Background: Transfer of right to use goods – a deemed sale.
Long before intellectual property service was introduced on the statute of service tax in the Finance Act, 1994 (the Act) with effect from 10th September, 2004, intellectual property right including trademark has been considered intangible goods. As such, its assignment or transfer has been exigible to sales tax. The issue for discussion however relates not to transfer or assignment of trademark but transfer of right to use trademark. In Commissioner of Sales Tax vs. Duke & Sons Pvt. Ltd. 1999 (112) STC 371 (Bom), Hon. Bombay High Court observed, “For transferring the right to use the trademark, it is not necessary to handover the trademark to the transferee or give control or possession of trademark to him. It can be done merely by authorizing the transferee to use the same in the manner required by the law as has been done in the present case. The right to use the trademark can be transferred simultaneously to any number of persons.” It is further observed, “In the instant case, there is no dispute about the fact that trademark is specifically included in the schedule of goods to the 1985 Act in entry no.7, the amount received by the assessee on the transfer of the right to use the same is therefore liable to be taxed under the said Act.” In Vikas Sales vs. Commissioner of Commercial Taxes (1996) 102 STC 106, the Supreme Court held that, even incorporeal rights like trademarks, copyrights, patent and right in persona capable of transfer or transmission such as debts are also included in the ambit of the term ‘goods’. The Court further held that patents, copyrights and other rights which are not rights over land related matters are included within the ambit of movable property. In another case, viz. SPS Jayam & Co. vs. Registrar Tamilnadu Taxation Special Tribunal and Others (2004) 137 STC 117 (MAD), it was held that trademark is intangible good which is subject matter of transfer and was further observed that simply because the assessee retained the right for himself to use the trademark and reserved the right to grant permission to others to use the trademark, it would not take away the character of the transaction as one of transfer of a right to use.
It is a known fact that vide 46th Constitutional Amendment in 1982 in the Article 366, a new clause (29A) was inserted. The said Article 366(29A) of the Constitution of India in sub-clause (d) reads as follows:
“ “tax on the sale or purchase of goods” includes:
(d) a tax on the transfer of the right to use any goods for any purpose (whether or not for a specified period) for cash, deferred payment or other valuable consideration.”
In this frame of reference, it is also interesting to note that in case of 20th Century Finance Corporation Ltd. vs. State of Maharashtra 2000 (119) STC 182, it was held, “the States in exercise of power under entry 54 of List II read with Article 366(29A)(d) are not competent to levy sales tax on the transfer of right to use goods, which is a deemed sale, if such sale takes place outside the state or is a sale in the course of inter-state trade or commerce or is a sale in the course of import or export.” Consequently, the Finance Act, 2002 with effect from 11-05-2002 amended the Central Sales Tax Act, 1956 whereby the definition of sales was enlarged by incorporating transactions included in clause (29A) of Article 366 for the purpose of levy of tax on sale or purchase of goods which take place in the course of inter-state trade or commerce. Thus, for the purpose of sale, deemed sale under Article 366(29A) is included and in turn, intangible property includes a trademark and thus is always treated as ‘goods’. The Supreme Court in Tata Consultancy Service vs. State of Andhra Pradesh (2004) 178 ELT 22 (SC) held that intangibility is not something which should determine whether a property is goods for the purpose of sales tax. The test is whether the property is capable of abstraction, consumption and use and whether the same can be transmitted, transferred, delivered, stored, possessed etc. The transfer of the right to use goods is distinct from mere transfer of goods but also an activity considered as liable for tax as sale of goods. The Andhra Pradesh High Court in G.S. Lamba & Sons vs. State of A.P. 2012-TIOL-49-HC-AP-CT held “The levy of tax under Article 366(29A)(d) is not on the use of goods. It is on the transfer of the right to use goods which occurs only on account of the transfer of the right.” [emphasis supplied].
