CA Prem T. Chhatpar

Prem ChhatparA. Introduction and background

It is well settled that “Goods” that are subject matter of tax under Entry 54 of the State List can be “Tangible goods” or even “Intangible goods” like Trademarks, Patents, Copyrights, Software (Canned /Off-the-shelf software), Technical Knowhow, etc. VAT is payable on their sale or even if there is a “transfer of right to use goods” falling in Article 366(29A)(d) of the Constitution which deems such transactions as “Sales”.

Normally, when a “transfer” takes place from the Transferor to the Transferee, property/ownership in the goods changes and vests in the hands of the Transferee. Similarly, when there is a grant of right to use accompanied by possession, during the term the goods are in the possession of the transferee, the Transferor is deprived of the benefit of user of the goods. However, as in the case of Tata Sons Ltd. – WP 2818 of 2012 decided on 20/1/2015, in case of intangible goods like Trademarks/Patents/Technical Knowhow, the question arises whether there is a “transfer” when the rights to the goods in question are “retained” as well as “transferred” to two or more persons and if so, whether sales Tax or Service Tax or both would be applicable.

B. Facts in the case of Tata Sons Ltd. – WP 2818 of 2012 decided on 20/1/2015

Tata Sons Ltd. had entered into an Agreement in 1998 in Mumbai (dispute in question pertained to 1998-99 to 2001-02) with various Tata Group companies titled “Tata Brand Equity and Business Promotion agreement” which envisaged Tata Sons Ltd. to undertake initiatives for protecting, enforcing and enhancing the image and goodwill of the TATA name and its brand equity. The agreement provided detailed guidelines for the use of the TATA name and the trademarks in the course of business by the subscribing companies. The exercise was aimed at pooling the resources of the subscribing companies and make a co-operative effort for the promotion of a unified TATA common brand. The subscribing companies were to ensure a common Code of Conduct in all their dealings with other group companies and third parties. As consideration for this, the subscribing companies had agreed to pay royalty to Tata Sons Ltd. which was subjected to tax by the Sales Tax Department and the levy was also confirmed by the Tribunal after distinguishing (rather summarily without assigning detailed reasons/ speaking order) other Tribunal decisions in the case of :

i. Smokin Joe’s Pizza P. Ltd. – App. 25 of 2004 decided on 25/11/2008

ii. Diageo India P. Ltd. – SA 1432 to 1438 of 2006 decided on 12/2/2009

iii. Deluxe Caterers P. Ltd. – SA 1589 to 1591 of 2006 decided on 9/2/2011

iv. Melrose Trading Corporation P. Ltd. – SA 503 to 505 of 2007 decided on 11/9/2011

In the above cases, the levy under the erstwhile Transfer of Right to Use goods Act was deleted on the basis of the concurring judgment given by Justice Dr. A. R. Lakshmanan in the case of BSNL (2006) 145 STC 91 (SC) in paras 97 and 98 which stipulate that:

“d. 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;

e. 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. “

Thus, apparently, going by these criteria, the right to use a particular “goods” cannot be the subject matter of transfer twice during the tenure of the earlier Agreement and it was assumed that after BSNL, the judgment in the case of Duke & Sons Ltd. 112 STC 370 (Bom.) was deemed to have been overruled.

D. Court’s Ruling and the grounds on which the same is required to be reconsidered

1. The Bombay High Court vide its ruling dated 20/1/2015 justified the levy (para 41) on the grounds that there was no denial of the fact that right to use was transferred – the only lament was that it was not exclusive but conditional as the transferor controlled the limited rights conferred in favour of the subscribers. However, the enactment and the definitions do not envisage exclusive and unconditional transfer of the above right as a pre-condition for levy of tax. Further, the benefit of Dr. Lakshmanan’s concurring judgment in BSNL was denied by stating that in BSNL, the SC was called upon to decide whether the services rendered by BSNL could be brought within the purview of Entry 54 of List II(Tax on sale or purchase of goods). The nature of the transaction by which Mobile phone connections are enjoyed is a service and the Central Government alone can levy service tax under Entry 97 of List I or Entry 92C of List I after 2003. Thus, the SC was concerned with what are “goods” in telecommunication services, was there any transfer of right to use goods by providing access or telephone connection by the Telephone Service provider to a subscriber, which is the nature of the transaction involved in providing Telephone communication. Such a controversy was not there in this case before the Court.

