Writing software on CD for specific use is manufacture- Says Supreme Court.

[C.A. DEV KUMAR KOTHARI]

Relevant links:

COMMR.OF INCOME TAX-V, New Delhi Versus M/S ORACLE SOFTWARE INDIA LTD. [2010 -TMI - 35190 -SUPREME COURT OF INDIA.

Other Citation: {2010}] 1 taxmann.com 21 (SC)

Commissioner of Income-Tax Versus Oracle Software India Limited. 2008 -TMI - 13557 - DELHI High Court Other Citation: [2007] 293 ITR 353, 211 CTR 60, 164 TAXMANN 478

Tata Consultancy Services v. State of Andhra Pradesh, 137 STC 62

Gramophone Co. of India Ltd. v. Collector of Customs, Calcutta, 1999 -TMI - 45304 - (SUPREME COURT OF INDIA)

Sections 33B and 80IA considered by the Supreme Court.

New definition of manufacture vide S. 2(29BA) of the Income-tax Act, 1961 inserted vide the Finance (No.2) Act, 2009 w.r.f. 01.04.2009.

Summary:

CIT Vs ORACLE SOFTWARE INDIA LTD [2010] 1 taxmann.com 21 (SC) The Supreme Court considered the meaning of 'manufacture' in context of section 80-IA(12)(b) read with Section 33B and came to conclusion that processing of blank CDs, dedicating them to a specific use, constitutes a manufacture in terms of  those sections.

A blank CD can be a writable CD or re-writable CD. A blank CD does not have data on it. By processing the CD data are stored on the CD. Data can be of different types. They can be software or simple data for use. Depending on data placed on CD its utility will be determined. For example, Direct Tax laws on CD by taxman contains data and information about direct tax laws of specified type. Similarly Taxmann group has prepared several other type of CD's as per information available on www.taxmann.com. All these CD's have different role and characteristics. Therefore, it can be said that all such CD's are product manufactured by the assessee.  We also find a new definition of manufacture vide S. 2 (29BA) of the Income-tax Act, 1961 inserted vide the Finance (No.2) Act, 2009 w.r.e.f. 01.04.2009. Though this definition does not find mention in reported judgment, however, the definition also covers the matter in favor of the assessee. In view of the purpose of the definition, and taking a liberal view it can be said that in context of incentives under I.T. Act, the words 'manufacture' and 'production' can be considered liberally and not strictly to deny incentives. For levy of charging sections of excise duty provision, the consideration can be different, because those provisions deal with tax liability whereas provisions of I.T. Act deal with certain concessions. 

Blank Compact Disc (CD) and written CD are different things:

We find two types of blank CD namely a writable CD and a re-writable CD. Both are two different categories and have different utility and significance. A blank CD does not have data on it. By processing the CD data are stored on the CD. Data can be of different types. They can be software or simple data for use. Depending on data placed on CD its utility will be determined. We can illustrate different CD with the following illustrations:

CD containing laws and case laws like various types of CD made by Taxmann group. We find CD of direct tax laws on CD which contains various direct tax laws (Act and Rules), circulars, Finance Bills and Act forms, Rules etc. This is a very comprehensive CD containing large volume of data and information. We also find CD on IT Act and IT Rules from Taxmann with their respective books. These CD contains some of information which are found on DTLaws on CD. The author himself use all these CD because they have different roles and functions in different manner. For example when only a provision is to be taken from IT Act, it is preferable to open CD of IT Act instead of DTL on CD because merely looking at provision of IT act will be much faster on IT Act CD. However, if the DTL on CD is already opened, then the provisions of IT Act can be seen on that CD. Some times both CD's are opened simultaneously because it may be that from DTL on CD some search pages are already opened and they are also required to be used. Therefore, to have a look on provision one can open CD on IT Act or IT Rules.

This clearly shows that different CD's are different article or thing and they have different functional role. Blank CD's were processed to store data on these CD's which are different things by name, utility, and contents. Thus operation/ process  carried on blank CD which is a commodity or article of one type say blank CD, is made fit for different usages for which it was  not so (when blank) before the process of writing on CD. Thus the operation/ process of writing CD falls within the meaning of the word "manufacture" because a new thing is produced - say CD of  DT laws.

Amendment in the income -tax Act, 1961:

A new definition has been inserted by the Finance (No. 2) Act, 2009, w.r.e.f. 1-4-2009 in section 2 which read as follows:

Definitions.

2. In this Act, unless the context otherwise requires,—

[(29BA) "manufacture", with its grammatical variations, means a change in a non-living physical object or article or thing,—

(a) resulting in transformation of the object or article or thing into a new and distinct object or article or thing having a different name, character and use; or

  (b) bringing into existence of a new and distinct object or article or thing with a different chemical composition or integral structure;

According to the above definition also it can be said that the process of recording CD amount to manufacture because a recorded CD is different from blank CD as contents, purpose, name and character of both are different. This definition was however not considered by the Supreme Court while deciding the case of oracle.

