

some modification or change that would be made

in the software sold. Whether any charges

collected by the seller towards such modification

or change, generally called as customization in

software sector, is a post sale or pre-sale

expenditure would depend on the

agreement/contract between the seller and the

buyer, and on the actual conduct of the parties

concerned as indicated by the relevant

42

documents and books of account. The fact

whether any such customization is done at the

seller’s premises or the purchaser’s premises

would not be of any relevance to determine this

aspect. Similarly, whether such charges were

collected in lump sum or on the basis of man

hours spent for such development would not by

itself be of any relevance to determine this aspect.

(3) Deemed sale or transfer of property

in software in the execution of a works contract

would ordinarily be that transaction pursuant to

a contract, in which a ready software or the one

which is developed/ programmed as per the

specifications of the purchaser would be delivered

/supplied to the purchaser by being loaded to the

purchasers equipment or any other similar device

and the relevant agreement /contract / order

envisages payment of charges for such service

rendered by the seller. As pointed out in the

earlier para, where such service rendered is a

pre-sale service making the transaction a direct

sale or is a post-sale service would depend on the

agreement/contract between the seller and the

buyer, and on the actual conduct of the parties

concerned as indicated by the relevant

43

documents and books of account. Such deemed

sale may also include a transaction in which the

seller integrates his software with a software

belonging to the purchaser either as a part of a

contract for maintaining, repairing, upgrading or

improving software or any device embedded with

software entered into between the seller and the

buyer. As pointed out earlier, such integration

leading to transfer of property in software from

the seller to the buyer for a consideration may

happen at the seller’s premises or the buyer’s

premises. In all such cases of deemed sale of

software or transfer of property in software in the

execution of a works contract (by whatever name

called), the seller would be liable to claim

deduction from his taxable turnover amounts

towards “labour charges and other like charges”

not involving any transfer of property in goods

actually incurred in connection with the execution

of such works contract under the provisions of

Rule 6(4) of the KST Rules, 1957 and Rule 3(2) of

the KVAT Rules, 2005.

(4) The third kind of transactions are the

ones that would not involve any transfer of

property in software (either as a part of a deemed

44

sale or as a result of other sale), but which would

involve a person or a-dealer providing manpower

or technical services for agreed consideration

(based on man hours or such other basis) to any

other dealer or any other person to program /

develop software for such other person or dealer

at the premises of the former or latter (the

manpower provider or technical service provider

could be a dealer engaged in selling of software

or other goods apart from providing manpower/

technical services and similarly the person

procuring such manpower/services could be a

dealer engaged in selling software or other goods

apart from being in business which does not

involve sale of goods). In such transactions, the

software so developed/ programmed would be

the property of the latter and the former would

not have any ownership over such software

developed/ programmed. Such transactions of

providing manpower/ services of technical

personnel may also be for the purpose of

implementing, deploying, testing, maintaining,

repairing, upgrading or improving software but

without involving any transfer of property in

software in the execution of the contract for the

45

work of providing manpower or providing or

performing services. The charges collected

(whether called as labour charges, consultant

charges, etc.,) by the manpower or service

provider in such transactions would not be

turnover for the purpose of the KST Act, 1957 and

the KVAT Act, 2003. However, whether a

transaction is a works contract involving transfer

of property in goods or is a mere service or labour

contract would depend on the agreement/

contract between the parties, and on the actual

conduct of the parties concerned as indicated by

the relevant documents and books of account.

3. All the concerned may note and follow the

above points made in all applicable cases. It is

once again emphasized that the classifications as

made above regarding the transactions relating to

development or programming of software into

those which are liable to tax under the provisions

of the KST Act, 1957, or the KVAT Act, 2003 are

only illustrative to guide the officers in this regard

and would apply only to such cases in which the

facts that are relevant for this purpose are more

or less similar. All the relevant facts and material

in each case would have to be examined by the

46

authorities concerned in the light of any binding

judicial pronouncements and action should be

taken as per the provisions of the KST Act, 1957

or the KVAT Act, 2003 and the rules made

thereunder to assess and recover tax due”.

21. The aforesaid circular recognizes three types of

transactions. Firstly, direct sale of software in which

software is sold to the purchaser in a deliverable state

through an appropriate media – floppy, C.D. etc., In this

type of transaction, the copyright or the intellectual property

relating to the software sold vest with the seller. The

position would be the same even in respect of software where

some modification or change is made to the software sold.

The same is generally called as customization in software

sector. The fact whether any such customization is done at

the seller’s premises or the purchaser’s premises would not

be of any relevance. The copyright or the intellectual

property rights of such modification also vests with the

seller.

47

22. In the case of deemed sale or transfer of property in

software in the execution of a works contract, the seller

would be liable to claim deduction from his taxable turnover

amounts towards labour charges and other like charges not

involving any transfer of property in goods actually incurred

in connection with the execution of such works contract. In

this case also, the copyright or the intellectual property right

in the goods vest with the seller and what the purchaser gets

is the right to use such copyright or the intellectual property.

