The Supreme Court has dismissed appeals by the Service Tax Commissioner to levy a service tax of more than Rs 56 crore on Quick Heal Technologies Ltd for its sale of anti-virus software during the period 2012-2014 .

The Court ruled that the sale of CD/DVD software is a sale of goods and that once sales tax is paid on the sale price, service tax is not payable on the same transaction reason that updates are provided to the customer.

The End User License Agreement granting the End User the license to use the Software is a transfer of right to use the goods and is a “deemed sale” pursuant to Section 366(29A)(d) of the Constitution.

Referring to the Supreme Court decision in Tata Consultancy Services c. State of Andhra Pradesh, (2005) 1 SCC 308, a bench comprising Judges Abhay S Oka and JB Pardiwala held:

“Once a lump sum has been charged for the sale of a CD (as in the present case) and sales tax has been paid on it, subsequent income can no longer levy tax on the services on the full consideration for the sale on the grounds that updates are in progress. We are of the view that the artificial separation of the transaction, as here, into two parts is not defensible in This is, in essence, a software sale transaction and once it is accepted that the software placed on the CD is a “good” then there can be no service element distinct in the transaction. We say this because even otherwise the user is put in full possession and control of the software. This amounts to a ‘deemed sale’ which would not attract service tax.”

The bench upheld the finding of the Customs Excise and Service Tax Appeal Tribunal (CETSTAT) that the service tax is not applicable to the retail sale of software packages and dismissed appeals filed by the tax authorities against the CETSTAT ruling. in favor of QuickHeal.

The Supreme Court’s analysis

The judgment written by Judge Pardiwala relied heavily on Constitution Bench in Tata Consulting Services case in which it was held that the sale of software packaged on a medium such as CD/DVD to the end customer is a sale of goods.

He stood in CDS that in India, the test for determining whether a property is a “property”, for sales tax purposes, is not limited to whether the property is tangible, incorporeal or incorporeal. The correct test would be to determine whether an item is capable of being taken, consumed, and used and whether it can be transmitted, transferred, delivered, stored, possessed, etc.

Revenues in this case argued that the service tax is due on the End User License Agreement (EULA), whereby the company agreed to provide the customer with regular electronic updates on the software initially installed. The income was based on the judgment of BSNL v Union of India (2006) 3 SCC 1, where the question was whether the sale of mobile SIM cards would incur a sales tax or a service tax. Based on this precedent, revenue argued that the service component in the EULA software can be dissected.

The Supreme Court noted that in the BSNL case, it was held that access to electromagnetic waves granted by a mobile phone company could not be considered a sale of goods and was considered a service.

The Court also referred to Section 366(29A) of the Constitution, which defines certain transactions as “deemed sales”. According to Section 366(29A)(d), the transfer of the right to use property for any purpose for consideration is deemed to be a sale.

The Court further noted that analysis of the definition of “service” as it appears in Section 65B(44) of the Finance Act 1994 clearly indicates that the service shall not include activities which include the transfer, delivery or supply of any property deemed to be a sale within the meaning of clause (29A) of section 366 of the Constitution.

The EULA is a transfer of right to use the software, therefore a “deemed sale”

In this context, the Court endorsed the Court’s finding that the EULA was in effect a transfer of the right to use the software, which will be a deemed sale under section 366(29A)(d).

“The Agreement provides that the Licensee will have the right to use the Software subject to the terms and conditions mentioned in the Agreement. The Licensee is entitled to use the RDM Software/Services from the date of activation of the license until the license expiration date. The Licensee is also entitled to updates and technical support. The terms set forth in the Agreement do not interfere with the Licensee’s free use of the Software. The mere fact that Quick Heal ― ‖ retains title and ownership of the software does not mean that it interferes with the licensee’s right to use the software.

Thus, viewed from all angles, the transaction in this appeal entails the right to use the software and would amount to a “deemed sale”. It is therefore not possible to accept the contention of the learned representative of the Department that the transaction would not be covered by subparagraph (d) of section 366 (29A) of the Constitution “judged by the Court.

The judgment explained from the court decisions, the established essential requirement of a transaction for the transfer of the right to use the goods as:

(i) it is not the transfer of ownership of the goods, but the right to use the ownership of the goods;

(ii) Section 366(29A)(d) read with the last part of clause (29A) which uses the words “and such transfer, delivery or supply”…would indicate that the tax is not on the delivery goods used, but on the transfer of the right to use the goods regardless of when or whether the goods are delivered for use, provided that the goods must exist to be used;

(iii) in the transaction of transfer of the right to use the goods, the delivery of the goods is not a condition precedent, but the delivery of the goods can be one of the elements of the transaction;

(iv) effective or general control does not always mean physical control and, although the manner, method, manner and timing of the use of the goods is decided by the lessee or the customer, they would be under effective control or general on the goods;

(v) approvals, concessions, licenses and permits relating to the goods would also be available to the user of the goods, even if such licenses or permits are in the name of the owner (transferor) of the goods, and

(vi) during the term of the contract, the exclusive right to use the goods together with any permits, licenses etc., shall vest in the lessee.

The Court dismissed the Commissioner’s appeals finding that the Tribunal’s contested order does not suffer from any jurisdictional or other legal infirmity.

Case Title: New Delhi Service Tax Commissioner v Quick Heal Technologies Ltd

Citation: 2022 LiveLaw (SC) 660

Summaries

Service Tax – License to use the software through an end user license agreement a “deemed sale” pursuant to Section 366 (29A) (d) of the Constitution – Service tax is not due simply because updates are provided to the customer

Service tax – Sale of software – if service tax is payable – Once a lump sum has been charged for the sale of the CD (as in this case) and sales tax has been paid on latter, subsequent income may not levy service tax on the entire sale consideration once again on the grounds that updates are provided. We are of the view that the artificial separation of the transaction, as here, into two parts is not defensible in law. It is, in essence, a software sale transaction and once it is accepted that the software placed on the CD is a “good”, then there can be no separate service element in the transaction. We say this because even otherwise the user is put in full ownership and control of the software. This amounts to a “deemed sale” which would not attract service tax – Tata Consultancy Services follow-up v. State of Andhra Pradesh, (2005) 1 SCC 308 – Paragraph 55

Constitution of India – Article 366(29A)(d) – Transfer of right to use property “deemed sale” – principles explained – Paragraph 52

Finance Act 1994 – Section 65B(44) – Definition of “service” – does not include activities listed as “deemed” sale under Section 366(29A) of the Constitution – Paragraph 36

Click here to read/download the judgment

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