Holding

A pre‑loaded operating system recorded on the hard‑disk drive forms an integral part of the laptop, so the laptop must be classified under heading 84.71 and the software value is deductible, not eligible for separate nil‑rate exemption under heading 85.24.

Summary

The Commissioner of Customs appealed against Hewlett‑Packard India Sales Ltd., which had imported laptops with hard‑disk drives pre‑loaded with operating‑system software. The importer claimed that the software‑loaded hard disks should be classified separately under heading 85.24 of the Customs Tariff Act, 1985 and enjoy nil‑rate duty under Notification 21/2002‑Cus, while the revenue classified the entire laptop‑software unit under heading 84.71 and demanded duty on the net value after deducting the software component. The Supreme Court examined the nature of pre‑loaded operating systems, held that such software is an integral part of the laptop and cannot be treated as a separate media item. Consequently, the laptop must be classified as a single unit under heading 84.71, with the software value deducted for valuation purposes, and the exemption under the notification does not apply. The Court set aside the Tribunal’s decision and allowed the revenue’s appeal.

Issues considered

Whether operating‑system software pre‑loaded on hard‑disk drives in laptops is to be classified as a separate entity under heading 85.24 (nil‑rate duty) or as an integral part of the laptop under heading 84.71 (applicable duty).
Whether the revenue’s method of valuing the laptop by deducting the software value is correct.
Whether the exemption under Notification No.21/2002‑Cus applies to the software component.

Legislation cited

Customs Tariff Act, 1985s. 84.71, s. 85.24

Subjects

customs dutyclassificationlaptopsoperating systemsoftwarehard disk drivetariff headingsexemption notificationintegral part

Judgment

I
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/

COMMISSIONER OF CUSTOMS, CHENNAI
A
v.
M/S. HEWLETT PACKARD INDIA SALES (P) LTD.

AUGUST 30, 2007

IDR.ARIJITPASAYAT ANDLOKESHWARSINGHPANTA,JJ.) B

Customs Tariff Act, 1985; Headings 84. 71 and 85.24 and Notification
No.2112002-Cus. Dated 1.3.2002 issued thereunder:

Classification-Import of Laptops with Hard Disc Drives-CTH 84. 71 C
or 85.24-Assessee claiming duty exemption-Exemption Notification-
Applicability of-Held: Assessee imported Laptops containing preloaded
Hard Disc Drives preloaded with <!perating systems which control the working
of the Computer-Value of Laptops depend on the operating system, which
is preloaded-A preloaded operating system recorded on Hard Disc Drives D
is an integral part of the Laptop-Assessee not only imported Laptops but
also imported Hard Disc Drives on which operating system recorded-
Software is classifiable u/CTH 85.24 and Laptop is classifiable u/CTH 84. 71-
Hence, Revenue rightly classified the Laptops, so imported, as a Unit
classifiable u/CTH 84. 71 and giving the benefit of deduction for the value
of software classifiable u/CTH 85.25. E
Words and Phrases:
'
'Hard disc~ 'platter' and 'software'-Meaning of

Revenue had demanded certain amount of customs duty from the F
respondent-assessee by classifying the goods imported by them as Laptop liable
for duty under Heading 84. 71 of the First Schedule of the Customs Tariff Act
and denying them benefit of exemption Notification No.21/2000-Cus.dated
I .3.2002. Assessee filed an appeal before CEST AT, the Tribunal, against the
demand so raised by the Revenue, which was allowed by the Tribunal. Hence
the present appeal. G
The question which arose for determination in this civil appeal was as
to whether the imported goods, the operating systems (software) which controls
the working of the computer and which is preloaded in the laptop (notebook),
641 H
642 SUPREME COURT REPORTS [2007] 9 S.C.R.

