27 August 2015 EY Tax Alert CESTAT rules that licence fees shall be included in the assessable value of commercial import of packaged software under Customs Act, 1962 Executive summary Tax Alerts cover significant tax news, developments and changes in legislation that affect Indian businesses. They act as technical summaries to keep you on top of the latest tax issues. For more information, please contact your EY advisor. This Tax Alert gives an update on the decision 1 of the CESTAT, New Delhi regarding inclusion of royalty / licence fee in the assessable value of import of packaged software under the Customs Act, 1962. The assessee was involved in importing packaged software (commercial and noncommercial) from the group company. Licence fee was collected from the Indian buyer and a percentage of the same was remitted to the parent company situated in USA only in case of commercial software. It was alleged that assessee was indulged in duty evasion since the declared value of packaged software did not include the value of licence fee. CESTAT held that licence fees remitted outside India shall be included in the assessable value in case of commercial import of packaged software. It also held that customs duty was not chargeable on electronic download of the software via internet. 1 2015-TIOL-1766-CESTAT-DEL
Background The assessee had been granted a right to duplicate and distribute the software in India by parent company situated in USA. The assessee imported packaged software (media pack) from its related group company in Dublin, Ireland. Both these companies are wholly owned subsidiaries of the parent company situated in USA. For delivery of media pack to customer, assessee further availed services of their related company to replicate the software on such media pack. As per the Master Services Agreement (MSA) entered amongst the group companies, assessee had to pay 56% of the licence fee collected from its Indian buyers to their parent company. While importing and clearing the goods through customs, assessee declared the value of media pack without adding the licence fee paid to parent company. Assessee issued separate invoices to the customer for the value of media pack and licence fee. The assessee also provided Annual Technical Support, wherein assessee provided version updates and technical assistance to customers. The demand in the instant case pertained only to version update fee. The Show cause notice (SCN) alleged, that the licence fee (paid or payable) was includible in the assessable value of the electronically downloaded software via internet. It was alleged that assessee was indulging in duty evasion since the licence fee was includable in the assessable value in terms of Rule 9 / 10 of the Customs Valuation (Determination of Value of Imported Goods) Rules,1988 / 2007, on the ground that the licence fee was a condition of sale. As per the above rule, royalties and licence fee, which a buyer is required to pay as a condition of the sale of goods are to be included in the assessable value of the imported goods. Also, duty was demanded on noncommercial media pack on which no licence fee was paid by the assessee to parent company. The duty on such pack was determined by computing notional licence fee. Consignments awaiting delivery were seized on the ground that they were similarly under-valued. Vide Order-in-original dated 12 January 2011 the allegations in the SCN were confirmed and customs duty was demanded. Thus, the issues before the CESTAT were as follows: Whether licence fee shall be included in the assessable value of imports? Whether customs duty is payable on the software downloaded via internet? Whether the license fee on which Service tax has been charged can be in included in the assessable value of media pack? Whether the extended period of limitation is invokable? Whether the impugned demands, interest, penalties and redemption fine shall be imposed? Assessee contentions Licence fee was paid to parent company for the grant of right to distribute software electronically or physically and not for purchase of media pack. Hence, licence fee was not a condition for sale of the imported media pack. Price charged for supply of media pack to the assessee was same, irrespective of whether the license fee was paid, by assessee to parent company in USA or not. Further, the license fee was liable to be paid by the assessee even when customers did not opt for physical delivery of such software. In the absence of mechanism laid down for levy and collection of duties on electronic download of software, customs duty cannot be levied on the same.
