In this two-part series, Ashwini Vaidialingam, a V Year Student at NLSIU, Bangalore analyses the recent development in the law surrounding taxation of right to use intangible goods, its validity and implications for IP Transactions. Read Part I here.
In the previous post, I examined the peculiar stance Maharashtra has adopted on what amounts to “transfers” of right to use IPs. I had argued that the stand taken by the Bombay HC blurs the line between transfers of right to use and right to use, potentially exposing license agreements to an improper levy of VAT.
In this post, I propose to generally examine the nature of indirect tax levy on transfers of right to use IPs. I argue that the double levy of VAT and service tax that is currently being imposed on such transactions is unconstitutional.
VAT
The power to levy any kind of sales tax, which includes VAT, vests in State Governments by virtue of Entry 54 of List II of the VII Schedule of the Constitution. The taxable event required for the levy of sales tax is the transfer of title over goods i.e. the sale of goods. However, Art. 366(29A) of the Constitution creates a legal fiction in the case of 6 additional events. These are understood to be “deemed sales”.
Of these, the event most relevant for our purposes is that specified in clause (d) of Art. 366(29A). It reads:
“(29A) 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;”
On a literal interpretation of the above clause, it is clear that it covers all transfers of right to use, irrespective of whether the transfer is temporary or permanent, partial or complete. Accordingly, a transfer of a right to use any IP will amount to sale, as long as IPs amount to ‘goods’.
The question as to the nature of intellectual property is no longer res integra. The SC in TCS v. State of Andhra Pradesh (here) conclusively held that the definition of goods provided under Art. 366(12) of the Constitution and S. 2(3) of the Sale of Goods Act, 1930 is broad enough to include intangible/incorporeal property. Naturally, this includes intellectual property.
Thus, as IPs amount to goods, and a transfer of a right to use them amounts to a taxable event, the levy of VAT on such a transaction is indisputable.
Service Tax
The real controversy regarding transfer of the right to use arises when the transaction is considered under the service tax regime. Prior to the introduction of the 2012 amendments to the Finance Act, 1994, the ‘positive list’ system prevailed i.e. only those services falling under the definition of “taxable service” under S. 65(105) were subject to service tax. However, after the shift to the negative list system, “service” under S. 65B(44) now means “any activity carried out by a person for another for consideration”. The over-breadth of this definition is tempered by a few exceptions, the most relevant of which states that any sale within the meaning of Art. 366(29A) is excluded. This is ostensibly to ensure that Centre does not encroach on Entry 54 of List II.
However, this attempt at constitutionality is short-lived. S. 66E(c) declares as a service, temporary transfers of intellectual property. This clearly falls within the scope of Art. 366(29A)(d) which covers all kinds of transfers; the transfers need not be permanent or otherwise
One approach that seeks to reconcile the difference between S. 66E(c) and S. 65B(44) is to harmoniously interpret them. Then, all transfers except temporary transfers will be understood as ‘sale’ and excluded. However, there is deliberate generality in the language of Art. 366(29)(d), which makes this a difficult proposition to accept. Parliamentary intention in drafting clause (d) was clearly to bring as many kinds of transfers as possible.
As the situation stands today, any temporary transfer of a right to use – say, as in the case of a 25 year assignment of copyright – will be taxable as a “service”. As VAT is equally liable to be paid, intellectual property holders may find themselves paying double tax on one transaction.
This appears to me to be in fundamental violation of the scheme envisaged in the VII Schedule. Once the states have been given the sole power to tax sales under Entry 54, and once Parliament has specifically amended Art. 366(29A) to increase the scope of “sale”, it is outrageous for them to try and levy service tax in this manner. The residual power under Entry 97 does not empower Parliament to encroach on List II. Such an understanding will find support in past decisions of the SC in BSNL v. Union of India (here and here), and Imagic Creative v. Commissioner of Sales Tax (here). The SC’s general disapproval of such kinds of double levy finds strongest expression in the latter – Imagic Creative – where it unambiguously states that service tax and VAT are to be mutually exclusive.
As a final point, it is important to note that the jurisprudence on the aspect theory in indirect tax – where two aspects of one divisible transaction are taxed as service and sale respectively – is likely to be inapplicable in the context of transfers of right to use. In the case of say, a building contract, it is possible to split the transaction into its respective service (the construction of the building) and sale (the transfer of title in materials like cement, brick etc. from the builder to the buyer) elements. Service tax is levied on the service aspect alone; similarly, sales tax is levied on the sales aspect alone. However, in the case of transfer of right to use an IP, there is no such divisibility possible. There is only one aspect to the entire transaction.
In conclusion, the levy of service tax on transfers of right to use through S. 66E(c) of the Finance Act, 1994, in addition to the levy of VAT, is undoubtedly unconstitutional. It will be very interesting to see when, where, and how it is challenged.