23. However, the third kind of transactions are the ones

that would not involve any transfer of property in software

either as sale or as a part of a deemed sale. This type of

transaction involves a person or a dealer providing

manpower or technical services for agreed consideration. In

such transactions, the software so developed/programmed

would be the property of the purchaser and the seller would

not have any ownership over such software

developed/programmed. Such transactions of providing

manpower/services of technical personnel may also be for

48

the purpose of implementing, deploying, testing,

maintaining, repairing, upgrading or improving software but

without involving any transfer of property in software in the

execution of the contract for the work of providing manpower

or providing or performing services. Therefore, the

department recognizes that the contract for implementation

does not involve any transfer of property.

24. The packaged, readymade, off the shelf software are

pure goods liable only to VAT. The customized software or

tailor made software for an individual customer, similar to

packaged software, where the copyright owned software is

put on the media and delivered by way of transfer of right to

use, will also be goods and is liable to VAT. In the case of

customized software, the customized portion is embedded to

the original software so as to become the customized

software, the copyright of the entire software including the

customized portion is exclusively owned by the developer of

the software. Therefore, in both packaged and customized

software, where copyright is held by the developer of

49

software and the copyrighted article alone is handed over to

the customer as a transfer of right to use goods, the software

is goods and liable to VAT alone.

25. However, in the case of customized software, it is

possible for an entity to work on a hired contract basis

rendering pure service and get delivered fully developed

software for a specified customer with future contracts for

upgradation and enhancement. In such a situation too, the

software emerges. However, the copyright in such software

belongs to the customer, as it is developed, and the

developer of the software does not retain any copyright in

such software. In such a situation, since there is no transfer

of property in goods and what is provided is only a pure

service, there can be no liability to VAT. The consideration

in such cases is liable only to service tax.

26. In the case of Annual Technical Support (ATS), if the

agreement of the contract includes the annual maintenance

involving both service and issuing upgraded or enhanced

50

software, then such a contract is a combination of both

goods and service. The contract is in the nature of works

contract. VAT is liable to be paid on the goods part and

service tax is to be paid on the labour aspect. In

upgradation and enhancement, the copyright is owned by

the developer of software and what is transferred to the

customer is the right to use.

27. In the case of implementation of customized software,

where the copyright of the customized software is with the

software developer, the implementation process is a pure

service rendition and does not involve any transfer of

property. If any source coding or scripting is done during

the process of implementation, the ownership or copyright or

any proprietary right would not vest with the software

developer. It works purely as a hired labour. The ownership

vests at all point of time with the employer who had issued

the assignment. In those circumstances, since there is no

transfer of ownership or the licence to use the software

(deemed sale), it is a pure service contract. There is no sale

51

of goods. It is a case of rendering service and is liable to

service tax only.

28. It is not in dispute in this case that the ‘finacle’

software owned by the assessee is goods. As is clear from

the material on record as this software package by itself is

not useful to the customer, he approaches the assessee for

customization of the said software to meet their

requirements.

29. In the proceedings dated 12.09.2007 recorded by the

Assistant Commissioner of Commercial Tax, it is stated as

under:-

The company was visited mainly to understand

the pre-sale and post-sale activities of software

product ‘Finacle’ developed by the company, such

as “identification of the clients/response to the

tenders floated by clients, preliminary

understanding of the requirements of the clients,

extent of the features inbuilt in ‘Finacle’ matching

the requirements of the customers sale of

‘Finacle’, adoption of ‘Finacle’ as per the

52

requirement of the customer needs i.e.,

customization of the standard product to meet the

required version of the customer to continue his

regular nature of work and implementation of the

software, training the staff, data transfer,

warranty maintenance and to discuss and

understand the process of development,

customization and implementation of the ‘Finacle’

programme developed, by M/s. Infosys.”

30. Therefore, from the aforesaid passage it is clear there

is a process of development, customization and

implementation of the ‘Finacle’ programme. Speaking about

customization it is stated as under :-

“1. Response to customers requirements –

Request for proposal (RFP). A functional request

for proposal is prepared in which the

requirements of the clients are classified as

* Standard feature - If the customer

requirements are already built in, then it is

treated as standard feature.

* Customization – Customer requirements are

available in Finacle software in some form, but

53

requires customization to match the clients’

requirements.

* Enhancement - Customer requirements are

not there in the software and also cannot be

customized but may be made available in the

next version of the software

* Alternative available - Customer

requirements may be met alternative feature

with all the relevant information.

* Unavailable – Totally not available.”

31. It also states the various aspects involved in the

customization activities of the ‘Finacle’ product. They can be

broadly classified as under :-

a. Reports (formatting to the data)

b. Scripting (Functional customization)

c. Configuration (parameters)

d. ONS customization (Screens)

e. Identification of product enhancements

32. After the customization is over and the finacle software

which meets the requirement of the customer is sold, starts

the implementation phase. The said implementation phase

54

includes (a) Training (b) Requirement Study (c) Transfer of

data.