2.  With due respect, it is submitted that, the BHC has erred in proceeding on the assumption that the petitioners agreed that there was a “transfer” of right to use but that as the transfer was “not exclusive but conditional”, lease tax would not be applicable.

In a case of this nature, the first question that is to be decided is

a. whether there was a “transfer” in the first place in the true sense as understood in sales tax laws OR

b. whether it is a case of granting access, granting benefit of user amounting to mere grant of licence without transfer. In fact, in BSNL itself, the SC was pleased to overrule the levy of sales tax in State of UP v. UOI 130 STC 1 on the ground that it was a case of grant of access to telephone network without the transfer of right to use the network ie. Electro-magnetic waves.

3. The Court observed that, unlike Tangible goods, the right to use trademark could be transferred simultaneously to any number of persons as was held in Duke & Sons Ltd. 112 STC 370 (Bom.) and so a different and relaxed rule would apply to Intangible goods. In this context, it would be pertinent to note the observations of the Constitution Bench in Sunrise Associates 145 STC 576 (SC) which overruled H. Anraj 61 STC 165 (SC) wherein quoting Hudson’s Commercial Law, the SC concurred that “Property’ – In commercial law this may carry its ordinary meaning of the subject-matter of ownership. But elsewhere, as in the sale of goods it may be used as a synonym for ownership and lesser rights in goods“. Hence, when used in the definition of ‘goods’ in the different sales tax statutes, the word ‘property’ means the subject matter of ownership. The same word in the context of a ‘sale’ means the transfer of the ownership in goods.

Hence, transfer of ownership or transfer of lesser rights in goods e.g. Right to use the goods is a precondition for falling within the ambit of Sales tax laws.

4. Further, in BSNL, the SC contrasted the positions in Rashtriya Ispat Nigam Ltd and Agrawal Brothers to bring out the difference between a. mere user of goods and b. user accompanied with a right to use and the dividing line was that in RINL there was no intention to transfer the right to use, while in Agrawal Brothers, effective control of the Equipment was transferred and the transferee was at liberty to use it the way it wanted, no strings attached.

Providing access or telephone connection does not put the subscriber in possession of the electromagnetic waves any more than a toll collector puts a road or bridge into the possession of the toll payer by lifting a toll gate. Of course the toll payer will use the road or bridge in one sense. But the distinction with a sale of goods is that the user would be of the thing or goods delivered. The delivery may not be simultaneous with the transfer of the right to use. But the goods must be in existence and deliverable when the right is sought to be transferred. Therefore whether goods are incorporeal or corporeal, tangible or intangible, they must be deliverable. To the extent that the decision in State of U.P. Vs. Union of India held otherwise, it was, in held to be erroneous.

5. It is thus clear that there should be divestment of rights by one in favour of the other atleast during the tenor of the agreement so as to be within the ambit of the Lease Act/Article 366(29A)(d) and that one uniform rule was applicable to both tangible and intangible goods. The taxable event is the “transfer of right to use goods” and not mere user unaccompanied by right to use the goods or conditional transfer in a manner that deprives /denies the transferee the rights as owner that is to say “possession and effective control over the goods”, a test formulated in Rastriya Ispat Nigam Ltd. (2003) 3 SCC 214. In fact, Article 366(29A)(d) deals solely with “right to use”, which is inherently intangible in nature. Although there may be points of distinction between right to use tangible and intangible goods as to the point of time when and the place (situs)where they can be said to have been transferred as was laid down at length in 20th Century Finance Corporation Ltd. v. State of Maharashtra 119 STC 182 (S.C.), for the transaction to be within the ambit of Lease Act/VAT, a transfer of right to use involving transfer of right of possession and effective control is a must, a test which has been accepted by CBEC vide its M.F.( D.R.) letter F. No. 334/1/2008 dt. 29.02.2008 albeit in the context of Tangible goods.

