National

Policy on Software Products 2014

Draft v2

Preamble
1. Software Products is a $1.2 Trillion dollar industry by revenue. By market
capitalization, it is 18 times bigger than the IT Services industry.

2. Software product industry can be the growth engine for India. It has already
demonstrated its potential. Further, it is aligned with our national
competitive advantage, and does not require prolonged infant industry
protection, unsustainable subsidies or difficult to justify preferential
treatment. It has the potential to generate substantial export earnings, and
contribute positively to Indias current account deficit.

3. India possesses the following foundational blocks for a thriving software
product industry. It has well demonstrated skills in software. Indian software
engineers, many working for MNC R&D Centers, are responsible for
developing complex products for worlds largest product companies. Many
of these talented engineers now aspire to be technology entrepreneurs.
Unlike hardware products, where it is clear that India lacks essential
elements of the ecosystem such as semiconductor fabrication and strong
hardware R&D, the software product ecosystem is reasonably well
developed. Further, mobile proliferation, commoditization of computing
hardware and advent of cloud computing have made it possible to deliver
software products across India. Finally, in the global market, thanks to
success of Indians in Silicon Valley product startups, there is a relative
absence of liability of origin effects. Indian companies like FusionCharts
have already demonstrated that it is possible to sell products online from
India without the liability of origin disadvantages that inhibit other industries
(e.g. Tata has not added the Tata brand name to their global Jaguar and Land
Rover brands for fear of these liability of origin effects).

4. For the first time in the history of the technology industry it possible for
small entrepreneurial teams to develop complex software products quickly1.
This is due the Combinatorial Innovation (Varian, 2004) becoming possible
with the rise of open source and web-services architecture. In India we have

1 The power of Combinatorial Innovation is well established and history is dotted with

several of these periods. Back in 1898 it resulted in Wright brothers beating Langley to
the creation of first powered flight despite Langley having a $70,000 grant from the US
Government and the Smithsonian Institute. Later, combinatorial innovation was
famously at work in Edisons lab in the creation of a useable filament based light bulb.
The electronics industry has used combinatorial innovation to turn hobbyists like Steve
Jobs into computer makers of the world. More recently web-apps started being built
using combinatorial innovation and these mash-ups resulted in rise of Yahoo and
other internet players. Finally, and to Indias advantage, this power of combinatorial
innovation has reached the world of business applications.

seen combinatorial innovation at work in the UID project. The core UID
application was built by a very small but talented team of volunteer
developers. They used many open-source components, built a few new ones,
and then glued them all together in an innovative fashion to rapidly create
the worlds largest identity management system.

5. Just like the mobile revolution where mobile penetration exploded
worldwide, a SaaS revolution is now underway. SaaS products are
penetrating every small business. This is because they offer high functionality
at a fraction of the cost of traditional enterprise software. The global market
is estimated to be $600 billion dollar global opportunity (out of the total US
$1.2 trillion dollar opportunity for software products). For the first time
Indian SaaS product companies are part of this emerging market opportunity
from the beginning and some early winners are starting to emerge2. It is vital
that we build on this early momentum. In the software product industry the
winners take most of the profits. Therefore timely intervention to nurture
and amplify the Indian software product industry momentum is vital.

6. India is blessed with the worlds largest number of small businesses, primary
and secondary schools, rural healthcare centers and farmers. As the mobile
revolution unfolds, it has become possible to upgrade their functioning by
use of software products (applications) at an affordable cost. Rather than rely
on central design and control and a scale-out approach, it is possible to
deploy software products using a spread-out model. This results in faster
and smoother adoption as it relies on local aspirations and has a built-in
mechanism for ensuring utility of the investment. Even today, Indian
software product companies3 are impacting 3 million small businesses. With
a policy impetus, this can grow to 30 million small enterprises. It is bring
competitiveness to small businesses, teaching effectiveness to schools,
productivity to healthcare centers and new skills to farmers.

7. A healthy software product industry is also pivotal to developing our defence,
aerospace and electronics industries. It is also necessary for creation as well
as maintenance of strategic technologies that are critical to national security.

8. A strong software product industry is of strategic importance for India. In
addition to its direct impact on GDP, exports and balance of accounts, this
industry also holds the potential to unleash social transformation,
simultaneously addressing the economic growth and human development
needs of India. Indian software product industry is in the maturation stage.
The National Policy on Software Products provides the springboard for India
to emerge as a global leader in this important industry.

2 When ZenDesk, the SaaS market leader in customer service desk management
products, did its roaring IPO earlier this year, it listed six key competitors in its
S-1 SEC [US Securities and Exchange Commission] filing. Four of these - Kayako,
Freshdesk, Supportbee and Tenmiles are Indian!
3 Like Tally for accounting, Fordian for School ERP, Practo for doctors, Forus for
eyecare, etc.


