Tuesday, 15 September 2015

Karnataka High Court rules that implementation of customized software is a service and cannot be subject to VAT


This Tax Alert summarizing the decision of the Karnataka High Court (HC) regarding the taxability of consideration received for implementation of customized software by a software company (petitioner) for banks.


The HC held that such an activity is a service and therefore, the consideration for the implementation of software should not be subject to VAT. It was observed that the implementation services are required to integrate the system to make the software functional or useable only after the supply of packaged and customized software. Thus, it is in the nature of post-sale activity. As there is no transfer of property in 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.


The HC also noted that a separate service contract is entered into for provision of services and rendering training to employees, so that the installed software starts functioning. Moreover, it was open for the customers to procure implementation services from any other competent agency. On these grounds, it was held that implementation activity cannot be considered as a part of customization of software. 


Where copyright is held by the developer of the software and the copyrighted article alone is handed over to the customer as a transfer of right to use the goods, the software is goods and is liable to VAT.


This is an important ruling, as the High Court has observed that since the implementation activity is already a subject matter of tax under the Service tax law, the States will have no authority to levy VAT on the same.

This would bring respite to the software industry already facing widespread litigation around this issue

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