33. Therefore, a case study was made in the case of UCO

Bank project and it is stated as under:-

“2) Once the ‘RFP’ is evaluated and approved the

software product ‘F’ is directly billed to end

customer against tax invoice and VAT collection

3) Customization/improvement: After ascertaining

the available standardized feature in the ‘Finacle’

program, it is then worked out to see the extent of

customization/scripting required in the

tender/WO’s floated using the tools & utilities in

Finacle Software.

4) If the extent of deviation from the standard

feature is large then the process of improvement

of the software program is undertaken in the

higher version or undertaken as patches.

5) Signing off: After the successful

implementation and effective functioning of the

software program ‘Finacle’, it is then closed by

signing off.”

55

34. It is to be noticed here that the authorities were

dealing with the case of UCO Bank. In the UCO Bank

project the assessee has sold the customized finacle software

to UCO Bank. M/s. Hewlett Packard India Sales (P) Ltd, who

is a systems integrator i.e., the person who is responsible for

implementation, was engaged by UCO Bank for the purpose

of implementation of the said software purchased. Therefore,

under the said contract, out of the total consideration

payable for customization and implementation, assessee was

paid the consideration for grant of license to use the

customized finacle software and M/s. Hewlett Packard India

Sales (P) Ltd., was paid the implementation charges. The

client UCO Bank did not pay any amount to the assessee

towards implementation. This only shows that the

implementation can be done by a third party also and not

necessarily the assessee who is the owner of the software.

But, incidentally, M/s. Hewlett Packard India Sales (P) Ltd.,

entered into a sub-contract with the assessee for the UCO

Bank project. Ex.G which gives the price and payment sets

56

out the implementation cost for Finacle core banking

solution (for first 5 branches in the PILOT phase) at

Rs.6,05,00,000/-. It makes clear that the remaining 20

branches will be rolled out and supported by HP and then it

sets out the charges payable to the assessee at different

rates for different activity per person per day.

35. The material on record shows that the assessee enters

into several types of contracts. One type of contract involves

contract of supply of customized products, contract of

implementation and contract for ATS. An example is the

assessee’s contract with Federal Bank which is also part of

the records. The 2nd type of contract is only contract of

supply of customized products and ATS contract, without

contract of implementation. An example of such contract is

the assessee’s contract with UCO Bank, which was

discussed above. Therefore, in order to find out what the

intention of the parties the entire contract is to be read as a

whole. Terms have to be looked into and then only we can

57

find out how the parties have given effect to the terms of the

contract.

36. In this background, we have to find out the nature of

the transaction in the instant case. We have already

examined above the contract with UCO Bank and noticed

how implementation is not part of the said contract. The

implementation agreement was with M/s Hewlett Packard

India Sale (P) Limited. Now, let us examine the contract

entered into by the assessee with Federal Bank, which was

also examined by the Assessing Authority in the impugned

order. Annexure I is the software which is licensed to the

customer. The said Annexure-I reads as under :-

“Annexure I – “Software”

1.1 Licensing Terms & Fees _________________________________________________________________

Sl. Product/Modules Licensing Terms License Fees ATS Fee No. in INR in INR

1. Finacle Core Branch License 6,80,00,000/- 12% of Banking Solution for 600 branches the license with Retail Corporate in India fee Trade Finance Reporting tools Sign

58

Cap Central FAB Connect 24 Branch FAB for 20 branches _________________________________________________________________

Branch is defined as a service outlet (SOL). The

total number of branches will be arrived by

counting the SOLs in the Finacle core banking

solution.

All the 600 licenses mentioned above to be

procured within 12 months from the date of UAT

sign off.

For additional branch license beyond the first 600

branches, the license fee for Finacle Core Banking

Solution shall be Rs.1,10,000/- per branch and to

be procured in lots of 10 branches.

Notwithstanding anything contained to the

contrary in the Agreement, the license has been

granted to Federal Bank and its branches in

India and shall not be assigned or transferred to

any other entity. However, in the event of

corporate actions including but not limited to

merger or acquisition the Parties shall in good

faith mutually agree and discuss the terms and

conditions of extending the license to merged or

acquired entity.

59

1.2 ATS Terms & Fee:

• ATS will commence from the date of first

branch GO LIVE

• Bank and INFOSYS may mutually renew ATS

by signing an Addendum to this Agreement.

Such renewal will be charged @ 12% for each ATS

period of 12 months, for the license granted under

this Agreement. This amount has to be paid in

full in advance at the beginning of each renewal

period. ATS Fee specified above is valid for 3

years from the Effective Date of this Agreement

and is subject to review thereafter.

• In the event of ATS not being renewed for

Software and/or Third Party Software. INFOSYS

has no obligation to extend any ongoing product

support either through helpdesk or through

product Upgrades, Maintenance Releases etc. to

BANK as stated under the Agreement.”

37. Annexure-I to the agreement shows the assessee sold

Finacle Core Banking Solution with Retail, Corporate, Trade

Finance, Reporting tools, Sign cap, Central FAB, Connect 24

and Branch FAB for 20 branches. What they sold was 600

branch licenses aggregating to Rs.6,80,00,000/-. Therefore,

60

no implementation charges is involved in the contract for

supply of software with Federal Bank also.