9. The rise of software product industry in India is path dependent. This means
that small interventions will have disproportionately large effects in the
future. To leverage these effects it is essential to understand the stages of
industry evolution that software product industry will go through. What is
appropriate for one stage can even become counterproductive in the next
stage. Therefore the National Policy on Software Products is built on the
evolution framework of the software product industry4.

I Vision

To drive the rise of India as a Software Product Nation and create in 10 years:
1,00,000 Product Startups in India
Employment for 3.5 million technical people
$500+ billion in Market Value, and
New levels of performance for 30 million small enterprises.

II Mission
1. To capture 8-10% of the global software product market of US $1.2 trillion
USD by 2025 by enabling all sectors of the software product industry.

2. To build domestic market and grow penetration of software products to 30m
SMEs in India thus raising their competitiveness, and emerge as Small
Business Application Software (SBAS) hub for the world.

3. To promote Indian mid-market SaaS products across the world with desk
selling and marketing, so that category leaders emerge in 12 segments.

4. To promote Indian software product companies in software infrastructure
sector. Software product industry has four segments: consumer applications,
business applications, software infrastructure and decision infrastructure.
While Indian software product companies are doing well in all segments,
there are global leaders emerging in the software infrastructure segment.

Cloud computing, explosion of data and video, usage of e-commerce, security
of BYOD, availability of real-time social media, programmatic advertising, etc.
are driving the need for new generation of software infrastructure.

There is an opportunity to create global leaders in several sub-segments of
the software infrastructure. Potential leaders in many areas already exist.
Druva, a Pune based startup is a global market leader for endpoint data
security and governance infrastructure. Adsparx is an emerging leader for
dynamic ad insertion infrastructure for mobile video. Unbxd is an emerging
leader for e-commerce search infrastructure. i7 Networks and Uniken are
emerging leaders for BYOD security infrastructure. Frrole and Qubole are

4 The evolution framework is described in the Appendix: Stages of Indian
software product industry evolution.

emerging leaders for real-time social media analytics infrastructure. Inmobi

is a global leader for mobile programmatic advertising infrastructure with
Vizury, Pubmatic and others also doing well in related segments.

5. To create novel business models and pathways for transformation of social
enterprises like rural healthcare centers, primary schools, small family farms,
etc. so that new capacity is created to meet the unmet demand for public
services.

6. To simplify rules for software products to prevent software product
companies moving away from India.

7. To provide a level playing field to Indian software product companies,
particularly related to seed funding and public sector procurements, so that
they can fully leverage the benefits of a large domestic market.

8. To refresh Brand India from the taint of being the back office of the world by
highlighting Indias credentials as a land of technology, disruptive ideas,
inventions and cutting-edge products.

III Objectives and Strategy

1. Ease of doing business. To publish an annual report on ease-of-doing
business for software product firms that will cover 5 facets: starting, running,
raising capital, giving stock options, M&A and going public.

a. Starting a software product company. This will benchmark India
against a goal of being able to start a software product company with a
day of effort, online with less than Rs 5000 by interacting with a single
site, and filling out a single form.

b. Running a software product company. This will benchmark India
against Ease of doing business as per the survey conducted among 185
economies by World Bank International Finance Corporation.

c. Raising capital. Regulatory changes are needed to allow VC and PE
firms to directly invest in India rather than through foreign shell entities
established in places like Mauritius.

d. Giving stock options. Stock options is a critical tool for software
product companies. Currently stock options cannot be granted to
promoters and independent directors or to foreigners. This is not the
global practice. In absence of this, it would become difficult for Indian
companies to hire deep technical experts and attract talented
independent directors. They are also crucial for entrepreneurs who have
less shareholding initially, and who rely on consolidating their
shareholding over time.

e.

f.

M&A. Technology M&A is crucial to the health of the software product

ecosystem. India ranks very poorly on this measure. It has 1.2X M&A
exits for invested capita over 5 years compared to 5X for Israel.
Pernicious regulations related to payouts to investors prevent small
M&As to happen in the software product industry.

Going public. There is an exodus of software product companies from
India. 30% of Top 30 Software Product Companies have already
redomiciled themselves outside India. 54% of new software products
that raised early stage capital hadredomiciled themselves. SME listing
and public listing norms need to be updated. For instance, public listing
norms require a minimum 3 years of profitability whch prevent
softwware product companies from listing here. It is imperative that
accelerating movement of software product startups from India to US
and Singapore jusrisdictions is reversed by having better regulations.

2. Tax. To bring clear demarcation in the tax regime between Software being
delivered as Service and Software as Product.

a. Software Product Defunition. A mechanism to notify a software
product definition10 shall be established so that there is homogenous
understanding across Central and State govermnets, and across Direct
and Indirect taxes.

b. NIC Code. An new National Industrial Classification (NIC) code shall also
be created for the software product industry11.

3. Buy Products, not Projects. To develop Model RFPs for buying software
products for Government systems. Buying software products will reduce cost
of ownership dramatically12. A special effort will be made to incorporate
domestic software products in the Defence sector. For PSUs and State Owned
Enterprises, "Preference to Domestically manufactured
Electronics products in Government Procurement" policy shall be extended
domestic software products as well.

