Saturday 28 January 2012

Transfer of right to use goods - VAT v Service Tax - A Critical Analysis

TAXATION of 'transfer of right to use any goods' as a concept was incorporated in the Constitution by virtue of the Constitution (Forty Sixth Amendment) Act, 1982 whereby clause (29-A) was inserted in Article 366 of the Constitution to define 'tax on the sale or purchase of goods'. Before we proceed any further let us momentarily look at the definition of 'tax on the sale or purchase of goods' in clause (29-A) ibid. It is an inclusive definition, the extract of which is given below for ready reference:
"(29-A) "tax on the sale or purchase of goods" includes-
(a) a tax on the transfer, otherwise than in pursuance of a contract, of property in any goods for cash, deferred payment or other valuable consideration;
(b) a tax on the transfer of property in goods (whether as goods or in some other form)  involved in the execution of a works contract;
(c) a tax on the delivery of goods on hire-purchase or any system of payment by instalments;
(d) a tax on the transfer of the right to use any goods for any purpose (whether or not for a specified period) for cash, deferred payment or other valuable consideration;
(e) a tax on the supply of goods by any unincorporated association or body of persons to a member thereof for cash, deferred payment or other valuable consideration;
(f) a tax on the supply, by way of or as part of any service or in any other manner whatsoever, of goods, being food or any other article for human consumption or any drink (whether or not intoxicating), where such supply or service, is for cash, deferred payment or other valuable consideration;"
The issue regarding levy of sales tax on 'transfer of right to use any goods' was in the limelight recently in view of the judgment of Hon'ble High Court of Andhra Pradesh in G S Lamba & Sons vs. State of AP - 2012-TIOL-49-HC-AP-CT. In this case, the appellants entered into a contract with their customer, Grasim Industries Ltd, for providing transit RMC mixers on hire for a specified period and for a consideration. Though the issue was with regard to levy of sales tax on this transaction under the APGST Act, the Hon'ble High Court traced the history of the legislative competence of States to tax this activity and analyzed in great detail the scope of the provisions in clause (29-A) of Article 366 of the Constitution, with specific reference to section 5-E of APGST Act and summed up the following principles to the extent relevant with regard to clause (29-A) of Article 366 of the Constitution:
"(a) The Constitution (Forty-sixth) Amendment Act intends to rope in various economic activities by enlarging the scope of "tax on sale or purchase of goods" so that it may include within its scope, the transfer, delivery or supply of goods that may take place under any of the transactions referred to in sub-clauses (a) to (f) of Clause (29-A) of Article 366. The works contracts, hire purchase contracts, supply of food for human consumption, supply of goods by association and clubs, contract for transfer of the right to use any goods are some such economic activities.
(b) The transfer of the right to use goods, as distinct from the transfer of goods, is yet another economic activity intended to be exigible to State tax.
(c)  There are clear distinguishing features between ordinary sales and deemed sales.
(d)  Article 366(29-A)(d) of the Constitution implies tax not on the delivery of the goods for use, but implies tax on the transfer of the right to use goods.The transfer of the right to use goods contemplated in sub-clause (d) of clause (29-A) cannot be equated with that category of bailment where goods are left with the bailee to be used by him for hire.
(e)  In the case of Article 366 (29-A)(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. In such a case taxable event occurs regardless of when or whether the goods are delivered for use. What is required is that the goods should be in existence so that they may be used.
(f)   The levy of tax under Article 366(29-A) (d) is not on the use of goods. It is on the transfer of the right to use goods which accrues only on account of the transfer of the right. In other words, the right to use goods arises only on the transfer of such right to use goods.
(g) 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.
(h) The agreement or the contract between the parties would determine the nature of the contract. Such agreement has to be read as a whole to determine the nature of the transaction. If the consensus ad idem as to identity of the good is shown the transaction is exigible to tax.
(i)  The locus of the deemed sale, by transfer of the right to use goods, is the place where the relevant right to use goods is transferred. The place where the goods are situated or where the goods are delivered or used is not relevant."
(emphasis supplied) 
The Hon'ble High Court also deliberated on the manner in which a contract between the parties has to be construed so as to ascertain the true nature of the contract between those parties and thereafter, apply the requisite law to determine the taxability thereof under that law. Along the way the Hon'ble High Court also referred to various landmark judgments of the Apex Court on the scope of clause (29-A) of Article 366 of the Constitution and taxability of 'transfer of right to use goods'.
After analyzing the settled decisions of higher judiciary, the Hon'ble High Court summarized the essential requirements of a transaction for 'transfer of right to use goods' as follows:
"(i) It is not the transfer of the property in goods, but it is the right to use property in goods;
(ii) Article 366 (29-A)(d) read with the latter part of the clause (29-A) which uses the words, " and such transfer, delivery or supply … " would show that the tax is not on the delivery of the goods used, but on the transfer of the right to use goods regardless of when or whether the goods are delivered for use subject to the condition that the goods should be in existence for use;
(iii) In the transaction for the transfer of the right to use goods, delivery of goods is not a condition precedent, but the delivery of goods may be one of the elements of the transaction;
(iv) The effective or general 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 or the customer, it would be under the effective or general control over the goods; and
(v) The approvals, concessions, licences and permits in relation to goods would also be available to the user of goods, even if such licences or permits are in the name of owner (transferor) of the goods, and
(vi) During the period of contract, exclusive right to use goods along with permits, licences etc, vests in the lessee."
(emphasis supplied)
While the petitioners contended before the Hon'ble High Court that the contract was for provision of transport service, after hearing the contentions of the counsels for both parties, perusal of various clauses of the contract entered into by the parties and following settled decisions of higher judiciary on the subject, the Hon'ble High Court held that it is subject to levy of sales tax in as much as there is a transfer of right to use the goods viz., transit mixers, by the petitioners in favour of Grasim Industries Ltd.
The above essential requirements enunciated by the Hon'ble High Court also resonate in another taxing provision viz., clause (zzzzj) of sub-section (105) of section 65 of Finance Act, 1994. This clause was inserted in the year 2008, by virtue of which the Central Government brought into service tax net the activity of 'supply of tangible goods' where the legal right of possession and effective control rests with the actual owner of such goods. The relevant clause (zzzzj) which defines the said taxable service reads as follows:
"(zzzzj) to any person, by any other person in relation to supply of tangible goods including machinery, equipment and appliances for use, without transferring right of possession and effective control of such machinery, equipment and appliances;"
(emphasis supplied)
The activity which would be leviable to service tax under this head is when the said service is provided to any person, by any other person in relation to supply of tangible goods including machinery, equipment and appliances for use, without transferring right of possession and effective control of such machinery, equipment and appliances.
The DO letter of JS (TRU) dated March 1, 2008 while explaining the scope of this new levy, stated as follows:
4.4 SUPPLY OF TANGIBLE GOODS FOR USE:
4.4.1 Transfer of the right to use any goods is leviable to sales tax / VAT as deemed sale of goods [Article 366(29A)(d) of the Constitution of India]. Transfer of right to use involves transfer of both possession and control of the goods to the user of the goods.
4.4.2 Excavators, wheel loaders, dump trucks, crawler carriers, compaction equipment, cranes, etc., offshore construction vessels & barges, geo-technical vessels, tug and barge flotillas, rigs and high value machineries are supplied for use, with no legal right of possession and effective control. Transaction of allowing another person to use the goods, without giving legal right of possession and effective control, not being treated as sale of goods, is treated as service.