5. The Bombay High court in the case of Commissioner of Sales Tax, Maharashtra State, Bombay v. Rolta Computer & Industries Private Ltd. {(2009) 25 VST 322} and recently again in General Cranes decided on 21/4/2015 has also followed the principles laid down in para 97 of BSNL’s judgment but this fact has not been brought to the notice of the Court. The Commissioner in the DDQ of Wings Travels DDQ – 11 -2008 / Adm 3/29/B-1 dt 11/4/2011 has also relied on these tests laid down in d. and e. in para 97 of BSNL and there is no reason for not applying the same principles to intangible goods when the taxable event is common – “transfer of right to use”.

6. The clarificatory observations in para 97 of BSNL are based on the enacting history which according to the Fourth Edition of Francis Bennion Statutory Interpretation is “the surrounding corpus of public knowledge relative to its introduction into Parliament as a Bill, subsequent progress through and ultimate passing by, Parliament. In particular it is the extrinsic material assumed to be within the contemplation of Parliament when it passed the Act. A text constituting an item of its enacting history may or may not be expressly mentioned in the Act. If inspected, it is unlikely to be self-explanatory. On the contrary it will probably require skilled evaluation.

The Statement of Objects and Reasons appended to the Constitution (Forty-sixth Amendment) Bill 1981 is part of enacting history and explains the situations to which Article 366(29A)(d) was intended to apply and would merit greater weightage and importance than the Objects and Reasons behind the enactment of the Transfer of Right to Use goods Act by Maharashtra.

The observations in para 97 clarify and supplement in a generic manner that the principles enunciated in BSNL in the context of Telephone services merit universal application in deciding whether in the first place, there is a “TRANSFER” of right to use goods regardless of whether the goods in question are tangible or intangible OR mere access to the goods or the functional benefit of the goods is granted without concomitant transfer of right to use the goods.

E. Stronger Case for non applicability of the levy to Franchise agreements

1. Franchise taxable, if at all wef. 1/4/2005 and not prior thereto

The Franchise entry was inserted for the first time wef. 1/4/2005 in Schedule C to the MVAT Act and reads as under:

“Franchise, that is to say, an agreement by which the Franchise is granted representational right to sell or manufacture goods or provide service or undertake any process identified or associated with the Franchisor, whether or not a trademark, service mark, trade name or logo or any symbol, as the case may be, is involved.

It may be pointed out that Tata Sons Ltd. case related to the period, 1998-99 to 2001-02 while Franchise Agreements became the subject matter of taxation (if at all taxable under VAT laws) only with effect from 1/4/2005 when “Franchise” as an item of taxable goods in Schedule C was consciously inserted in the Maharashtra Value Added Tax, 2002 despite full knowledge that Franchise services had become taxable services with effect from 1/7/2003. Only intangible goods mentioned in Schedule C are liable to tax whereas other intangible goods not covered in Schedule C fall in Schedule A i.e. Tax Free or exempted goods.

2. Essential characteristics of a Franchise agreement are materially different

On a reading of the above Entry itself, it is clear that a franchise is a license issued to someone to operate a business using a common Trade Description / Trade name, a common operating support system and involving the payment of consideration/initial fees.

Thus, by definition, a Franchise is merely a business model which creates an ongoing relationship between the franchisee and the franchisor – the franchisee will pay a franchise fee, and in return for this fee, the franchisee will receive a wide variety of ongoing types of services/help from the franchisor company and general assistance as far as manufacturing methods, training brochures, advertising, marketing and so on. The company which runs the franchise will grant the franchisee the use of the popular Corporate name / Trade name which is distinct from grant of Trademark.

On a bare reading of the Franchise entry, at best, it speaks of possible “involvement” of trademark and not “transfer of right to use” trademark. There may be a Franchise agreement wherein only the tradename of the Franchisor is permitted to be used say in a chain store but the goods sold in the chain store may not be under the trademark of the Franchisor but of the respective manufacturers of the goods.

