Customised Software Designed For Specific User Remains Taxable As 'Goods': Kerala High Court

The Kerala High Court recently reiterated that software customised for a specific user and not sold to other users still falls under the category of 'goods' defined under Article 366(12) of the Constitution for the purposes of levy of sales tax under the Kerala General Sales Tax Act (KGST Act).

A Division Bench of Justice A.K Jayasankaran Nambiar and Justice Mohammed Nias C.P added that customised software satisfies the attributes of 'goods' as it possesses utility, and can be bought, sold, transmitted, transferred, delivered, stored, and possessed.

"even a customised software will satisfy the definition of 'goods' for, it is evident that it has the attributes having regard to (a) its utility; (b) capable of being bought and sold; and (c) capable of being transmitted, transferred, delivered, stored and possessed. Once the said attributes are seen satisfied in the software in question, then whether the software is treated as customised or non-customised, it would nevertheless be categorised as 'goods' for the purposes of levy of tax... We are therefore of the view that merely because the software developed by the respondent/assessee in the instant case was customised for a particular user and was not sold to other users, the charges collected from the customer cannot escape the levy of sales tax under the KGST Act."

The Court was dealing with a few Sales Tax Revisions filed by the State against an order issued by the Kerala Sales Tax Appellate Tribunal in six appeals. Three of these appeals were related to assessments for the years 2002-03, 2003-04, and 2004-05, while the other three were regarding penalties imposed on the respondent/assessee.

The respondent, a software business, had not registered or paid sales tax assuming that the activity of developing and supplying customised software to clients would attract only service tax and not sales tax. The Sales Tax Department initiated penalty proceedings against the respondent for not taking necessary registration and paying tax, which was confirmed by the First Appellate Authority. The Tribunal allowed the appeals and ordered in favour of the assessee, overturning both the assessment orders and the penalties.

Aggrieved by this decision, the State had approached the High Court. The revision petitions were allowed and remitted back to the Tribunal by the High Court. Following the remand, the Tribunal found in favour of the respondent/assessee denied the applicability of Tata Consultancy Services v. State of Andhra Pradesh [(2005) 1 SCC 308] and held that customised software could not be taxed under the KGST Act. As such, the Tribunal allowed the appeals against assessment orders and penalties.

The Division Bench found that in the revisions preferred by the State, the issue of taxability of customised software was ambiguous, leading to several rounds of litigation in favour of the assessee. 

Regarding the State's challenge of the Tribunal's order that set aside the assessment orders for the years 2002-03, 2003-04, and 2004-05, it was found that the tribunal's reasoning was that customised software developed and supplied by the assessee could not be taxed under the KGST Act, as per the Tata Consultancy Services case.

However, upon reviewing the judgment, the Court found that the Supreme Court's findings in the said case were applicable not only to "canned software" but to uncanned/customised software as well.

In Tata Consultancy Services, the Apex Court had observed that in the context of software, when copies of a software program are made and marketed, it becomes goods subject to sales tax, irrespective of whether it is customised or off-the-shelf. The Court emphasized that the focus should be on the software's marketability, utility, and capacity to be bought, sold, transferred, delivered, stored, and possessed.

Based on this understanding, the Court concluded that even customised software satisfies the attributes of goods, and therefore, the charges collected from customers for customised software could not escape the levy of sales tax under the KGST Act. The Court stated that the mere fact that the software was customised for a particular user did not exempt it from being classified as goods for tax purposes.

Regarding the penalty, the Bench ruled that the respondent had not engaged in contumacious conduct to evade tax, considering the ambiguity surrounding the taxability of customised software. 

Therefore, the Court dismissed the State's revisions seeking to reinstate the penalty orders. However, the court allowed the State's revisions challenging the Tribunal's decision on sales tax assessments for the relevant years, stating that the software, whether customised or not, fell within the definition of 'goods' and was liable for sales tax.

Special Government Pleader Mohammed Rafiq appeared for the State while the respondents were represented by Advocates C.M Andrews, Boby M Sekhar, Shyam Padman and S.K Saju. 

Case Title: State of Kerala v. V.C Vinod and connected matters

Citation: 2023 LiveLaw (Ker) 359

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