No. DDQ-11-2001/Adm-5/83/B-7, dated August 31, 2004 in the case of M/s. Mastek Ltd.
Question ; Whether the agreement for development of Software is a pure Contract for Service requiring skill and labour and not a Sale under the Bombay Sales Tax Act, 1959 or under the Maharashtra Sales Tax on the Transfer of Property in Goods involved in the execution of Works Contract Re-enacted) Act, 1989 ?
ORDER
M/s. MASTEK Limited is a Company incorporated in India under the Companies Act, 1956 and is registered under the Bombay Sales Tax Act, 1959 under Registration Certificate No. 4000025/S/1608. They are in the business of providing Software Development Services.
Transaction :
They have sought determination on whether the transaction entered by them with HDFC dated 7th August, 2000 and evidenced vide Invoice No. 003 dt. 31st January, 2001 for Rs. 4,24,048/- is a Sale as per Section 2(28) of the Bombay Sales Tax Act, 1959 ?
Details :
M/S. MASTEK Ltd. provides Software Services to its clients. For each requirement, the client sends a description of the Software. Skill required in the development work and the MASTEK Professionals carry out the software development work. For cacti such engagement, a separate Agreement, Work Order is entered into between M/s. MASTEK and the Client. This Agreement explains the nature of services provided by MASTER viz. the Software Development and also includes the designation of the Software Professionals in the team, nature of assignment, location and MASTEK’S resource rates. All rights, title and interest in and to .my computer programme, specifications, systems, data, material owned by MASTEK prior to the execution of the agreement and used by MASTEK remains the exclusive property of MASTEK. When the pay men tin full is made for all the services, the developed Software rendered as per the agreement, the client gets the right, title and interest in the developed Software and to any work product patent, inventions or copyrightable materia! resulting from the performance of any of the Masteks Services under the Agreement. Further all rights relating to any Computer Programme furnished to MASTEK by the client remains the property of the client.
Contention :
It is contended by MASTEK that the contract under the circumstances is a pure Service Contract and neither a Sale far the purposes of the Hombay Sales Tax Act, nor for the purposes of the Works Contract Act, 1989 takes place.
Documents Attached :
1. Copy of the Agreement made with HDFC, Title Agreement for Software Consulting Servicer.
2. Copy of the Work Order with HDFC.
3. Copy of the bill raised by Masteks Ltd. on HDFC dated 31-1-2001.
On scrutiny of the Application, it was seen that many facts relating to transaction in question were not clearly emerging from the Application. The Applicant was therefore requested to reveal the necessary information by furnishing details like the question in clear terms, the nature of transaction, the cause of dispute, the agreement and the exact nature of the product agreed to be supplied and also the tax treatment given by the Applicant to the transaction.
2. The case was fixed for hearing on 23-3-2004. Shri V. P. Patkar, Advocate alongwith Shri Nitin Vanjara, and Miss, Jyoti Shivramkrishnan, Company’s Representative attended the proceedings. At the time of hearing, he gave a Written Submission containing the replies to the queries addressed to them by this office prior to the hearing. The Advocate con tended that the present con tract falls under the category of ‘Maintenance of Software’, According to them, it is not covered by the definition of ‘sale’ as per the Bombay Sales Tax Act, 1959. At the time of hearing, the Applicant submitted a Written Submission on the nature of work that was undertaken by HDFC. The information given in the submission is as under: -
It is stated that work assigned to them was of Maintenance of Software Application, which was developed by HDFC, The question for determination is whether the services which MASTEK provides to HDFC for maintaining their existing Software Application is a Service Contract or a Works Contract or a Sale. The Software which is existing at HDFC was their own Software and developed by the HDFC Staff. The services of MASTEK were hired in terms of providing different categories of staff at different rates fixed on man-month basis. The word ‘Software Development’ which is used in the Contract between MASTEK and HDFC should be understood in the context of the work of Software Maintenance undertaken by MASTEK. It is stated by them that there is no intangible product as far as this HDFC object is concerned and relationship between the Applicant and HDFC is that of Consultant/Service. Provider.
A brief note on the nature of the transaction was given which can be summarized as follows :-
(i) HDFC has its own IT Team. All the Software Applications have been designed, developed and maintained by HDFC.
(ii) In 2000, the HDFC Applications were to be changed due to which HDFC contemplated taking the services of MASTEK mainly for the Software Application Maintenance.
(iii) The MASTEK engagement with HDFC was with HDFC Home Loan Group. Thy engagement was for maintenance and support of their Housing Loan Applications jnd lfujse services rendered can be summarized. S. Rs. i.e. Service Request for enhancing and issues handling.
(iv) Service Request and Issue-handling Request were received in all the three Application Modules ILPS, LACS, and RPS.
(v) Consolidation was another activity that was carried out.