Sale vs. Service:
In terms of the judicial pronouncements cited above, it can be inferred that there is a marked distinction between transfer of right to use a trademark or a similar intellectual property and assignment of trademark. By way of assignment, the owner of the trademark/intellectual property divests his right, title or interest but while transferring the right to use the same, he does not give up his right, title or interest. However, sale or deemed sale both are exigible to VAT. Having so determined, the fact is that the transaction other than those of mere sale or transfer of intellectual property i.e. temporary transfer or permitting the use or enjoyment of any intellectual property is declared as ‘service’ u/s. 66E of the Act with effect from 01-07-2012 and under the earlier dispensation of service tax law as well, intellectual property service was defined in section 65(55b) as ““intellectual property service” means, — (a) transferring, temporarily; or (b) permitting the use or enjoyment of, any intellectual property right” and was considered “taxable service” with effect from 10th September, 2004 as stated hereinabove.
While the intent of legislation in principle is to exclude both ‘sale’ and “deemed sale” from the purview of service tax is clear in many forms, the implementation has not matched the intention always. To illustrate, the definition of ‘service’ as introduced in section 65B(44) with effect from 01- 07-2012 specifically excludes transfer, delivery and supply of goods which is deemed to be sale for the purpose of Article 366(29A) of the Constitution. However, there is a contradiction made in the law itself by defining temporary transfer or permitting the use of enjoyment of any intellectual property as declared service as stated above. Earlier, judiciary also made pronouncement on this subject matter when in Imagic Creative (P) Ltd. vs. Commissioner of Commercial Taxes & Others 2008 (9) STR 337 (SC) wherein it was held by the Supreme Court that VAT and service tax are mutually exclusive. Thus, even though there is a settled law that a transaction cannot be simultaneously ‘sale’ and ‘service’ and therefore not exigible to both VAT and service tax, it is quite a matter of challenge to correctly determine the nature of a transaction whether of sale of goods or provision of service and consequently, should be exigible to only one of the levies. Like the declared services of development of information technology software and transfer of goods by way of hiring, leasing or licensing etc. (discussed in May, 2013 and November, 2012 issues of BCAJ respectively under this column), this is one more controversial declared service which is extremely prone to litigation on account of overlap of VAT and service tax. The law in this regard is still under evolution and hence there is no finality.
In a landmark decision of Bharat Sanchar Nigam Ltd. vs. UOI 2006 (2) STR 161 (SC), the Supreme Court observed, “……. If there is an instrument of contract which may be composite in form in any case other than the exceptions in Article 366(29A), (Note: The reference here was to works contract and catering contract) unless the transaction in truth represents two distinct and separate contracts and is discernible as such, then the State would not have the power to separate the agreement to sell from the agreement to render service and impose tax on sale. The test therefore for composite contracts other than those mentioned in Article 366(29A) continues to be – did the parties have in mind or intend separate rights arising out of the sale of goods. If there was no such intention, there is no sale even if the contract could be disintegrated. The test for deciding whether a contract falls into one category or the other is to as what is the substance of the contract. We will, for the want of a better phrase, call this the “dominant nature test”. In para 97, the Court dealt with the question as to what would constitute a transaction for the transfer of the right to use the goods exigible to VAT and held that such transactions must have the following attributes:
a. There must be goods available for delivery;
b. There must be a consensus ad idem as to the identity of the goods;
c. The transferee should have a legal right to use the goods – consequently all legal consequences of such use including any permissions or licenses required therefor should be available to the transferee;
d. For the period during which the transferee has such legal right, it has to be the exclusion to the transferor this is the necessary concomitant of the plain language of the statute – viz. a “transfer of the right to use” and not merely a license to use the goods;
e. Having transferred the right to use the goods during the period for which it is to be transferred, the owner cannot again transfer the same rights to others.
[emphasis supplied].
All the aforesaid attributes vis-à-vis “transfer of right to use goods” certainly would hold good in case of tangible goods. This aspect was also observed in G.S. Lamba & Sons (supra). However, transfer of right to use incorporeal property such as trademark would not be able to fulfill the last two tests out of the above 5 tests viz.