38. Annexure – I does not include the implementation.

Annexure-I makes it clear that ATS will commence from the

date of the first branch GO-LIVE. It is in this context Article

2 speaks about title. Article 2 of the agreement which deals

with TITLE makes it clear that INFOSYS and Third Party

Vendors shall at all times retain all title, copyright, and other

proprietary rights in Software and Third Party Software

respectively, any Enhancements, upgrades, maintenance

releases etc. thereto and translations thereof and Bank does

not acquire any rights in the same other than those specified

in this Agreement. Subject to the Bank paying the required

license fee and observing all terms of the Agreement,

INFOSYS grants to the BANK a non exclusive, perpetual, non

transferable, limited license to use the Software.

39. Therefore, from the aforesaid clause it is clear at all

times, the assessee has retained copyright and several

61

proprietary rights in software and what is transferred is a

non-exclusive, perpetual, non- transferable limited license to

use the software.

40. The material on record discloses that finacle software,

which is owned by the assessee as a packaged software, is a

software before customization. The authorities call it as a

software with standard features, where the customer

requirements are already built in. In other words, these

software, which is available on the shelf, is a copyrighted

article. It is also known as a branded software. As is clear

from the impugned order though the customer requirements

are available in finacle software in some form it requires

customization to match the clients’ requirements. It is for

this purpose RFP is entered into, where the customer gives

his requirements. It is only if the assessee is able to meet

the said requirements then he enters into a contract

prescribing consideration for such customization. Once, for

the purpose of customization, scripting is done, which is

otherwise known as source code or code writing, the software

62

which comes into existence, which would satisfy the

requirement of the client, is also owned by the assessee.

However, that software is embedded in the package

software/standard software of the assessee. Once this

customization takes place it becomes an un-branded

software i.e., Customized copyright article in the form of

finacle. When that software is transferred to the customer,

what is transferred is the right to use the software. The

copyright continues to vest with the assessee. Article 2 of

the agreement makes this position clear. In other words,

there is no transfer of copyright. However, there is transfer of

right to use the software embedded in that product. By

virtue of Article 366 (29A)(d) the right to use that software is

deemed sale and is subjected to VAT.

41. As is clear from the impugned order at the time of

evaluating the RFP there exists a standard feature or a

packaged software. After knowing the requirement of the

customer, the customization is done to meet the

requirements of the customer. Therefore, in the agreement

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where they have defined the word “Software”, it is a

customized software. As per the definition, ‘software’ means

the object code of INFOSYS proprietary software and

documentation such as user guides and any other

documentation provided from time in conjunction with

Software, for which Non- Exclusive License in accordance

with the terms of the agreement is granted by INFOSYS to

BANK, as listed in Annexure I and any Addendums thereto

signed by both the parties, and the intellectual property

rights for which are owned by Infosys.

42. Clause 5 of the agreement speaks about the “technical

support”. It provides that the scope of technical support

includes :

A. HelpDesk Technical assistance on Software

and if agreed, on Third Party Software through

Telephone/Facsimile/E-mail for

Problem solving and trouble shooting,

Rectification of any bugs reported

B. Upgrades and Maintenance releases of

Software and if agreed, Third Party Software,

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excluding separately Priced/optional products or

modules for which BANK has not purchased any

rights.

43. “Upgrades” have been defined to mean subsequent

improved versions and releases of Software or Third Party

Software as the case may be, which may be provided in

accordance with the terms mutually agreed to between the

parties, and which are generally made available to

customers covered under ATS at no additional charge.

Upgrades may include Software Trouble Reports (STR) fixed

and Software Enhancements incorporated.

44. It also provides certain exclusions:

“Any on-site support, whether for Software

or Third party Software will be outside the scope

of this clause. Any such onsite support will be

charged extra to BANK at the prevailing INFOSYS

onsite support rates. It is also made clear all

Customizations and Developed Software are

outside the scope of ATS and shall be maintained

by Bank.”

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45. Therefore, the copyrights in the enhancements,

upgrades, maintenance and releases vests with the assessee

and the same is not transferred to the customer and what is

transferred is only the right to use. Therefore, the said right

to use these enhancements, upgrades, maintenance and

releases also constitutes goods and is liable to VAT. The

record shows that the assessee has paid VAT on these

enhancement and upgrades. Therefore, it is clear ATS is a

works contract. It is a contract to permit right to use

enhancements, upgrades, maintenance and releases as well

as annual technical support services as it was indivisible by

virtue of 46th amendment which falls under Clause (b) of

Article 366 (29A).

46. Implementation is also set out in Annexure-IV under

the heading ‘services’. It reads as under :-

“Definitions

1.1 “Pilot is defined as Finacle Core Banking

solution going live in 15 branches

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1.2 “Going Live”

“Going Live” shall mean BANK start using the

licensed Software at “Pilot” to offer Banking

services to its customers.