10 Appendix lays out the Principles for taxing software products.
11 The Indian NIC code was last updated in 2008. This is when a new code (#72)
was added for all computer related activities including activities such as
consultancy of hardware and software configurations, software supply, data
processing and data base activities as well as repair and maintenance of (mostly
smaller) computers and office machines. This is clearly out of date and doesnt
reflect the state of the IT industry at all.
12 A recent survey by iSPIRT of 57 Mayors shows that each was using a custom
developed solution for providing birth and death certificates. While this
duplication of effort is good for the software services industry, it raises the costs
for the country as a whole.

4. eGov Open APIs. To upgrade all eGov Services to Open APIs15. This will
empower ordinary citizens with responsive governance, driving greater
public efficiency and satisfaction. It will bring tangible benefits for millions of
people. Small Businesses will see greater efficiencies leading to increase in
velocity of transactions, better collaboration, and corresponding growth.

5. MSME Competitiveness. To catalyze 5 million MSMEs into a fully cashless
era in 5 years by providing tax rebates to MSME's on cashless transactions.
This would set in motion a virtuous cycle of technology upgrades leading to
improved competitiveness of this important sector that contributes to
employment and economic activity. A side benefit would reduce tax leaks and
increase granularity of actual data leading to more informed planning
decisions and interventions.

6. Employment. To create occupational standards along with an inexpensive
but modern training ecosystem for technical operators of software products
in the SME segment. Software adoption in 30 million SMEs is expected to
create 3m technical operator jobs16.

7. Seed Funding. To promote a Software Product Development Fund to address
the acute shortage of early stage capital for India software product startups19.
Availability of angel and seed stage capital is a key driver in the growth of the
software products industry. It will reduce mortality before the product-
market fit stage.20 It also has number of multiplier effects. These range from
follow-on innovations to deepening of the entrepreneur pool to creating
winners by increasing speed of execution. The Software Product
Development Fund will be setup as a fund-of-funds21.

15 This requires participation by other Ministries. For example, APIs for GST
require Ministry of Finance to be on board.
16 Technical operator jobs are created when software products are implemented
by SMEs. Tally trained accountants are well known. Use of Fordian, a school ERP,
requires technical operators as well. Same is the case with Practo, a doctor ERP,
or with Premise Management System for small hotels.
19 This has been surfaced in Sep12 Report titled Creating a Vibrant
Entrepreneurial Ecosystem in India by Committee on Angel Investment and
Early Stage Venture Capital, appointed by the Planning Commission, under the
chairmanship of Shri Sunil Mitra, former Revenue Secretary, Government of
India.
20 An iSPIRT survey has shown that currently 67% of the software product
startups are pre-product-market fit stage. This is available as iSPIRT Product
Industry Monitor report dated Feb14.
21 Any new program should have three features. First and foremost, it should
follow the funds-of-funds model and support many small angel and venture
funds. Second, it should not try to pick winners. Third, it should foster
relationships between Indian and International (Singapore, Israel and US) angel
and seed investors.
In effect, we do not recommend an approach where there is a single venture
fund. Given the diversity of the Software Product Industry this approach is


8. Incubators. To foster competition amongst incubators and accelerators by
weeding out big players and poor performers after a 5 year period and
replacing them with new players. The public good is served when incubators
compete for startups attention based on their track records22.

9. Strategic Research. To create a Software Product Industry Research
Program (SPIRP) that will focus on building strategic technologies at
IISc/IITs/IIITs and providing privileged access to multiple startups at the
same time. It will develop a symbiotic relationship between publicly funded
research centers and multiple product companies to achieve the kind of
benefits that DARPA and Cambridge have provided to their local product
ecosystems23. The immediate focus areas will be on technologies, like Deep
Packet Inspection (DPI), Finite Elements Analysis, Shock Analysis, Special
Effects processors, which are strategic for Indias security infrastructure and
might be on the US Export Control list.


unworkable. In terms of picking winners, governments and even venture
capitalists themselves have a poor record of trying to guess which industries will
grow the fastest over a 10-year horizon. The most successful investors in
startups have therefore been those that remain flexible, able to adapt to
unexpected innovations and the changing economic environment.
Early-stage investing operates locally because only those embedded in the
community have the information needed to place wise bets on unproven
managers. Government has a important catalyst role to play in growing th pool
of early stage investment managers. US did this with its SBIC Program in 1958
and Israel did the same with Yozma Program in 1993. Its time for India to
replicate this in 2014.
22 Creating one mega incubator is not the answer. In fact, reducing competition is
positively detrimental to the ecosystem.
23 SPIRP goes beyond creating and promoting research centers of excellence
within IISc/IITs/IIITs. It provides a way to integrate these centers with multiple
product companies on the other side. The current model of having partnerships
with specific individual companies is not viable given the rapid technology
evolution. The half-life of a technology startup is too short. This is why, it is
important to have collaborations with multiple companies at the same time.
There are two other alternatives hat were considered but both are not
appropriate at this stage of the software product industry. First is the current
system of providing write-offs of R&D expenses against future profits. This is not
a practical solution. The Indian software product industry doesnt (yet) have the
wherewithal to fund core research in this technology.
Second alternative is SEMATECH like consortium approach where Indian
software product firms enter a consortium in search of R&D projects
complementary to the ones that they have on hand. We do not favor this
approach for two reasons. First, Indian software product firms are young and
immature. Second, given that we are a low-trust society, operating a consortium
is fraught with operational risks.