On perusal of the submission, the Applicant was asked by the Commissioner to give a write-up on some of the items marked as Exhibit ‘A’ [Point Nos. (3), (4) and (5) in the said submission]. The Applicant promised that the same would be delivered in the coming week. It was intimated to the Applicant that on receipt of write-up, a hearing may be given if necessary.
3. A second Written Submission was made by MASTEK dt. 7th April, 2004 clarifying the Point Nos. 3, 4 and 5. The explanation has been given as under :
Point Nos. 3 & 4 : Service Retquest - Service Request refer to the requests received from HDFC Staff for changing their already existing Software to meet the changing business needs of the Home Loan Division of HDFC. The various activities performed by MASTEK included Requirement Gathering, Requirement Analysis, Impact Analysis to study how to change the existing Application Software to meet their changed requirement, Effort Estimation,, Test Plan Preparation, Software Source Code Charges, Unit Testing Support during Acceptance Testing by HDFC Staff and release of Software. The Service Requests by HDFC, IT Staff were for different issues. After the changes made by MASTEK were found correct and appropriate, the Softwares were accepted. There was also Emergency Request which could arise due to bugs existing in the Software. There was also Documentation Service Request for implementation looking into the needs or lack of facilities in Existing Software. Sometimes there were small changes which were classified as ‘issues’ if the impact was expected to be minimal or very localised.
Point No. 5. - Consolidation was an activity that was carried out as HDFC had a number of branches which were to be consolidated. In order to accomplish this, MASTEK analysed the Data Base Structure supporting the Existing Software which would connect to each of the database and copy the data into a different but fresh database. This was accomplished by testing the Software using a small sub-section of the data and analysing for any unanticipated issues, if any issues were noticed, the Softwares were checked for correctness or if they were incorrect, the approach was changed. The order in which data is to be stored is also important, so proper, sequencing of the Software was also done and the sequence were also tested for correctness. It the sequence was incorrect, the data would not get copied.
4. The issue before me is whether the transaction entered into by M/s. MASTEK with HDFC is a transaction of Sale attracting tax under the Bombay Safes lax Act 1959 or is a Service Transaction, not attracting tax. For gaining any sort of insight into this matter, it would he imperative to examine the Agreement entered into by MASTEK with its client. The transactions effected by MASTEK as well the procedure of billing adopted by MASTER needs close scrutiny. Let me first examine the work done by MASTEK for HDFC, the details of which have been provided by the Applicant himself.
It is stated by the Applicant that the work assigned to MASTEK was ‘Maintenance of Software Application. HDFC has its own team which has developed its own Software Applications. In 2000, the Applicant was hired by HDFC for changing their existing Applications .The engagement was supposedly for maintenance and support of existing Applications and it encompassed the following :
The Existing Software (which was developed by HDFC) was to he changed to meet the changed business needs of the Home Loans Division, Service Re quests were made by HDFC to ‘meet the changed business needs of the Home Loans Division’ and the various activities were performed by MASTEK including Requirement Gathering Requirement Analysis, Impact Analysis to study how to change the existing Application Software to meet the changed requirements. After completing the work done, the HDFC Staff were also to he given training to operate the given Software. This simply means that the Existing Software was to be used as a base for developing a new one which could cater to the changed needs of the expanding department. An example is given of the ‘MIS’ - Monthly Information System which had to be newly generated in order to enable the Top Brass to keep track of the daily sanctions. The Applicant has termed it as a ‘modification’ but it remains that it is not a mere modification but generation of new ‘Software’, it was not Servicing of Software but was preparation of new Software catering to the needs arising out of new situations.
*It is required to be made clear at this juncture, that on the facts of the case, it is very much clear that HDFC have had its own Software and Software Programme developed by its IT Department. It was not successful in its operation for the changed needs of HDFC The task was assigned to MASTEK. The Service Requirements were of different nature for which Existing Software with HDFC was inadequate to deal with. To make such Software suitable to changed needs was the task of MASTEK. MASTEK had therefore developed its own programme looking into the needs of HDFC and given them a different Software. It may be called "Software Development" however, it remains a fact that newly developed Software was given by MASTEK which may be independently useful or coupled with Existing Software of HDFC becomes useful. It is also to be appreciated that Software Development is a conceptual change that takes place with passage of time and the changing needs of the user. The earlier one becomes obsolete and the changed one becomes successful. In this situation what is seen is that it is not the maintenance of Existing Software of HDFC but giving them a new Software which may be with or without Existing Software, that should suitably operate to the changed needs. The Applicant Companies claim that it was purely a Maintenance Contract for Existing Software of HDFC is an untrue claim on the facts of the case. In this situation, the documents and the admission of the Applicant Company clearly reveals that it was a situation of giving a New Software to HDFC by MASTEK. The intellectual property in developing the New Software through different programmes was undertaken by MASTEK Employees. This Intellectual Properly in the form of Software is transferred from MASTEK to HDFC on its successful operation. And as such it would constitute a sale of Software under the Bombay Sales Tax Act, 1959.