A is classifiable as a separate entity under CTH 85.24 at 'nil' rate of duty or
as an integral part of the laptop under CTH 84.71 at the appropri,ate rate of
duty.
l ~. :
Allowing the appeal, the Court

B HELD: 1.1. The Revenue has classified the laptop as a machine 'under
CTH 84.71 of the Customs Tariff Act, 1985 and has demanded di.ty on the
assessable value determined by deducting the software value from the total
value of the laptop whereas the assessee has classified the software loaded
Hard Disk Drive under CTH 85.24 separately from the laptop and. has claimed
the benefit of Notification No.21/2002-Cus dated 1.3.2002.
C lPara 7) (647-A)

1.2. The assessee imported laptops containing preloaded Hard Disc
Drives (HDD). The said drives were preloaded with operating systems
(software) which controls the working of the computer. The value of the laptop
depends on the operating system, which is preloaded. The computer cannot
D open without the operating system. (Para 91 (648-DJ

1.3. It may be clarified that the operating system can also be imported
as a packaged software which is like an accessory and which is classified by
the Revenue under CTH 85.24. However, a preloaded operating system
E recorded on HDD is an integral part of the laptop (unit).
(Para 9) (648-E)

1.4. A laptop is a stand alone unit classifiable under CTH 84.71. A laptop
is a small portable Personal Computer. It runs either on battery or electricity.
Laptop has a screen and a small key board. (Para 91 (648-FI
F
1.5. The preloaded operating system recorded in HOD in the laptop,
the imported item, forms an integral part of the laptop. Wh~t was imported
in the present case was a laptop as a stand alone item (unit). Present dispute
relates to the transaction value of the unit. An importer who buys a laptop
containing an operating system pays for the laptop as a unit. Without the
G operating system, the laptop cannot work. The computer cannot open without
operating system. The respondent has not only imported laptops, it has also
imported HDDs on which the operating system was recorded (packaged
software) which has been classified by the Revenue unde~ CTH 85.24.
However, when a laptop is imported with in-built preloaded.opehttingsyste'm
recorded on HDD the said item forms an integral part of the laptop (computer
H '
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COMMR. OF CUSTOMS v. HEWLEIT PACKARD INDIA SALES (P) LTD. [PASAYAT, J.] 643

system) and in which case the Revenue is right in treating the laptop as one A
single unit imported by the assessee. The Revenue has rightly classified the
laptop as a unit under CTH 84.71. (Para 10) (648-G; 649-A, BJ

2. Revenue has rightly taken the value of the laptop as a unit and it has ·
given the deduction for the value of the software. There is rio error in the
computation, particularly, when the assessee has refused to give the value of B
the software to the adjudicating authority despite being called upon to do so.
The imported laptops were classifiable under CTH 84. 71 whereas operating
software recorded on HDD imported as packaged software were classifiable
under CTH 85.24. (Paras 11 an 12) (649-C, D, E)

CIVIL.APPELLATE JURISDICTION : Civil Appeal No. 5854 of2006. C
From the Final Order No. 441/2006 dated 26.05.2006 of the Customs,
Excise and Service Tax Appellate Tribunal, South Zonal ~ench at Chennai in
Appeal Nos. C/PD/34/2006 and C/46/2006.

Vikas Singh, ASG, K. Radhakrishnan, Binu Tamta and B. Krishna Prasad D
for the Appellant.

V. Lakshmikumaran, Alok Yadav and M.P. Devanath for the Respondent.

The Judgment of the Court was delivered by
E
DR. ARIJIT PASAYAT, J. I. Challenge in this appeal is to the order
passed by the Customs Excise and Service Tax Appellate Tribunal, South
Zonal Bench, Chennai (in short 'CESTAT') allowing the appeal filed by the
respondent. By the impugned judgment CESTAT held that the Software-
Joaded Hard Discs are classifiable under Heading 85.24 of the First Schedule
to Customs Tariff Act, 1985 (in short 'Tariff Act'). It was further held that F
respondent will be eligible for duty exemption under Notification No.21/2002-
Cus as amended. It was held that rest of the machine would be classified
under Heading 84.71.

2. Background facts in a nutshell are as follows:
G
The Department had demanded customs duty of about Rs.5.9 crores
from the respondent by classifying goods imported by them under Heading
84. 71 of the First Schedule of the Act and denying them benefit of exemption
Notification No.21/2000-Cus. dated 1.3.2002 (as amended). Demand was
questioned before CESTAT. An application seeking waiver of pre-deposit and H
644 SUPREME COURT REPORTS [2007] 9 S.C.R.

. A stay of recovery in respect of this amount of duty was filed. After exal}lining
the records and hearing both sides, CESTAT found prima facie case for the
assessee in view of the Tribunal's decision in the case of Barber _S~ip
Management(/) Pvt. Ltd. v. Commissioner, (2000) 117 ELT 456 (Tri.) as well
as the decision in the assessee's own case reported in 2005 ( 126) ECR 124 (Tri-
Del) and, accordingly, CESTAT have dispensed with pre-deposit of the duty
B amount. Further, having heard both sides at length and having regard to the
high stake involved in the case, the appeal was taken up for final disposal.