10. R&D Credit. To extend deferred tax credit to 7 years after the R&D
investment. The current write-offs of R&D expenses against profits do not
work for most young product companies because they do not have profits at
the initial stage when their R&D expenses are high.

11. R&D Grants. To extend DSIRs PRISM program (formerly TePP) to software
product industry. The potential for positive impact has been demonstrated in
the biotechnology field.

12. Challenge Grants. To setup challenge grants for social transformation moon-
shots in Education, Healthcare, Sanitation, Agriculture and other sectors in
collaboration with Science Parks24 and Think Tanks25. While our previous
moon-shots in Space and Nuclear sectors could not leverage the private
sector in this way, Challenge Grants are appropriate for the current plans to
develop domestic technology in the Defence sector. Challenge Grants are a
powerful tool to use26 at this stage of the industry evolution. They create
valuable social results and drive the maturation of the industry.

13. Trade Promotion. To integrate Indian software products in Indias foreign
aid programs, and to develop trade promotion linkages with product nations
like China, Korea, Taiwan, Israel and USA.

Government Structures.
14. DEITy to have a senior officer focused on the software product industry. A
separate division shall be created.

15. To setup a National Software Products Mission with industry participation to
evolve programmes in pursuit of laid down policies and also to create
institutional mechanisms to advance the implementation of various
programmes aimed at achieving the objectives in this policy and to promote
India as a Software Product Hub and brand India as a Product Nation.

16. To establish an Office of Technology, Innovation and Research to guide long
range, horizon 3, strategic investments in technology, innovation and
research. This Office will orchestrate the long-range roadmap for the industry
with participation from Think Tanks.

17. States would be actively encouraged to promote Software Products industry



24IKP Knowledge Park in partnership with USAID and the Bill & Melinda Gates
Foundation has run the Grand Challenge on TB Control.
25 iSPIRT as a Think Tank is designing challenge grants under its iPrize initiative.
26 Challenge Grants have a chequered past. The oldest challenge grant is the
British Governments Longitude Prize established in 1714. More recently, the
Ansari Space XPrize has been successful in fostering private space industry.
Recently, Google Lunar Xprize Board is generating news with Team Indus, an
Indian team, rising to the top three.

Draft for:
Mr. Raj Kumar Goel,
Joint Secretary, DEITy, Government of India,

V.1 Appendix. Principles for taxing software products

Software Products need to reach out to the masses, and therefore, need a
lubricated way to distribute and resell, whether for initial delivery and/or initial
subscription, upkeep and/or renewals.. Today there are several anomolies in the
what sales/service/excise tax is charged on software creation friction that is
holding back the software product industry.

By clarifying priciples for taxing software products, we hope to ensure that both
Center and State Governments have a common vie about when, and why, which
tax is supposed to be applicable. The source of confusion comes from the fact
that software products are delivered in many ways, sometimes as a tradable
license (packaged software), sometimes as non-tradable use (SaaS), and
sometimes tradable right to use/service (which is where SaaS is going).
Introduction
This Software Industry in general, and the Software Product Industry, in
particular, are amongst the new-age economic activities which have stressed
traditional definitions of goods and services, and therefore, associated
legislative interventions. India, in particular, is peculiarly affected due to its dual
legislative authorities of center and state each having constitutional
jurisdiction for taxation.

To quote Peter Hill, from his paper titled Tangibles, intangibles and services: a
new taxonomy for the classification of output, written just before he took a
position with UN Economic Commission for Europe:

The distinction between goods and services has been traditionally interpreted by
economists as if it were equivalent to a distinction between physical commodities, or
tangible material products, on the one hand and immaterial, or intangible, products on the
other. The economics literature is full of statements to the effect that goods are material,
or tangible, whereas services are immaterial, or intangible. Such statements are casual
and conventional rather than scientific, as the nature of an immaterial product is not
explained. In practice, intangible products deserve more serious attention because they
play a major role in the information economy. They are quite different from services.

To understand the reasons why the new-age economic activities have created a
problem, we should first examine the most common definitions of good and,
again quoting Peter Hill:

Two characteristics of a good are the following:
A good is an entity that exists independently of its owner and preserves its identity through
time. If ownership rights can be established it follows that they can also be transferred
from one economic unit to another, which implies that goods must be exchangeable: i.e.,
tradable or vendible as emphasized by Smith and others.

