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Royalty and Taxability Under Vat Laws

Written by: Sanjeev Malhotra - F.C.A, F.C.S, A.I.C.W.A.
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Intellectual Property Rights (IPR) and Incorporeal goods is the most talked of subject as on date. Law on various aspects on this subject is still in the making. Over the period, the definition of “GOODS” has undergone a sea change. The development of economies have resulted in shifting the focus from tangibles to intangible goods. In an attempt to shore up revenue, Governments also keep trying to find out new items which could be taxed under their revenue laws. Liberalisation and globalization of Indian economy has brought in new methods and arrangements in Commercial Enterprises in India. In order to expand their reach, MNC’s have entered into various kinds of tie ups with domestic companies. In this manner, domestic companies reap the benefit of strong technical knowledge base, brand value, customer base of these multi national companies.

In return MNC’s charge royality from these domestic companies. Intangible or Incorporeal goods are taxable is not a new knowledge. The taxability of transfer of Right to use goods has also been included in VAT laws of all the states. In this background, an attempt has been made in the following article to analyse the nature of Royality payments and its taxability under VAT laws. Intellectual Property Services other than Copyrights and also Franchise services are taxable for service tax under the provisions of Finance Act, 1994.

Is right to use trademarks or IPR’s a matter of taxation under VAT laws or Service tax?

Patents and Trademarks as GOODS

In the landmark judgment of Vikas Sales Corporation v. Commissioner of Commercial Taxes (1996) 102 STC 106 (SC), the Supreme Court observed that
“Even incorporeal rights like trademarks, copyrights, patents and rights in personam capable of transfer or transmission, such as debts, are also included in its ambit." The Court, in the later part of the said judgment, again observed as follows:
"Similarly, patents, copyrights and other rights in rent which are not rights over land are also included within the meaning of movable property."

In another landmark judgment of Tata Consultancy Services Vs State of Andhra Pradesh (2004) 24 PHT 581 (SC)(FB), the Supreme Court observed that the test to determine whether a property is “goods” for the purpose of sales tax, is not whether the property is tangible or intangible or incorporeal – the test is whether the concerned item is capable of abstraction, consumption and use and whether it can be transmitted, transferred, delivered, stored, possessed etc.

Right to use

Pursuant to the 46th amendment in constitution, almost all the states amended the definition of sales in their respective sales tax laws to include therein, “ the tax on transfer of right to use any goods for any purpose (whether or not for a specified period) for cash, deferred payment or other valuable consideration. Thus any item, the sale of which is taxable under the sales tax laws of the state, in case given on lease for any period, the rent received for such would also be taxable under the sales tax law of the state.

Intellectual Property Right

The term “ Intellectual Property Right” IPR has been defined in Finance Act, 1994 as “ means any right to intangible property, namely, trade marks, designs, patents or any other similar intangible property, under any law for the time being in force, but does not include copyright”.

“ Intellectual Property Right” service means:
(a) transferring temporarily or
(b) permitting the use or enjoyment of any intellectual property right.

Vide clarification no. 80/10/2004 dated 17.09.2004, department has clarified that intellectual property emerges from application of intellect, which may be in the form of an invention, design, product, process, technology, book, goodwill etc.

In another clarification department had clarified that “ A permanent transfer of intellectual property right does not amount to providing of service. On such transfer, the person selling these rights no longer remains a holder of intellectual property right so as to come under the purview of taxable service. After this clarification, the amendment was made in taxable clause to provide for this effect.

Thus the department of excise recognize that IPR can be sold as movable goods. Then how can the transfer of right to use these IPR’s temporarily be made a subject of service tax under Finance Act, 1994 and not under State Vat Acts.

Franchise Service

Franchise Service is also subject to service tax under Finance Act, 1994. It has been defined as “ Franchise” means an agreement by which the franchisee is granted representational right to sell or manufacture goods or to provide service or undertake any process identified with franchisor, whether or not a trade mark, service mark, trade name or logo or any such symbol, as the case may be, is involved. This service also recognize the RIGHTS which are transferred by Franchisor to Franchisee for a period.

Status of Service providers under VAT

Service providers were not subjected to sales tax under Sales tax laws. But VAT laws brought them under tax net by amending the definition of business in their respective laws.

Delhi VAT Act, 2004 defines Business as “ Business” includes
(i) the provision of all services, but excluding services provided by an employee.
(ii) To (v) …
Haryana VAT Act, 2003 has added following explanation to the definition of “ Business”

“ Trade” includes trade of goods and services.

With the above changes the scope of VAT laws has widened as service providers now are also covered by it.

Taxability of Royality on use of Trade Mark

In the case of S.P.S. Jayam and Co. vs Registrar, Tamil Nadu Taxation Special Tribunal and others (2004) 137 STC 117(MAD), the High Court held that the Royalty received as consideration of use of trade mark is consideration of transfer of right to use a movable asset and upheld its taxation under the sales tax laws. The court observed that “ For transferring the right to use the trademark, it is not necessary to hand over the trademark to the transferee or give control or possession of trademark to him.” The court further observed that “Simply because the assessee retained the right for himself to use the trademark and reserved the right to grant permission to others to use the trademark, it would not take away the character of the transaction as one of transfer of a right to use.”
In the case of Delhi Public School Society Vs Commissioner of Service Tax (2006)(4) STR 460 (Tri – Del), the matter of DPS Society charging from the DPS schools run under franchisee arrangement came up before Tribunal. In this case revenue is trying to impose service tax on DPS Society under the chapter of Franchise services.

Applicability of VAT or Service Tax

Considering the widening of coverage of VAT laws by inclusion of service providers and also application of the ratio of SPS Jayam and Co. case, the VAT becomes applicable on all the services supposed to be covered by two different chapters of Finance Act, 1994. All the payments of royalty also become a case of close scrutiny to determine their chargeability under VAT laws.

The author can be reached at: sanjeevmalhotra@legalserviceindia.com / Print This Article

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