The respondents are engaged in the manufacture of, and trading in,
computers including Laptops (otherwise called 'Notebooks') falling under
Heading 84.71 of the CTA Schedule. They imported Notebooks (Laptops)
C with Hard Disc Drivers (Hard Discs, for short) preloaded with Operating
Software like Windows XP, XP Home etc. These computers were also
accompanied by separate Compact Discs (CDs) containing the same software,
which were intended to be used in the event of Hard Disc failure. The Bills
of Entry filed by the importer declared the value of Laptop and the value of
D Software separately, the software value including the Hard Disc value also. .
The Bills of Entry classified the Software-loaded Hard Discs under Heading
85.24 of the CTA Schedule and claimed exemption in terms of SI. No.157 of
Notification No.21/2002-Cus ibid. These Bills of Entry were filed with the
Chennai Air Customs Authorities in July 2005. Long before this, by a letter
dated 7.10.2003 the respondents had informed the Addi. Commissioner of
E Customs, Chennai that they would be filing Bills of Entry for separate
assessment of Computers and Software-loaded Hard Discs in view of the
Tribunal's decision in Barber Ship Management's case (supra). It was also
informed that they would claim duty exemption under SI. No.157 ofNotification
No.21/2002-Cus. ibid. Subsequently, under cover of letter dated 11.10.2003,
F the respondents had also supplied to the Addi. Commissioner the OEM
pricelist for the various models of 'Notebooks' imported by them. They had
also provided a worksheet indicating separately the value of Hard Disc, value
of Operating Software and the CD & replicating charges.

In the meantime, at Delhi, they had imported Laptop computers with
G Hard Discs preloaded with Software and claimed classification of the Software-
Joaded Hard Disc Drives under Heading 85.24. The department issued a show-
cause notice for demanding duty on these goods in terms of Heading 84.71.
This demand was confirmed by the original authority, against which appeal
before the Commissioner (Appeals) was preferred, who sustained the decision
of the lower authority. But the appeal prefer,·ed to the Tribunal was allowed
H
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COMMR. OF CUSTOMS v. HEWLETT PACKARD INDIA SALES (P) LTD. [PASAYAT, J.] 645

and it was held that the Hard Disc Drives preloaded with software required A
to be assessed separately in tenns of 85.24 of the CTA Schedule by virtue
of Note 6 to Chapter 85 of the said Schedule vide Final order No.380/2005-
NB-A dated I l.10.2004 reported in 2005 (126) ECR I24 (Tri-Del).

However, the Appraising Officer at Chennai Air Customs, dealing with
the goods in question, queried the respondents as to why the value of the B
Hard Discs should not be included in the value of the 'Notebooks' for the
purpose of assessment under Heading 84.71. The respondents replied by
pointing out that, in terms of the Tribunal's decision in Barber Ship
Management's case (supra) which had been upheld by this Court as reported
in 2002 (144) ELT A293, the Software-loaded Hard Discs could only be classified
under Heading 85.24. They also cited, in support of their stand, Fi~al Order C·
No.380/2005-NB-A dated I I. 10.2004 (supra) passed by the Tribunal in their
own case. Their arguments, however, did not weigh with the assessing
authority, which proceeded to assess the Bills of Entry on a provisional basis.
The jurisdictional Asst. Commissioner of Customs, after hearing the party and
considering their submissions, found Hard Disc as integral part of Notebook- p
computer and accordingly passed Order-in-Original dated 31. I 0.2005 classifying
the Notebooks together with the Hard Discs assembled therein, under Heading
84.71 as 'automatic data processing machines'. This order was upheld by the
Commissioner (Appeals) as per Order-in-Appeal dated 25.11.2005. lt is on the
basis of the appellate Commissioner's order that the assessments were finalized.
Hence the demand of duty which is on the assessable value comprising the E
value of the Notebook computers with Hard Discs excluding the value of
Software. Appeals were preferred against the appellate Commissioner's order.