This fundamental property is inherently absent in a service since it can be

used or consumed but not transferred.


The transferability of a good allows for an owner to reach out and deliver to far-
flung customers of good through direct, distribution, and/or retail chains.

In recent times, the concept of right to service as a tradable instrument has
stressed the definitions and distinctions of good versus service. For example, a
concert ticket is tradable, and the value of the ticket is not the value of the
ticket material, but the value of the concert service. However, the concept of
the ticket allowed for easier distribution and sale, and resale.

The telecom industry aggravated the problem with Prepaid Cards where again,
a right to service was sold through multi-tier distribution channels, challenging
the traditional concepts of taxation.

The Software Industry amplified this problem multi-fold and software-enabled
services set to magnify it even further, like electronic books and music. In the
days ahead, we can anticipate fresh debates with 3D-printing changing the very
fundamentals of even tangible goods, and how its associated commerce takes
place.

This Appendix provides a simple framework that can definitively resolve
and lubricate the issues associated with the Software Product Industry, and
potentially have a broader application to almost all new-age economic
activities.

The importance of doing this cannot be understated. The overall ability for
massive inclusion of entities participating in economic growth requires that
access to technology exists. Access to technology requires the ability to
lubricate and promote the commerce associated with it.
Similarities and distinctions between tangible goods, intangible goods, right to
service, and service
Right to Service and Intangible Goods have several of the same characteristics
as Tangible goods. Borrowing from Peter Hill/Smith, each of these three:
Can exist independently of the owner
Preserve their identity through time
Can be transferred from one economic unit to another
Are exchangeable, that is, tradable or vendible

Since they all have an associated title or ownership rights at a given moment in
time, the process of transferring the title/rights is tantamount to trade, and
within the state, liable for VAT, and across states, liable for CST.

In contrast, a service has none of the above characteristics. Quoting again from
Peter Hill:

A hospital can hold stocks of medical goods and equipment ready for use but it cannot
hold stocks of appendectomies ready to meet an epidemic of appendicitises. The notion of a

stock of appendectomies that exists independently of both surgeons and patients is pure
nonsense

Services cannot be traded, in the same way that a manufacturing activity (of
tangible goods) is not a trading activity. Both these services and manufacturing
activity for the most part fall under the legislature of the Center (with a few
exceptions like Alcohol manufacture). And they attract Service Tax, or Excise
Duty as the case may be. Both these laws are constructed on the premise of
non-tradability, and their associated rules inherently do not have a one-to-one
correlation of purchase and sales which is implicit in trading activities and
associated laws (like VAT and CST).

The problem that arose over time is the concept of a tradable service which
concept is inherently paradoxical. Yet, it exists though not as a tradable
service, but as the trading of a right to service.

The pitfalls of treating all tradable concepts like Intangible Goods and Right-to-
Service in the same bracket as Tangible Goods also exist. Tangible Goods get
produced/manufactured, and become economically relevant inventory of the
producer/manufacturer. This activity attracts Excise Duty and confers a
title/ownership right of that inventory. Its sale now attracts VAT or CST.

However, Intangible Goods and/or Right-to-Service do NOT have these same
properties of production/manufacture, nor their coming into existence creates
an economically relevant inventory for the owner. For example, if you walk into
a music store, and buy a coupon for Rs. 100 which gives you rights to download
the soundtrack of a new movie that coupon has ownership value only to the
store which stocked it, and the person who purchased it, and has no value to the
producer of the coupon. Neither does the sale of the coupon require the
producer to reduce any inventory even if the soundtrack is downloaded
since there was no tangible goods to produce. However, the moment an
intangible good or right to service moves to a distributor and/or retailer, it has
inventory value of the same characteristic as a tangible good.

This overlap of similarities between tangible goods, and distinction from
tangible goods has caused enough historical confusion in legislations, with
corresponding aggravation of the legal system, as well as friction in the day-to-
day commerce of new-age activities.

In fact, the concept of right-to-service and intangible goods are almost
identical and we can treat right-to-service as a special case of intangible
goods.

Taking all of the above, we attempt to craft an encompassing framework.
The framework, in some detail
This framework covers the following methods of commercial activities for
Software Products:

1. The manufacture and subsequent distribution/sale of packaged software (a

dying breed, since almost all software has moved away from media-based
sales)
2. The distribution/sale of licenses which allow the end-buyer to download
and use the software.
3. The distribution/sale of right-to-upgrades/AMCs/Service Contracts for a
defined period which allow the end-buyer services on top of their
purchased packaged software/license
4. The online sale of the license (point 2 above), or upgrade/right-to-
upgrade/AMC/Service Contract (point 3 above)
5. The use of the software over the internet also called Software-as-a-Service
(SaaS), which a buyer may buy online for a defined period
6. The distribution/sale of right to SaaS which allow the end-buyer to avail
the required service for a defined period

Each of the above six transaction types have sub-types which is: end-buyer buys
from company, end-buyer buys from intermediary.
Dealing with Service Tax.
It rests on the premise that a reseller of a right-to-service is selling a good, but
not the service. Therefore, the reseller should not be required to fulfill the
norms of Service Tax. However, the original producer of the right-to-service,
and therefore, the service-provider must pay the required Service Tax. This
Service Tax cannot be made available as input credit to the Reseller since the
Reseller is not using/consuming the service.

