By TIOL News Service

MUMBAI, NOV 09, 2016: THE Appellant is authorized replicator appointed by M/s Microsoft Licensing (Microsoft), a wholly owned subsidiary of M/s Microsoft Corporation to reproduce Microsoft products under certain terms and conditions.

The Appellant imported kits containing CDs software from M/s Mediagate, Singapore/Data Pulse, Singapore and COA from M/s Dealrue, UK. The COA were printed on the labels and all the three were packed in a kit for onwards sale to OEM(Original Equipment Manufacturer) or Distribution Service Partners (DSPs) who has licensing agreement with M/s Microsoft. Upon placing purchase order with the Appellant and receipt of such report of purchase by M/s Microsoft, the OEM pays royalty to M/s Microsoft which is calculated as per the terms of licensing agreement between such OEMs and M/s Microsoft.

The software purchased from the appellant has a product key which is used to activate the software in the computers sold by the OEM to their customers. The recovery CD is used to recover the operating system in case of hard disk crash or system breakdown. The OEM while billing to their customer charges the cost of such software packs purchased from appellant as well as Royalty amount paid by them to M/s Microsoft.

Some of the OEMs like M/s HCL Info systems Ltd. and others also directly import replicated packs where the entire value is charged on invoice and no royalty is paid on such direct imports as it is included in the cost of software and they pay excise duty on same while clearing from factory. In case of sale of software kit purchased by the DSPs they further sell it to their customers. In both cases, the OEM and DSPs who purchase software Kits from Appellant they directly pay loyalty to M/s Microsoft. The Appellant received enquiry and query by the Customs department on such importation of CD regarding their valuation.

The goods were provisionally assessed and out of charge was given. The Appellant were later issued SCN proposing to reject the declared value of CD containing software in terms of Rule 4(2) read with 10A of the Customs Valuation Rules, 1988 and to re-determine the same under Rule 8 of the said Rules; to demand and recover differential custom duty of Rs.24,91,25,321/-; to confiscate the imported goods and to impose interest and penalty; to finally assess the Bill of entry on the basis of re-determination as proposed and to enforce the provisional duty bonds towards duty liability.

The demand was confirmed with penalties and interest and in appeal the matter was remanded by the CESTAT. In remand proceedings, the demand was again confirmed and this the second round of appeal before the Tribunal.

After considering the elaborate submissions made by both sides, the CESTAT observed –

+ Before installation/use/sale of the software to the OEMs or DSPs they should have licensing agreement with M/s Microsoft so that the software installed in the machines which is brought from the Appellant can be used and the operating system can be put to work. It is only after entry of COA/product key number in the system bought from the Appellant that the computer starts working.

+ If the OEM or DSPs has no licensing agreement, the system will not work as it is only after agreement of royalty of OEMs and DSPs that the whole process of software loading can be initiated. Further, it is only after CD kit/software pack is purchased from the Appellant and product key issued by the Appellant is entered that the system works. Thus it is case where M/s MSLI is controlling all the prices and has control over each transaction. Only the sale of the software has been routed and bifurcated in such a way that the Royalty of the software escapes the payment of duty on its importation.

+ In cases where the software is purchased directly from M/s MSLI the cost of licence is included in the sale value of CD kit and there is no need to pay the royalty charges separately to M/s Microsoft by the OEM or the DSPs. In nutshell, it shows that the royalty charges are part of the cost of software. If there is no licensing agreement for payment of royalty, the software cannot be operated.

+ As per Appellant's Authorized Replication Service (OEM) agreement the Appellant can sell goods only to those OEM and DSPs who are having a valid agreement with MSLI which clearly shows that it is a restriction sale of goods and the clause 4(2) of the Customs Valuation Rules is applicable in the present case. In such case the transaction value declared by the importer cannot be accepted.

+ Once the product key is procured by the OEM and DSPs from the Appellant there is no restriction on use of software provided they have licensing agreement with the MSLI. It is an undisputed fact that all the OEMs had agreement with the MSLI known as Microsoft Distribution channel agreement that the OEM had to sell unopened and unaltered package as received from Appellant as no further processing was required. The Distributors in turn while selling these goods added royalty paid or to be paid by them to M/s MSLI. This clearly shows that the Software package is of no use without royalty and it is the royalty payment or an undertaking/agreement to pay royalty which is prerequisite of working of package.

+ The goods imported by the appellant are not merely blank CD but is loaded with the software for which key is provided by the Appellant themselves. It shows that the goods are always inclusive of royalty which is otherwise recovered by M/s MSLI from the OEMs/DSPs and Microsoft are not connected even though the every benefit is accruing to M/s MSLI. The Royalty is payable on each software package sold by the Appellant and if no software is sold there would be no commensurate royalty. Thus the royalty is an integral part of the package sold by the Appellant.

+ Further as seen from the statement of General Manager of M/s Ingram Micro they were importing retail packs from MSLI while purchasing OEM pack from Appellant ,the price was inclusive of royalty. Only in case of goods brought from Appellant by OEM that the royalty was paid separately to M/s MSLI. From the above undisputed facts it is clear that the royalty which is for a right to use the software is includible in the value of the CD and the price declared by the Appellant cannot be accepted for custom assessment.

+ It is also a fact on record that the transaction value declared by the Appellant is less than USD 1 per piece, the OEMs were charging Rs.3000 to 4600 per piece after inclusion of royalty amount for the same product. This shows that the selling price of the goods was determined by the Royalty amount which in the instant case has to be added to the value of the imported goods. The goods imported by the Appellant is not blank CD but is consisting of complete software alongwith the product key and no further action is required.

+ The value of CD is not only the value of CD but it must also include the value of the Software and the right to use such software i.e. Royalty towards such charges without which the software cannot be operated. We, therefore, hold that the declared assessable value of the imported goods is not correct and required to be re-assessed.

Notification 6/2006-CE – CVD exemption - Eligibility thereof

+ Exemption under serial No. 27 of said notification is available only to software which are developed form basic building blocks resulting in emergence of new software product. However, in this case it is a customized software and not specific software and hence not eligible for exemption under the said notification.

Valuation method- Rule 7 or 8

+ Appellant has objected the method of valuation under Rule 8 adopted by the adjudicating authority. It is their objection that deduction as contemplated in Rule 7 was not given. However we find that since the identical goods of greatest aggregate quantity are not imported, the recourse to Deductive Value Method i.e. Rule 7 of Customs Valuation cannot be taken and, therefore, recourse has to be taken of Rule 8 (Residual method) of Customs Valuation Rules, 1988 by giving reasonable flexibility. The price list of M/s Esys Information Technologies and M/s Ingram Micro have been given to the Appellant as relied upon document which acts as a bench mark to calculate the assessable value. We, therefore, direct the lower authorities that while arriving at assessable value in terms of Rule 8 of the appropriate adjustment towards expenses, taxes and profit margins has to be given to the Appellant.

Confiscation, Penalty etc.

+ No infirmity in the observations of the adjudicating authority and therefore the confiscation of goods as well as imposition of redemption fine and penalties is upheld.

Conclusion:

The case is remanded back to the adjudicating authority only for the limited purpose of re-quantification of duty by determining the assessable value in terms of Rule 8 of Customs Valuation Rules, 1988 after taking into consideration the Appellant's submission on appropriate adjustment towards expenses, taxes and profit margins.

(See 2016-TIOL-2905-CESTAT-MUM)