1.3 “Parameterisation”

“Parameterisation” shall mean capturing and

defining as parameters in Software. BANK’s

banking business requirements and environment

like the chart of Accounts. Business rules,

products and schemes and rules for handling

exceptional conditions by INFOSYS and BANK

based on information provided by BANK. Under

Parameterisation, Software is configured using

standard parameters available in Software.

‘Customisation’ as defined in the Agreement is

outside the scope of Parameterisation.

1.4. “Parameterisation Sign-off”

“Parameterization Sign-off” shall mean sign-off

between BANK and INFOSYS upon completion by

INFOSYS of the parameterization of licensed

Software. This sign-off shall be completed prior to

Going Live with licensed Software

2. Scope of Pilot Implementation:

Pilot Implementation services included under the

scope of this Agreement are specified below.

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INFOSYS will be responsible for:

• Project management of the pilot project

• Initial systems study to understand

BANK’s requirements

• Core Team Education for a team of up to 25

members of BANK’s core team

• Installation of Software at the Data Centre

• The pilot implementation phase shall be

deemed to be complete when Software shall

Go Live in Data Centre and 15 number of

branches.

BANK will be responsible for:

• Job Cards and Process Manuals

preparation.

• Providing inputs for Parameterization.

• Data extraction from the current system.

• Systems Integration Testing (SIT) and

Simulation Run. INFOSYS will assist in the

same.

• End user training

• Infrastructure readiness

• Program management

3. Core Team Education

Scope of Core Team Education:

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• Training for the BANK’s Core Team on the

licensed Software as per Annexure1

• Core team education will be done for 1

batch.

• Size of the batch shall not be more than 25

people.

• The Training will be conducted at INFOSYS

facilities in Bangalore

• During core team training at Bangalore,

traveling, lodging and boarding expenses of

BANK officials will have to be borne by BANK.

4. PILOT IMPLEMENTATION FEES

• Pilot Implementation Fess for Finacle Core

Banking will be INR 220,00,000/- (two crores

and twenty lakhs only). This cost is inclusive

of 2500 man days of customization efforts.

Infosys will provide the capacity planning

recommendation for the hardware for Finacle

core banking solution.

• Core Team Education Fee for Finacle Core

Banking Solution for the modules licensed is

INR 30,00,000/- (thirty lakhs only). This

training fee includes the charges for two

executive appreciation programme and one

audit training.

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• All applicable taxes shall be charged extra

to BANK

5. Professional Services Rates

Professional services outside the scope of the

agreed implementation can be availed by the

BANK as per INFOSYS Professional Services

charges mentioned below :

Role Classification Charges in INR

Implementation /post 8,000/- per person

Implementation/customization per day

Services of software engineer

Implementation/post 10,000/- per person

Implementation/customization per day

Services of project leader

Implementation/post 15,000/- per person

Implementation/customization per day

services of project manager

/Application consultant

Training (core team) EAP 40,000/- per instructor

day

Database tuning 25,000/- per person per

Day

Note:

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• “Person Day” is defined as Eight hours per

day or part thereof.

• All services required by BANK, beyond the

scope of the services defined under Clause 1

to 4 of this Annexure either during or after Pilot

Implementation will be charged to BANK at

mutually agreed rates.

• These professional services rates are exclusive

of travel

• Travelling expenses (return economy class

airfare from the point of origination), hotel

room charges at actuals and local conveyance

will be charged extra to the BANK in case of

cities other than Bangalore and all onsite

services beyond the pilot phase

implementation. The boarding and other

expenses will be charged for the total duration

of the INFOSYS Engineer/Consulant/Project

Manager’s stay at the Bank’s site including

non-working days during that stay.

3. Detailed scope of work for the services to be

provided by Infosys shall be detailed out in a

statement of work which shall be agreed

between the parties.

4. Termination

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Following termination of the Agreement or this

Annexure by either Party, BANK shall pay to

INFOSYS charges for all Services provided to the

BANK up to the date of termination.”

47. Therefore, all the required responsibilities of the

assessee is clearly set out. It includes Project management

of the pilot project, initial systems study to understand

Bank’s requirements, core team education for a team of up

to 25 members of bank’s core team and installation of

software at the Data Centre. The pilot implementation phase

shall be deemed to be complete when software shall Go Live

in Data Centre and 15 number of branches. Article 3 deals

with Core Team Education which includes training for the

bank’s core team on the licensed software as per Annexure-I,

core team education will be done for one batch, size of the

batch shall not be more than 25 people, training will be

conducted at INFOSYS facilities in Bangalore, during core

team training at Bangalore, traveling, lodging and boarding

expenses of the bank officials will have to be borne by the

Bank. Then Article-4 specifies the fees payable for pilot

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implementation. Then Article-5 speaks about professional

Services Rates. In none of these provisions, there is a

mention of any software coming into existence which will be

made use of in the implementation process. On the

contrary, it is specifically stated that before pilot

implementation programme commences, there should be

installation of software. Therefore, the implementation of

programme starts only after the installation of software

which is the goods which is transferred under the agreement

i.e., the customized copyrighted article ‘finacle’ of the

assessee. The nature of the services rendered is in the

nature of imparting training to the bank officials who will

have to operate the system and the fees for implementation

is based on 2500 man days and professional service rates is

collected on the basis of Rs.8,000/- per person per day.

