VAT is payable on transfer of right to use

The division bench of the Kerala High Court, in Malabar Gold Private Limited versus commercial tax officer, Commissioner of Central Excise and Customs and ors (2013-TIOL-512-HC-KERALA-ST) has overruled the judgement delivered by the single judge and held that the transaction of letting the franchise use the trademark owned by the franchiser without the right to transfer or sub-let the trademark to a third party cannot be considered as "transfer of right to use".

Accordingly, the royalty amount received by the franchisor for letting the franchise to use its trademark cannot be held liable to value added tax (VAT) and the same would only be liable to service tax under the category of "franchise services".

The issue before the bench wasn't a new one. There are numerous instances of an overlap between VAT and service tax.

There are precedents available in terms of the apex courts' landmark judgments in Bharat Sanchar Nigam Ltd and anr versus Union of India and ors (2006-TIOL-15-SC-CT-LB) and Tata Consultancy Services versus State of Andhra Pradesh (2004-TIOL-87-SC-CT-LB) wherein the principle to differentiate between a mere licence to use the trade mark and transfer of legal right to use the same to the exclusion of the owner has been clearly laid out.

However, Karnataka VAT authorities contended that the trademark is a good as per the definition of the goods provided in the Karnataka VAT and any transaction of assigning rights to use such goods for a consideration would amount to transfer of rights to use, deemed to be sale of goods under the KVAT.

Accordingly, the franchiser would be liable to pay VAT on the royalty that it has received for allowing the franchise to use its trademark.

In keeping with the principle laid down by the apex court on the issue, the high court has deliberated on the finer differentiation between the mere licensing for use and the transaction of legal transfer of right to use the goods.

The high court observed that according to the terms of the agreement between the franchiser and the franchise, the latter is merely allowed to use the trademark in the manner authorised by the franchiser to promote and sell the goods that the franchiser deals in.

The franchise has to abide by the standards and procedures of use of trademark with a clear exclusion as to its right to sub-let, sub-lease, sale, transfer, distribute, delegate or assign the rights to use the trademark to any third party. At the same time, the franchiser is free to assign such rights to use the trademark to any number of other franchisees that it may choose to do so.

Accordingly, the right to use assigned to the franchise is not to the exclusion of the franchiser in any way and could not be considered as 'transfer of right to use' the trademark.

The current practice, which was also the contention of the Karnataka VAT authorities in the present case, is that the VAT authorities would invariably treat any such transaction where the licence to use trademarks or to say intellectual property rights (IPR) is involved, irrespective of the terms and conditions of its use as the transfer of right to use and demand VAT on the same.

In this decision, the Karnataka High Court laid emphasis on the fact that there was no 'transfer' of the right to use the trademarks.

It observed that a transfer would be in favour of the transferee and to the exclusion of all, including the transferor. In the present case, there was certainly a licence to use the trademark. However, this was quite different from a transfer of the right to use the trademark.

It is the latter that creates a transaction that is subject to tax under value added tax law.

Therefore, the court made it clear that either there was a transfer of the right to use the trademark (which would create a VAT liability) or there was a licensing of the trademark, which would attract service tax. The two types of transactions are mutually exclusive.

It is hoped that the decision of high court would bring some relief to the intellectual property rights industry which is currently struggling with the double taxation issue.

The tax authorities concerned with the issue should also take a cue from the decision and issue appropriate instructions or clarifications to put a logical end to the dispute.

The Author is Leader, Indirect Tax Practice, PwC India pwctls.nd@in.pwc.com
Supported by Tajinder Singh