Now, in order to allow the buyer (if the buyer is not a consumer, but a company)
the associated Service Tax credit, the producer should be allowed to provide a
pure service tax credit advice which can be used by the buyer to avail the
relevant credit. In all cases, the Government is tax neutral, since the Service Tax
has been fully paid for. If the buyer has directly purchased from the service
provider, the invoice itself acts as the Service Tax credit.

The above change will yield the following transaction flow (assume a right-of-
service as Rs. 1000, with reseller margin of Rs. 200):
Company invoices to Reseller: Rs. 800 + Service Tax (12.36% on Rs. 1000),
but no VAT (since no title got transferred).
Reseller invoices to Customer: Rs. 1123.60 + VAT (say 5%) cannot claim
Service Tax input credit, and needs to pay the output VAT.
Customer: IF the customer is eligible for Service Tax input credit, can seek the
corresponding Service Tax Credit Advice from the Company. Else, the
transaction closes.

In this chain, the Center has received the relevant Service Tax amount, and the
State has received the relevant VAT for trading the right to service.

In contrast, the current laws require the Reseller to both charge Service Tax, as
well as take credit for it. However, the nature of the transaction is a trading
activity and NOT a service. For example, if the reseller was unable to sell this right

of service, he/she could have done a sales return to the company, and similarly,
accepted a sales return from the customer in case the customer chose not to
avail the service. Additionally, while the Company could directly sell to the
Customer without any prior purchase/manufacture step, the Reseller does NOT
have such an ability since the reseller is simply trading on something one has
purchased, and is hence selling. Lastly, when the final invoice contains both Service
Tax and VAT, it violates the constitutional principle of concurrency of legislature
on tax since no provision for concurrency exists for any area of tax.

The simpler transaction flow, is of course, the Company directly selling to the
Consumer when the invoice would be Rs. 1000 + Service Tax.
Dealing with Excise Duty.
The first, of course, is applicability of Excise Duty itself. This should be
applicable only if a tangible good is being produced in the form of physical
packaged software.

Side note: if the previous concept of right-to-service is implemented in
completeness, it may be more beneficial to the Government to treat all software,
including packaged software, as attracting Service Duty uniformly, and the
concept of packaged software is simply a right to service since it IS an
intangible goods sale. Currently, due to the high friction of trading a right to
service as explained in italics above, it seems more trade-friendly to have
Excise Duty.

The current abatement of Excise Duty at 15% of MRP, does not take the ground
reality of software distribution costs into account. Most software, if sold through
a distribution/reseller chain, have margins ranging from 25% to 50% - as the
only viable means to counter the temptation and threat of piracy, and to
encourage the eco-system to deal in legal software. The spirit of abatement,
which is to tax the economic benefit arising to the manufacturer/producer is not
met through an abatement of 15%.

This should either become ad valorem that is, the actual invoice value, or the
abatement should become 35% at least.

Making it at the actual invoice value has additional benefits of simplifying multi-
seat licensing which inevitably goes at significant discounts to the MRP. Once
again, having the current concept of abatement does not take these new-age
methods of commerce into account where many of these problems were
irrelevant in the traditional businesses.
Dealing with TDS
An anomaly has been created in the commercial process of Software Products
which needs correction.

The concept of TDS was introduced to pre-tax incomes accruing to a given entity
and not to tax turnover accruing to a given entity. This is the reason why TDS
does not exist on any trading activity.

Except for Software Products, and right to services which are not incomes for
the distribution/retail chain, but are equal to goods.

On one hand, this is fundamentally flawed to apply TDS on a tradable good.
From the Government point of view, it attempt to give some relief to the
industry by converting it to single point and requiring all further trading
points to carry a declaration on their invoice that TDS has already been
subjected to. From a trading community perspective, life is simpler to not deal
in software and require this compliance since any negligence would land up
with their losing almost their entire potential income in terms of cash flow.

On another hand, most (if not all) Software Product companies work with both
negative cash flow, and negative profits in their inception years. Even with
single point TDS (which is inherently flawed as mentioned above), this
aggravates their cash flow to the point of non-viability.

On a third hand, more and more of the commerce is shifting to online purchases
even when a Service is being purchased. It is almost impossible to have a
workable method which allows TDS to be administered both from the buyer and
seller side.

TDS, as an instrument of early tax collection, works very well when there is
regular commerce between buyer and seller, typically on credit. The obligations
to pay the TDS and ensure that the TDS credit is available to the seller, happens
smoothly in such situations. In situations where the seller is selling to hundreds
of thousands of buyers with whom no direct contact can be established for
completing a TDS denominated transaction it is very evident that this frame is
flawed. This is exactly the situation for all goods which is also why TDS is not
applicable in any of those situations.