Similarly Rs.10,000/- per person per day; Rs.15,000/- per

person per day. Therefore, the professional charges are paid

for the services rendered. In the entire scheme of the

services, there is no whisper of any software coming into

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existence without which the implementation cannot be

completed. In fact the word ‘Going Live’ gives an indication

that the bank starts using the licensed software at ‘Pilot’ to

offer banking services to its customers. The word ‘Pilot’ is

also defined as Finacle Core Banking Solutions going live in

15 branches. Similarly the word ‘Parameterisation’ means

capturing and defining as parameters in software, Bank’s

banking business requirements and environment like the

chart of accounts, business rules, products and schemes

and rules for handling exceptional conditions by INFOSYS

and Bank based on information provided by the Bank. Under

Parameterisation, software is configured using standard

parameters available in software. In other words, it is an

integration of several systems which are available in the

software to make the bank to use the software. It is made

clear that the ‘Customization’ as defined in the agreement is

outside the scope of parameterization. In other words, in the

process of integration and making the system workable, if it

becomes necessary to script/write a code, it would be client

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specific and it also amounts to customization. But this

customization which is defined under the agreement means

modifications done outside the source code of software or the

third party software using the customization or extensibility

infrastructure provided by software or third party software

which are outside the scope of software and the right to re-

use and/or incorporate into software or third party software

such customizations is retained by the assessee but the

ownership of the said software vests with the customer.

Therefore, it is clear, in substance implementation means

the customized software is integrated into several other

systems so that the bank can start using the licensed

software. In the process, there is no transfer of any goods or

right to use any goods, what is rendered is service and

therefore, the said consideration paid as service charges is

not subjected to VAT but subjected to service tax.

POINT No. 2:-

48. The argument is that implementation is a part of

customization. Without the software being implemented it is

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not saleable, useable, functional and therefore VAT is

payable on the transactional value which includes

implementation charges. Without implementation the

software is not capable of being marketed or saleable.

49. In fact, today, on behalf of the State, a statement is

filed showing the turnover declared by the assessee in

respect of the local sale of finacle and CST sale of finacle. A

reading of the aforesaid statement shows in April 2005 the

total value of local sale of finacle software is

Rs.2,61,93,743/-. No consideration is received for

customization. Similarly in the case of CST sale of finacle.

50. According to the State, customization includes

implementation. Therefore it is contended that without

customization without implementation, the software is not

complete saleable, useable and functional. However, when

we look at the aforesaid table, assessee has sold software

without the same to the extent of Rs.2,61,93,743/-, If that

is so, the argument that without the implementation the

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finacle product is not saleable is without any merit. Equally,

the argument that implementation is a pre-sale activity and

not a post sale activity, is also not acceptable.

51. In the impugned order, the Assessing Authority

proceeds on the basis that the assessee customizes the

software built by it and after carrying out the

implementation, delivery is made to the customer. Though

billing is made earlier at the time of delivery and handing

over of the customized software, it clearly points out that the

customization receipts are pre-sale expenditures and the

said charges so collected in the guise of services is

includable in the taxable turnover. The said customized

software sold remains the copyright of the assessee and

could not be altered or modified without the permission of

the assessee. Mere raising an invoice depicting sale of

software will not change the nature of property delivered i.e.,

customized finacle software. Further, the assessee will

continue to hold its control over the said delivered software,

even after the billing date. So, when the assessee is having

77

control over the said goods even at the stage of usage by the

client, it is wrong to say that, he has no authority over the

software sold, immediately after the billing is made. After

referring to several clauses in the agreement, it was held that

the assessee though issues tax invoice for the sale of finacle

software, only customized finacle software is delivered to the

client and hence, the splitting up of a single activity into

divisible activity i.e., one for sale and the other for

service/customization is not correct and, therefore,

proceeded to hold that the implementation of the project is a

pre-sale process and it is subjected to VAT. The aforesaid

factual finding recorded is contrary to the material on record.

52. The understanding of the authorities is that the

assessee has developed a software viz., ‘Finacle software’

which is a basic software relating to banking activities and is

the copyright holder for the same. Whenever customer

namely a bank approaches the assessee to develop software

for their business activities, the assessee will take steps to

develop the said software as per the requirement of the

78

customers. In this activity, the assessee will make changes

to the finacle software held by it by customizing the same to

the requirement of the customers and will deliver the

improved/modified version of the finacle software to them.

Here, what is transferred is the software with all

modifications as per the request and the proposal made by

the customers. This implementation process is nothing but

value addition to the finacle software, but the dealer while

declaring the turnover, splits the said transaction into two

parts namely, sale part and service part. This act of the

dealer in splitting the contract as one for sale and the other

for implementation of finacle software, thereby claiming

exemption on the latter part is not correct because in almost

all the instances, what is supplied by the assessee to the

customers is the software as per the requirements and the

amount received towards the whole process of customization

has to be considered as the amount received for the supply

of customized finacle software.

