FEBRUARY 18, 2014

By Manindar Kakarla, CA

INTELLECTUAL property emerges from application of intellect, which may be in the form of an invention, design, product, process, technology, book, goodwill etc. In India, legislations are made in respect of certain Intellectual Property Rights (i.e. IPRs) such as patents, copyrights, trademarks and designs. Temporary transfers or permitting the use of all these intellectual property rights are subject to service tax. Initially all types of intellectual property rights, other than copyrights, were subjected to service tax.

Taxability position under Finance Act, 1994:

With effect from 01.07.2010, levy is introduced on temporary transfer or permitting the use of copyright. The scope of levy includes cinematographic films and sound recordings while original literary, dramatic, musical and artistic works are specifically excluded.

Under the negative list regime, temporary transfer or permitting the use of all these intellectual property rights is specifically included under declared services. Entry no 15 of Notification No. 25/2012-ST dated 20.06.2012 exempts temporary transfer or permitting the use of a cinematographic films also in addition to original literary, dramatic, musical and artistic works. However, with effect from 01.04.2013, exemption relating to copyright of cinematograph films is restricted to those rights related to exhibition in cinema hall or theatre. Temporary transfer or permitting the use of copyright in other areas like satellite or television rights, dubbing/remake rights etc. are subject to service tax from 01.4.2013 onwards.

Whether Intellectual Property is goods ?:

Article 366 (12) of the Constitution defines 'goods' to include all materials, commodities and articles. In the case of Tata Consultancy Services vs. State of Andhra Pradesh - 2004-TIOL-87-SC-CT-LB the larger bench of the Supreme Court has held that the expression 'all materials, commodities and articles' is very wide and would include both tangible and intangible property. Further, the apex court also held that properties which are capable of being abstracted, consumed and used and/or transmitted, transferred, delivered, stored or possessed etc. are 'goods' for the purposes of VAT/Sales tax.

Intellectual Property which emerges out of intellect is intangible in nature. In the case of Associated Cement Companies Ltd vs. Commissioner of Customs - 2002-TIOL-08-SC-CUS it was held that intellectual property would acquire the character of goods the moment they are kept on media like paper, diskette or anything.

Thus sale of music/video CDs, DVDs, Books are nothing but sale of goods as they being intellectual property kept on media attracting VAT/Sales Tax. But often, intangibles are not transferred outright like any tangible goods. Many a times, some restrictions are placed at the point of transfer of these items which may include restrictions relating to use for particular purpose, not to transfer, reproduce etc.

In the example of sale of music CD, DVDs, books, one acquires a limited right to use and enjoy the material content. The buyer cannot acquire all such rights to do what the owner is generally expected to undertake like right to reproduce and sell more copies, right to change the underlying work, right to license its use to other and the right to transfer copyright itself.

Then why are they considered as sale of goods? Apart from these, transactions which involve license to use goods are considered to be deemed sales for the purpose of levy of VAT/Sales Tax in terms of Article 366 (29A) of the Indian Constitution. No Service tax is applicable on these transactions. Then what constitutes temporary transfer or permission to use in order to attract service tax? We will try to find some justifiable answers for all these issues in the subsequent paras in the light of two recent judgments of Kerala High Court and Madras High Court.

Temporary Transfer or Permitting the use vis-a-vis Transfer of Right to Use:

Certain transactions which are not sales as per normal understanding of the term 'sale' are specifically included within the meaning of 'Sale' as defined in Article 366 (29A) of the Indian Constitution so as to empower the State Governments to levy VAT/Sales Tax. These transactions are called deemed sales. One of these is the transfer of right to use goods. The scope of 'Right to Use' was subjected to judicial examination in the recent past. The essential principles laid out in several landmark judgments are as follows;

i. In the case of Rashtriya Ispat Nigam Ltd vs. CTO - (1990) 77 STC 182 (AP), wherein the Appellant had hired construction machinery to their contractor allowing their usage only in contracts executed for them.It was held that the agreement has to be read as a whole to determine the nature of transaction. The contract did not create exclusivity of use, and the contractor was entitled to use the machinery only for executing the work entrusted. In order to constitute a transaction as transfer of right to use, effective control over the goods is required to be transferred which is absent in the instant as the contractor is not allowed to use machinery in other contracts during the period of lease. Therefore it was held that the lease of machinery does not constitute transfer of right to use.

ii. The Supreme Court in the case of BSNL VS. UOI - 2006-TIOL-15-SC-CT-LB has opined that to constitute a transaction for the transfer of the right to use the goods, the transaction must have the following attributes:

a. There must be goods available for delivery;

b. There must be a consensus ad idem as to the identity of the goods;

c. The transferee should have a legal right to use the goods-consequently all legal consequences of such use including any permissions or licenses required therefor should be available to the transferee;

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

iii. In order to constitute right to use, it is not always a case where the control and possession gets transferred to lessee from lessor. In the case of GS Lamba & Sons vs. State of Andhra Pradesh - 2012-TIOL-49-HC-AP-CT, held that it is well established that in a transaction of right to use goods, delivery of goods is not a condition precedent but delivery of the goods may be one of the elements of a transaction. It was also observed that "in the case of Article 366 (29A)(d), the goods are not required to be left with the transferee. All that is required is that there is a transfer of the right to use goods. The transfer of right is the sine qua non for the right to use any goods, and such transfer takes place when the contract is executed under which the right is vested in the lessee. Further clarified that effective control does not mean always physical control and even if the manner, method, modalities and the time of the use of goods is decided by the lessee , it would be said that goods are under the effective control of the lessee.