In this regard, assessee relied on the judgement of Supreme Court in the case of CIT Bangalore v. B.C. Srinivasa Setty 2, in the context of income tax, where it has been held that the charging section is not attracted where computation provision is not applicable. As Service tax is being paid on licence fee under the category of Information technology software Service, customs duty cannot be demanded on the same value. In this context it relied upon the Supreme Court decision in the case of Imagic Creative Pvt. Ltd v. CCT 3, where it was held that payment of Service tax and VAT are mutually exclusive. On non-commercial imports, there was no license fee required to be paid by the assessee to parent company in USA, and accordingly, the license fee was required to be added in non-commercial imports. The notional value of licence fee determined by the Revenue on the non-commercial media pack was exponentially higher than the actual fee charged for commercial media pack. The assessee also contended that, the entire duty demand is barred by limitation as it has been raised beyond the period of six months. Accordingly, interest and penalty cannot be demanded. Reliance was placed on the case of Tonira Pharma Ltd. v. CCE, Surat 4 to contend that penalty and interest cannot be levied unless the provisions relating to penalty and interest of the Customs Act, 1962 are borrowed under the Customs Tariff Act, 1975. Revenue contentions The transaction between the group companies are related party transactions since the three entities are covered under MSA. The parent company has granted licence to market its software in India. However, copyright of the software are retained by the parent company. 2 2002-TIOL-587-SC-IT-LB 3 2008-TIOL-04-SC-VAT 4 2007 (208) ELT 38 The assessee pays royalty on a predetermined basis of the licence fee as they are governed by MSA. A unique order number gets generated in the system after the agreement is signed by the Indian customer for payment of the licence fee. Further, this can be accessed by all group entities through a common Order Management System. Payment of such licence fee was considered as a condition for import of goods. Thus, the same was to be included in the assessable value for commercial as well as non-commercial media pack. Software of any kind being intangible, when brought into India from a place outside India, whether physically or electronically would be goods and liable to customs duty. Since the fact of non-declaration of licence fee remitted to the parent company emerged only through investigation, the Revenue alleged that the assessee knowingly suppressed information relating to actual valuation of the media pack. Thus the Revenue contended that section 28 of the Customs Act, 1962, which deals with the time period for issuance of SCN to recover duties not levied / short levied, was squarely applicable. Hence, customs duty was demanded from the assessee by invoking the extended period of limitation and the interest thereon. CESTAT Ruling CESTAT observed that, each shipment of commercial media pack was for a particular Indian customer identified by the unique order number. Hence, payment of licence fee was a condition to sale. Given the factual matrix, with respect to commercial imports of media pack, licence fee remitted to parent company was includable in the assessable value. Further, any subsequent (post importation) increase in number of users of the software imported in media pack was not known at the time of import, and hence is not addable.
In respect of non-commercial import of media pack, no licence fee was payable nor paid by the customers to assessee. Hence demand in respect of such imports cannot be sustained. Regarding electronically downloaded of software via internet, CESTAT observed that the Customs Act, 1962 provides a mechanism / procedure for levy and collection of duty only in respect of tangible goods. Such electronically downloaded software already qualify as goods. Further it was to be considered as an intangible, since it can be downloaded from anywhere, at any time. CESTAT further held that the Customs Act, 1962 in its present format lacks the mechanism for levy and collection of duty for such electronic downloads. Also, it is a well settled principle of taxation that in absence of mechanism for collection of tax, the levy fails. Thus, the same is not liable to customs duty. In case of value of software on which Service tax is paid, CESTAT observed that the ratio laid down in the case of Imagic Creative Pvt Ltd vs CCT cannot be extrapolated to mean that customs duty and Service tax are mutually exclusive. There is no provision under Customs Act 1962 warranting exclusion of licence fee from assessable value where Service tax has been levied on such licence fee. The assessee s relationship with group companies is evident from the response to Special Valuation Bench questionnaire submitted prior to seizure. Thus, suppression of facts stands negated. CESTAT clarified that it was a pure interpretational issue. Further, the demand in relation to commercial physical import of media pack (except those which were seized) was held to be time barred. Hence, extended period of limitation was not invokable. Accordingly, the impugned demands, redemption fines and penalties on the assessee were set aside. Comments The aforesaid judgment would have a significant impact on the software industry, since most of the software companies follow a similar royalty model for distribution of software products in India. Further, it may result in hardship for these companies since based on this decision, both Service tax and customs duty may be levied on the royalty payments. At the same time, the CESTAT has held that customs duty should not be levied on electronic download of software, which is a relief. Also, recently CESTAT in the case of United Shippers Ltd 5 gave an opposite view, that Service tax and customs duty are mutually exclusive, which was subsequently affirmed by the Supreme Court. While that judgment was in a different context (pertaining to the logistics sector), the contrary decisions on mutual exclusivity of Service tax and customs duty are likely to result in ambiguity on this point. 5 2015-TIOL-172-ST-LB
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