• The transferee cannot use the right to use the goods to the exclusion to the transferor as the transferor of the right to use intangible can himself continue to use the said intangible goods as physical transfer is not required for intangibles.
• Right to use intellectual property can be transferred to others simultaneously.
[This characteristic was observed in the decisions of Duke & Sons P. Ltd. (supra) and SPS Jayam & Co. (supra)].
Both the above tests are not fulfilled because of the inherent characteristic of “intangible goods” being intangible in nature as physical dispossession or transfer does not happen in this case. Heavily relying on the above, the Kerala High Court reversed its own ruling of the earlier cases in a recent judgment analyzed below:
Malabar Gold Pvt. Ltd. vs. Commercial Tax Officer 2013-TIOL-512-HC-Kerala-ST.
In this recent decision, the Division Bench of Kerala High Court was approached challenging the levy of VAT under KVAT Act on royalty received from franchisee companies. The petitioner company engaged in marketing/trading export and import of jewellery under the name “Malabar Gold” paid VAT on the sale of jewellery without any dispute. However, the appellant had entered into franchise agreements with various franchisees which sold the jewellery under the name “Malabar Gold” and interalia displayed such board with design approved by the Appellant and paid royalty to the Appellant under the franchise agreement. Admittedly, franchise service is a notified category of service taxable under the service tax law vide section 65(105)(zze) read with section 65(47) & (48) of the Finance Act, 1994 from 1st July, 2003 and the company paid service tax on royalty received in terms of the franchise agreement. The Commercial Tax Officer initiated proceedings for recovery of VAT contending that royalty received by the Appellant from its franchisees for the use of trademark was exigible to VAT as transfer of right to use any of the goods would be taxable. Relying on the decision of the Apex Court in BSNL (supra) and Imagic Creative P. Ltd. (supra), the petitioner’s stand was that the transaction being of franchise service attracted service tax alone which they had already paid. In turn, the VAT authority interalia relied on Tata Consultancy Service (supra) and Division Bench decision of Kerala High Court in Mechanical Assembly Systems (India) Pvt. Ltd. vs. State of Kerala 2006 (144) STC 546.
Earlier, the single Judge in this case rejected the Appellant’s appeal reported at 2012-TIOL-1032-HC. Kerala- VAT wherein it was held that royalty received by the dealer was exigible to KVAT Act. Hence this writ petition was filed. It was pleaded for the appellant that royalty fee was paid under the franchise agreement. The concept of franchise agreement was explained and as ruled in Imagic Creative P. Ltd. (supra) by the Supreme Court, once the transaction was clearly covered under the relevant provisions for payment of service tax, then it was not liable for VAT simultaneously. As regards “right to use”, it was pleaded that in Tata Consultancy Service’s case (supra), it was clearly laid down that the item concerned should be capable of abstraction, consumption and use which can be transmitted, transferred, delivered, stored, possessed etc. and referring to various paras from the decision in BSNL (supra), it was contended that considering the peculiarities of the franchise arrangement and the concept of “right to use the goods”, the test laid down in BSNL’s case was not satisfied as the franchise was not provided to the exclusion of the franchisor. It was also submitted interalia that assuming there was a conflict between the entries in Lists I & II under the Seventh Schedule to the Constitution, the Finance Act, 1994 would prevail.
