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Import of Software (Freeware) and the Taxman’s Noose
Can Customs Duty be levied on the import of goods when there is no sale involved in the import, where the goods have no value endowed onto them for the purposes of their movement and transmission, and with no intendment to organise the transaction as a value loaded event, moots Anandh Venkataramani.
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Albert Einstein once exclaimed that the hardest thing to understand in this world is taxes. This is the person whose theories are still being mulled by the most eminent and qualified physicists of our time. But then again, taxes are also still being mulled, debated and litigated. At least Einstein’s theories, as theories of pure science, can be proven or disproven to a point of finality, but that is not quite the case with taxes, whose interpretation, applicability and validity shall be continually fought between man and the sovereign that imposes the taxes, till the end of time as we know it. Reasons for debate or litigation could be many, such as of evasion; of interpretation of the letter of the statute to decide whether a specific subject matter comes under the ambit of taxation; of questioning the validity of any provision of a statute, among others.
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In other words the competence to tax, the liability to be taxed, the extent of taxation, the determination of taxability, the fairness of procedures etc. constitute the taxman’s highways and by-lanes. In essence, the most basic question on which pivots all litigation is that whether a certain person, a thing or an activity is taxable or not. This paper also seeks to put forth such a question. The Customs Act of 1962, the successor of the Sea Customs Act of 1878, is a legislation, as we all know, for the purpose of collection of Customs Duty on the import and export of goods and services to and from India respectively. Where the Duty on export is minimal or absent, Duty is present on almost all goods imported into India. The quantum of duty is calculated as per the Customs Tariff Act, 1975. Section 12, called the charging section, under the Customs Act, 1962, reads as follows: |
“Section 12 - Dutiable goods – (1) Except as otherwise provided in this Act, or any other law for the time being in force, duties of customs shall be levied at such rates as may be specified under [the Customs Tariff Act, 1975 (51 of 1975)], or any other law for the time being in force, on goods imported into, or exported from, India.
[(2) The provisions of sub-section (1) shall apply in respect of all goods belonging to Government as they apply in respect of goods not belonging to Government.]”
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| The rates as given in the Tariff Act, are to be computed on the value of the goods being imported or exported. For the purpose of ascertaining the value of the imported goods, Section 14 of the Customs Act has been enacted, which reads as follows. For the sake of brevity, only the portions relevant to this discussion are reproduced below: |
“Section 14 - Valuation of goods for purposes of assessment - (1) For the purposes of the Customs Tariff Act, 1975(51 of 1975), or any other law for the time being in force, the value of the imported goods and export goods shall be the transaction value of such goods, that is to say, the price actually paid or payable for the goods when sold for export to India for delivery at the time and place of importation, or as the case may be, for export from India for delivery at the time and place of exportation, where the buyer and seller of the goods are not related and price is the sole consideration for the sale subject to such other conditions as may be specified in the rules made in this behalf:
Provided that such transaction value in the case of imported goods shall include, in addition to the price as aforesaid, any amount paid or payable for costs and services, including commissions and brokerage, engineering, design work, royalties and licence fees, costs of transportation to the place of importation, insurance, loading, unloading and handling charges to the extent and in the manner specified in the rules made in this behalf...
...Provided further that the rules made in this behalf may provide for, - (i) the circumstances in which the buyer and the seller shall be deemed to be related; (ii) the manner of determination of value in respect of goods when there is no sale, or the buyer and the seller are related, or price is not the sole consideration for the sale or in any other case...” |
| Section 14 of the Customs Act provides for drafting of rules for the purposes of valuation. The Customs Valuation (Determination of Value of Imported Goods) Rules, 2007 has been enacted under the authority of this section, providing for the manner under which valuation of the imported goods may take place. Now, let us get to the question. Can Customs Duty be levied on the import of goods when there is no sale involved in the import, where the goods have no value endowed onto them for the purposes of their movement and transmission and with no intendment to organise the transaction as a value loaded event?
What could be instances where no sale is taking place causing the import of goods, where the import is not at the instance of a sale? One such instance for which rules have also been drafted is goods being brought in as baggage. Baggage up to a certain value is exempt from levy of duty, which is provided under the Baggage Rules, 1998. So, why is it that after a certain limit, import of goods through baggage is taxed? Before this question is answered, one must understand this; that as a general principle of taxation, what the government seeks to tax is the value attached to the activity that is being taxed (transfer, sale etc.), which would reflected by the value of the goods or services, or rights, as the case may be. Take for instance, a transfer of an intellectual property right. The right that is being transferred has a quantifiable value, which is why it is being transferred or “sold” in the first place. The government has the right to tax this activity, and what it taxes is the activity and its value.