Normally, as per the Franchise agreement, no right to use any trademark is “transferred” to the franchisee – Only the franchisee is permitted to use the Trade description, which is defined separately in Section 2(za) of the Trademarks Act, 1999 and includes “name and address or other indication of the identity of the manufacturer or of the person providing the services or of the person for whom the goods are manufactured or services are provided” while “Trademark” is defined as:

(zb) ” trade mark” means a mark capable of being represented graphically and which is capable of distinguishing the goods or services of one person from those of others and may include shape of goods, their packaging and combination of colours; and-

(i) in relation to Chapter XII (other than section 107), a registered trade mark or a mark used in relation to goods or services for the purpose of indicating or so as to indicate a connection in the course of trade between the goods or services, as the case may be, and some person having the right as proprietor to use the mark; and

(ii) in relation to other provisions of this Act, a mark used or proposed to be used in relation to goods or services for the purpose of indicating or so to indicate a connection in the course of trade between the goods or services, as the case may be, and some person having the right, either as proprietor or by way of permitted user, to use the mark whether with or without any indication of the identity of that person, and includes a certification trade mark or collective mark;

In case of Franchise, the Franchisor is in a position to duplicate/replicate the business model at different geographical locations and expand its horizons at a lower cost due to cost sharing, which exactly was the avowed objective of the Agreement in the case of Tata Sons Ltd. – the right to use “TATA” trademarks, logos, etc. always existed with the respective companies.

While, grant of a right to use trademark always entails application of the mark to the goods or the services for the purpose of showing the nexus between the goods/service and its Seller/Service provider. The Franchise fees are thus received for entering into a typical Franchise relationship which is akin to a Principal – Agent/Distributor relationship but with a greater degree of control over the Agent/Distributor and not for the transfer of right to use any goods from the Franchisor to the Franchisee although the benefit of user may be there. The subject matter is not the goods though goods may be “involved” in the transaction and a mere right to represent under the Tradename of the Franchisor does not constitute “goods” nor does the user of the trademark constitute “Transfer of right to use” within the meaning of Article 366(29A) as held by the Keral HC in the case of Malabar Gold WA No. 2213 of 2012 decided on 24/6/2013. So the important question to be decided is whether there was a transfer of right to use “Trademarks” or whether there was right granted to the subscribing companies to use the “TATA” trade description as part of their corporate name without the involvement of “Trademark” as defined above?

3. Tata Sons judgment not applicable to Franchisee agreements

The judgment does not apply to “Franchise agreements”, at least for the moment. In fact, in para 25 of the judgment, the Departmental representative has himself rested his case on the ground the Tribunal may not have given detailed reasons for distinguishing the facts in Tata Sons Ltd. case from those prevailing in Smokin Joe’s Pizza P. Ltd. – App. 25 of 2004 decided on 25/11/2008 and Diageo India P. Ltd. – SA 1432 to 1438 of 2006 decided on 12/2/2009 but the “foundation on which it has proceeded is sound in law. So long as the Tribunal has not ignored the agreement or the stipulations and clauses therein, the provisions of the Act, its order cannot be termed as perverse.

In para 58, the Court has expressly refrained from making any observations about the correctness or otherwise of the other decisions of the Tribunal which are pending before the High Court in separate proceedings by way of reference. Thus, by doing so, even the Court has not given the factual reasons for distinguishing the decisions of the Tribunal in Smokin Joe and Diageo. Since the Tribunal is considered to be the highest fact finding body, the shortcoming of not providing detailed reasons for distinguishing on facts would have been better addressed by remanding the matter to the Tribunal to bring on record what are the facts which distinguish Tata Sons case from the other decisions passed with a direction to pass a speaking order as far as facts are concerned.