Analysis of recent judgment in case of Oracle:

Question involved was "whether the process by which a blank Compact Disc (CD) is transformed into software loaded disc constitutes "manufacture or processing of goods" in terms of Section 80IA(1) read with Section 80IA(12)(v), as it stood then, of the income Tax, 1961?

The Assessment Years involved are 1995-96 and 1996-97.

Nature and business of assessee:

Assessee is an Indian company and is 100% subsidiary of Oracle Corporation, USA.

The software is developed by Oracle Corporation, USA.

Assessee imports Master Media of the software from Oracle Corporation, USA.

The assessee is entitled to sub-licence such software without making any changes in it. For this purpose assessee duplicated original software on blank discs, pack them and sell in the market along with relevant brouchers.

A lump-sum amount and royalty at the rate of 30% is paid by assessee to oracle Corporation, USA.

The only right which the assessee has is to replicate or duplicate the software. They do not have any right to vary, amend or make value addition to the software embedded in the Master Media.

Assessee use various machinery to convert blank CDs into recorded CDs which along with other processes become a Software Kit.

Blank CD in the present case constitutes raw-material.

Master Media cannot be conveyed as it is.

Assessee also contended that in order to sub-licence, a copy of master media  has to be made and it is the making of this copy which constitutes manufacture or processing of goods in terms of Section 80IA and consequently assessee is entitled to deduction under that Section.

Revenue contended that in the process of copying, there is no element of manufacture or processing of goods because the software on the Master Media and the software on the recorded media remains unchanged, there is no manufacture or processing of goods involved in the activity of copying or duplication, hence, the assessee was not entitled to deduction under Section 80IA. When the Master Media is made from what is lodged into the computer, it is a clone of the software in the computer and if one compares the contents of the Master Media with what is there in the computer/data bank, is no difference, hence, according to the Department, there is no change in the use, character or name of the CDs even after the impugned process is undertaken by the assessee.

Relevant provisions considered are as follows with high lights for anlaysis:

"80IA - Deduction in respect of profits and gains from industrial undertakings, etc in certain cases.

(I) Where the gross total income of an assessee includes any profits and gains derived from any business of an industrial undertaking or a hotel or operation of a ship (such business being hereinafter referred to as the eligible business), there shall, in accordance with and subject to the provisions of this section, be allowed, in computing the total income of the assessee, a deduction from such profits and gains of an amount equal to the percentage specified in sub-section (5) and for such number of assessment year as is specified in sub-section (6).

(12) For the purposes of this section, -

(b) "industrial undertaking" shall have the meaning assigned to it in the Explanation to Section 33B,"

Explanation to Section 33B,""Explanation: In this section, "industrial undertaking" means any undertaking which is mainly engaged in the business of generation or distribution of electricity or any other form of power or in the construction of ships or in the manufacture or processing of goods or in mining."

From reading of above highlighted provisions we can consider that controversy was on the issue of manufacture it would be sufficient to notice that the gross total income of the assessee in this case must include profits derived from any eligible business of an industrial undertaking from the manufacture or processing of goods. Other related aspect is whether blank CD and recorded CD can be considered as goods.

About Section 80 IA the court observed and held as follows:

That Section 80IA comes in Chapter VIA.

That Chapter, in a way, is a code by itself.

The Chapter provides for special deductions.

These special deductions are incentives provided for setting up industrial undertaking in backward areas or, for earning profits in foreign exchange, or for setting up hotels, etc.

It is this background that one has to interpret the meaning of the expression "manufacture or processing of goods".  Technological advancement in computer science makes knowledge as of today obsolete tomorrow is another important aspect to be considered and we need to move with the times.

Unlimited deductions are not permissible under Chapter VIA.

Therefore, in each case, where an issue of this nature arises for determination, the Department should study the actual process undertaken by the assessee.

 Duplication can certainly take place at home, however, one needs to draw a line between duplication done at home and commercial duplication.

 Even a pirated copy of a CD is a duplication but that does not mean that commercial duplication as is undertaken in this case should be compared with home duplication which may result in pirated copy of a CD.

The point to be noted by the Department in each of such cases is to study the actual process undertaken by the licensee who claims deduction under Section 80IA of the Income Tax Act, 1961.

About product:

From the details of Oracle Applications, it is noticed that the software on the Master Media is an application software and not an operating software or a system software.

It can be categorized into Product Line Applications, Application Solutions and Industry Applications.

 A commercial duplication process involves four steps. For the said process of commercial duplication; one requires Master Media, fully operational computer, CD Blaster Machine (a commercial device used for replication from Master Media), blank/ unrecorded Compact Disc also known as recordable media and printing software / labels.

The Master Media is subjected to a validation and checking process by software engineers by installing and rechecking the integrity of the Master Media with the help of the software installed in the fully operational computer. After such validation and checking of the Master Media, the same is inserted in a machine which is called as the CD Blaster and a virtual image of the software in the Master Media is thereafter created in its internal storage device.

The virtual image is utilized to replicate the software on the recordable media.

Virtual image is a very large image that is stored in computer memory and it cannot be shown on the screen being too large to fit in screen.

