The division bench of the Bombay High Court comprising of Justice S C Dharmadhikari and Justice G.S Patel, in a path-breaking judgment, held that sub-licensing of technology is a ‘transfer of right to use’ which attracts “Service Tax”. In another petition, the Court expressed that Maharashtra Value Added Tax (MVAT) is Applicable in case of “franchising agreements” since they provides only a permissive use. The relevant portions of the decision are stated below.
M/s, Monsanto India, One of the petitioners, which is a joint venture company of Monsanto Investment India Private Limited and the Maharashtra Hybrid Seeds Co. Monsanto India. The petitioners are engaged in the business of developing and commercializing insect-resistant hybrid cottonseeds using a proprietary “Bollgard technology”, one that is licensed to Monsanto India by Monsanto USA through its wholly-owned subsidiary, Monsanto Holdings Private Limited. This is further sub-licensed by Monsanto India to around 40 seed companies on a non-exclusive and nontransferable basis to use, test, produce and sell genetically modified hybrid cotton planting seeds. The fees received by the Petitioners for the above transaction is based on the number of packets of seeds sold by the sub-licensees.
The petitioners submitted that these agreements whereby the ‘Monsanto technology’ is granted by the Petitioner to the seed companies amounts to mere permissive useand, therefore, a service under Section 65(B)(44) of the Finance Act, 1994. The Revenue, on the other hand maintained that it is a “deemed sale” in the nature of “transfer of right to use goods” under clause (b)(iv) of the Explanation to Section 2(24) of the MVAT Act read with Article 366(29A)(d) and Entry 54 List II of the Constitution.
Regarding the applicability of the ratio of BSNL case in the instance case, the Court observed that “We must note that Mr. Venkatraman’s submission that the BSNL test must always be present in each and every case for a transaction to be considered a transfer of the right to use goods is overbroad. We do not think that in BSNL the Supreme Court intended to prescribe a test of global or universal application without regard to individual circumstances. The judgment of the Supreme Court (in paragraph 90) notes the factual aspects. There, the entire infrastructure, instruments, appliances and exchange remained in the physical control and possession of the petitioner at all times and there was neither any physical transfer of such goods nor any transfer of the right to use such equipment or apparatuses. One of the issues that arose for consideration was whether there was any transfer of the right to use goods by providing access or a telephone connection by the telephone service provider to a subscriber. This BSNL test, was, therefore, set out in these circumstances. The Court had no occasion to consider its applicability to intangible property like intellectual property. This is how BSNL has been interpreted by us in Tata Sons. We think that this interpretation is correct. In any case, it binds us. The Kerala High Court in MalabarGold, in paragraph 35, took a contrary view. It took the BSNL twin test to be applicable as a general proposition, i.e., one that admits of no variance. As discussed above, we do not think this can ever be a correct reading of BSNL.”
On the basis of the above findings, the Court held that the above transfer is a clear case of a transfer of the right to use goods. It was further opined that “In our opinion, the most fundamental aspect of permissive use of goods is that at the end of the period for which the use is granted, the goods must be returned to the transferor. Let us consider this in the context of a car hire service, a book library service, Amazon Kindle Unlimited and ITunes Radio. When a car is taken on hire, a fee is paid and the car can be used for a certain period of time. During this time, the person renting the car can only use it. He cannot part with it and certainly cannot destroy it. Once the period of hire comes to an end, the car must be returned to the transferor. Therefore, the effective control over the car remains with the transferor. Likewise, in the case of a book library, the books must be returned to the library. With the Kindle Unlimited, one must pay a subscription fee to gain access to an unlimited number of books in the proprietory AZW format. When the subscription expires, all the books are repossessed. ITunes Radio too is a similar concept. A subscription fee is paid, which allows access to music. Once this expires, access to the music is denied. These, in our opinion, are cases of permissive use. The Monsanto India sub-licensing transaction could only be a service in one circumstance, i.e., if the seed companies gave Monsanto India a bag of seeds to mutate and improve with the Bollgard Technology which would, thereafter, be returned to the seed companies. That might perhaps be a service.”
In the second petition, the petitioner, Subway contended that the service tax is applicable on them since the franchise agreement is not one for sale or transfer of right to use but merely permits the franchisee to display certain marks and to use certain technologies and methods in preparing the salads and sandwiches for sale. The petitioners relies on the cases of Tata Sons to urge that in Subway’s case, all that is granted is a permissive use. The franchisee under the agreement obtains a mere permission to display the name ‘Subway’ in a particular fashion, along with other services.
On behalf of the Revenue, it was argued that the franchise agreements are covered under the MVAT Act since “franchises” and “trademarks”, are expressly covered under the MVAT Act since 2005. The Government of Maharashtra, under the powers conferred by Entry 39 of Schedule C of the MVAT Act, issued a Notification (No. VAT- 1505/CR-114/Taxation-1), dated 1st June 2005, in which trademarks and franchises were included as “goods” for the purpose of Entry 39.
The division bench observed that “We believe that Mr. Shroff is correct when he says that the agreement between Subway and its franchisees is not a sale, but is in fact a bare permission to use. It is, therefore, subject only to service tax. In our opinion, the fact that the agreement between Subway and its franchisee is limited to the precise period of time stipulated in the agreement is vital to Subway’s case. At the end of the period of the agreement, or before in case there was any breach of its terms, the right of the franchisee to display the mark ‘Subway’ and its trade dress, and all other permissions would also end. This is what setsthis agreement apart from the case of Monsanto and its sublicensee. There, the seed companies could do as they pleased with the seeds; they could alienate or even destroy them. In Subway’s case, there are set terms provided by the agreement which have to be followed. A breach of these would result in termination of the agreement. We believe that there is no passage of any kind of control or exclusivity to the franchisees. In fact, this agreement is a classic example of permissive use. It can be nothing else. For all the reasons in law and fact that the sub-licensing of technology in Monsanto is held to be a transfer of right to use, this franchising agreement must be held to be permissive use.”
While concluding, the Court added that “In our opinion, the mere inclusion of ‘franchises’ under the MVAT Act would not automatically make all franchise agreements liable to sales tax. What must be looked at is the real nature of the transaction and the actual intention of the parties. The agreement must be considered holistically, and effect must be given to the contracting parties’ intentions. The label or description of the document is irrelevant. An agreement styled as a franchise might, on a proper examination, turn out to be nothing more than a mere license (as in Subway’s case). On the other hand, an agreement that calls itself a license might actually be a franchise. If, in a given case, a franchise agreement is effectively nothing more than a mere permissive use, it cannot be made liable to VAT. It would be a service, and hence liable to service tax. When interpreting a taxing statute, or for that matter any statute, full effect must be given to the words used by the Legislature. This, however, does not mean that this principle must be stretched to a point which leads to an absurd result, or one that was not contemplated by the Legislature. The Legislature is presumed to know the law and to have acted in accordance with it. We, therefore, do not think that the Legislature intended for this Notification to have such a sweeping effect as to bring all franchise agreements within the ambit of the MVAT Act. Presumably, what the Legislature intended was to included only those franchise agreements that involved a transfer of the right to use or some other aspect of a deemed sale as defined under Article 366(29A) of the Constitution. As discussed above, we find that Subway’s franchise agreement grants to the franchisee nothing more than mere permissive use of defined intangible rights. It is therefore a service, and is not amenable to VAT. We also hasten to clarify that we are not determining whether any particular kind of arrangement is or is not a franchise. Any examples we have given are merely illustrative, and not binding or final findings.”
Read the full text of the Judgment below.
