A recently pronounced Bombay HC judgement is the latest in a long line of cases dealing with the taxation of licences to use intangible property, with the preceding chapter being written by the same court in Tata Sons v. State of Maharashtra. Given the number of sharply conflicting decisions at the High Court level, it is safe to say that the legal questions at issue have been the subject of as much jurisprudence as juris-imprudence in the past. We’ve covered Tata Sons in a couple of guest posts, here and here. Elsewhere, Sai Deepak has written on Tata Sons.
Over the course of these posts, I deal with the evolution of the Indian tax regime’s treatment of IP licences. I lay the groundwork in this post, followed by a description of the most recent judgement (Monsanto v. Union of India). In a future post, I will attempt to bring my hatchet to bear on the ruling.
(Readers familiar with the tax jurisprudence involved may choose to skip the next few paragraphs)
The legal question
When abstracted to the broadest level, the question is simple: under what circumstances would the licensing of IP rights by their holder amount to a sale of goods, and under what circumstances would they amount to the rendering of a service?
The sale/service dichotomy is, to the best of my knowledge, a uniquely desi conundrum, begotten by the federal structure of our tax regime. Hopefully, with the implementation of the GST regime, mine will be the last bottle of ink to be needlessly shed in the quest to hammer the square peg of an IP licence into the round hole of the sale/service dichotomy.
For those of our readers unfamiliar with India’s current tax regime, here’s an overview:
The Constitution, through the Articles 246, 268A and the Seventh Schedule, codifies the distributed scheme of legislation and taxation that I referred to above. The Union List contains entry 92C, which provides for
“92C. Taxes on services.”
while the State List contains entry 54, which reads:
“54. Taxes on the sale or purchase of goods other than newspapers, subject to the provisions of Entry 92A of List I.”
The upshot of this scheme is that an IP transaction will generally be taxed by the Union if it is classed as the rendering of a service, and taxed by the States if it is classed as a sale of goods.
This has led to the development of a considerable body of jurisprudence, in which assessees have attempted to dodge either a central or a state levy on the ground that the nature of the transaction put it outside the scope of the imposing power’s constitutional authority.
Composite contracts: transfer v. permissive use
The legal position, after litigation and constitutional amendment, is as follows:
- Composite contracts which include elements of sale as well as service cannot be taxed twice over. (State of Madras v. Gannon Dunkerley) Sales tax (or VAT) and service tax are mutually exclusive levies.
- Transfers of the right to use goods (“TRUGs”) are deemed to be sales. (366(29A)) IP is goods.
- The mere permissive use of IP would not amount to a sale.
States have repeatedly asserted that IP licences amount to a TRUG, and have sought to deem them as sales on this ground. State of Andhra Pradesh v. Rashtriya Ispat Nigam Ltd. (2002), held that in order to constitute a TRUG and therefore incur sales tax liability, there had to be an exclusive transfer of effective control over the property. TRUG jurisprudence peaked with BSNL v. Union of India (2006), in which Lakshmanan, J. (sep. op.) laid down five criteria that had to be fulfilled for a transaction to qualify as a TRUG:
- There must be goods available for delivery;
- There must be a consensus ad idem as to the identity of the goods;
- The transferee should have a legal right to use the goods – consequently all legal consequences of such use including any permissions 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 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 licence 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.
Whether this line of precedent is applicable to IP licences remains an open question with the Madras and Kerala High Courts holding that it does, while the Bombay High Court seems to be in a minority of one in consistently holding that it does not.
Bombay HC shoots Monsanto’s IP licence with a double-barrelled tax gun
On August 11, a DB of Dharmadhikari and Patel, JJ. (Bombay HC) pronounced judgement in two connected matters, Mahyco Monsanto Biotech v. Union of India and Subway Systems v. State of Maharashtra. In both matters, parties to IP licensing transactions sought to argue that they were being doubly taxed, since the licences in question were being taxed as sales by Maharashtra and as services by the Union. The disposition went against Monsanto on the one hand, and in favour of Subway on the other.
Justice Patel has spoken for the bench, and it begins in characteristic style with some nifty wordplay on the “kernel (or seed, as it were)” of Monsanto’s case. The 66-page document also has the table of contents that we’ve come to expect from his lengthier judgements, significantly aiding readability.
