Wednesday, September 05, 2007

TDS Troubles (Woes) reselling Software Subscriptions

My company sells Computer Software from reputed vendors like Microsoft, Oracle, Symantec, Red Hat, IBM, Novell, Adobe, Computer Associates etc.

We are an authorised channel partner of Red Hat in India to resell their software products. Recently we sold a good number of Red Hat Enterprise Linux 1 year Subscriptions to a software company. Upon receipt of the payment, we noticed that it was short by about Rs.1,25,000/-. Inquiry revealed that TDS (Tax Deducted at Source)was deducted from the payment at the rate of 11.33%.

Upon inquiry with the cusotmer - we learnt that since it was a sale of 'Technical Service' hence as per prevailing Income tax laws TDS was deducted. But, we pointed out the customer that we were 'an authorised reseller' and not the Actual Service Provider i.e., Red Hat. Customer's argument was that while it's true (but) as per prevailing law they are obliged to deduct TDS from the supplier because there is no mechanism by which they can deduct TDS from the Actual Service Provider i.e,, Red Hat!

So, we thought for a while and came up with this idea that we should deduct TDS from our Supplier who is an authorised distributor for Red Hat in India. Upon disccussion - distributor (Supplier) agreed for the same. Here the 'logic' we had in mind was that like VAT - we would get credit for the TDS deducted by the customer.

But we soon learnt from our Chartered Accountant that we WILL NOT GET any credit for the TDS already deducted by the customer! What ever TDS that we deduct from our Supplier will have to entirely paid to Government promptly! So, our assumption of making TDS payment on our 'Gross Profit' by taking in to consideration TDS deducted by Customer - was wrong. In summary, it did not make sense to deduct TDS from our supplier and make the entire payment to the Government. So, we made full payment to our supplier without deducting any TDS.

What's lesson we learnt from this? Do not resell 'Software Subscription' or 'Software Maintenance' or 'Software Maintenance Renewal' because Indian Income tax laws do not have any provision for 'resell' of 'Technical Service'!

We talked with Red Hat people about this. They could understand our difficulty and promised to look in to the matter and get back to us with a solution. And we are waiting.

We talked to our Chartered Accountant to take up this issue through their 'Association'. They said nothing can be done by their association; as Finance Minister or Income Tax Department does not ask their opinion or listen to them. Only way this can be done is by making representation to Income Tax department by the 'Association of Software Resellers'. What is it called - lobbying - I suppose. And we do not have any association of 'Computer Software Resellers' in India. Bad luck!

So, who will do the representation to the Income Tax department and ensure that suitable amendments are done to the Income Tax laws which makes provision for 'Input Credit' similar to VAT and Central Excise laws? I do not know.

OK that's that. But the funny part comes now. Keep reading...

1. Red Hat's competitor Novell is selling it's Suse Linux Enterprise Server not as a 'Subscription' but as a 'Software Product'. They are charging 4% VAT; and Red Hat charges 12.36% Service tax. So, what's moral of the story? It's obvious.

Note added on 30-10-2007: Not really. Recently when we sold Suse Linux Enterprise Server with 1 year subscription to one customer they deducted TDS while making payment to us! So, what have we learnt? Pray to God! God please save India from it's complex tax laws.

2. One of our old-time and good customer - who are a big time Software House - started deducting TDS on the sale of Software license. Just in case, if you do not know - Software license is treated as a "Product" and it attracts 4% VAT. It is NEVER considered as a 'Technical Service', hence it does not attract Service Tax. So, there should not be any TDS deduction on the sale/resell of Software license.

Upon inquiry we learnt that their 'Consultant' had opined that 'License Fees' charged towards sell of Computer Software is liable to attract TDS due to a new provision in the Income tax laws. So I decided to read this provision. Upon reading I learnt that it was all about applicability of TDS on the payment of 'Royalty' paid on usage of Scientific invention etc.! It said that TDS is to be deducted whenever "Royalty" is paid because of an "License granted" by the Inventor. Reading of full text makes it amply clear that it's all about 'Royalty' payments only.

So, how did the 'Consultant' came to this conclusion that sell of Software license attracts TDS? Oh, it was the presence of the single word 'License' that was the culprit. I reasoned to the customer that usage of word 'license' was in relation of 'royalty' payment and not in relation to 'usage of computer software' or 'grant of software license'. But Consultant's opinion was that - due to 'Stringent Penalty' for non-compliance of Income tax laws - customer was advised to be on safer side and deduct TDS!

So, what's the end result?

1. In first 5 months of the current year -we have paid more TDS than our entire year's Income tax liability. So, at the year end we will be asking for Income tax refund. Do I have to mention - how easy or difficult it is to get the refund the from Income tax department?

2. We have decided not to allow any more TDS to be deducted from the receivables. How do we do it?

We will have to apply to the Service tax department of the Income tax for a certificate which will allow either "no TDS" or "TDS at a lower rate (which is decided by the Income tax officer)" - up to the financial year end or for ever (left again to the discretion of the Income tax officer).

I learnt from my Chartered Accountant that getting this certificate is neither easy not cheap. It would cost us Rs.10,000/- or more. And of course, it will take many trips to the Income tax department and lot of time to get it - if at all.

Update on 30-10-2007: We made an application. Our CA was told upfront that it would get rejected. Why? Because we had paid self-assessment tax in the previous 3 years! Isn't it normal thing to do? What a logic!!

Well, what about 'merit' of the case? Well we can file an appeal to them when it's rejected! About 15 days back we got the rejection letter. What next? File an appeal - what else?

Update on 1-4-2008: No I'm not making April Fool. We got the Certificate of lower deduction from Income tax under section 197(1) at 1.4% on 15-3-2008. We got it after lot of arguments, loads of papers and paper projections and lot of sweat. What's validity? It's valid up to 31-3-2008. We could not use it because we could not find an existing customer in this 15 days - who was going to deduct TDS in this 15 days. Sad!

Update on 9-8-2008: We applied for the same certificate once again in April 2008 with similar load of papers. We got it on 12-5-2008. This time it was for TDS at 1.5%. It's useful.

Another case: We had sold Software Maintenance to a large Bank. Payment came with 4.25% deduction. When TDS certificate came after lapse of 15 months we realised that certificate was for only 2% amount. What about balance 2.25% deduction? Upon inquiry we learnt that it was towards WCT (Works Contract Tax). Well, we told cusotmer that WCT is not applicable on Software Maintenance. They said nothing can be done now (after 18 months) because it is already deducted and paid to the government. What about the certificate? We will get it. What do we do with it? We are thinking of framing it in a nice photoframe and write 'thanks to tax laws in India' this certificate worth more than Rs.30,000 is hanging on our wall.

That's life in India.

Any comments or suggestions?