4. Rights to the trademarks already held by subscribing companies – Question of “Transfer” does not arise

Further, even before the entering of the “Tata Brand Equity and Business Promotion agreement,” various Tata entities were already using the TATA name as part of their company name. Tata Steel Ltd. was incorporated in 1907 and did have “TATA” as part of its name. Tata Sons Ltd. itself was incorporated 10 years later in 1917 and the question of transferring the right to use “TATA” as part of its corporate name in 1999 via this Agreement does not arise. As recited in the Agreement, the exercise was to pool the resources of the subscribing companies and make a co-operative effort for the promotion of a unified TATA common brand and save costs and not for acquiring rights/Property afresh to use the trademarks for the first time from Tata Sons Ltd. under the Agreement.

In all probability, all the subscribing companies to the said Agreement may have already been using the TATA name as a trademark or as part of their corporate name as a matter of right and the rights were not acquired by them for the first time pursuant to the Agreement in question in 1998. If the transfer of right to use the TATA as corporate name was already given to the subscribing companies even before the commencement of the “Transfer of Right to use goods Act, 1985”, then as per the Bombay High Court judgment in the case of Vimal Leasing, no tax would be payable as the taxable event of “transfer of right to use goods” took place before the commencement of the Act and the fact that some consideration (assuming that it was consideration) was charged pursuant to the “Tata Brand Equity and Business Promotion agreement executed in 1999 would be immaterial.

Vimal Leasing which has been accepted by the Commissioner while passing the DDQ upon remand by the High Court. Similarly, direct reference was withdrawn in the case of Western India Glass Works Ltd. – SA 1338/1339 of 1994 dt. 4.9.1999.

5. Trademarks are valuable property even if unregistered

One needs to take into account the historical background of the Trademarks Act, 1999 which has been discussed in CIT v. Finlay Mills Limited [1951] 20 ITR 475 (SC). Even before its enactment in 1999, it was well recognised that an action lay for infringement of a trade mark independently of an action for passing off goods. The Act opens with the preamble ” whereas it is expedient to provide for the registration and more effective protection of trade ………… “

With the enactment, by virtue of registration of trademark, the owner is absolved from the obligation to prove his ownership of the trade mark. It is treated as prima facie proved on production of the registration certificate. It thus merely saves him the trouble of leading evidence, in the event of a suit, in a court of law, to prove his title to the trade mark. It has been said that registration is in the nature of collateral security furnishing the trader with a cheaper and more direct remedy against infringers. Cancel the registration and he has still his right enforceable at common law to restrain the piracy of his trade mark.

Although, in determination order dated 31-8-1990 passed by the Commissioner in the case of M/s. Hasmukhrai and Co. which was subsequently followed by this Tribunal in a number of cases such as M/s. Bhave Supari (Second Appeal Nos. 696 and 697 of 2000 decided on 4-12-2004), the word ‘trademark’ or ‘brand name’ has to be interpreted to be ‘registered trademark’ or ‘registered ‘brand name’ only, it was in the context of disallowance of Resales claims in the hands of the holders of Trademark so as to tax the value addition.

F. Franchise – whether liable to VAT or Service tax or both?

Franchise is defined in identical terms in Section 65(105)(zze) of the Finance Act, 1994 wef. 1/7/2003 relating to levy of service tax and so the question whether sales tax and/or service tax is payable is required to be decided. Whether grant of representation right is “Goods” is also a moot but vital question that has not been decided. This issue of dual levy was also not raised in Tata Sons Ltd. and the petitioner’s sole reliance apparently was on the concurring judgment of Dr. Lakshmanan in the case of BSNL cited supra and the issue whether grant of representational rights/Franchise was taxable during 1998-99 to 2001-02 was not raised or decided. Hence, even the Service Tax Department ought to have been impleaded as respondent in the proceedings so as to decide whether VAT or Service tax is applicable.

In Malabar Gold WA No. 2213 of 2012 decided on 24/6/2013, the Kerala High Court in an appeal against the order of Single Judge, has held that such agreements which entail multiple grant of licence to use trademarks coupled with rendering of services would be “Franchise” and would not be taxable under VAT laws but only under Service tax. This judgment was also neither cited nor taken note off although earlier Kerala High Court judgments that were in fact, overruled by this judgment, were considered.

