Recently, the High Court of Karnataka has delivered a landmark judgement in the case of, Finance Department of Karnataka Department vs IBM India Private Limited, STRP No. 215/2011 dated 18th September 2015, wherein the following aspects in respect of sale and development of customized software has been held with regard to their taxability:

1. The packaged, readymade, off the shelf software are pure goods liable only to VAT.
2. The customized software or tailor made software for an individual customer, similar to packaged software, where the copyright owned software is put on the media and delivered by way of transfer of right to use, will also be goods and is liable to VAT. In the case of customized software, the customized portion is embedded to the original software so as to become the customized software, the copyright of the entire software including the customized portion is exclusively owned by the developer of the software. Therefore, in a customized software, where copyright is held by the developer of software and the copyrighted article alone is handed over to the customer as a transfer of right to use goods, the software is goods and liable to VAT alone.
3. In certain cases of customized software, it is possible for an entity to work on a hired contract basis rendering pure service and get delivered fully developed software for a specified customer with future contracts for upgradation and enhancement. In such a situation too, the software emerges. However, the copyright in such software belongs to the customer, as it is developed, and the developer of the software does not retain any copyright in such software. In such a situation, since there is no transfer of property in goods and what is provided is only a pure service, there can be no liability to VAT. The consideration in such cases is liable only to service tax.
4. In the case of Annual Technical Support (ATS), if the agreement of the contract includes the annual maintenance involving both service and issuing upgraded or enhanced software, then such a contract is a combination of both goods and service. The contract is in the nature of works contract. VAT is liable to be paid on the goods part and service tax is to be paid on the labour aspect. In upgradation and enhancement, the copyright is owned by the developer of software and what is transferred to the customer is the right to use.
5. In the case of implementation of customized software, where the copyright of the customized software is with the software developer, the implementation process is a pure service rendition and does not involve any transfer of property. If any source coding or scripting is done during the process of implementation, the ownership or copyright or any proprietary right would not vest with the software developer. It works purely as a hired labour. The ownership vests at all point of time with the employer who had issued the assignment. In those circumstances, since there is no transfer of ownership or the licence to use the software (deemed sale), it is a pure service contract. There is no sale of goods. It is a case of rendering service and is liable to service tax only.