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53. From the aforesaid findings, it is clear that the

Assessing Authority is of the view that the customization is

equivalent to implementation. During customization when

scripting or code writing is done in order to make the

standard or package software useful to the client, the

consideration paid for customization constitutes the

consideration for transfer of goods. The said aspect is not

disputed by the assessee.

54. What the assessee contends is that the assessee has

the packaged software ‘Finacle’ a banking solution. If the

said software cannot be used as such by the banks, then

they make known their requirements to be incorporated in

the said packaged software either by way of modifications,

additions and so as to make it customer specific, which is

called as customization. What is sold by the assessee to the

bank is the customized software and not the packaged

software. It is clear from the invoice that for the

consideration received for this customized software, the

assessee has paid VAT because the assessee has copyright

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not only in the packaged software but also in the customized

software and what is transferred to the bank is only the right

to use the said software which is a deemed sale. After this

customized software is installed in the premises of the bank,

before bank starts using it, the process of integration with

other systems has to be carried out. It is for that purpose a

separate contract called service contract is entered into. The

terms of the said contract as set out above involves only

rendering service and rendering training to the employees of

the bank, so that the installed software starts functioning.

The terms of the agreement makes it clear that it is not

obligatory for the bank/customer to have the services

rendered only by the assessee as a part of contract of sale or

a condition of sale. It is open to the customers to have the

services rendered by any other competent agency. Therefore,

the Assessing Authority has misconstrued this

implementation to that of customization of the software and

erred in holding that the customization involves transfer of

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goods and the assessee cannot avoid payment of VAT by

describing the same as implementation.

55. Whether any charges collected by the seller towards

such modification or change, generally called as

customization in software sector, is a post sale or pre-sale

expenditure would depend on the agreement/contract

between the seller and the buyer, and on the actual conduct

of the parties concerned as indicated by the relevant

documents and books of account. The fact whether any such

customization is done at the seller’s premises or the

purchaser’s premises would not be of any relevance to

determine this aspect. Similarly, whether such charges were

collected in lump sum or on the basis of man hours spent for

such development would not by itself be of any relevance to

determine this aspect. Whether service rendered is a pre-sale

service making the transaction a direct sale or is a post-sale

service would depend on the agreement/contract between

the seller and the buyer, and on the actual conduct of the

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parties concerned as indicated by the relevant documents

and books of account.

56. Therefore, in the instant case, as is clear from the

invoice at Annexure-1, the price paid is for the customized

Finacle software. The Annual Technical Support commences

from the date of first branch GO LIVE. ATS fees specified is

valid for 3 years from the effective date of the agreement and

is subject to review thereafter. The contract also includes

pilot implementation fees which is calculated for 2500 man

days of customized efforts. Separate fee is also charged for

core team education fee. This training fee includes the

charges for two executive appreciation programme and one

audit training. Professional services outside the scope of the

agreed implementation can also be availed by the customer

as per the assessee’s professional services mentioned in the

agreement. It is stated that, before pilot implementation

programme commences, there should be installation of

software. Therefore, the implementation of programme

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starts only after the installation of software which is the

goods which is transferred under the agreement i.e., the

customized copyrighted article ‘finacle’ of the assessee. As

only after the supply of packaged and customized software,

service is required to integrate the system to make the

software functional or useable under the contract if that

function is also entrusted to the assessee, the assessee

renders services for implementation of the project. It is in

the nature of post sale activity. As there is no transfer of any

goods at the time of implementation of the project, there is

no direct sale or deemed sale. It is in the nature of service

simplicitor. Therefore, irrespective of the timing of the

contract and the payment of the money as consideration of

the contract, even if it includes consideration for

implementation of the project, the said payment is for post

sale activity and it is for service to be rendered to integrate

the system and implement the project. No VAT is required to

be paid on this aspect.

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57. Though there is one composite contract, it is in

different parts – one part deals with the contract of sale of

customized software and another deals with the services to

be rendered for implementation. Yet another agreement

speaks about the technical service which is in the nature of

a works contract. The assessee has paid VAT on the

contract for sale of customized software. The assessee has

also paid VAT in respect of the goods aspect in the works

contract. Whereas the service contract does not involve sale

of goods nor it is exclusively a contract for sale of goods but

on the contrary it is an exclusive contract for rendering

service.