Scrolling and panning are used to bring the unseen portions of the virtual image into view

Burning is a process involved in writing of a data electronically into a programmable read only memory (PROM) chip by using a special programming device known as a PROM programmer, PROM blower, or PROM blaster [As per Microsoft Computer Dictionary].

The above processes in the light of the details given hereinabove, commercial duplication cannot be compared to home duplication. Complex technical naunces are required to be kept in mind while deciding issues of the present nature. The term "manufacture" implies a change, but, every change is not a manufacture, despite the fact that every change in an article is the result of a treatment of labour and manipulation. However, this test of manufacture needs to be seen in the context of the above process.

 If an operation/ process renders a commodity or article fit for use for which it is otherwise not fit, the operation/ process falls within the meaning of the word "manufacture". Applying the above test to the facts of the present case, The court took view that, in the present case, the assessee has undertaken an operation which renders a blank CD fit for use for which it was otherwise not fit.

 The blank CD is an input. By the duplicating process undertaken by the assessee, the recordable media which is unfit for any specific use gets converted into the programme which is embedded in the Master Media and, thus, blank CD gets converted into recorded CD by the afore-stated intricate process. The duplicating process changes the basic character of a blank CD, dedication it to a specific use. Without such processing, blank CDs would be unfit for their intended purpose. Therefore, processing of blank CDs, dedicating them to a specific use, constitutes a manufacture in terms of Section 80IA(12)(b) read with Section 33B of the Income Tax Act.

The Court did not find merit in the argument of revenue that the software on the Master Media and the software on the pre-recorded media is the same, there is no manufacture because the end product is not different from the original product, for the reasons that the input in this case is blank disc, and the test applied by the Department may not be relevant in the context of computer technology.

Court them referred to Tata Consultancy Service Vs State of Andhra Pradesh, 137 STC 620 in which question involved was whether a software programme put in media for transferring or marketing is "goods" under section 2(h) of the Andhra Pradesh General Sales Tax Act, 1957. In that case it was held that a software programme may consist of commands which enable the computer to perform a designated task. The copyright in the programme may remain with the originator of the programme. But, the moment copies are made and marketed, they become goods. It was held that even an intellectual property, once put on to a media, whether it will be in the form of computer diskes or cassettes and marketed, it becomes goods. It was further held that there is no difference between a sale of a software programme on a CD/ Floppy from a sale of music on a cassette/CD. In all such cases the intellectual property is incorporated on a media for purposes of transfer and, therefore, the software and the media cannot be split up. It was further held, in that judgement, that even though the intellectual process is embodied in a media the logic or the intelligence of the programme remains an intangible property. It was further held that when one buys a software prograqmme, one buys not the original but a copy. It was further held that it is the duplicate copy which is read into the buyer's computer and copied on memory device. If one reads the judgment in Tata Consultancy Services (supra), it becomes clear that the intelligence/ logic (contents) of a programme do not change. They remain the same, be it in the original or in the copy.

The Department needs to take into account the ground realities of the business and sometimes over-simplified tests create confusion, particularly, in modern times when technology grows each day. To say, that contents of the original and the copy are the same and, therefore, there is no manufacture would not be a correct proposition. What one needs to examine in each case is the process undertaken by the assessee. The judgment is considered to confined strictly to the process impugned in the present case.

It is for this reason that the American Courts in such cases have evolved a new test to determine as to what constitutes manufacture. They have laid down the test which states that if a process renders a commodity or article fit for use which otherwise is not fit, the operation falls within the letter and spirit of manufacture.

In Tata Consultancy Services (supra) it has also been held that there is no difference between a sale of software programme on CD/Floppy and sale of music on CD/Cassette. Therefore, the judgment of the Supreme Court in the case of Gramophone Co. of India Ltd. Vs. Collector of Customs, Calcutta would also apply. In that case it was held that a blank audio cassette is distinct and different from a pre-recorded audio cassette and the two have different use and name. Applying that test also to the facts of the present case, court held that a blank CD is different and distinct from a pre-recorded CD. In Gramophone Co of India Ltd. (supra), it was held that an input/raw material in the above process is a blank audio cassette. It was further held that recording of an audio cassette on duplicating music system amounts to manufacture because blank audio cassette is distinct and different from pre-recorded audio cassette and the two have different uses and names. Therefore the High Court was right in coming to the conclusion that the judgment of the Supreme Court in Gramophone Co of India Ltd. (supra) is squarely applicable to the facts of the present case. In the case of Tata Consultancy Services (supra), as stated above, it has been held that a programme may consist of commands which enable the computer to perform designate task, but, the moment copies are made and marketed, they become goods. Therefore, applying the above judgment to the facts of the case of Oracle the Court took view that marketed copies are goods and if they are goods then the process by which they become goods would certainly fall within the ambit of Section 80IA (12)(b) read with Section 33B because an industrial undertaking has been defined in Section 33B to cover manufacture or processing of goods. Thus the appeals of the Department, were considered to have no merit and were dismissed.