3. Stand of respondent before the Tribunal revolved round decision in
Barber Ship Management's case (supra) which was affirmed by this Court in
[202 (144) ELT A 293]. It was pointed out that, in their own case involving
F
import of similar goods at Delhi, the Tribunal had classified Software-loaded
Hard Disc Drives under Heading 85.24. It was argued that the issue arising
in this case had already been conclusively decided by this Court in the case
of Barber Ship Management's case (supra) and, therefore, there was nothing
further to be examined in this case. It was submitted that Software-loaded G
Hard Disc, being "recorded media for sound or other similarly recorded
phenomena ...excluding products of Chapter 37" was to be classified under
Heading 85.24. The department had no objection to classifying Software-
recorded Hard Disc Drive, if imported without any other apparatus, under
Heading 85.24. Hence the lower authorities should have been taken the aid
H
646 SUPREME COURT REPORTS [2007] 9 S.C.R.

A of Note 6 to Chapter 85 for classifying the Software-loaded Hard Disc Drives
under heading 85.24. Reference was also made to the HSN Notes under
Heading 85.24. It was submitted that the authorities below had failed to note
the clear distinct.ion between Computer and Software despite decisions of this
Court on the point. In this connection, reference was made to this Court's
judgment in CCE v. PSI Data Systems, (l 989) 39 ELT 692 and Commissioner
B v. Acer India Ltd, (2004) 172 EL T 289. The ratio of the Supreme Court's
decision in the case of Sprint RPG India Ltd v. Commissioner, (2000) 116 ELT
6 SC was wrongly applied to the facts of the case by the lower appellate
authority ..

4. While issuing notice this Court noted that the matter appeared to be
C covered by 3-Judge Bench's decision of this Court in Commissioner ofCentral
Excise, Pondicherry v. ACER India Ltd, [2004] 8 SCC 173. But it was contended
by learned Additional Solicitor General that the question whether Hard Discs
fitted to the Computer would be treated as a Software was not specifically
de,alt with in the said case. Notice was issued and the matter was listed for
D final hearing.

5. A short question which arises for determination in this civil appeal
is : Whether operating systems (software) which controls the working of the
computer and which is preloaded in the laptop (notebook) is classifiable as
a separate entity under CTH 85.24 at 'nil' rate of duty or as an integral part
E of the laptop under CTH 84.71 at the appropriate rate of duty.

6. To answer the above question CTH 85.24 and CTH 84.71 need to be
quoted:

CTH 85.24:
F
"Media recorded with sound or similar recording, whether or not
presented together with the apparatus for which they are intended or
assembled with constituent parts of machines of heading 84.69 to
84.72 (e.g. disc packs) are in all cases to be classified in this heading;"

CTH 84.7I
G
"Automatic data processing machines and units thereof; magnetic or
optical reader, machines for transcribing data on to data media in
coded form and machines for processing such data, not elsewhere
specified or included."
H
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COMMR. OF CUSTOMS v. HEWLETI PACKARD INDIA SALES (P) LTD. [PASAYAT, J.) 647

7. The Department has classified the laptop as a machine in CTH 84.71 A
and has demanded duty on the assessable value determined by deducting the
software value from the total value of the laptop whereas the assessee has
classified the software loaded Hard Disk Drive (for short, 'HDD') under CTH
85.24 separately from the laptop and has claimed the benefit of Notification
No.21/2002-Cus dated 1.3.2002.
B
8. To answer the above controversy meaning of the words software,
hard disk and platter need to be noted (See: Computer Dictionary by Microsoft
- Fifth Edition at pp.489, 246 and 408 respectively):

"Hard disk. A device containing one or more inflexible platters coated
with material _in which data can be rec_orded magnetically, together C
with their read/write heads, the head-positioning mechanism, and the
spindly motor in a sealed case that protects against outside
contaminants. The protected environment allows the head to fly I0 to
25 millionths of an inch above the surface of a platter rotating typically
at 3600 to 7200 rpm; therefore, much more data can be stored and D
accessed much more quickly than on a floppy disk. Most hard disks
contain from two to eight platters. See the illustration. Also called:
hard disk drive.
Hard disk drive n. See hard disk
Platter. One of the individual metal data storage disks within a hard E
disk drive. Most hard disks have from two to eight platters. See the
illustration. See also hard disk.