58. That apart ‘goods’ has been defined under the

Constitution at Article 366(12). The State legislature has

defined ‘goods’ in the VAT Act at Section 2(15). While

dealing with the levy of tax it is the definition given in the

Constitution which has to be taken note of and whatever

may be the definition in the State legislation, it has to yield

to the definition in the Constitution and, therefore, any

85

attempt on the part of the State to bring the transaction in

question under the definition of the goods as defined in the

VAT Act has to be ignored. Even as per the definition under

the VAT Act, there is no difference and a service pure and

simple cannot be read into the definition of goods. With

effect from 16.5.2008 service in relation to information

technology software have been brought under the service tax

net by virtue of Section 65 (105) (zzzze). Section 65 (105)

(zzzze) of the Finance Act, 1994 defines information

technology services which includes adaptation, upgradation,

enhancement, implementation and other similar services

related to information software. Subsequently, the word

‘service’ is defined under Section 65B(44) of the Finance Act,

1994 which has come into effect from 1.7.2012 which

excludes any activity which constitutes merely such transfer,

delivery or supply of any goods which is deemed to be a sale

within the meaning of clause (29A) of Article 366 of the

Constitution. Once implementation is included in the

definition of taxable service under the Service Tax Act, the

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State Legislature has no power to levy VAT treating it as

involving transfer of property in goods or otherwise. Section

66E provides for ‘declared services’. One such declaration is

found at clause (d), i.e., development, design, programming,

customization, adaptation, upgradation, enhancement,

implementation of information technology software.

Therefore, once the Parliament has expressly declared the

aforesaid activities as a declared service, the jurisdiction of

the State to levy tax on such activity stands excluded.

Therefore, seen from any angle, the case of the State that the

implementation of information technology software is a pre-

sale activity and, therefore, constitutes sale is without any

substance.

59. In fact this Court had an occasion to consider a

somewhat similar situation in the case of Sasken

Communication Technologies Limited –vs- Joint Commissioner

of Commercial Taxes, Bangalore (Appeals)-3 Bangalore

reported in (2012) 55 VST 89 (Karn.). After considering

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numerous judgments of the Apex Court on the point, this

court, at para-35 held as under:

“Therefore, computer programming and

providing of computer software involves two

aspects, one falling within the power of the

Parliament and the other falling within the power

of the State Legislature to enact the law, the law

so enacted cannot be found fault with. When the

programming and providing of computer software

is treated as works contract, as the works

contract necessarily involves an agreement to

render service and an agreement for sale of

goods, service aspect could be taxed by the

Parliament and the sale of goods aspect could be

taxed by the State Legislature. But, this

distinctiveness of two transactions is to be

ascertainable from the terms of the composite

contract. If such an intention is not discernible

from the terms of the contract then we have to

find out what is the pith and substance of the

contract or in other words what is the true nature

and character of the contract. If on an

examination of the contract as a whole, it is not

possible to discern that the contract involves sale

of goods but is essentially an agreement to render

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service, neither the concept of a works contract

nor the concept of aspect theory is attracted.”

60. In view of the aforesaid legal position well enunciated,

the contract for implementation, which is nothing but a

service contract, is not liable to VAT. In view of the

provisions contained in the Finance Act, 1994, ‘contract’ for

implementation specifically falls within the definition of

service and is taxed, as such, under the said law. The same

activity cannot be taxed under VAT, as rightly contended by

the learned Counsel for Union of India. In that view of the

matter, the order passed by the Assessing Authority is

unsustainable. Accordingly, it is hereby set aside.

61. In the instant case, the assessee has paid VAT for the

customized software. In fact the assessment orders passed

earlier recognized this fact, accept it and confirm the

transaction. No VAT is levied in respect of this part of the

consideration meant for implementation. In those

assessment orders, they categorically refer to the fact that

implementation is a post sale activity.

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62. In view of the fact that relief is granted to the assessee

on interpretation of the constitutional and statutory

provisions, it is not necessary for us to go into the

constitutional validity of the provisions which are impugned.

Probably that is the reason why even the Counsel for the

petitioner stressed on interpretation and if his argument is

accepted, it is not necessary to go into the question of vires

on the constitutional law.

63. In so far as the other aspects which are involved in the

impugned order is concerned, they are to be agitated by the

assessee in a regular appeal under statute and that cannot

be decided by the High Court. Therefore, if the assessee

were to prefer a separate appeal within 30 days from the

date of receipt of a copy of this order, the Appellate Authority

shall decide those issues by entertaining the appeal on

merits without going into the question of limitation.

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64. For the aforesaid reasons, we pass the following:

O R D E R

i) Writ petitions are allowed;

ii) The impugned order in so far as levying of VAT on

the assumption that the implementation is

nothing but customization of the software is

hereby set aside;

iii) As the assessee has already paid VAT for

customized software, it is not liable to pay any

VAT for implementation which happens after the

installation of the customized software in the

premises of the assessee.

iv) In view of the fact that the impugned order is set

aside and the petitioner has succeeded in these

petitions, the amounts deposited by virtue of the

order directing the petitioner to deposit the

amounts in terms of the interim order, is ordered

to be refunded to the petitioner.

v) The petitioner is at liberty to file a regular appeal

under statute, on the other issues not dealt with

in these Writ Petitions, within 30 days from the

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date of receipt of a copy of this order and, if the

petitioner does so, the Appellate Authority shall

decide those issues on merits without going into

the question of limitation.

vi) No costs.

Sd/-

JUDGE

Sd/- JUDGE

ckl/ksp/ng/nsu/-