Based on the above landmark judgments, the essential characteristics that should be present in order to constitute a transaction as a transfer of right to use are that (i) there should be a transfer of legal right to use goods which has to be to the exclusion of all persons including the transferor and during the period of such transfer, the transferor cannot again transfer the same rights to others. (ii) Such exclusive transfer of right to use the goods is by way of effective control over the transferred goods which need not always be through physical transfer. Such effective control over the goods is said to have happened even if the manner, method, modalities and the time of the use of goods is decided by the lessee.

So, a transaction wherein exclusive right to use goods is not transferred during the contract period, then it is only a case of temporary transfer or permitting the use of goods. Such transactions attract service tax and are outside the scope of VAT/Sales tax. These are the broad principles laid out for determining whether a transaction amounts to 'transfer of right to use goods' or not.

Recently, the issue - whether granting of license to use trademark under a franchisee agreement while retaining the right to grant similar license to others constitute transfer of right to use so as to attract VAT had originally come up for consideration before single member bench of Kerala High Court in the case of Malabar Gold Pvt. Ltd vs. CTO - 2012-TIOL-1032-HC-KERALA-VAT. In the said case, the appellant received royalty for sharing business know how as well as for granting license to use trademark. The principle laid down in the BSNL case (Supra) has been disregarded stating that the same is not applicable to intangibles and held that the transaction amounts to transfer of right to use and attracts VAT.

Subsequently, the larger bench of Kerala High Court in the case of Malabar Gold Pvt. Ltd vs. CTO - 2013-TIOL-512-HC-KERALA-ST has considered the principle laid down by BSNL case (supra) in order to decide whether license to use trademark constitutes transfer of right to use or not. On perusal of the franchise agreement, license to carryout trade under trade name 'Malabar Gold' is granted to the franchisee apart from business support. The franchisee is exclusively required to sell the goods of Appellant Franchisor only. Appellant has retained the right to grant franchise & license to use trademark to other persons for carrying out business at other locations. The franchisee right to use trade mark is limited to the period of franchise agreement.

The larger bench of the High Court after considering the dictum laid in the earlier case by single member bench has held that on an analysis of the franchise agreement, it is seen that only a license to use trade mark is granted and such license is not to the exclusion of transferor as the company retains the right to transfer to others also.

Coming to copyrights of Cinematographic films, the producer of the film make commercial exploitation of these rights in many ways including but not limited to theatre rights (both distribution & exhibition), Satellite & Television rights, DVD rights, dubbing and remake rights. Further, these rights will be granted to various people simultaneously for exploitation in different regions. In such a backdrop, issues arise as to whether a transaction constitutes transfer of right to use or not and attracts VAT or Service tax, as the case may be.

The Madras High Court in the case of AGS Entertainment Pvt. Ltd & others vs Union of India - 2013-TIOL-521-HC-MAD-ST has considered the issue of Constitutional validity on levy of Service tax on transfer of copyrights. The Appellants being film producers and distributors contended that Central Government is not competent to levy service tax on copyrights of cinematographic films as the power to levy is conferred with State Government on all copyright licenses in lieu of Article 366(29)(d).

The Madras High Court has examined the transactions and it was held that in case of leasing of copyrights to distributor, the distributor do not get absolute right over the cinematographic films as the producer still retains the distribution rights over other areas, satellite, television rights etc. Thus the Madras High Court has held that entire copyright should be transferred to the other person in order to treat it as permanent transfer or the entire copyright should be leased out for certain period in order to constitute the transfer as right to use to attract VAT. "Transfer/lease of entire copyright" in the present context means transfer/lease of right to exploit all the possible modes of commercial exploitation without reserving all or any of the modes.

It is very clear from the above that even in a case where there is an outright assignment of copyright pertaining to a particular mode of commercial exploitation; it is not a case of transfer of right to use or permanent transfer of copyright.

The above is the broad principle that can be understood on perusal of the judgment. When the same principle is applied in certain cases, it resulted into absurdities. As mentioned earlier, sale of music CD, DVDs, books, one acquires a limited right to use and enjoy the material content. The buyer cannot acquire all such rights to do what the owner is generally expected to undertake like right to reproduce and sell more copies, right to change the underlying work, right to license its use to other and the right to transfer copyright itself. But still these transactions are considered as sale of goods and VAT is levied. If the above analogy is applied, these transactions cannot be subjected to VAT as the owner of the copyright reserves the right to transfer similar content to others.

The Counsel for the respondents' had bought to the notice of the court a particular scenario where global television and satellite rights are out rightly transferred by an agreement for consideration without retaining any rights. The Honorable High Court refused to express a view on these type of transactions stating that such isolated transactions do not make provisions unconstitutional. The author's view is that the Madras High Court has indirectly opined that such transactions constitute sale or transfer of right to use.

If this view is accepted, then the absurdity noticed in the above transactions gets resolved. In the case of sale of music CD, DVDs, books, the right that is transferred is the usage of content embedded in the media. It is for this limited purpose that the right is given to the user of music CD, DVDs, books. This right is granted to the buyer permanently for life time.

Under such pretext, a right to commercially exploit a copyright in a particular manner is either permanently transferred or is out rightly assigned to the exclusivity of every person including the copyright holder, then it is a case of permanent transfer of copyright so as to constitute transfer of right to use copyright. This is because of the reason that such transaction satisfies all the essential conditions of right to use as laid out by Supreme Court in BSNL vs. UOI - 2006-TIOL-15-SC-CT-LB.

Conclusion:

Consequent to the above discussed legal developments, a transaction constitutes 'permanent transfer of copyright' only in a case where entire copyright (all modes of commercial exploitation) is transferred or leased to the exclusion of all persons including owner of such copyright. It is seen that no clarity has been brought out in case where a right over a particular manner of commercial exploitation is assigned outright in a permanent manner while retaining right over other modes of commercial exploitation. In such a circumstance, the author is of the view that no service tax is payable.

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