Reliance challenges the constitutionality of service tax on copyright transactions: Sale or Serivce?

In a story first broken by Kian Ganz, of Legally India, it appears that Reliance Big Entertainment Pvt. Ltd., one of the biggest production houses in the country, has challenged before the High Court of Delhi, the constitutionality of Section 65(105)(zzzzt), of the Finance Act, 2010 through which Parliament seeks to impose service tax on the transfer of copyright from one entity to another. We had carried a guest post by Ayan Roy Choudhary over here. The provision reads as follows:

Section 65: In this Chapter, unless the context otherwise requires, (105) – “Taxable service” means any service provided or to be provided, –
(zzzzt) : to any person, by any other person, for—
(a) transferring temporarily; or
(b) permitting the use or enjoyment of, any copyright defined in the Copyright Act, 1957, except the rights covered under sub-clause (a) of clause (1) of section 13 of the said Act.”

By excluding from the ambit of the above provision, works from sub-clause (a) of clause (1) of Section 13 of the Copyright Act, Parliament has assured that only cinematograph works & sound recordings are covered by the impugned provision. This provision is not yet operative and will be operationalized only from the 5th of August, 2010. The reason that Reliance Big, one of the largest production houses in the country, is challenging this provision now, is due to the fact that respective State Governments are already taxing such transactions under their ‘sales tax’/VAT legislations. By having to pay an additional service tax to the Central Government, Reliance Big, will in effect be paying two taxes of an identical nature to two different governments for the very same transaction. This problem is not unique to the licensing of copyrights. Apparently trademark owners are facing the same problem wherein trademark licensing agreements are being subject to both sales tax by the State Government and service tax by the Central Government. The state government views the licensing of a trademark as a sale since the rights in the trademark are transferred to another person. The central government views the licensing of a trademark as a service since the licensor is manufacturing the goods on behalf of the trademark owner thereby rendering to him a service.

Reliance Big’s main ground of challenge is that the transactions described in the impugned provision are in effect sales and not services and that Parliament lacks the legislative competence to levy a tax on such transactions since under List II of the Seventh Schedule to the Constitution only the State Governments have a right to tax ‘sales’. Parliament derives its power to levy ‘Service Tax’ under Entry 92C of List I of the Seventh Schedule to the Constitution. The Seventh Schedule to the Consitution, read with Article 246 of the Constitution, lays out the distribution of powers between the Central Government and the State Governments. List I is the Union List, List II is the State List and List III is the concurrent list.

The distinction between a ‘service’ and a ‘sale’ is a moot point in this case and the interpretation of this will depend essentially on Supreme Court precedents. If Reliance Big fails to convince the High Court that the transactions covered by the impugned provisions are in fact ‘sales’ then in that case it will be presumed that Parliament had the legislative competence to tax such transactions either under Entry 92 C of List I or alternatively, under Entry 97 of List I, which provides Parliament with residuary powers to tax all those transactions not covered by either List II or III. Therefore all that the Central Government is required to argue is that the transaction is not a sale regardless of whether it can be classified as a service.

In its petition Reliance Big has attempted to establish, on the basis of a plethora of Supreme Court precedents, as also Article 366(12), that for the purposes of taxation a copyright is considered to be “goods” thereby implying on the basis of the definition of ‘tax on the sale or purchase of goods’, under Article 366(29D) of the Constitution, that any transaction regarding a copyright is necessarily liable for ‘sales tax’ which as already explained can be levied by only States. As per Article 366 (29D), ‘tax on the sale or purchase of goods’ is defined as, amongst others, (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;’.

It would therefore appear that Reliance Big has an open and shut case. The reality however is not that simple. The impugned provision in question is quite candid in regards the fact that it does not apply to ‘sales’ but only to ‘temporary transfer’ (i.e. exclusive licensing) or ‘permitting the use or enjoyment’ (i.e. licensing). In relation to copyrights there are two instances in which a ‘sale’ occurs. The first one is when the copyright is ‘assigned’, as understood in Section 18 of the Copyright Act, 1957 i.e. when the title of ownership in the copyright is transferred to another party. This is pretty much equivalent to a ‘sale’. The second instance of a ‘sale’ in the context of a copyright is when the medium on which the copyright is fixed i.e. a negative print or a VCD or a DVD is tranasferred to another person. In this instance only the ‘medium’ i.e. the VCD or DVD is sold. The copyright in the work fixed on the medium continues to exist with the person who sold the medium.

In the case of a ‘license’ as understood in terms of Section 30 of the Copyright Act, 1957 or ‘exclusive licence’ as understood in the terms of Section 2(j) of the Copyright Act, 1957, the copyright is temporarily transferred for the purposes of enjoyment. Transfer of title in the copyright under an assignment deed which is a sale is not by itself taxed under the impugned provision. Parliament has therefore taken care to confine its taxation to only ‘licences’ and not ‘sales’, in which case Reliance’s challenge must necessarily fail. If this interpretation of mine is correct then it is not Parliament but the State Legislatures which have over-stepped their boundaries by enacting legislations to tax even copyright licensing agreements and not merely sales.

In any case, while concluding, I should inform you that tax law has regretably been a shaky area for me.

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