Hiring of Goods: Declared Service or Deemed Sale?

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Preliminary:

Under the negative list based taxation of services introduced from July 01, 2012, service is defined by section 65B(44) of the Finance Act, 1994 (the Act) to mean an activity carried out by a person for another for consideration and also includes declared services followed by a list of excluded transactions as follows:

? An activity resulting in transfer of title in goods or immovable property by way of sale, gift or in any other manner.

? Deemed sale of goods in terms of Article 366(29A) of the Constitution.

? A transaction only in money (other than activities relating to use of money or conversion of money for which consideration is charged).

? A transaction only in actionable claim.

? Employment contract for service by an employee to an employer.

? Fees payable to a court or tribunal.

In turn, “Declared Service” is defined by section 66E of the Act containing nine activities like renting of immovable property, construction of a complex or a building including one intended for sale to a buyer, temporary transfer of intellectual property rights, design development etc. of information technology software, agreeing to tolerate an act or refraining from an act, transferring goods by hiring without transferring right to use goods, hire purchase transactions, works contract and catering contracts. In this feature, one of the declared services described in subclause (f) of the said section 66E of the Act is discussed below.

Statutory provisions.

Section 66E:

“The following shall constitute declared services: namely:-

(a) ………………;
(b) ………………;

Explanation
(I) ……………….;
(A) …………..;
(B) …………..;
(C) …………..;
(II) ………………;
(c) …………………..;
(d) …………………..;
(e) ………………….;
(f) transfer of goods by way of hiring, leasing, licensing or in any manner without transfer of right to use such goods”

Activity of providing goods on hire:

While explaining the scope of this service, the Government in the Education Guide dated 20/06/2012 issued while introducing Negative List based taxation of services has provided as follows “Transfer of right to use goods is a well recognized constitutional and legal concept. Every transfer of goods on lease, licence or hiring basis, does not result in transfer of right to use goods”. In support of the above statement, it has cited Supreme Court in the case of State of Andhra Pradesh vs. Rashtriya Ispat Nigam Ltd. 2002 (126) STC 0114 (SC) which ruled in the context of the facts of that case that “Transfer of right of goods involves transfer of possession and effective control over such goods” and “Transfer of custody along with permission to use or enjoy such goods, per se does not lead to transfer of possession and effective control”.

The readers may note that the above ruling was pronounced in a case where the machinery belonging to Rashtriya Ispat Nigam Ltd. (the company) was provided to the contractor for the use in the project work of the company on the site of the company and the contractor merely was responsible for the custody of the same. However, the effective control and possession was not transferred to the contractor. The contractor was not free to make use of the machinery for the work other than that of the company. Therefore, the decision that effective control and possession was not passed on by the company to the contractor, is with reference to the facts of the case that the machinery belonged to the company and the contractor was merely retained to operate the same and responsible for its security as the machinery was placed in his custody only for the project work of the company.

It is, thus, true that transfer of right of goods involves transfer of possession and effective control. However, in the above case of Rashtriya Ispat Nigam Ltd. (supra) wherein the custody of machinery belonging to the company was merely provided to the contractor for operation of the same. The machinery was not ’hired’ to the contractor. This does not mean that in every transaction where goods belonging to owner or lessor are provided on hire, there does not occur ‘transfer’ of right to use such goods. The issue therefore is, when an equipment is provided on hire or on operating lease or when tangible or intangible goods are licensed to the licensee for the use of the licensee for a specific period whether “transfer of right to use” occurs and therefore the transaction is considered a “deemed sale” in terms of Article 366(29A) of the constitution, exigible to VAT under State laws and therefore specifically excluded from the definition of ‘service’ or whether there is no ‘transfer’ of right to use occurring and the person uses the goods without enjoying the right to use and therefore, the same is to be considered as a “declared service” as defined above and is subjected to service tax. The issue is complex and requires interpretation of the facts of each case. It has been dealt with by Courts time and again. A few such important decisions are discussed below:

Test laid down by the Supreme Court in BSNL:

The test laid down by the Hon. Supreme Court in the benchmark decision of Bharat Sanchar Nigam Ltd. vs. UOI 2006 (2) STR 161 (SC) provides direction in the matter. This test is recognised by the Government in the Education Guide for determining whether a transaction involves transfer of right to use goods. It has been followed by the Supreme Court and various High Courts. The test lays down as follows:

? There must be goods available for delivery.

? There must be consensus ad idem as to the identity of the goods.

