Inclusion of value of software fitted in Computer in Value of Computer

Case: Commissioner of Central Excise, Pondicherry v/s Acer India Ltd.

Citation: 2004 (172) ELT 0289 (S.C.)

Issue:- Whether the value of operational softwares loaded in the Computer should be included in the entire value of the computer and whether excise duty will be payable on the entire value of the computer including the value of operational softwares?

Brief Facts:- Respondent is a company manufacturing computers, peripherals, servers, note books and accessories. Upon a licence obtained by WIPRO, the Respondent, on orders received from the customers load operational softwares. While calculating the amount of central excise payable thereupon, it would deduct the value of the operational softwares from the total value of the computer supplied to the customers. Revenue objected to the said procedure on the premise that excise duty is payable on the entire value of the computer including the value of operational softwares.

Show cause notice was issued to the respondent for the period July 2001 to May, 2002 asking to pay the differential duty. Another show cause notice was issued demanding differential duty for the period 1-7-2000 to 30-6-2001 in terms of the proviso appended to Section 11A(1) of the Central Excise Act, 1944. The Commissioner passed an order directing respondent to pay the differential duty specified in the two show cause notices with interest and imposed penalty.

It was further held that the loading of operational software in the factory would come within the mischief of ‘transaction value’ of the computer in terms of Section 4 of the Central Excise Act, 1944 with effect from 1-4-2000 having regard to the expressions “by reason of sale” or “in connection with the sale” as contained in the definition thereof.

Respondent preferred an appeal before the Tribunal which was allowed. The Tribunal had relied upon judgment given in PSI Data Systems Ltd. v/s Collector of Central Excise [1997 (89) ELT 3 (S.C.)].

The Division Bench of this Court in its order dated 27-2-2004 doubted the correctness of the said decision opining that as a computer would not function without an operational software, the latter would form a part of the former and, thus, excise duty would be payable on the total value thereof.

Thus the matter is referred to Larger Bench. The Tribunal had held that no central excise duty is payable on a software loaded in a hardware, i.e., computer.

Revenue has filed the appeal before the Supreme Court challenging the same.

Appellant’s Contentions:- Revenue contended that the operational software implanted in a hardware becomes a part thereof and as such central excise duty is leviable on the total value of the computer. Referring to the provisions of Section 4 of the Central Excise Act, 1944 and in particular the definition of “Transaction Value” as contained in Clause (d) of Sub-Section (3) of Section 4 thereof, it was submitted that the same would include the value of all manufactured goods charged as price including any amount that the buyer is liable to pay by reason of or in connection with the sale together therewith any other amount which adds to the value thereof. As a software implanted is a part of the computer, it was urged, excise duty would be payable on the total value thereof.

With regard to the judgment in PSI Data Systems Ltd,it was submitted that in that judgment this Court was not concerned with any software, which was implanted into a computer and was only concerned with a software which is a tangible one being of the nature of discs, floppies and CD-ROMs. It was also not concerned with intellectual property also called software, that is recorded or stored thereon.

It was submitted that a software which is implanted with a licence to right to use the informations contained therein should not be compared with a disc, floppy or CD-ROM which is available in the market separately.

Revenue submitted that not only the operational softwares like Windows 98 OS or W2K are implanted in the computers by the Respondent but as would appear from the price list furnished by it the configurations of different models of computers including operational software are also quoted therein. Furthermore, Respondent was also being under an obligation to preload a software on the computer before clearing the same from the factory, the central excise duty would be payable on the entire value thereof.

Respondent’s Contentions:- Respondent, on the other hand, submitted that a computer which is a hardware is marketable as such containing a firm or etched software being implanted therein, the valuation thereof also is taken into consideration for the purpose of excise duty but the operational softwares which are implanted on specific orders placed by the customers would retain the characteristics of software and would not lose its identity only because the information contained therein together with the right to use the same is implanted in the computer itself. A computer may have different systems, respondent would contend, containing parallel or sequential process which would make a computer system complete and the same should not be confused with a mere hardware.

It was further submitted that the hardwares and softwares are classified differently under different Headings, viz., 84.71 and 85.24 of the Customs Tariff Act. Whereas in respect of the computers the rate of duty is 16%, for softwares the same is nil and, thus, the assessee was entitled to claim deduction of the value thereof from the total value of the computer. It was argued that as both the hardware and the software are assessed separately, keeping in view Chapter Note 6 of Chapter 85, which contains a legal text, the valuation of a computer and software cannot be clubbed together for the purpose of assessment of excise duty.