In case of baggage, the sale of the goods (as baggage) has already taken place before the act of import. So the import is not occasioned by the sale. Keeping in mind the previous paragraph, the government seeks to tax the import and the value attached to it, i.e. the value of what is being imported. Regardless of the fact that the sale of the goods, to the person who carries them as baggage, might have taken place before the activity of import, the act of import and the value of the goods render them liable to taxation. There is price the importer has paid to acquire the goods in question, hence they have a quantifiable value.
But what of goods that have been imported into India as a gift, where the importer has not paid any consideration for the import? The government has exempted gifts received from abroad by persons residing in India from the whole of duties of Customs and from restriction under Foreign Trade (Development & Regulations) Act. At present, import of goods up to the value of Rs. 5,000/- is allowed as gift, duty free. Any gift over the value of Rs. 5000/- is taxed by the customs department. The rationale behind such taxation is that (a) such goods do have an independent marketable value, that if the goods hadn’t been a “gift”, their import would have been at a certain cost paid by the importer and such costs would be the basis of valuation and (b) if such “gifts” are let free of import duties, then every importer would declare the goods to be a gift and escape taxation. In the view of the author of this article, there is a sound reason behind taxing the “gifts” as has been stated above, which is grounded in the realities of business transactions and arrangements that may be used to avoid liabilities. Further, if one looks at the un-amended Section 14 of the Customs Act, i.e. the pre 2007 Section, such taxation would be correct. The relevant portion of the older section is reproduced below:
“Section 14 - Valuation of goods for purposes of assessment - (1) For the purposes of the Customs Tariff Act, 1975 (51 of 1975), or any other law for the time being in force where under a duty of customs is chargeable on any goods by reference to their value, the value of such goods shall be deemed to be the price at which such or like goods are ordinarily sold, or offered for sale, for delivery at the time and place of importation or exportation, as the case may be, in the course of international trade, where the seller and the buyer have no interest in the business of each other and the price is the sole consideration for the sale or offer for sale...”
The old Section relies on the deemed valuation method of computing the value of the goods. Applying this section to import of gifts, the value of the goods can be determined as the price at which such goods would ordinarily be sold at the time and place of importation in the course of international trade. Hence, even if the no consideration has been paid for the importation, the deemed value of the goods shall be the basis of taxation. But now the deemed valuation has been repealed, and the transaction value is to be considered. However, reason (b) still stands strong as a basis of taxing import of gifts. Such taxation is in conformity with Article 14 of the Constitution in so far as no person has the liberty to evade taxes and everyone is subject to the same uniform tax.
So it would seem that goods that have been imported “free of cost”, so to speak, without the occurrence of a sale as the instance of import, can also be subject levy of customs duty. The sale, in these cases, has taken place before the actual import. But let us now remove one of the pillars on which such taxation rests. Let us now suppose that the imported goods have no independent marketable value. For illustrating the same, the present author proposes to use the example of software, more specifically a freeware. In using the same example, the present author shall illustrate certain shortcomings, to say the least, in the Customs Act, 1962 and the Customs Valuation Rules, 2007.
Before we discuss freeware, let us see how the import of software in general is treated. As per the Customs Tariffs, there is no levy of Basic Customs Duty on the import of software. Which means that if is software embedded or loaded on a metallic or optical disc or any machine is imported, it will not attract the levy of basic customs duty. However, under Section 3 of the Customs Tariff Act, certain additional customs duty is to be charged. Prior to the Notification 31/2010 – Customs, dated 27 February, 2010, addition duty equal to excise duty leviable on a like article (software in this case) produced or manufactured in India was to be charged, under Section 3(1) of the Customs Tariff Act. This additional duty, also (but erroneously) called Countervailing duty (CVD) now has been exempted under the said notification.
What is charged is under Section 3(5) of the Tariff Act, which is the additional duty of customs, also called Special Additional Duty (hereinafter referred to as SAD). The explanation to Section 3(5) makes it clear that even if the imported article was not sold in India, tax will be leviable on the basis of sales tax, VAT, or other tax that would have been payable if the goods were sold, purchased or transported in India.
Usually when software is transferred, what is transferred is the right to use the software, and for this right to use the software, a certain consideration is given in exchange. Transfers of software are usually governed by licence, or sometimes even royalty agreements, where the creator or owner of the software grants a licence to the user of the software to use the software. The amount paid as the licence fee is often the indicator of the value of the software in the absence of an invoice or any like document evidencing a price paid. The manner for determining the value of the software for the purpose of SAD is provided under Section 3(6) of the Tariff Act. This Section takes into consideration the assessable value determined under Section 14(1) of the Customs Act for determining the value for the purpose of SAD.