? The transferee should have legal right to use the goods – consequently all legal consequences of such use including any permission or licenses required therefore should be available to the transferee.

? For the period during which the transferee has such legal right, it has to be the exclusion of 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.

? 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.

The Education Guide also indicates that whether a transaction amounts to transfer of right or not cannot be determined with reference to a particular word or clause in the agreement laying down terms between the parties, but the agreement is required to be read as a whole to determine the nature of transaction.

Further, the Ministry in the Education Guide has also listed certain illustrations as under:

“6.6.2 Whether the transactions listed in column 1 of the table below involve transfer of right to use goods? (Refer Table on the next page)

The Education Guide states that the list in the Table is only illustrative to demonstrate how Courts have interpreted terms and conditions of various types of contracts to see if a transaction involves transfer of right to use goods. The nature of each transaction has to be examined in totality keeping in view all the terms and conditions of an agreement relating to such transaction.

Admittedly, the issue has been contentious and there may be a thin line of divide between the facts of one case from the other and which may have led to reach different conclusions by Courts at different times. For instance and as against the decisions cited in the above table, viz. International Travel House and Ahuja Goods Agency ( supra), in the case of K. C. Behera vs. State of Orissa (1991) 83 STC 325 (Ori.), buses were hired by State Transport Corporation (STC). The bus was to be run for STC as per the agreement and under directions of an officer. Transaction of hiring was held as ‘sale’ within its extended meaning. Providing driver etc. notwithstanding, there was a transfer of right to use bus for consideration and effective control, general control and possession of the bus vested in STC. As against this, in Laxmi Audio Visual vs. Assistant Commissioner of Commercial Taxes 2001 (124) STC 426 (Kar), it was held that when there is only hiring of audio visual and multi media equipment, where the equipment is at the risk of the owner and possession and effective control remains with the owner, in such circumstances, it cannot be said that the customer has the right to use the equipment and therefore there was no deemed sale. Similarly, in the background of somewhat different facts, in the case of State of Orissa vs. Dredging Corporation of India Ltd. (2009) 25 VST 522 (Orissa H.C.), the company Dredging Corporation of India engaged its dredgers for dredging the floor of Paradeep Port under the Paradeep Port Trust (PPT) and did not disclose the income from dredging charges as ‘sale’ income. On perusal of the agreement between the parties, the Court held that transfer of right to use any goods is not a bailment, for had it been a bailment, the State would have no power to tax it. It is a sale by a fiction of law engrafted in Article 366(29A)(a) of the Constitution and resultantly in section 2(g)(iv) of the OST Act. So, what is determinative as to whether or not there was a transfer of right to use the chattel (the dredger) is the stipulation in the agreement between the Board and the appellant. The Court also observed:

“The agreement provides as follows:

……….. the Corporation hereby agrees to deploy its Cutter Auction Dredges MOT Dredge-II in the dredging work. There are stipulations to do a work, to dredge the sea-bed with men and machine deployed for the purpose, against a valuable consideration. So find it a works contract without transfer of property in goods in execution of such a contract.” The Court held, “there is nothing in the agreement to prove that there was a transfer of right to use the dredges.”

The readers may consider whether or not in the above case, the contract was that of service of dredging and “hiring of a dredge” was absent?

However, the facts in the case of Deepak Nath vs. ONGC (2010) 31 VST 337 (Gau) may also be examined. In this case, trucks, trailers, tankers and cranes were made available by owner to ONGC under contract in writing for operational charges as agreed to during the contract. It was held by the Division Bench that goods were made available 24 hours a day throughout the contract. Method and manner of using the goods was decided by ONGC, there is a transfer of right to use the goods even though the staff remained under his control.

The case of G.S. Lamba:

The recent decision of the Andhra Pradesh High Court in G.S. Lamba & Sons vs. State of Andhra Pradesh 2012-TIOL-49-HC-AP-CT appears most ex-haustive. It has considered the test laid down by the Apex Court in BSNL, all the significant decisions on the subject matter including those cited in the Education Guide to consider the short point of whether there exists a “transfer of the right to use” in transit mixers to M/s. Grasim Industries Ltd., when Ready Mix Concrete (RMC) manufactured by Grasim was to be transported under a contract by hiring specially designed transit mixers OR as it was pleaded by the petitioner, whether the contract amounted to “transportation service”. Under the contract in the case, the transit mixers are never transferred and effective control over running and using these vehicles as well as disciplinary con-trol over drivers remained with the contractor. The responsibility to obtain route permits, to take the risk or loss of transportation, to decide shifts of driver and vehicles, to maintain and upkeep the vehicles all vests in the contractor. After considering various decisions vis-à-vis facts of each case which interalia included Harbanslal vs. SO Haryana (1993) 88 STC 357 (P&H), 20th Century Finance (2000) 119 STC 182 (SC), IOC vs. Commissioner of Taxes (2009) 22 VST 70 (Gau), R P Kakoty vs. ONGC (2009) 22 VST 136 etc., the Hon. Court in Para 30 observed as under:

“30. From the judicial decisions, the settled essential requirement of a transaction for transfer of the right to use goods are:

(i)    it is not the transfer of the property in goods, but it is the right to use property in goods;

(ii)    Article 366(29A)(d) read with the latter part of the clause (29A) which uses the words, “and such transfer, delivery or supply … ” would show that the tax is not on the delivery of the goods used, but on the transfer of the right to use goods regardless of when or whether the goods are delivered for use subject to the condition that the goods should be in existence for use;

(iii)    in the transaction for the transfer of the right to use goods, delivery of goods is not a condition precedent, but the delivery of goods may be one of the elements of the transaction;

(iv)    the effective or general control does not mean always physical control and, even if the manner, method, modalities and the time of the use of goods is decided by the lessee or the customer, it would be under the effective or general control over the goods; and

(v)    the approvals, concessions, licences and permits in relation to goods would also be available to the user of goods, even if such licences or permits are in the name of owner (transferor) of the goods, and

(vi)    during the period of contract exclusive right to use goods along with permits, licences etc., vests in the lessee.”

Further, the Court followed the principles of interpretation of documents as listed below:

•     Construe the document as a whole.

•     To understand the meaning of a document or a part of it from documents itself.

•     To give literal meaning to the words used in a document.

•     In the event of intrinsic incongruities and inconsistencies flowing from the words and language used in the document, the intention would prevail over the words used. The intention of the parties has to be determined from the attending circumstances leading to the transaction.

(This principle is an exception to the first three principles. If the language used in the document is very clear, rights and obligation cannot be inferred by resorting to the fourth principle.)

Hon. A. P. High Court inter alia made the following observations while holding that the tax is not on use of goods, but on account of transfer of right to use of goods.

•    In other words, the right to use goods arises only on the transfer of such right to use goods and that the transfer of right is the sine quo non for the right to use any goods. The contract involved provision of transportation service for shipping RMC by hiring specifically designed transit mixers. The effective control of running the mixers and the disciplinary control remained with the contractor agreeing to provide the above service.

•     Article 366(29A)(d) would show that the tax is not on the delivery of goods used but on the transfer of the right to use goods regardless of when or whether goods are delivered for use. This is subject to the condition that goods are in existence for use. Delivery of goods is not a condition precedent, but one of the elements of the transaction.

•     Effective control does not mean always physical control and even if the manner, method modalities and time of the use of goods is decided by the lessee, it would be under the general control over the goods.

•     During the period of contract, exclusive right to use goods along with permits, licences etc. vests in the lessee. Although the drivers are appointed by the lessor, their roster fixed by them, licences, permits and insurance are taken in their names and they renew them. However, the product is delivered to customers of lessees.

•     The entire use in the property in goods is to be exclusively utilised for a period under contract by lessee.

•     The existence of goods is identified and transit mixers operate and are exclusively used for 42 months in the business of the lessee. In putting the property in transit mixers to economic use of the lessee, the lessors figure nowhere. It thus conclusively leads to the conclusion that lessor transferred the right to use the goods to the lessee.

Summing up:

On going through the above, whether a transaction is one of “deemed sale” involving transfer of right to use or is a “declared service” is a question which may not have a definite answer. Professionals may differ from each other. Nevertheless, the test provided in BSNL’s case (supra) appears decisive. Based on it, one may at least be able to answer whether a person can use goods without there being a transfer of ‘right’ to use the same to the exclusion of the lessor or owner on the lines discussed and analysed above in G.S. Lamba & Sons (supra) at least in case of common situations like hiring of vehicles. The Government appears to be tilted towards the view that in an ordinary and common contract of providing a vehicle on hire, the right to use is “not transferred”. In this scenario, it is likely that a law-compliant assessee under service tax law could be visited with recovery action under VAT law of the States and vice-versa. Whether one has to wait till implementation of GST to achieve a finality on the above remains to be seen. In the interim, uncertainty and long drawn litigations appear to be the only visible consequence at this point of time.