Respondent submitted that the value of the goods which would be subject matter of central excise cannot be enhanced by implanting a software as it retains its own character irrespective of the fact that the information contained therein are loaded in the computer itself.

Respondent argued that the value of the goods may be enhanced in terms of the definition of the “Transaction Value” but the explanation contained therein must be read in the context of the main provision, viz., Section 4(1) and not de’hors the same.

Reasoning of the Judgment:- The Supreme Court referred to the definition of “excisable goods” under Central Excise Act, 1944 and Section 3 thereof, the meaning and definition of Computer, Application Program as well as definition of software in Firmware and in Operating system. It was concluded that there are different operating systems.

It was noted that Computers of various models and types with different configurations including Servers and Personal Computers are manufactured by the Respondent. They are classifiable under Chapter Sub-heading 8471.00 of the Central Excise Tariff Act, 1985 as automatic data processing machines. It was further noted that as general practice in the computer industry, the value of the firmware etched on to the EEPROM is always included in the assessable value of the computers.

For the purpose of this case, the Supreme Court proceeded on the premise that all the computers are cleared with the softwares loaded onto the hard disks and with the CDs containing the softwares along with the licence to use.

It was noted that the invoice-cum-challan issued by the assessee contains the total value of the computer but therefrom value of the operating softwares is deducted for the purpose of computing the central excise duty payable thereupon.

It was further held that a duty of excise primarily is levied upon a manufacturer or producer in respect of the commodity manufactured or produced. It is a tax upon goods and not upon sales or the proceeds of sale of goods. In terms of Entry 84, List I of the Seventh Schedule of Constitution of India, the taxable event in respect of the duty of excise is the manufacture or production. No tax in terms of Article 265 of the Constitution of India can be imposed, levied or collected except by the authority of law.

The following cases were relied upon by the Supreme Court on the point of interpretation of a taxing statute: -

CapeBrandy Syndicate v. Inland Revenue Commissioners [(1921) 1 KB 64 at p. 71]
State of West Bengal v. Kesoram Industries Ltd. and Ors.[2004 (1) SCALE 425]
St. Aubyn (LM) and Others v. Attorney General (No. 2) [(1951) 2 All ER 473, p. 485]
W.M. Cory & Sons Ltd. v. Inland Revenue Commissioners [(1965) 1 All ER 917]
Union of India and Others v. Play World Electronics Pvt. Ltd. and Another [(1989) 3 SCC 18]
Mathuram Agrawal v. State of Madhya Pradesh [(1999) 8 SCC 667]
Indian Banks’ Association, Bombay and Ors. v. M/s. Devkala Consultancy Services and Ors. JT 2004 (4) SC 587
Hansraj and Sons v. State of Jammu and Kashmir and Others [AIR 2002 SC 2692 : (2002) 6 SCC 227]
OxfordUniversityPress v. Commissioner of Income-tax, [(2001) 3 SCC 359]
K.P. Verghese v. Income Tax Officer, Ernakulam and Another, [(1981) 4 SCC 173]
Maddi Venkatraman & Co. (P) Ltd. v. Commissioner of Income Tax, [(1998) 2 SCC 95]
Mysore Minerals Ltd., M.G. Road, Bangalore v. The Commissioner of Income Tax, Karnataka, Bangalore [(1999) 7 SCC 106]
O.R.G. Systems v. Commissioner of Central Excise, Vadodara [1998 (102) ELT 3 (S.C.)]
HCL Hewlett Packard Ltd. v. CCE, Meerut, [2000 (116) ELT 667].
Sprint R.P.G. India Ltd. v. Commissioner of Customs, Delhi [2000 (116) ELT 268 (Tribunal)]
Shriram Bearings Ltd. v. Collector of Central Excise, Patna [1997 (91) ELT 255 (S.C.)]
Photopone Industries Pvt. Ltd. v. CCE, Goa, [1999 (108) ELT 523].
Philips India Ltd. v. Collector of Central Excise, Pune [(1997) 6 SCC 31]

On the basis of principles enumerated in the afore-said judgments, the following relevant provisions interpreted:

Section 2(d) of Central Excise Act, 1944 – It defines the “excisable goods” to mean the goods specified in the First Schedule and the Second Schedule to the Central Excise Tariff Act, 1985 as being subject to a duty of excise. That it must be ‘goods’ which would be subject to a duty of excise and not the ‘goods’ which would not be.
Section 3 of Central Excise Act, 1944 – It is the charging provision. It not only lays down the mode and manner for levy and collection of central excise duty but in no uncertain terms states that a duty of excise shall be levied on all excisable goods which are produced or manufactured in India, as, and at the rates, set forth in the Tariff Act.
Section 4 of Central Excise Act, 1944 – It provides for the manner in which an enquiry is required to be made for valuation of goods for the purpose of levy of excise duty on “goods”. In terms of Clause (a) of Sub-section (1) of Section 4 when the duty of excise is chargeable on the concerned excisable goods with reference to their value, the same shall be calculated in the manner laid down therein.

Accordingly, it was held that only because the expressions “by reason of, or in connection with the sale” have been used in the definition of “Transaction Value”, the same by itself would not take away the rigours of Sub-section (1) of Section 4 as also the requirement of charging section as contained in Section 3.

It must be borne in mind that central excise duty cannot be equated with sales tax. They have different connotations and apply in different situations. Central excise duty is chargeable on the excisable goods and not on the goods which are not excisable. Thus, a ‘goods’ which is not excisable if transplanted into a goods which is excisable would not together make the same excisable goods so as to make the assessee liable to pay excise duty on the combined value of both. Excise duty, in other words, would be leviable only on the goods which answer the definition of “excisable goods” and satisfy the requirement of Section 3. A machinery provision contained in Section 4 and that too the explanation contained therein by way of definition of ‘transaction value’ can neither override the charging provision nor by reason thereof a ‘goods’ which is not excisable would become an excisable one only because one is fitted into the other, unless the context otherwise requires.

It is not a case where the software is being supplied to the customer along with the computer by way of incentive or gift. The Respondent is charging the price therefore. Software therefore along with a computer is being sold both in the form of the information loaded in the computer as also in the form of a CD-ROM. In the invoice, the composite price of the computer and software is being shown, as noticed hereinbefore and there from, the price of the software is only being deducted. The invoice price, thus, also shows the actual price of the computer as also the price of the software together with the licence to use the same. The Appellant while calculating the price of the computer had shown all expenses which are borne by it in terms of the decision of this Court in Union of India and Others v. Bombay Tyre International Ltd. and Others [(1984) 1 SCC 467]. Thus, the requirements contained in the second part of the definition of ‘transaction tax’ are met. Furthermore, invoice value is not always excisable value in respect of the goods.

Relying upon Bombay Tyre International Ltd, it was further held that the excisable value of the computer has been disclosed. The cost of loading the softwares which would enhance the value of the goods had also been added. There cannot, thus, be any doubt whatsoever that while computing such costs of manufacturing expenses which would add to the value of the excisable goods (in this case the computer) must be taken into consideration but not the value of any other goods which is not excisable.

With regard to classification, it was noted that Automatic data processing machines are classifiable under the sub-heading 84.71. Softwares, however, are classifiable under the sub-heading 85.24; the duties payable for are 16% and ‘Nil’ respectively.

Thereafter, the general principles of interpretation were considered keeping in view of the Chapter (s) of the Tariff Act. And it was noted that the softwares, thus, whether they are cleared with the apparatus for which they are intended, viz., with the computer or not they remain classified under the same heading. By reason of the provisions of the Tariff Act, the rate of duties specified becomes part of a Parliamentary Act. Chapter Note 6 of Chapter 85 being the legal text must be taken aid of for the purpose of interpretation of the different headings in preference to the interpretation rules. Suffice it to point out that once ‘no duty’ is payable on softwares being classified under 8524.20 being a magnetic tape, the recorders whereof is classified under 8520.00, a duty would not be payable only because the information contained therein are loaded in the hardware.

It was held that in terms of Chapter Note 6 of Chapter 85, software retains its character irrespective of the fact as to whether it is sold with the apparatus, viz., the computer. Once it is held that the essential characteristic of a software is not lost by reason of its being loaded in the hardware; having regard to the different sub-headings contained in different chapters of the Tariff Act, the intent and purport of the legislature cannot be permitted to be withered away only because the information contained in a software are loaded in a hardware. In other words, as the central excise duty is not leviable on software in terms of the Act, only because it is implanted in a hardware which can be subjected to the assessment of central excise under different head, the same would not attract central excise duty.