The assessable value under Section 14(1) of the Customs Act refers to the transaction value of the goods. The Customs Valuation Rules made under this section aid the determination of this assessable value. The Rules, among other things, prescribes a hierarchical procedure of valuation, where if the first method fails, the next method in the hierarchy is to be employed, and so forth, to determine the assessable value in case the transaction value cannot be accepted. The hierarchy begins with finding the transaction value of a contemporaneous import of identical goods; in the absence of which, value of similar goods; in the absence of similar goods, the job is to find the deductive value of the goods; when the deductive value cannot be found, the computed value of the goods; and where none of the above is possible, at the end of the hierarchy, the residual method.
So, now that we know how the import of software is treated, and how the additional customs duty is computed and levied, let us discuss the shortcomings in the Customs Law. The question that was asked, “Can Customs Duty be levied on the import of goods when there is no sale involved in the import, where the goods have no value endowed onto them for the purposes of their movement and transmission and with no intendment to organise the transaction as a value loaded event?”, talks about a situation where no sale is involved in the import. Now, why is the concept of sale and the presence or absence of it of such consequence? Let us finally begin to answer these questions.
Section 14(1) deals with the valuation of the imported goods. It provides that the value of the goods for the purposes of the Customs Tariff Act shall be the Transaction Value of the goods. It then goes on further to explain what the transaction value is for the purpose of the Act. According to the Section, the transaction value is the price actually paid or payable for the goods when sold for export to India for delivery at the time and place of importation, where the buyer and seller of the goods are not related, and the price is the sole consideration of the sale. From the language of the section and the words used, one thing has been made explicit and certain; that the value of the goods, as the section and code perceives it, is the transaction value and only the transaction value.
The expression Transaction Value and the explanation given to it under the Section, makes it clear that the value of the goods shall be the value attached to it in the course of a sale of those goods. This is made apparent by the usage of the words “price actually paid or payable for the goods when sold for export to India...”, “Buyer and seller of the goods”, and “price is the sole consideration of the sale”. It is evident that the Section contemplates a situation where the import is occasioned by the sale of the goods. Though the Section refers to a sale of the goods for export to India, it would also bring within its ambit a sale that might have taken place before the actual export to India. This is made evident by the fact that baggage and gifts are charged customs duty for the reasons that have been elicited earlier in this article. Thus, it can be said that the Section contemplates only a situation where there is a sale in some form or the other.
It had been pointed out earlier that what the government seeks to tax is the activity, and the value attached to that activity. In case of customs, the import and the value of the goods that is being imported is what is sought to be taxed. This is reflected in Sections 12 and 14 of the Customs Act, where Section 12 states that an import shall be charged with duty, and Section 14 deals with the value of the article being imported on which the duty is to be charged. Section 14 clearly provides that the value of the goods shall be the price paid or payable in the course of a sale. Reading the two sections together, it is amply clear that what the Act contemplates as an import, is one in which a sale has taken place.
Let us begin discussing freeware. Freeware is a type of software governed by a “General Public Licence’. Usually, most software are copyright protected, and the terms of the licence which allow their use do not allow modifications in them. Many such software are ‘pay and use’ software, i.e. the terms of the licence require the payment of a certain price for using the software. A general public licence on the other hand, is governed the ‘Copyleft’ principle, which preserves the freedom of the recipient of the freeware to modify the software, and be further transmitted only under the same licence terms. No software under a General Public Licence can be sold for a price, as the terms of the licence prohibit it, because the whole purpose behind the licence is free transmission of information.
When software is imported into India, SAD is charged. The means of finding the value have been explained in earlier in this article. Under the present law, if a freeware is imported, it would be subject to levy of SAD. To illustrate why such taxation is wrong and ultra vires of the Act, let us study an example of a freeware import. Linux is an operating system, similar to Microsoft Windows, except that it is governed by a General Public Licence, it is a freeware. If, let us say, 50 compact disks with Linux loaded on them, are imported, the Customs Department would then, under Section 14(1) attempt to find the transaction value of the goods. Since no such value of Linux would be found, the department would then proceed to find the value of a contemporaneous import of an identical or similar article. They would find that Microsoft Windows is an identical or similar article, and on this basis load a value onto the compact disks containing Linux. Based on this value, the SAD would be computed. Such taxation, it is submitted, is patently wrong and is beyond the scope of Section 14. Why it is so shall now be explained.