*Consolidation activity was also undertaken by the Applicant, The data of various branches was to aggregated into a single system. This activity is also not mere consolidation or modification of the Existing System but it entailed the development of a New Software which contained the data of consolidation and also of providing the Operating System facilitating the changed needs such as Daily Disbursement Receipts for Management Decisions. It is mentioned in the write-up that ‘for consolidation, the Applicant analysed the existing Data Base Structure, supported the Existing Software which would connect to each of the databases one after the other and copy the data into a different fresh database. This aspect itself makes it clear that the Applicant had supplied a new Operative Software which was given for the changed needs of management decision.
The aforesaid points show that the work undertaken by MASTEK was not of maintenance of Existing Software of HDFC. It was also not restricted to a mere modification but was certainly of developing a programme to create a New Software which were necessary to make it suitable to the changed needs. Such development of programme was nothing but development of ‘Software Packages’ wherein properly was transferred from MASTEK to HDFC and therefore it would certainly amount to Sale in terms of the provisions of Section 2(27) of the BST Act, 1959,
In the TNTST Judgment in the cast: of M/s Upasana Finance (113 STC 409), the Tribunal while discussing the issues of taxability defined Software as "a totality of programme, procedure, rules and assembler raised in conjunction with a Computer". The Programme would provide answers to the problems and the method of solving the problem. The development of Software depends on the skill of the person or a company. Once the programme is installed in a customer’s Computer, the customer can play the programme and the customer pays a fee for the programme Software". In the instant case, the Applicant has repeatedly stressed the fact that the Existing Software was only changed. Bui in order to change the Existing Software, new programme had to be written which may or may not be compatible with the existing programme and therefore it would be nothing but a development of new Software.
It is argued by the Applicant that the Contract between them and HDFC is a Service Contract. They only provided service for the maintenance of the Existing Software which was already developed by HDFC, As explained earlier, it is not a correct statement of fact. It is repeated for the sake of clarity that MASTEK has undertaken development of a new Programme and new Software may be useful with or without Existing Software of HDFC to see that it satisfies the changed needs of HDFC’ for different management decision. It may be true that when a product is owned by the client, the property only remains with the client. But they result into a new Programme and new Software resulting into the emergence of a new ‘Software’ in totality also. In the context of ‘modification’ or ‘servicing’ in this case, new programme had to be written and new procedures/rules were defined. The photocopies of the SR’s given shows that for ‘SR’s and ‘consolidation’, the MASTEK Staff had to devise and define new programs and procedures which in the language of Information Technology amounts to development of ‘Software’. Therefore, what is done by MASTEK is not servicing but creation of a new Software wherein property is transferred from MASTEK to HDFC and the transaction would amount to ‘sale’ of Software.
5. The Agreement between M/s. MASTEK and HDFC also could be scrutinized on this aspect Under the Heading "Nature and scope of Services to be provided by Mastek’ the following is stated :
‘MASTEK will provide Software Development Services to the CLIENT. For each requirement, the CLIENT will send a description of the Software required for the Software Development Work and MASTEK’s Professionals will carry out the Software Development Work.’
The Applicant has argued that the work only relates to modification and not to development. They have also submitted that the terms ‘Development’ in the Agreement should be construed as servicing. Such a submission cannot be accepted. The Agreement clearly says otherwise and a different interpretation cannot be given to a legal document signed by both parties concerned evidencing their commitment to the proposals therein and also authenticates it. In the Agreement, the work is described as ‘Development Work’, After the requisite work is done and the services rendered, new Software gets produced wherein the property is created by the services rendered by MASTEK and such property passes from MASTEK to HDFC. The Agreement between MASTEK and HDFC has the following clause under the heading ‘PROPRIETARY RIGHTS’.
"(a) All right, title and interest in and to any Computer Programs, Program Specifications, Systems, Data or materials owned by MASTEK prior to the execution of the Agreement and used by MASTEK in the performance of this Agreement shall remain the exclusive property of MASTEK, unless otherwise agreed to between the parties.
(b) MASTEK agrees that when payment in full for ail the services rendered hereunder has been made by the CLIENT and for its clients, the CLIENT or their clients have their right, title and interest in and to any work product, patents, inventions or copyrightable material resulting from the performance of any of MASTEK’s Services under this Agreement. MASTEK shall assign and transfer all rights in and to the programs and other products resulting front the performance of any of MASTEK’s Services under this Agreement to the CLINT or their client, its successors and assigns, and further agrees to take any actions and execute any documents as may be necessary to vest such rights, including the copyright and all of MASTEK’s right, title and interest in the resultant programs and other resultant products to the CLIENT or their clients."