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29 September 2016

Testing whether a transaction is sale or service

The High Court of Bombay in [Mahyco Monsanto Biotech (India) P Ltd v. UOI, 2016 (44) S.T.R 161 (Bom.)] examined whether the transaction undertaken by the petitioners would be exigible to service tax or to VAT where the petitioners were involved in different transactions though both urged that their transaction was a service and not a sale. They argued that no transfer of goods took place and consideration received was for permissive use of goods. The first petitioner ‘sold’ cotton seeds impregnated with technology to make the plant resistant to insects. The (third party) buyer could commercialise the technology and, produce and sell more seeds to cotton growers. As per the terms of the contract, the company did not exercise control over what a buyer did with the seed in terms of disposal after a period, use etc. The company did not undertake sale of such hybrid seeds once it had sold them to select third party buyers for each territory. The petitioner argued that what was being provided was right to use the technology and the media (the seed) which carried the technology was irrelevant. The petitioner also argued that to qualify as sale there must be a transfer – divesting of right by the transferor and investing of right in the transferee and if transferor and transferee exercise control simultaneously over the goods, ‘transfer’ is not satisfied.

The second petitioner contended that the consideration received from ‘franchisees’ for use of the logo, trade dress etc., was not exigible to VAT since the mere reference as a franchise agreement did not impart the character of transfer of goods (deemed sale) and the franchisee was only  permissive user of the intellectual property. On facts, the franchiser exercised complete control over layout of the outlets, raw materials used, etc., and there was no divesting of rights and no territorial exclusivity was given to the franchisee.

The High Court tested the transaction on the following points:

  • Transfer - In case of the first petitioner, since it was excluded from dealing in the territory of its buyer, it had divested some of its rights. In case of the franchisor-petitioner, there was no transfer or deemed sale since the rights were with the franchisor at all times and franchisee was permitted only to use them.
  • Loss of effective control over goods – The Court held that although the twin test of transfer and control need not be satisfied always, in case of the first petitioner, effective control over the goods did not exist once the technology embedded seeds were given to the buyer. In case of the franchisor, the franchisees could not sub-franchise the permission obtained and at all times the franchisor was in control.
  • Return of goods/ termination of use – In case of cotton hybrid seeds the contract did not obligate the buyer to return the seeds with technology embedded in them while in case of franchisee, the intellectual property could not be used on expiry of the term.

The Court thus held that the transaction of ‘sale’ of cotton seeds to third party buyers was exigible to VAT while that of franchise- in terms of the agreement between the party was one of permissive use, exigible to service tax.