“Transfer of right to use” vis-à-vis “Permissible Use”

Recently Hon. Bombay High Court had an occasion to deal with the above delicate issue once more in above matters. The important aspect of the Writ Petitions is that along with VAT department of State Government, Service Tax Department of Central Government was also made party to the Writ Petition. Both writ petitions are decided by common judgment. However, facts in both cases are different.

It will be useful to refer to judgment in each case separately.

Mahayco Monsanto Biotech (India) Pvt. Ltd. (W.P. No.9175 of 2015 dated 11.8.2016).

The facts as noted by Hon. High Court in above case are as under:

“11. The Petitioner in Writ Petition No. 9175 of 2015, Monsanto India, is a joint venture company of Monsanto Investment India Private Limited (“MIIPL”) and the Maharashtra Hybrid Seeds Co. Monsanto India develops and commercializes insect-resistant hybrid cottonseeds using a proprietary “Bollgard technology”, one that is licensed to Monsanto India by Monsanto USA through its wholly-owned subsidiary, Monsanto Holdings Private Limited (“MHPL”). This technology is further sublicensed by Monsanto India to various seed companies on a non-exclusive and nontransferable basis to use, test, produce and sell genetically modified hybrid cotton planting seeds. In return for this technology, Monsanto India receives trait fees based on the number of packets of seeds sold by the sub-licensees. These sub-licensing agreements, with almost 40 seed companies, are the transactions in question. Respondent Nos.1 and 2 in the Monsanto Writ Petition are the Union of India and the State of Maharashtra respectively. Respondent No.3 is the Principal Commissioner of Service Tax. Respondent No. 4 is the Commissioner of Sales Tax.”

The arguments were from various angles including the argument that the allowance touse is non exclusive and not covered by ‘transfer of right to use’ category in view of judgment in case of Bharat Sanchar Nigam Ltd.(145 STC 91)(SC). Payment of service tax on same amount was also pointed out in the arguments made. Judgment in case of Tata Sons Ltd. vs. State of Maharashtra (80 VST 173)(Bom) of Hon. Bombay High Court was argued to be distinguishable as well as otherwise argued to be per incurium. It was urged that no distinction can be made between tangible and intangible goods and therefore, the law laid down in BSNL equally applies to intangible goods also.

However, Hon. High Court did not concur with above submission and justified levy of VAT . Hon. High Court concluded as under:

“37. We have considered most carefully this submission. It is indeed sophisticated in its construction, and, at first blush, appears most appealing. On reflection and a closer examination, we find ourselves unable to subscribe to the interpretation Mr. Venkatraman so eloquently commends, viz., that his transaction is one of a merely permissive use. We find this interpretation not to be supported by law, and we have the most serious reservations about the universal applicability of his propositions, which seem to us to be overbroad and to cast the net too widely. The first question is whether there is a ‘transfer’ within the meaning of Article 366(29A)(d). We believe there is. It is true that the essence of a ‘transfer’ is the divesting of a right or goods from transferor and the investing of the same in the transferee, and this is what Salmond on Jurisprudence and Corpus Juris Secundum both say. In our opinion, the seeds embedded with the technology are, in fact, transferred. Monsanto India is divested of that portion of the technology embedded in these fifty seeds and these are fully vested in the sub-licensee. Mr. Venkatraman is not correct when he says that the effective control of the ‘goods’ is with Monsanto India. In RINL, the Supreme Court concluded that the contractor (transferee) did not have effective control over the machinery, despite the fact that he was using it, since he could not make such use of it as he liked. He could not use the machinery for any project other than that of the transferor’s, nor could he move it out during the period of the project. We do not see how we can draw a parallel from that case to the one at hand. The effective control over the seeds, and, therefore that portion of the technology that is embedded in the seeds, is entirely with the sub-licensee. That sub licensee is not bound to use the seeds (and the embedded technology) in accordance with Monsanto India’s wishes. Monsanto India cannot further dictate to the sub-licensee what he or it may do with these technology-infused seeds. The sub-licensee can do as it wishes with them. It may not use them at all. It may even destroy the seeds. Once the transaction is complete, i.e., once possession of the technology-imbued seeds is effected, and those seeds are delivered, Monsanto India has nothing at all to do with the technology embedded in those fifty seeds given to the sub-licensee.

At no point does Monsanto India have access to this portion of the technology. In other words, the transfer is to the exclusion of Monsanto India. This clearly satisfies the so-called BSNL “twin test” that Mr. Venkatraman is at pains to propound. Mr. Venkatraman’s argument that the seeds are “merely the media” and therefore irrelevant is, in our opinion, erroneous. They are relevant for the simple reason that the technology could not have been given to the sub-licensee without them; and there is no other method demonstrated anywhere of effecting any such transfer.”

Thus, Hon. High Court rejected all arguments about transfer of technology within scope of permissible use but held it as complete transfer of right, to constitute deemed sale liable under VAT . Hon. High Court has also cited various examples about what constitutes goods in relation to intangible goods.

The alternative argument that it is sale of seeds, hence exempt under Schedule Entry A-41 of MVAT Act was also rejected.