Further, with effect from 1/7/2012, a paradigm shift in the taxation of services in India was brought about by way of introduction of the Negative List regime. Under the Negative List regime, the definition of ‘service’ under section 65B(44) of the Act specifically excludes transfer, delivery or supply of any goods which is deemed to be a sale within the meaning of clause (29A) of Article 366 of the Constitution.

Further, as per section 66E(e) of the Act, Transfer of goods by way of hiring, leasing, licensing or in any such manner without transfer of right to use such goods has been defined as a ‘declared service’.

Hence, any decision on whether VAT or service tax is applicable would not be complete without first deciding whether there is a transfer of right to use goods or not. To start with the presumption that there is a transfer of right to use Trademarks would be a fallacious approach.

G. Inter se adjustment of tax dues by Centre and States

Although there are many instances of “Aspect theory” being applied to justify dual levy of tax, in a case where the transaction is squarely covered by Article 366(29A)(d) over which the State Government has the jurisdiction, that “aspect” is to be left untouched by the Centre – there has to be another aspect in the first place to justify the levy of service tax on that part of the transaction as does not fall in “Sale price.” With the definition of “Franchise” being identical under MVAT Schedule and the Service tax laws, there cannot be two aspects /meanings of the same transaction – either VAT or Service tax would be payable and not both.

In Essar Telecom Infrastructure (P.) Ltd. V. UOI – WP No. – 2459-2482 OF 2011 (T RES) dated April 7, 2011, the Karnataka High Court held that Renting of Mobile towers were liable to VAT and the State Government was directed to seek refund of service tax wrongly paid by the petitioner, from the Central Government to discharge Sales tax liability of the petitioner.

The SLP of Tata Sons in the SC should also be referred to a Bench larger than in BSNL (3 Judge) say 5 Judge Constitution Bench so as to decide whether the observations in Dr. Lakshmanan’s concurring judgment in BSNL (3 Judge Bench) could be applied universally to both transfer of right to use of tangible and intangible goods.

H. Synopsis

Although the Trade Circular 11T of 2015 dt. 13/7/2015 has claimed that all controversies have been put to rest with the passing of the judgment in the case of Tata Sons Ltd., the issue is far from settled. It is submitted that the true nature of the Agreement was not looked into –

a. whether there was a transfer of right to use goods in the first place,

b. whether possession and effective control, which are symbols/ingredients of ownership of property,

c. whether the Agreement was in the nature of “Franchise” entailing mere grant of representational rights to the Tata group companies, which, if at all taxable under VAT laws, became taxable only with effect from 1/4/2005 and not during the periods in question, 1998-99 to 2001-02.

d. whether the taxable event of “transfer of right to use” had taken place after the introduction of Article 366(29A)(d) / enactment of the Lease Act especially when all the subscribing companies were already using the “TATA” logo, trademark as a matter of right even prior to the entering of the impugned agreement. The subscribing Tata group companies were already owners of the property – trademark – with right to sue against any attempt to pass off or infringement of Trademarks according to the historical background of Trademarks Act as highlighted in CIT v. Finlay Mills Limited [1951] 20 ITR 475 (SC) and no fresh property/right to use trademarks, logos was acquired pursuant to the ” Tata Brand Equity and Business Promotion agreement” from Tata Sons Ltd. Merely resources were pooled by the subscribing companies to make a co-operative /collective effort for the promotion /enhancement of a unified TATA common brand image and goodwill at reduced costs. Such pooling of resources in the hands of a single entity cannot be said to be “Consideration” for the transfer but only a cost-sharing, cost-reduction exercise only.

Whether the judgment is able to withstand judicial scrutiny in the Supreme Court, only time will tell. However, for the moment, the Department cannot claim that the judgment would be equally applicable to Franchise agreements until Smokin Joe and Diageo’s cases are decided. In a Franchise agreement, as part of the bundle of services, the Franchisee is allowed the benefit of user of the Trade description/Trade name of the Franchisor (representation right) without contemplating the transfer of right to use the Trademarks or Trade name, which is the taxable event. Hence, Franchise is a taxable service that does not involve a transfer of right to use goods.

 (Author can be reached at premchhatpar@gmail.com)

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