4.4.3 Proposal is to levy service tax on such services provided in relation to supply of tangible goods, including machinery, equipment and appliances, for use, with no legal right of possession or effective control. Supply of tangible goods for use and leviable to VAT / sales tax as deemed sale of goods, is not covered under the scope of the proposed service. Whether a transaction involves transfer of possession and control is a question of facts and is to be decided based on the terms of the contract and other material facts. This could be ascertainable from the fact whether or not VAT is payable or paid.
While explaining the scope of levy, TRU clarified that transfer of the right to use any goods is leviable to sales tax / VAT as deemed sale of goods [Article 366(29A)(d) of the Constitution of India]. Transfer of right to use involves transfer of both possession and control of the goods to the user of the goods. It was further clarified that this new levy of service tax is applicable in a situation where the transaction of allowing another person to use the goods, without giving legal right of possession and effective control, not being treated as sale of goods, is treated as service (emphasis supplied).
Now, compare this TRU clarification on the scope of clause (zzzzj) ibid with the essential requirements summarized by the Hon'ble High Court of Andhra Pradesh (supra) to subject this transaction of 'transfer of right to use goods' to sales tax and the principles underlying clause (29-A) of Article 366 of the Constitution as enumerated by the Hon'ble High Court (supra).
After analyzing the provisions of clause (29-A) ibid, the Hon'ble High Court observed that in the transaction for the 'transfer of the right to use goods', delivery of goods is not a condition precedent, but the delivery of goods may be one of the elements of the transaction. The Hon'ble High Court also observed that the effective or general 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 or the customer, it would be under the effective or general control over the goods. The Hon'ble High Court also observed that in the case of Article 366 (29-A)(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. In such a case taxable event occurs regardless of when or whether the goods are delivered for use. What is required is that the goods should be in existence so that they may be used (emphasis supplied).
On the contrary, the TRU clarifies that the proposal is to levy service tax on such services provided in relation to supply of tangible goods, including machinery, equipment and appliances, for use, with no legal right of possession or effective control. It was further clarified that supply of tangible goods for use and leviable to VAT / sales tax as deemed sale of goods, is not covered under the scope of the proposed service.
When we read clause (zzzzj) ibid harmoniously with the law laid down by the Hon'ble High Court of Andhra Pradesh in r/o clause (29-A) of Article 366 of the Constitution, there appears to be a clear overlap of the condition precedent required for bringing a transaction which entails 'transfer of right to use goods' within the scope of levy of sales tax/VAT as well as service tax i.e. the lessee need not have effective physical possession and control over the goods whose right to use is transferred to the lessee for a consideration.  
In such a scenario, when an activity/transaction that is clearly subject to levy of sales tax /VAT under a State legislation [supported by clause (29-A) of the Constitution and validated by various judicial forums including the latest judgment of Hon'ble High Court of Andhra Pradesh supra], is also brought under the levy of tax under a Central law, it would lead to ambiguity and a question would arise as to whether the State law should yield to the Central law or vice versa. Constitutional law on this controversy deals with such an anomaly by applying the Doctrine of 'Pith and Substance' (deals with 'subject matter' of laws made by Parliament and State Legislatures as enumerated in Article 246 of the Constitution). This Doctrine is applied when the legislative competence of a legislature with regard to a particular enactment is challenged with reference to the entries in different legislative lists, because a law dealing with a subject in one list within the competence of the legislature concerned is also touching on a subject in another list not within the competence of that legislature.
I am not delving deep into the Constitutionality issue at this stage as it would be prudent if it is best left to Constitutional experts to deal with, when the matter reaches High Courts or Supreme Court. However, in my view, it is certain that the levy of service tax on the transfer of right to use goods would be a subject matter of bitter court battles in the days to come.

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