The other main argument about non attraction of VAT as Service Tax is paid did not impress the court. The further plea to direct transfer of service tax paid to VAT department was also not considered by Hon. Court by observing as under:

“53. Mr. Venkatraman makes one more, without prejudice argument, in case neither of his previous arguments succeeds. He submits that even if the agreement in question is held to be a transfer of the right to use (deemed sale) and that it does not fall under the exemption for seeds in the MVAT Act, then the levy and collection of Service Tax by the Union of India would be without the authority of law since VAT can only be levied and collected by the States. As argued earlier, the same transaction cannot be taxed as both a sale and a service. Monsanto India has already paid service tax for the entire period at a rate significantly higher than what is provided under the MVAT Act and therefore he says that it is not liable to pay further tax. For the period between May 2007 and February 2009, it has paid service tax at a rate of 12.36%, for March 2009 to March 2012 at a rate of 10.3%, for April 2012 to May 2015 at 12.36%, and for the period beginning June 2015 at a rate of 14%.

Under Entry 39 of Schedule C of the MVAT Act, the applicable rate of sales tax is only 5% since April 2010, prior to which it was 4%. He therefore seeks a Writ of Mandamus directing Union of India to transfer the amount paid as service tax from the Consolidated Fund of India to the Consolidated Fund of State of Maharashtra. He argues that such a transfer would not amount to unjust enrichment. We decline to enter into this debate. We leave it to Monsanto India to adopt suitable proceedings in this behalf, and leave their contentions open to the necessary extent.”

There will thus be a looming question of double tax payment.

Subway Systems India Pvt. Ltd. (W.P.No.497 of 2015 dated 11.8.2016)

The facts in this case are noted by High Court as under:

“55. A brief description of Subway’s business is this. Subway was granted a non-exclusive sub-license by Subway International B.V. (“SIBV”), a Dutch limited liability corporation to establish, operate and franchise others to operate SUBWAY -branded restaurants in India. This non-exclusive license was granted to SIBV itself by Subway Systems International Ansalt, which in turn was granted such a license by Doctor’s Associates Inc., an entity that owns the proprietary system for setting up and operating these restaurants.

These restaurants serve sandwiches and salads under the service mark SUBWAY. The agreement includes not only the trade mark SUBWAY , but also associated confidential information and goodwill, such as policies, forms, recipes, trade secrets and the like.

Typically, Subway enters into franchise agreements with third parties, under which it provides specified services to the franchisee. In return, the franchisee undertakes to carry on the business of operating sandwich shops in Subway’s name. The agreement only provides for a very limited representational or display right, and the franchisee cannot transfer or assign these exclusive rights to any third person. Subway also reserves the right to compete with these franchisees in the agreement. Under this agreement, Subway receives two kinds of consideration, one being a one-time franchisee fee which is paid when the agreement is signed; and the second is a royalty fee paid weekly by the franchisee on the basis of its weekly turnover. A sample franchise agreement is annexed. Under these agreements, the franchisees have no more than a right to display Subway’s intellectual property in the form of marks and logos, and a mere right to use such confidential information as Subway discloses and as prescribed by the franchise agreement.”

Based on above facts, the issue was examined by the Court. In this case also the ratio of BSNL relied upon. Hon. High Court ultimately held as under:

“69. We believe that Mr. Shroff is correct when he says that the agreement between Subway and its franchisees is not a sale, but is in fact a bare permission to use. It is, therefore, subject only to service tax. In our opinion, the fact that the agreement between Subway and its franchisee is limited to the precise period of time stipulated in the agreement is vital to Subway’s case. At the end of the period of the agreement, or before in case there was any breach of its terms, the right of the franchisee to display the mark ‘Subway’ and its trade dress, and all other permissions would also end. This is what sets this agreement apart from the case of Monsanto and its sublicensee. There, the seed companies could do as they pleased with the seeds; they could alienate or even destroy them. In Subway’s case, there are set terms provided by the agreement which have to be followed. A breach of these would result in termination of the agreement.

We believe that there is no passage of any kind of control or exclusivity to the franchisees. In fact, this agreement is a classic example of permissive use. It can be nothing else. For all the reasons in law and fact that the sub-licensing of technology in Monsanto is held to be a transfer of right to use, this franchising agreement must be held to be permissive use.”

Thus on ground that the agreement is for permissible use, it is held that it is not a sale by transfer of right to use but a ‘service agreement’.

One more issue dealt with by Hon. High Court is that for situs of sale by transfer of right to use, the place of agreement, as decided by Supreme Court in case of 20th Century Finance Corp. Ltd. ( 119 STC 182)(SC), is relevant.

In this case, the agreement was signed in Delhi and hence High Court held that otherwise also the transaction cannot be taxed in Maharashtra, inspite that the users are in Maharashtra.

Conclusion
The issue about sale by transfer of right to use or service transaction has become vexed and requires decision on facts of each case. Even in above judgment, Hon High Court has observed that each agreement, whether titled as franchise or something else, will be required to be decided on the basis of actual terms and scope of agreement. The dealers will thus be under threat of uncertainity taxation and most probably by both departments, till the issue gets resolved at a higher forum. Some undisputable criteria for deciding nature of transaction is required to be specified to avoid such uncertain situation.