KVAT Act | Tax Doesn't Apply To Transfer Of Goods But To Transfer Of 'Right To Use' Goods: Kerala High Court

In a significant ruling, the Kerala High Court recently held that the tax under the KVAT Act applied not to the transfer of goods but to the transfer of the right to use goods.

A division bench of Justice A.K Jayasankaran Nambiar and Justice Mohammed Nias CP added that the taxable event occurs when the contract for goods delivery is executed, irrespective of whether the transfer is exclusive.

"...in a contract for the transfer of the right to use the goods, the taxable event is the execution of the contract for delivery of the goods, and if that has taken place, it was immaterial whether the transfer was exclusively or to the exclusion of all others."

The respondent was an assessee registered with the Commercial Tax Officer, Ernakulam. The assessing officer discovered that the respondent had received a substantial amount of nearly Rs.3.7 crores as income from copyright and royalty for transferring the right to use ringtones during several assessment years from 2005-2006 to 2010-2011.

It was determined that the respondent had not declared this income in their tax returns. Therefore, the assessing authority reopened and completed the assessments under Section 25(1) of the Kerala Value Added Tax Act (KVAT Act).

The respondent appealed the assessing officer's decision and received an outcome in their favour. Dissatisfied with this, the State filed a second appeal before the KVAT Appellate Tribunal, which dismissed the State's appeal.

Challenging this dismissal, the State approached the High Court. 

The central issue was the taxability of the receipts related to royalty and the transfer of the right to use intangible property.

The assessing authority argued that under Entry 68 of the III Schedule of the KVAT Act, intangible items like copyright were included. It was argued that Section 6(1)(c) of the KVAT Act taxed the transfer of the right to use goods for a specified period at 4%. They added that royalties received from intangible assets, like copyright, should also be subject to taxation, similar to the transfer of the right to use tangible goods.

However, the respondent submitted that they were paying service tax and that VAT and service tax were mutually exclusive, citing Imagic Creative Pvt. Ltd. v. Commissioner of Commercial Taxes. Further, for the assessment year 2005-2006, they argued that the assessment was barred by limitation.

The First Appellate Authority ruled in favour of the respondent primarily on the ground that the activity was subject to service tax under Central Legislation and that the requirements for a deemed sale were not met.

The KVAT upheld this decision relying on judgments that emphasised the need for an exclusive transfer of the right to use goods.

However, in its revision petition, the State argued the transfer of the right to use goods, even without exclusivity, constituted a taxable event. 

Government Pleader Mohamed Rafiq appeared for the State while Advocates K.V Vimal, Jaikrishna R, Narayani Harikrishnan and Anish P represented the respondent. 

After hearing both sides, the Court found that the State's contentions were valid. It affirmed the principle laid down in Commissioner Service Tax, Delhi v. Quick Heal Technologies Ltd. [(2023) 5 SCC 269] that the tax applied not to the transfer of goods but to the transfer of the right to use goods.

"A reading of the above judgment clearly shows that the issue is not whether there is a transfer of property in goods but if there is a transfer of the right to use the property in goods."

The court deemed the tribunal's analysis to be flawed in its focus on exclusive transfer. They also referred to the decision in Quick Heal Technologies, which clarified the requirements for a transaction to qualify as a deemed sale.

The Bench added that it is not legally necessary that there should be a transfer of the entire right to the exclusion of the transferor for there to be a transfer of the right to use.

"The transfer of the right to use goods is distinct and separate from the transfer of goods. The Tribunal has clearly erred in considering the question as to whether there is a transfer of the property in goods. It has clearly misdirected itself in not finding out whether there has been a transfer of the right to use goods, and if it is answered in the affirmative, surely the activity is exigible to sales tax."

As such, the Court set aside the tribunal's order and restored the assessing officer's orders except for the 2005-2006 matter. The said matter was remanded to the assessing officer for reconsideration regarding the plea of limitation raised by the respondent.

Case Title: State of Kerala v. M/s Sathyam Audios and connected matters

Citation: 2023 LiveLaw (Ker) 463

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