The transaction at issue here was the sub-licensing of Bollgard technology by Monsanto to seed companies on a non-exclusive, non-transferable basis. Bollgard II technology is patented, and it must follow that the patent licence must form a part, if not the core, of the technology transfer. Monsanto provides 50 sample seeds, called donor seeds, which contain the Bacillus Thuringlensis (BT) gene to the licensee. Monsanto also provides a manual and trains licensees to enable them to produce industrial amounts of BT cotton seeds. In addition, Monsanto trains licensees to carry out tests to validate their breeding plans, and also assists the licensees in obtaining marketing approval for their seeds. Once all of this is done, the licensee sells BT cotton seeds to farmers. Monsanto receives a fixed fee in the beginning, as well as a recurring consideration from the licensees based on the number of packets of seeds sold by them.
Monsanto held the view that the transaction amounted to a temporary transfer or permissive use of intellectual property, attracting service tax liability under Section 66E of the Finance Act. With the advent of the VAT regime from FY2005, the Maharashtra taxman came a’knockin’, demanding that VAT be paid on all new or amended tech transfer agreements entered into by Monsanto since the transaction was a transfer of the right to use the technology, and therefore a deemed sale.
Monsanto’s core claim was that the transaction was a permissive use, rather than a TRUG. If the court bought this, then the revenue wouldn’t have a leg to stand on, since it’s settled law (BSNL v. UoI, Imagic v. CTO) that a single composite transaction cannot be taxed both as a sale and as a service, thus leading to the unassailable conclusion that one of the two levies had to be thrown away for good.
Monsanto built its case from basics, arguing that the word “transfer” entailed the acquisition of an object or right by one party, and its corresponding loss by the other. Building on the strength of the English language on its side, Monsanto invoked Rashtriya Ispat Nigam Ltd. to submit that the vesting of exclusive and effective control over the goods in the transferee was an essential condition for a TRUG to take place. Transactions in which the transferee did not obtain such control (eg. bailment) could not possibly be a TRUG. These would merely amount to permissive use of the goods by the transferee, and fall outside the ambit of VAT.
Monsanto then cited Justice Lakshmanan’s opinion in BSNL, and pleaded that the transaction could not possibly be a TRUG, given the absence of two out of five criteria laid down in that judgement as essential elements of a TRUG. These were respectively the requirement of exclusivity and the bar on concurrent transfers of the same right by the transferor.
Finally, Monsanto asked that two prior decisions of the Bombay HC, Commissioner of Sales Tax v. Duke and Sons and Tata Sons v. State of Maharashtra, be declared per incuriam. This was fairly plucky, given that it was Justice Dharmadhikari who wrote the Tata Sons opinion, relying to a great extent on the logic of the Duke court in his analysis. Monsanto took the plunge fully, even asking that Duke be declared per incuriam since there was no Supreme Court guidance on the interpretation of Art. 366(29A)(d) when it was decided, in 1998.
The court held that a transfer had indeed occurred in the transaction in question – the seeds embedded with Bollgard technology were transferred from Monsanto to the licensee. On effective and exclusive control, the court once again dismissed Monsanto’s argument on the ground that such control over the seeds transferred was, in fact, with the licensee and not with Monsanto. The court rejected Monsanto’s argument that the seeds were merely the media in which the technology was transferred, holding that there was no other method of effecting such a transfer.
In response to Monsanto’s reference to Malabar Gold v. Commissioner of Central Excise and Customs (which held that the BSNL test was applicable to IP transactions), the court expressed the opinion that Malabar Gold was incorrect, and that its own view in Tata Sons (that BSNL did not apply to IP) was correct. The court also endorsed its earlier ruling in Duke, holding that transfers of trademark rights did not have to satisfy the RINL effective control test in order to be deemed sales.
The crux of the holding raises its head at paragraph 42, when the court finally explains what, in its opinion, would distinguish a permissive use from a TRUG: time. Essentially, in the court’s view, any transaction that has an expiry date, at which point the licensee is divested of all rights to the goods and the licensor is re-vested with them, would qualify as a permissive use. If it’s impossible to wind back the clock, go back to the start, and neatly recreate the parties’ positions as they were before the license was entered into, then tough luck, kids, you’re going to have to pay VAT on the licence.
It is on this distinction that the bench is able to find against Monsanto and for Subway – the Monsanto contract did not require parties to return to their pre-licence states upon termination, while the Subway contract did. I find the rationale deeply problematic, and I’ll tell you all about it over the next post.