For simple equivalence of treatment, and associated lubrication of commerce,
TDS should be removed completely.
Summary
The above framework has been tested against all the problems and issues raised
in this document. The proposed framework will lubricate all the channels of
commerce that have been discussed.
A compelling proposal
The importance of the Software Product Industry comes far more from its
Indirect Impact on the Economy, rather than its direct impact. It is a
foundational enabler for upliftment of citizens and businesses alike, who will
collectively contribute to the economy of the country.

There is a compelling argument to say that software products, in all its forms,
should be exempt from all taxes, for say a period of 5 years (till 2020), such
that the entire economy gets a major shot in the arm.

Conclusion
Software products are sold under a variety of business models, in much the same
way that other industries do. A taxataion framework for software products has
to recognize this fact. This framework provides elegant priciple for taxation
while retaining the distinction of the various transactions types, and therefore,
the various applicable taxes.

V.2. Appendix. Stages of Indian software product industry evolution

The rise of software product industry in India is path dependent. This means that
small interventions will have disproportionately large effects in the future. To
leverage these effects it is essential to understand the stages of industry
evolution that software product industry will go through. What is appropriate
for one stage can even become counterproductive in the next stage.

Indian Software Product Industry has five stages of evolution. The Indian is now
entering Stage 3.

Stage 1: Underground Movement. 1999-2010

During the 11 years since 1999 Indian software product industry was an
underground movement. Not many people, even in the IT Industry, were
interested in this area. Yet, much was happening. The nascent industry was
building confidence.

During this stage, three success stories came to the fore that provided confidence
to broader audience that software product industry can take root in India. In the
Large Business Application Software (LBAS) segment, iFlex showed the way. Its
acquisition for over $1 Billion dollars in 2005 by Oracle was a big boost to Indian
software product industry. In the Small Business Application Software (SBAC),
Tally sold to more than a million SMBs in India. This was a big milestone even by
global standards. Tally joined a select club of software product companies in the
world that have more than a million business customers. Finally, out of Kolkatta
no less, FusionCharts sold its charting software to over ten thousand businesses
outside India without having any sales office or sales presence in US. This

success galvanized the belief in Indias ability to be a player in the booming

global SaaS market.

Towards 2007, we saw industry leaders in Indian software product industry
come together, first to celebrate success, then to create media awareness of the
Industry and finally to create public goods necessary to take the industry
forward.
Stage 2: Emergence of Indian software product industry. 2010-2013.
The three success stories mentioned earlier iFLex, Tally and FusionCharts
acted as an impetus to the creation of software product startups. Today we have
good software product startup density in Bangalore, Pune and Chennai with
NCR, Mumbai and Hyderabad also showing good momentum. The charts below
show city-wise analysis based on GitHub27 analysis.

27GitHub is a social network for mostly software product programmers. Analysis
courtesy S. Anand.

Software product startup density in India is now healthy. On Angel List28, India
now 3.2 times more startups (2123 versus 651) than Israel, which is a shining
example of hi-tech industry.

Given these excellent numbers, we dont need policies to boost software product
startup rates. Instead we need policies and institutions to reduce software
product startup failure rates and improve outcomes.
Stage 3: Maturation. 2014-e2017
This is the stage where the software product industry reaches a critical mass of
companies needs to consolidate its position. This stage is typically characterized
by a string of positive outcomes substantial VC investments, M&As and IPOs
that give the industry much needed validation and a boost of confidence.

Conventional wisdom, not just in India but across the world, holds that 2123
Indian software product industry startups listed on Angel List will have much
poorer outcomes than the 651 Israeli software product industry startups. This
belief is supported by data. An isoftware product industryRT and SignalHill
analysis29 reveals that India has the worst multiple in terms of M&A exits. In
Israel the M&A exit value was ~7X of the VC/PE investment during the same
period. In US the multiple was ~5X. In India it was only 1.1X (and this too was
inflated because it counted IT Services M&A exits as well).

28 Angel List is the leading platform for technology startups looking for early-
stage funding. Data as of 3rd Nov 2013.
29 This is dated 10th Oct 2013.



At this stage of evolution of Indian software product industry, we have startups
but have poor outcomes for those startups. Therefore the focus has to be on
improving software product industry startup outcomes rather than boosting
software product industry startup density. If this is not done, the exceptionally
high startup failure rates will trigger disenchantment amongst potential
entrepreneurs. This can bring the current momentum in startup density growth
to a halt.