The Customs Act, reading Sections 12 and 14 together, as has been explained above, contemplates an import only as one in which a sale has taken place in some form or the other. Even if there is no sale, as in the case of a gift, the marketable value of the goods can be the basis of levy of customs duty. So what the Act seeks to tax is the import and the transaction-able value of the article being imported. But here stands a case before us, where the goods being imported, do not have any marketable value at all. The transmission of these goods do not contemplate any value being attached to them. The recipient of freeware does not award any consideration to the person who transfers or transmits the software to him/her. There is no intention, on either of the parties, to endow the transaction with any value. There is no price tag attached to such a transfer. In case of other ‘pay and use’ software, a consideration is paid in the form of a licence fee.
However, there is no such fee for freeware. All other articles or goods that are imported and on which customs duty is charged, have a value that can be attached to their transfer or movement. They can be subject to sale. Freeware on the other hand, cannot be. Only the compact disk onto which the freeware is loaded is subject to tax, as per the rates under the Customs Tariff Act, as the compact disk has a transaction-able value independent of the software loaded onto it, and can be subject to a sale. Therefore, where no value, leaving aside that of the compact disk, as contemplated by the Customs Act, can be attached to the goods, such an import would remain an import, but outside the purview of Section 14. And since, by reading Sections 12 and 14 together, an import as contemplated by the Act, is only one in which a sale has taken place in some form or the other, or a marketable value can be attached to the goods, the import of freeware would be outside the purview of the Customs Act.
Even if one takes a step back, and takes a look at the pre 2007 Section 14, where the deemed valuation method of computing the value of the goods is employed, it would still not bring freeware within the ambit of taxation. Under the old section the value of the goods are deemed to be “the price at which such or like goods are ordinarily sold, or offered for sale...” Even under the deemed method, it talks of a situation where the goods would be subject to sale. The freeware can never be subject to sale. And if it ever is, to an unsuspecting customer, it would be against the terms of the licence that governs it, and hence against law.
Let us begin discussing freeware. Freeware is a type of software governed by a “General Public Licence’. Usually, most software are copyright protected, and the terms of the licence which allow their use do not allow modifications in them. Many such software are ‘pay and use’ software, i.e. the terms of the licence require the payment of a certain price for using the software. A general public licence on the other hand, is governed the ‘Copyleft’ principle, which preserves the freedom of the recipient of the freeware to modify the software, and be further transmitted only under the same licence terms. No software under a General Public Licence can be sold for a price, as the terms of the licence prohibit it, because the whole purpose behind the licence is free transmission of information.
But wait a moment. Section 14 does mention a ‘no sale’ situation. The relevant portion of the section reads “...Provided further that the rules made in this behalf may provide for, - ...(ii) the manner of determination of value in respect of goods when there is no sale”. So, from this, is it to be assumed that the section does indeed bring within its ambit an import where there is no sale? It would seem so. Clearly the legislators did consider such a situation, and made all the bother to delegate the power to make rules on that regard, where it is another question that no such rules have been made. But the author of this article emphatically negates the assumption that the section brings within its ambit an import where there is no sale, a fortiori the discussions in the preceding paragraphs. It is infinitely clear how the legislators intended ‘value’ to be understood, i.e. as the transaction value; the value of the goods in the course of a sale, and neither is it to be understood, nor interpreted in any other way.
It is generally held that revenue laws are neither remedial laws nor laws founded on any permanent public policy. On the contrary, they operate to impose a burden on the public, or to restrict them in the enjoyment of their property and pursuit of occupations and hence have to be strictly construed. For anything to be taxed, it must be clear from the taxing statute that the thing is to be taxed. In case where the taxing statute is unclear as to the same, the thing cannot be taxed. This is firmly grounded in the principle that all taxation must be by legislation. Neither the Executive, nor the Court can extend its operation. Article 265 of the Constitution of India, states “No tax shall be levied or collected except by authority of law.” This not only means that when an activity or person, as the case may be, is not covered by any taxation law, it cannot be taxed, it also means that unless the tax statute is clear as to whether a certain act or person is covered by it, such an act or a person cannot be subject to the tax
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A rigid application of the tax laws is for the protection of the citizen who should be informed in unambiguous terms of the amount and nature of his duty and if at all the duty exists or not. An extremely limited and narrow implication of the section under the taxing statute must be taken. The government is not at the liberty to widen the ambit of any provision, which is clear in its words and meaning. In Cape Brady Syndicate v. IRC, the Court had very lucidly stated - “In a taxing statute one has to look merely at what is said. There is no room for intendment. There is no equity about a tax. There is no presumption as to a tax. Nothing is to be read in, nothing is to be implied. One can only look fairly at the language used.” Further, A.V. Fernandez v. State of Kerala, the Supreme Court states the principle as follows: “If the revenue satisfies the court that the case falls strictly within the provisions of the law, the subject can be taxed. If, on the other hand, the case is not covered within the four corners of the taxing statute no tax can be imposed by inference or by analogy or by trying to probe into the intentions of the legislature and by considering what was the substance of the matter.” Hence, in taxing statutes, the language cannot be strained.
