Telangana High Court Quashes ₹52.39 Crore VAT Demand On TCS's Customised Software Services

The Telangana High Court has set aside a ₹52.39 crore Value Added Tax (VAT) demand imposed on Tata Consultancy Services (TCS).

It held that transactions involving the development of custom-made or customised software did not constitute a sale where TCS did not acquire ownership or title over the software. The Court found that there was no transfer of property in goods.

A Division Bench comprising Justice P. Sam Koshy and Justice Narsing Rao Nandikonda passed the common order. It allowed the lead writ petition and the other writ petitions on similar lines.

The Court was considering VAT demands raised on service turnover relating to software development, business process outsourcing, Digital Signature Certificate services, and maintenance and support services.

In the lead petition, TCS had challenged assessment orders for the assessment years 2010-11 to 2012-13. The orders imposed VAT of ₹52,39,44,119 on a turnover of ₹11,50,52,48,700.

The authorities had demanded VAT at 4% or 5%, as applicable during the relevant period. The assessment was based on the view that TCS had collected consultancy charges at different stages of software development and had not established that the turnover did not represent a sale of software.

The authorities also took the view that software in any form, whether customised or otherwise, constituted goods under Entry 2 of Schedule IV of the Telangana Value Added Tax Act, 2005. They further alleged that even maintenance transactions involved the development and sale of software.

TCS contended that its activities involved the development of custom-made and customised software. It also provided maintenance, technical support and other IT services, which it said did not involve any sale of software.

TCS submitted that it had discharged service tax on the transactions under the taxable category of “Support Services of Business or Commerce” under Section 65(104c) of the Finance Act, 1994.

The Revenue, on the other hand, argued that software and the medium on which it was supplied could not be split. It also contended that customised software was made for a particular customer and sold to that customer.

According to the Revenue, this did not make customised software any less of goods than non-customised software. It further argued that customised software had the attributes necessary to constitute goods.

The Revenue also argued that intellectual property, when put on a medium, became goods. It contended that a Digital Signature Certificate was an electronic key with embedded software.

The Court examined the agreements entered into by TCS with its customers. It found that the terms did not indicate any sale of software and made it clear that the arrangements were service contracts.

The agreements provided that the products, software, maintenance, associated copyright and other intellectual property rights emerging from the work would be the sole and exclusive property of the customers. The Court therefore held that TCS did not own any property that could be said to have been transferred to the customers for consideration.

The Bench noted that, in some agreements, the intellectual property vested in the customer from inception. In other cases, it vested momentarily in TCS during the rendering of services.

In the latter situation, TCS granted the customer a perpetual, non-exclusive and paid-up licence to use the intellectual property. The Court held that this did not amount to a transfer of goods for consideration.

The Court also found that the software was tailor-made for the requirements of a particular customer on a “work for hire” basis. It was incapable of being marketed or sold to any other person.

Referring to the Supreme Court's decision in Tata Consultancy Services v. State of Andhra Pradesh, (2005) 1 SCC 308, the Court noted that even unbranded software may constitute goods when it is marketed or sold in the open market.

The Bench, however, distinguished the software developed by TCS from software marketed or sold in the open market. It held that TCS's tailor-made software could not be equated with such software because it was developed specifically for individual customers and was incapable of being marketed or sold to others.

The Court held that the essential element of a sale, namely transfer of property in goods, was absent from the transactions. The transactions therefore remained service contracts and could not be subjected to sales tax or VAT in the absence of such a transfer.

The Court further held that the development of custom-made or customised software by TCS for its customers was a pure service contract. The mere inclusion of software development or customisation in a contract did not automatically mean that there was a transfer of title.

“...we are of the considered opinion that the transactions in question, both in relation to development of custom-made / customized software and in relation to issuance of Digital Signature Certificates, do not constitute a 'sale' so as to attract levy of Value Added Tax under the TGVAT Act, 2005...” the Court ruled.

The Court also considered the issuance of Digital Signature Certificates by TCS. It noted that TCS was a licensed Certifying Authority under the Information Technology Act, 2000.

The Bench held that issuance of the certificates was purely a service. It did not involve any element of sale of goods.

“...the issuance of such certificates is purely in the nature of a service rendered by the petitioner in its capacity as a licensed Certifying Authority under the Information Technology Act, 2000, and does not involve any element of sale of goods”, it said.

The bench accordingly held that the assessing authority was not justified in treating TCS's service turnover as representing the sale of software or other goods. The levy of ₹52,39,44,119 was held to be wholly unsustainable in law and on facts.

The assessment order dated March 18, 2016, and the revised assessment order dated March 22, 2016, were accordingly set aside and quashed.

The lead writ petition was allowed. The other writ petitions were also allowed on similar lines. There was no order as to costs.

For Petitioner: Senior Advocate V. Lakshmikumaran, assisted by Advocates Narendra Dave, Chanda Sumanth and Anushka Rastogi

For Respondent: Special Government Pleader Swaroop Oorilla