It was further held that while calculating the value of the computer the value of the hard disc, value of the firmware, the cost of the motherboard as also the costs for loading operating softwares is included. What is excluded from the total value of the computer is the value of the operating softwares like Windows 2000, Windows XP which are secondary softwares. Indisputably, when an operating software is loaded in the computer, its utility increases. But does it mean that it is so essential for running the computer that exclusion thereof would make a computer dead box?

Considering the erasibility, its reloading character, it was held that An operational software, therefore, does not form an essential part of the hardware. Thus, the answer to the aforesaid question a must be rendered in the negative.

It was noted that in the judgment given in PSI Data Systems Ltdwhat was excluded was a firm or etched software and not the operational software. It has been clarified that the softwares with which the Bench was concerned were tangible softwares of the nature of discs, floppies and CD-ROMs. It is not in dispute that the operational softwares despite being implanted in the computer retain its characteristic of a tangible software of a CD-ROM and can be marketted separately. This Court also noticed that the computers and softwares are classified differently in different chapters being Chapter Nos. 84 and 85 under the heading 84.71 and heading 85.24 respectively.

It was held that the functional test or the essentiality test, thus, had been given a complete go by in the said judgment and, thus, it is not possible to agree that without an operating software, the computers would become dis-functional.

In the end, the Supreme Court held that:

Computer and operative softwares are different marketable commodities. They are available in the market separately. They are classified differently. The rate of excise duty for computer is 16% whereas that of software is nil. Accessories of a machine promote the convenience and better utilization of the machine but nevertheless they are not machine itself. The computer and software are distinct and separate, both as a matter of commercial parlance as also under the statute. Although a computer may not be capable of effective functioning unless loaded with softwares, the same would not tantamount to bringing them within the purview of the part of the computer so as to hold that if they are sold along with the computer their value must form part of the assessable value thereof for the purpose of excise duty.

Both computer and software must be classified having fallen under 84.71 and 85.24 and must be subject to corresponding rates of duties separately. The informations contained in a software although are loaded in the hard disc, the operational software does not lose its value and is still marketable as a separate commodity. It does not lose its character as a tangible goods being of the nature of CD-ROM. A licence to use the information contained in software can be given irrespective of the fact as to whether they are loaded in the computer or not.

The fact that the manufacturers put different prices for the computers loaded with different types of operational softwares whether separately or not would not make any difference as regard nature and character of the ‘computer’.

Even if the Appellants in terms of the provisions of a licence were obliged to preload a software on the computer before clearing the same from the factory, the characteristic of the software cannot be said to have transformed into a hardware so as to make it subject to levy of excise duty along with computer while it is not under the Tariff Act.

In other words, computers and softwares are different and distinct goods under the said Act having been classified differently and in that view of the matter, no central excise duty would be leviable upon determination of the value thereof by taking the total value of the computer and software.

So far as, the valuation of goods in terms of ‘transaction value’ thereof, as defined in Section 4(3)(d) of the Act is concerned, suffice it to say that the said provision would be subject to the charging provisions contained in Section 3 of the Act as also Sub-Section (1) of Section 4.
The expressions “by reason of sale” or “in connection with the sale” contained in the definition of ‘transaction value’ refer to such goods which is excisable to excise duty and not the one which is not so excisable.

Section 3 of the Act being the charging section, the definition of ‘transaction value’ must be read in the text and context thereof and not de’hors the same.

The legal text contained in Chapter 84, as explained in Chapter Note 6, clearly states that a software, even if contained in a hardware, does not lose its character as such. When an exemption has been granted from levy of any excise duty on software whether it is operating software or application software in terms of heading 85.24, no excise duty can be levied thereupon indirectly as it was impermissible to levy a tax indirectly.

In that view of the matter the decision in PSI Data Systems must be held to have correctly been rendered.

It was clearly provided that the Supreme court have not considered larger question as to whether the information contained in a software would be tangible personal property or not or whether preparation of such software would amount to manufacture under different statutes.

Decision: - Appeals of Revenue dismissed.

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