Software Development Companies are “Factories”!

Introduction

By a circular dated November 22, 2002 issued by ESI, New Delhi (“ESI Circular”), software development companies have been included under the aegis of the Employees’ State Insurance Act, 1948 (“ESI Act”). The ESI Act is generally applicable to all factories and establishments including shops, hotels & restaurants, cinemas, newspaper establishments, educational institutions, medical institutions and road motor transport where workers draw wages up to INR 15,000 p.m.¹ Further, the Hon’ble Bombay High Court (“the Bombay HC”) in its judgment dated July 11, 2012 in Employees’ State Insurance Corporation Vs. Western Outdoor Interactive Pvt. Ltd. and Reliable Software Systems Ltd. Vs. Employees’ State Insurance Corporation held that software development activity will be considered as “manufacturing process” and, therefore, a software development establishment will be considered “factory” for the purpose of ESI Act.

In light of the above development, it becomes imperative that we discuss the case and analyze if software development be considered as manufacturing process and be brought within the ambit of ESI Act. The present bulletin highlights the applicability of ESI Act on software developers in the state of Maharashtra on the basis of the latest judgment given by the Bombay HC.

1. Facts of the Cases

The Bombay HC heard two appeals together, one filed by the Employees’ State Insurance Corporation (“ESIC”) against Western Outdoor Interactive Pvt. Ltd. (“Western Outdoor”) and another filed by Reliable Software Systems Ltd. (“Reliable Software”) against ESIC. Both, Western Outdoor and Reliable Software are engaged in the business of software development in Mumbai. In both the cases, same question of law regarding the coverage of the computer industry under ESI Act was involved and ESIC was a common contesting party. Hence, the appeals were heard together and decided by a common order. The issues in each case were as follows:

ESIC Vs. Western Outdoor: The appeal² was directed by ESIC, Mumbai against the order passed by ESI Court, Mumbai. After a visit at the Company, the ESIC informed the Company that the activities of the Company, viz., software development, maintenance of software, content management, creation and maintenance of designs, integration and development of activities for aircrafts, etc. are covered under the definition of “manufacturing process” as provided under the Factories Act, 1948 and 62 persons were

employed in the Company in the month of January, 2001. As no contribution had been made since 2001, a demand of contribution under ESI Act for the period of January 2001 to September 30, 2002 was made. The Company challenged this demand before the ESI Court. The ESI Court dismissed the demand and held that the Company is involved in the commercial activities³ and not manufacturing activities. However, in the ESI Circular computer units where manufacturing process is not carried out, were not covered under the definition of factories but if they are involved in systematic commercial and business activities they are considered as “Shop” under the ESI Act. Keeping in view the date of applicability of above ESI Circular, the ESI Court held that the ESI Circular cannot be made applicable retrospectively. Hence, ESIC filed the current appeal against the order of ESI Court.

Reliable Software Vs. ESIC: This appeal⁴ was directed by Reliable Software against the Order passed by ESI Court, Mumbai. The ESIC informed the Company that the activities of the Company viz. software development and maintenance of software are manufacturing activities and demanded a contribution plus interest under ESI Act for the period of January 1998 to March, 2004. The Company challenged the coverage before the ESI Court. But, in view of the ESI Circular issued, commercial activities as mentioned above were also covered under the ESI Act. Therefore, the Bombay HC held that the Company needs to pay the contribution. Hence, the Company filed the appeal against the order of ESI Court.

2. Judgment

The main issues in both the petitions were related to the interpretation of the definitions of “Manufacturing Process”⁵ and “Factory.”⁶ The Bombay HC combined the above two petitions and decided the matter. The Bombay HC ruled that the ESI Act applies to software development companies as creation or development of software itself is a manufacturing process and the premises where computers are involved in manufacturing process is factory under the ESI Act. Consequently, IT and the software industry are liable to pay the contribution as demanded by the ESIC.

The ESI Court has relied on the ESI Circular wherein it was mentioned that certain establishments engaged in commercial and economic activities leading to the sale and

purchase of goods are to be treated as “shops”⁷ under the ESI Act. The computer units where the manufacturing process is not carried out were not covered under the definition of factories but as they are involved in commercial and business activities, they were covered under the definition of “Shop” and, hence, fall under the purview of the ESI Act.

The Factories Act was enacted in 1948 and at that time, the use of computer and software was unknown and the words describing the activities of the computers i.e. development of software, programming of data, etc. were not in practice. There are many words like fitting, welding, drilling, ironing, cooking, painting, etc that are not specifically mentioned in the definition of manufacturing activities, though these are considered as part of the manufacturing process in different work places and are used while defining a manufacturing process. As per the ESI Act, the definition of manufacturing process has the same meaning assigned to it in the Factories Act, 1948. Therefore, the Bombay HC held that though computer related activities like development, programming and application are not mentioned in the definition, they are “manufacturing activities”.

Keeping the above in mind, the Bombay HC set aside the order passed by ESI Court in appeal against Western Outdoor. However, the appeal filed by Reliable Software was dismissed and the order passed by the ESI Court was maintained. Consequently, both the companies were liable to pay the contribution to ESIC.

3. Impact of the Judgment

The judgment given by the Bombay HC is binding on all software development companies in the state of Maharashtra and will have a persuasive value in the courts of any other jurisdictions till any appeal is filed against the order of the Bombay HC. Until then, software development companies will fall within the ambit of the ESI Act. Consequent to this extended applicability of the ESI Act, the impact of the same on companies is:

• Registration: Registration of software companies with ESIC has become a statutory responsibility and all the registration requirements such as filing of declaration forms, issuance of codes of companies and sub-codes of offices of companies etc. needs to be fulfilled. Companies have to apply for registration to the appropriate Regional Office within 15 days from the date the company falls under ESI Act;

• Register of employees: A register of employees is maintained in respect of every employee by the companies. It contains information such as wages, contribution, and number of days for which wages are paid;

• Contribution: It is the sum payable by the companies to the ESIC. Companies will have to contribute 4.75% of the total wages in respect of each employee covered. Simple interest @12% p.a. is levied in case of delay in payment of contribution.

The impact of this judgment on the employees of software companies is:

1. Contribution: Employees who are covered under ESI Act will also have to contribute 1.75% of their total wages to ESIC;

• Benefits arising out of the judgment: Medical treatment or facility of reimbursement is provided to the insured employees in case of sickness certified by medical practitioner and to the insured female employees in case of miscarriage or sickness arising out of pregnancy. Companies have to pay compensation to the insured employees in case of disablement and death due to employment injury and pay funeral expenses on the death of insured employee.

• Other Acts: An insured employee receiving benefit under ESI Act is not entitled to receive benefits under any other Act. Employee is not entitled to receive more than one benefit, e.g. benefit of sickness cannot be combined with benefit of maternity, etc.

Conclusion

The implementation of the ESI Act is territorial in nature. This judgment is applicable on individuals who have been associated with software industry in Maharashtra. It would not be wrong to say that this is indeed very pivotal and significant for the other states as well. The revisions in ESI Act were designed for the welfare of employees. Since IT and the software industry are liable to pay the contribution as demanded by the ESIC, eligible employees of computer software companies are entitled to benefits under the ESI Act.

Authored by:
Jaya Moorjani