To improve software product industry startup outcomes several areas have to be
addressed. These range from addressing early stage financing gap, to providing
better playbooks to software product industry startups, to having privileged
access to strategic technologies, etc. These are covered in more detail in a later
section.
Stage 4: Building Global Ecosystems. e2015-e2019
The speed at which Nokias handset business deteriorated has shocked
everybody. It went from being a market leader in smartphones to being unviable
as a company in less than 20 months. Nowadays, Blackberry is undergoing the
same tragic downtown in fortunes. In fact this movie has been played several
times before in the hi-tech industry. Back in 2001, Glenayre Technologies, a
market leader in the two-way pager business, went from a technology darling to
a basket case in under two years. Further back in time, in 1985, the famous
Osborne computer had suffered the same fate. Its business collapsed in one year.
Why do some good firms collapse so suddenly? Nokias CEO Stephen Elop
provides the answer in his now infamous 9th Feb 201 memo. He said:

The battle of devices has now become a war of ecosystems, where ecosystems include not
only the hardware and software of the device, but developers, applications, ecommerce,
advertising, search, social applications, location-based services, unified communications

and many other things. Our competitors aren't taking our market share with devices; they
are taking our market share with an entire ecosystem. This means we're going to have to
decide how we either build, catalyse or join an ecosystem.

In many cases, the very success of a product firm results in a competitive

response where the battle of products becomes the war of ecosystems. If a firm
has not planned for this new kind of competition, it quickly loses its market
position and fades away.

We expect that there will be about five software products companies with a
billion dollar market cap (e.g. InMobi, Zoho, QuickHeal, Pubmatic) in the coming
years. Of these, at least one of them will have to engage in this war of ecosystems
in the coming years. We know that losing this ecosystem war has delirious
consequences. In contrast, winning the war of ecosystems has big benefits. By
turning a product franchise into a developer ecosystem, a company becomes less
vulnerable and has better financials. There are other benefits as well. Microsoft
claims an employment of 15m in its ecosystem30. SAP, Google and OpenSource
ecosystems also report similar benefits.

There are significant challenges in creating developer ecosystems. These relate
to three areas. First, there are no clear guidelines for performing correct and
insightful modeling of developer ecosystems. Second, conducting an ongoing
health analysis of an ecosystem is still a daunting data-mining task: what are the
indicators to look at? How can data be found on the revenues of our partners?
How many new developers join the ecosystem every year? And how much do
these really contribute? Third, relates to the issue of Governance. This addresses
the issue of how to govern developer ecosystems to gain measurable success in
terms of staying power, profit, usage and participation.

India has not yet built a software ecosystem though one local ecosystem building
project is underway. UIDAI is trying to build a developer ecosystem around its
offerings. This is a good for India to strengthen its ecosystem building muscles.

In time, we are confident that at least one Indian software product industry firm
will be successful in building an ecosystem around its products. Only when this
happens, will it signify that the next Google or the next Microsoft has been
born from India. Getting to this stage is something that (even) the Israeli hi-tech
industry has not been able to do. What is working in Indias favor is the presence
of a big domestic market in India.
Stage 5: Outward Investment. e2019 onwards.
This stage is characterized by outward investments to deal with transformative
technologies and strengthening of the moat around the India software product
industry ecosystems. It is only at this stage that a truly sustainable India
software product industry would be created.


30http://www.informationweek.com/microsoft-says-its-software-ecosystem-
em/202404791

V.3. Appendix. Principles for interventions in software product industry

A set of principles guides our specific interventions in the software product
industry. These principles are non-protectionist and avoid infant industry
protection.

We are not recommending plan-oriented economy type interventions as they
wouldnt work in this fast paced industry. We refute the traditional approach
that involves identification of a R&D trend, setting goals, providing grants to
private sector for R&D and reviewing achievements. We do not believe in this
approach and have seen this fail numerous times, most recently, in US, Malaysia
and Japan.

We also do not expect the Government to guide the market towards planned
structural change. Instead of favoring an optimal degree of openness and
optimal degree of outside competition, we subscribe to maximum openness
and perfect competition.

There are 8 key principles behind our interventions are:

1. Our belief is that the primary focus of policy should be to provide social, legal
and economic infrastructure so that private enterprise can flourish.
2. We believe that software product start-up communities are networks
glorious in all their messiness and chaos. Yet they aren't simply organic
phenomena. They need careful nurturing and support.
3. We believe that market interventions should be simple, transparent and
subject to rules rather than official discretion.
4. We believe that Government should not create a software ecosystem for a
specific product. It should restrict its role to being a market maker or to
making public platforms (e.g. UID, GST) that have open access.
5. We believe that co-evolution of institutions will be critical to success given
the path dependent nature of software product industry evolution. This co-
evolution of institution can only be achieved within the framework of public-
private governance of these institutions.
6. We believe that urgency is important. There are favorable international
market conditions right now and quick action on policy and institution front
can recreate the East Asian miracle for India in software products.
7. We believe that greater degree of cluster integration of the Indian software
product industry with Silicon Valley and Israel startup clusters is desirable.
8. We believe that we should not pick technology winners. Not withstanding
any specific mention of technologies, if a better technology emerges thats
better in total cost, time, ease of use or effeciency for similar purpose; it
should be treated on par and may supersede the preferences mentioned in
the policy.