Recent litigations in Maharashtra to levy VAT on royalty and license fee charged by foreign companies

The levy of service tax (central tax) or VAT (state tax) on a transaction has been debated numerous times under the erstwhile Indirect Tax regime specifically in relation to intangible goods. The characterization of intangibles as a deemed sale (‘transfer of right to use of goods’) is still unsettled with several contrary rulings on this issue.

In the recent times, the State VAT authorities in Maharashtra have issued notices proposing to levy MVAT on the royalty received by foreign entities from their Indian counterparts. The VAT authorities are proceeding basis the decision of the VAT Tribunal in the case of Merk KGAA, Germany v. The State of Maharashtra, 2016-VIL-13-TRB.

This Outlook is an attempt to familiarize readers with this emerging issue and NITYA’s take on the same.

1. Background of Merk’s decision

The taxpayer (foreign company) had entered into an agreement with its subsidiary to grant license to use the trademark. The agreement was signed by the subsidiary in Mumbai and subsequently countersigned by the taxpayer in Germany. The authorities contended that there was a transfer of right to use the goods and the same would be subject to VAT as a deemed sale. The VAT Tribunal upheld the levy of VAT based on the following grounds:

• There was an exclusive right granted by the taxpayer to the Indian company to use the trademark for a consideration.
• As per the Supreme Court judgment in the case of 20^th Century Finance Corporation v. State of Maharashtra, 2000-VIL-5-SC-CB (‘20^th Century’s case‘), the situs of sale would be the place where the agreement to sale is executed. The Tribunal rejected the taxpayer’s reliance on 20^th Century’s case on the ground that the decision was pronounced in respect of tangible goods whereas the instant case pertains to the right to use a trademark which is intangible in nature. The situs of the trademark is where the trademark is registered and where the royalty payment is made i.e. India.

2. NITYA Comments

In our view, the judgment of Tribunal is incorrect and other taxpayers can consider following arguments to refute the contentions raised by the department:

• VAT and Service Tax are mutually exclusive being applicable to goods and services respectively. Both taxes cannot be levied on the same transaction.
• At first place, it needs to be determined whether there is transfer of right to use the goods or not. In the case of BSNL v. UOI, 2006-VIL-07-SC-LB (‘BSNL’s Case’), the Supreme Court held that there should be an exclusive transfer to the transferee in case of transfer of right to use the goods. In other words, the owner cannot transfer the same right to others. Consequently, only where the right to use intangible is transferred to one person and cannot be transferred to another, the grant of such right shall qualify as a ‘deemed sale’. While the Tribunal held that BSNL’s case will not apply on intangibles, the Supreme Court did not lay down any such distinction. This is duly supported by various judgments of the High Courts including the Bombay High Court:
• The Bombay High Court in the case of Mahyco MonsantoBiotech (India) Private Ltd. & Subway Systems India Pvt Ltd v. Union of India, 2016-VIL-457-BOM, held that where an agreement grants mere ‘permissive use’ of a trademark, the transaction cannot be categorized as deemed sales.
• The Delhi High Court in the case of McDonald’s India Private Limited v. CTT, 2017-VIL-283-DEL, held that the licensee is not empowered to safeguard violation of the trademark in case of franchise agreements. Thus, only a limited right is transferred in case of trademarks.
• In relation to determination of situs of sale, the decision of the Apex Court in 20^th Century’s case applies to all goods i.e. tangible and intangible goods. There is no distinction created between the two types of goods and thus, the tests laid down in this judgment would have universal application. In the instant case, as the agreement was counter-signed outside Maharashtra, it would be considered to have been executed outside Maharashtra. Thus, the situs of sale would be outside Maharashtra and the VAT authorities do not have power to tax such transaction.