It’s taxing to deal with intellectual property

As we count down to Budget 2015, what is eagerly awaited is definitive clarity and guidance in respect of certain issues that have been vexing tax-payers. One such issue that has found its way into pre-budget memorandums for at least five years in a row, is the legal quagmire pertaining to the taxation of licensed intellectual property right

Vide the 46th amendment to the Constitution of India in 1982, Article 366 (29A) was introduced which inter alia extended the levy of VAT to transactions entailing “transfer of right to use goods for any purpose”. Since IPR is judicially recognised to be goods, grant of the right to use IPR for consideration came within the folds of VAT. Much later in 2004, the coverage of service tax was expanded to include both “temporary transfer” and “permitting use and enjoyment” of IPR, under the taxing entry for “Intellectual Property Services”. Since the legislative framework for levy of VAT and service tax failed to spell out parameters that would help demarcate the scope of one levy from the other, there arose a situation of overlap; this gave way to prolonged litigation and judicial interpretation.

In an attempt to address the conundrum, the legislature in 2012 sought to exclude transfers undertaken in accordance with Article 366(29A) from the scope of “service” as defined under Section 65B(44) of Chapter V of the Finance Act, 2014. However, no criteria were laid down to help determine transactions that would attract VAT and thus escape the rigours of service tax. Accordingly, by virtue of temporary transfer or permitting the use or enjoyment of IPR being included within the scope of service tax as declared services, the mayhem continues.

Judicial precedents have since attempted to decipher the intention of the legislature and lay down principles to determine coverage of each of the stated levies in the context of licensed IPRs. The Supreme Court in the landmark BSNL ruling observed that for a transaction to attract VAT, all rights and legal consequences including licences for use should transfer and to the exclusion of the transferor and consequently, post-transfer, the transferor cannot transfer the same right to others. This decision fortified the test of ‘exclusivity’. Further, in the case of Nutrine Confectionery, the Andhra Pradesh High Court ruled that grant of right to use IPR attracts VAT, irrespective of whether such grant is to the exclusion of the transferor, or whether the transfer is for perpetuity or a limited period in view of the use of the term “transfer...for any purpose”.

Recently, the Bombay High Court in the case of Tata Sons, upheld the levy of sales tax on transfer of right to use goods of intangible or incorporeal nature such as patents and trademarks. It is interesting to note that while the court has concurred with the decision of BSNL and various other judicial precedents, it has emphatically observed that the principles laid down in BSNL cannot be read in isolation. The court then went on to deviate from the exclusivity test enunciated in BSNL to state that levy of sales tax did not warrant an unconditional or exclusive transfer, much less to the exclusion to the transferor.

This view is directly at variance with the view adopted by the High Courts of (i) Allahabad in Seagram India; (ii) Delhi in Indus Towers; (iii) Kerala in Malabar Gold; and (iv) Madras in Vitan Departmental Stores, which unanimously endorsed and upheld the exclusivity test.

Therefore, any apprehension that the industry has in the context of this subject, will likely be resolved only with the rollout of the Goods and Services Tax (GST) as every transaction of supply (whether entailing transfer of the right to use or a mere licence to use) will be taxable. However, in terms of what is currently known, if the Legislature chooses to treat such transactions as goods, it will attract the additional non-creditable levy of 1 per cent. It is thus critical that the GST definitively addresses this issue.

The writers are with Economic Laws Practice. The views are personal