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Overview of common software related transactions

Taxation of software-related is a hotly debated today. Companies spend huge amounts of money in hiring the best lawyers to argue their case at Indian courts, if tax authorities issue notices to them. One reason for this is that on account of improved means of technology, there are new ways of accessing or using the same kind of software. For example, the same software can be purchased on a CD from a bookstore or it can be downloaded from the internet by payment through credit card. Does that change the character of the software or the legal treatment of the purchase transaction? It should not, but the law is not settled in all cases.

Often, software is sold on a medium (e.g. CD, pen-drives, etc.), and one is tempted to treat it in the same way as tangible property. However, there are problems with this understanding too. When real property is sold to a person, complete ownership rights are transferred to the purchaser. Under property law, no restrictions of a property can be imposed, if the purchaser is an owner. The purchaser is free to do what he wants, and to modify or distribute the property, or to even destroy it. However, purchase of a unit of software is actually coupled with an end-user license agreement (EULA) which lays out the terms of the license to use the software. Modification of the software is categorically prohibited in most cases.


Note All proprietary softwares prohibit copying, modification and distribution. In case the software has been copy-lefted, modifications to the software are allowed. More about copylefted software will be discussed in Module VII.


This restriction on modification or the limitation on use is inconsistent with the concept of ownership as applied to tangible property.

Therefore, it becomes difficult to determine whether a particular software transaction is a sale of the software or provision of a service relating to software, and courts sometimes give inconsistent judgments. Taxation of each kind of software transaction has not been categorically stated by the Supreme Court or any law, and tax authorities in different states may issue notices to software manufacturers/ purchasers / commercial users. 

In this chapter we will explain how software related transactions are taxed in practice. Please note that the law on this area is not settled and in a state of flux, with new cases being instituted before various tax authorities and at the High Courts. In a real scenario, multiple taxes may simultaneously be applicable depending on the specific facts of each case. Students are encouraged to use this discussion as a guide that helps in decoding taxation on the various ingredients of a software transaction.
A software transaction can attract one or more of the following taxes (they are explained in detail later):
  • Excise duty – applicable on manufacture of packaged software
  • Customs duty – applicable to import of packaged software
  • VAT/ Central Sales Tax – applicable to sale of packaged software
  • Service Tax – applicable on any services related to custom-made software)
  • Income tax – applicable to the software seller. In certain cases, the purchaser has the obligation to withhold tax on behalf of the seller.


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