Software. Computer programs; instructions that make hardware work.
Two main types of software are system software (operating systems),
which controls the workings of the computer, and applications, such
F
as word processing programs, spreadsheets, and databases, which
perform the tasks for which people use computers. Two additional
categories, which are neither system nor application software but
contain elements of both, are network software, which enables groups
of computers to communicate, and language software, which provides G
programmers with the tools they need to write programs. In addition
to these task-based categories, several types of software are described
based on their method of distribution. These include packaged software
(canned programs), sold primarily through retail outlets; freeware and
public domain software, which are distributed free of charge; shareware,
H
--~
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648 SUPREME COURT REPORTS [2007] 9 S.C.R.

A which is also distributed free of charge; although users are requested
to pay a small registration fee for continued use of the program; and
vaporware, software that is announced by a company or individuals
but either never makes it to market or is very late. See also application,
canned software, freeware, network software, operating .system,
shareware, system software, vaporware, Compare firmware, hardware,
B liveware."

9. On the basis of the above dictionary meanings it becomes clear that
a software is a computer programme. It con~ists of instructions that make
hardware work. There are two types of softwares, I!amely, system software
C which controls the working of the computer an,d application softwa_re such as.
word processing programmes, databases etc., which perform the tasks for
which we use computers. In addition, we now have network software which
enables groups of computers to communicate, and language software which
provides programmers with the tools with which they write programmes. We
also have what is called as packaged softwares which are sold through retail
D outlets. In the present case, the respondent imported laptops containing
preloaded HDD. The said drives were preloaded with operating systems
(software) which, as stated above, controls the working of the computer. The
value of the laptop depends on the operating system, which is preloaded. The
computer cannt>t open without the operating system. The laptop without an
E operating system is like an empty building. At this stage, it may be clarified
that the operating' system can also be imported as a packaged software which
is like an accessory and which in the present case is classified by the
department under CTH 85.24. However, a preloaded operating system recorded
on HDD is an integral part of the laptop (unit). Such preloaded operating
system on the HDD forms an integral part of the laptop. It is important to note
F that laptop as a stand alone unit is classifiable under CTH 84.71. A laptop
is a small portable Personal Computer (in short 'PC'). It runs either on battery
or electricity. Laptop has a screen and a small key board. Most of the laptops
run on the same software as their desk top counterparts. Most of the laptops
accept floppy disks, CD ROM Drives, Extenial or Internal Modem etc. A
G notebook computer is a laptop. ·Jt is a machine. A CD or a floppy disk is a
peripheral.

I 0. Applying the abo~e tests to the facts of the present case, we are
of the view that preloaded operating system recorded in HDD in the laptop
(which is the item of import) forms an integral part of the laptop. What was
H imported in the present case was a laptop as a stand alone item (unit). Present
/'

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COMMR. OF CUSTOMS v. HE\\1.ETT PACKARD INDIA SALES (P) LTD. [PASAYAT, J.) 649

dispute relates to the transaction value of the unit. An importer who buys a A
laptop containing an operating system pays for the laptop as a unit. As stated
above, without the operating system, like Windows, the laptop cannot work.
The computer cannot open without operating system. In the present case, the
respondent has not only imported laptops, it has also imported HDDs on
which the operating system was recorded (packaged software) which has
been classified by the Department under CTH 85.24. However, when a laptop B
is imported with in-built preloaded operating system recorded on HOD the
said item fonns an integral part of the laptop (computer system) and in which
case the Department is right in treating the laptop as one single unit imported
by the respondent. The Department has rightly classified the laptop as a unit
under CTH 84.71, quoted above. C
11. Before concluding it may be pointed out that in none of the decisions
cited on behalf of the respondent, the question raised in the present dispute
was ever raised. Although laptop is similar PC, the former is more compact.
lt cannot be assembled as easily as PC. In the present case, the Department
has rightly taken the value of the laptop as a unit and it has given the D
deduction for the value of the software. There is no error in the computation,
particularly, when the respondent has refused to give the value of the software
to the adjudicating authority despite being called upon to do so.

12. For the afore-stated reasons, we are of the view that the imported
laptops were classifiable under CTH 84. 71 whereas operating software recorded E
on HOD imported as packaged software were classifiable under CTH 85.24
and accordingly Civil Appeal filed by the Department deserves to be allowed,
and the impugned judgment of the Tribunal is set aside. There will be no order
as to costs.

S.K.S. Appeals allowed. F