Where the meaning of a statutory provision is clear, it must be followed strictly, no reliance can be placed on any external or internal aids or on any rules of interpretation. However, where there is ambiguity or when the provision is unclear, certain well-recognised rules of interpretation, or in other words, aids, may be relied upon. One such aid is to look at the interpretation clause or the interpretative notes. Section 14 itself is not aided by any interpretative clause or notes. However, the rules made under the section, i.e. Customs Valuation (Determination of Value of Imported Goods) Rules, 2007, do contain interpretative notes. As to whether subordinate legislation can be taken into consideration for interpreting an ambiguous provision in the statute, the English view answers this question in the negative.
The present author would agree with this view. However, for the sake of discussion and debate, the Rules may be looked into. But these notes too would come to no aid of the proposition that Section 14 contemplates a ‘no sale’ import. If one peruses the interpretative notes to the Rules, it would, rather, make it clearer that the sale is an essential component of the import. The repeated usage of terms such as ‘price paid or payable’, ‘sale price’, ‘condition of sale’ etc. would make it inescapably apparent that Section 14 contemplates only an import where there is a sale.
When the meaning of a word in the statute is unclear, then one may look at the context in which the word is used, and the intent behind the usage of the word. But our present discussion does not merit such a search into the context and intent of the words being used. The context of ‘value’ in Section 14 is quite clear, owing to the explanation given in the section itself, i.e. transaction value, which is also explained. It can thus be safely concluded, without any ambiguity, that Section 14 does not contemplate a ‘no sale’ import
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It is a common practice of the legislators to delegate legislation when knowledge of technicalities or any special knowledge is required. It is understood that the delegatee, i.e. the body that shall enforce the law, would be more equipped to understand the intricate ins and outs of the subject matter. But this delegated legislation must not go beyond what is expressly provided in the parent Act. The delegation should not be, if the parent Act itself does not clearly deal with a subject matter, and provide guidelines for the same. Such delegation, if does exist, is bad in law. English Law answers in the negative to the question as to whether a subordinate legislation can be taken into consideration for interpreting an ambiguous provision in the statute. The author of this article concurs. This is so because not all delegation may be correct, and often, the subordinate legislation may go beyond what the parent legislation might have intended
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If the government had indeed made rules for circumstances of an import where there is no sale, it would have been an example of a bad delegation, and unfit for reliance for clearing ambiguities, if any, in the parent Act. In fact, in the opinion of the present author, even the intention of the legislators to delegate the power to make rules in a ‘no sale’ circumstance is wrong in law. Why?
A delegation can be bad, so to speak, on two counts: (i) when what is to be contained in the principal Act, i.e. principles, guidelines etc., is delegated, and (ii) when the principal Act doesn’t contain any guidelines, and leaves it to the discretion of the delegatee. What we’re dealing with, in Section 14, is the error of the second kind. Where the Section contemplates only an import in which a sale has taken place, it seeks to delegate authority to make rules for a situation of an import without a sale. Now this would leave room for intendment in the hands of the taxing authority. Under normal, error free circumstances, the principal Act would, and must clearly say what exactly is to be done, or in this case, what exactly is to be taxed. When the Act does not do the same, does not lay down guidelines, and then asks the delegated authority to do what it must have done itself, i.e., asks the delegated authority to frame its own guidelines, and act on them, it leaves enough room for intendment.
Let the principles stated in Cape Brady Syndicate v. IRC and A.V. Fernandez v. State of Kerala echo now, that there is no room for intendment; that in a taxing statute, one must look merely at what is clearly said; that only if the revenue satisfies the Court that the case falls strictly within the four corners of the taxing statute, can a tax be imposed. The example that has been used in this article to illustrate certain fault lines in Section 14 is Freeware, and in the opinion of this author, is just one among many that may come about, to trouble the Customs Department with questions they would not be able to answer, given the current law. In the above scenario, cannot one legitimately pose a question as to whether Section 14, as it stands and its premises in relation to import without sale, and its assumed scope are not open to serious debate and challenges?
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| Anandh Venkataramani is a 5th year student pursuing B.A.LL.B from Symbiosis Law School, Pune.
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