Next in line, the facts in the case of Mechanical Assembly Systems P. Ltd. vs. State of Kerala (supra) were distinguishable as in that case, transfer of know- how on permanent basis was involved and it was totally different from the franchise arrangement. It was further submitted that the subsequent decisions of the Kerala High Court in Jojo Frozen Foods P. Ltd. vs. State of Kerala (2009) 24 VST 327 and Kreem Foods P. Ltd. vs. State of Kerala (2009) 24 VST 333 on the identical issue even though considered liable for sales tax, they were under the GST Act and in all the 3 decisions of the same Kerala High Court, the period prior to 2003 was involved i.e. prior to introduction of franchise service from 01/07/2003 in the service tax law and the Division Bench had no occasion to examine the effect of the provisions of the Finance Act, 1994. Further that in those cases, transfer from one dealer to another was involved whereas in the instant case license alone is involved and that the findings of those cases could not be supported in the light of pronouncement of law by the Supreme Court in BSNL’s case (supra). It was strongly pleaded that the learned Single Judge did not go into the question whether service tax alone is payable by the Appellant and did not consider the other related legal issues. Discussing the decision of the Bombay High Court in Duke and Sons Pvt. Ltd. (supra) relied upon in Jojo Foods (P) Ltd.’s case (supra) also, it was submitted that this decision based on special facts was distinguishable.
The VAT authority on the contrary contended that the 3 decisions of the Kerala High Court (referred above) would show that transactions by way of transfer of know-how as well as right to use the trademark were found covered by KVAT Act. The instant case not being different from those 3 cases, Article 366(29A)(d) would have relevance.
Considering the contentious issue, the Court ex-amined in detail provisions of franchise service in the Finance Act, 1994 and also those in relation to intellectual property service viz. section 65(55a) and 65(55b) alongside the provisions of KVAT Act as regards definition of ‘sale’ and relevant Explanation (v) thereof dealing with “transfer of right to use any goods for any purpose” and section 6 providing for levy of tax on sale or purchase of goods. All the important terms of model franchise agreement entered into by the Appellant with its franchisees were considered to examine the crux of the arrangement. In a nutshell, the franchisee was granted license to pursue retailing of gold and diamond ornaments, watches etc. at the showroom authorized by the Appellant under their trade name and logo Malabar Gold. At its own discretion, Malabar Gold provided support right from project plan to selection of product mix, implementation of system, raising of funds, specification & guidance on showroom operations etc. Franchisees were not allowed to use the showroom for any other products in their name. The relationship was defined as that of products in their name. The relationship was defined as that of principal to principal and franchisee was allowed not to act as their agent and all other responsibilities and compliances had to be solely of franchisee. Lastly on termination, interalia included non-compete clause for a 2 year period. It was noted by the Court that franchise service was introduced with effect from 01-07-2003 and KVAT was introduced from 01-04-2005. In the light of the said franchise arrangement, principles stated by the very Court in Mechanical Assembly System’s case (supra), Jojo Frozen Foods (supra) and Kreem Foods (supra) were discussed. The case of Mechanical Assembly System was distinguishable as although consideration was termed as ‘royalty’, in that case, there was an outright transfer of know-how involved and not a case of transfer of use of know-how. Therefore, question was whether dictum in the other two cases whether was distinguishable in the light of peculiar facts of the franchise arrangement in the appellant’s case and the question that whether the principles laid down in BSNL’s case would support the appellant’s case.
The Court noticed that both appellant and revenue relied upon relevant principles explaining the meaning of ‘goods’ in case of Tata Consultancy’s case (supra). On examining the said judgment, the Court formed the view that ‘goods’ used in Article 366(12) of the Constitution and as defined in the KVAT Act is very wide and includes all types of movable properties, tangible or intangible. Then, in juxtaposition, BSNL’s judgment was examined. On analysing relevant paras viz. 50, 56 & 57, 73, 75 of BSNL’s case (supra) as regards ‘goods’ in a sales transaction and delivery thereof, the Court observed that in the light of principles stated therein, actual delivery of the goods is not necessary for effecting transfer of right to use the goods but the goods must be deliverable and delivered at some stage and if what is claimed as goods are not deliverable at all, the question of right to use those goods would not arise. Thus if there is no deliverable, there is no transfer of user and this is true for both tangible and intangible goods. Finally the Court noted the 5 attributes contained in para 97 of BSNL’s case (supra) to constitute a transaction for transfer of the right to use the goods (provided above under sale vs. service). In terms of this test, the appellant’s case involved only a license to use trademark. The transfer of its use was not to the exclusion of the transferor i.e. the appellant retained the right to transfer it to others also. The Court also noted that BSNL’s case (supra) was also considered in Imagic Creative P. Ltd. (supra) while examining a case of composite contract. Further, referring to interalia the decision of the Bombay High Court in Rolta Computer & Industries P. Ltd. (2009) 25 VST 322 it was observed that the Bombay High Court followed the above dictum laid down in BSNL’s case (supra). In this case, an amount was paid on hourly basis for the use of CPU to process accounting applications. The sales tax authorities held that as soon as the terminal was allowed to be used, transfer of right to use took place and therefore sales tax was attracted. Following the above dictum of BSNL’s case (supra), it was held in this case that the possession of computers & terminals was never parted with. Merely when a person agrees to provide a particular customer the service during a particular period to the exclusion of other customers, it would not mean goods are delivered to the exclusion of owner himself. It was nothing more than a service contract and no sales tax was attracted.
The Court found that this judgment supported the appellant’s case besides the case of State of Andhra Pradesh vs. Rashtriya Ispat Nigam (2002) 3 SCC 314 (SC) wherein the crucial relevant factor was that there was no transfer of right to use machinery in favour of contractors to the exclusion of owner was made. The contractor was appointed to only operate the machinery for owner’s own project work in owner’s premises and therefore the effective control and possession over the machinery other than for owner’s use was never transferred to the contractor to attract sales tax. In the light of this, through appellant’s franchise agreement, franchisee did not get effective control of the trademark but got only limited rights and even during subsistence of the agreement, the appellant could use the trademark for itself and for other parties, the dictum laid down in BSNL’s case (supra) was found applicable and the Court found the transaction to be not of “deemed sale” but of “franchise service” in terms of section 65(105) (zze) read with 65(47) & 65(48) of the Finance Act, 1994 although it was strongly pleaded on behalf of the respondent that no service was referred to in the model agreement. The Court accordingly stated that Jojo Frozen Foods Ltd.’s case (supra) and Kreem Foods Pvt. Ltd.’s case (supra) had no occasion to consider entry 97 and provisions of the Finance Act, 1994. Further, the Court found that the definitions of ‘franchise’ & ‘franchisor’ were important to consider, as in terms of these definitions, granting of representational right to sell or manufacture goods or to provide service or undertake any process identified with the franchisor was covered whether or not any trademark, service mark, trade name or logo or symbol was involved. Based on this, these judgments were found distinguishable. Accordingly, the single judge’s decision that the transaction was of “deemed sale” as defined in KVAT Act was not agreed upon as in the instant case, the Court did not have to deal with a case involving transfer of intellectual property right like trademark but the matter involved was of franchise agreement and accordingly the judgment was reversed by concluding that it did not attract the provisions of KVAT Act.
Conclusion:
The above case is of a typical franchise arrangement and based on this specific arrangement, the Division Bench reached the decision as above reversing the stand taken in the two earlier cases on identical issue. However, many situations or transactions of supply of tangible goods for hire, transfer of right to use intellectual property, electronic transfer/downloads of standard software, transactions involving providing customised software etc. suffer a hanging sword of the other levy even if in good faith one of the taxes is paid with bonafide intentions. An honest tax payer is pushed to the wall to undergo strenuous, lengthy and expensive litigation deterring him to under-take business venture in India on account of the existing complex legal system. Trial and error in judiciary for interpretation of different provisions contained in both the legislations is done at the cost of an assessee – business enterprise whose interests and conveniences are considered of least importance in the gamut of tax collection and administration. Is the issue of interpretation on account of overlap between the two legislations and tug of war between the two administrations on account of revenue a simple affair for us to wrap up as professional opportunity or does it require a serious consideration for drawing attention of lawmakers to address the issue irrespective of implementation of GST?
