When an exclusive license to use a trademark is granted, no service tax is levied

Facts and issues of the case

The Commissioner of Service Tax, Delhi-II1 has filed this appeal to assail the order dated May 18, 2015 passed by the Principal Commissioner of Service Tax, New Delhi2, by which the show cause notices dated April 24, 2014 and April 22, 2015 have been discharged. The show cause notices had been issued to M/s. Future Brands Ltd3 alleging therein that the respondent had not paid service tax on the “right to use” component of the Trademark License Agreement executed on August 27, 2008 between the respondent and Pantaloon Retail (India) Ltd4 for brand ‘Ajile’.

The Principal Commissioner, by the impugned order dated May 18, 2015, dropped the show cause notice for the reason that the grant of license under the Trademark License Agreement would amount to deemed sale under article 366 (29A) of the Constitution and, therefore, could not be subjected to levy of service tax. In support of his contention, the Principal Commissioner placed reliance upon the judgment of the Supreme Court in Bharat Sanchar Nigam Ltd. vs Union of India.

In order to appreciate the submissions advanced by the learned authorized representative appearing for the Department and the learned counsel appearing for the respondent, it would be appropriate to refer to the relevant clauses of the aforesaid Trademark License Agreement dated August 27, 2008 between the respondent (referred to as the licensor in the Agreement) and Pantaloon Retail (India) Ltd. (referred to as the licensee in the Agreement). A similar Trademark License Agreement was executed between the respondent and Future Value Retail Limited for brand ‘Srishti’.

It would also be appropriate to note that a Retail License Agreement was also executed on October 01, 2007 between the respondent and Pantaloon for brand “Dreamline”. Under this Agreement, a non-exclusive, non-transferable license to use the Trademark was granted by the respondent to Pantaloon. Clause-V of this Agreement relates to Quality and Control. It stipulates that Pantaloon agrees that the respondent has the right to control the standards and quality of the products in connection with which the Trademarks are used by Pantaloon and that Pantaloon also agrees that it will manufacture the products in accordance with such minimum quality standards and manufacturing specifications as the respondent may furnish or fix from time to time. The period of dispute in the present appeal is from 2008-009 to 2013-14 and in connection with the Trademark License Agreement, the respondent has produced details of the royalty component on which service tax was paid and the ‘right to use’ component on which service tax was not paid and only VAT was paid.

Observation by the court

The learned authorized representative appearing for the appellant submitted that the “right to use” under the Trademark License Agreement had not been transferred in absolute and unrestricted terms and the legal right of possession and effective control remained with the respondent. Therefore, there was no ‘deemed sale’ and in support of his contention learned authorized representative placed reliance upon the decision of the Tribunal in Eicher Good Earth Ltd. vs Commissioner of Service Tax, New Delhi6.

Learned counsel appearing for the respondent, however, supported the impugned order and submitted that on a careful analysis of the terms of the Trademark License Agreement and the decision of the Supreme Court in BSNL, it is clear that the Agreement seeks to transfer the ‘right to use’ in terms of paragraph 91(d) of the said judgment. Learned counsel submitted that the transfer of ‘right to use’ of Trademark on an exclusive basis would qualify it as ‘deemed sale’ under article 366(29A) of the Constitution thereby, attracting levy of VAT and would consequently be outside the purview of service tax.

To appreciate, whether service tax can be levied on the transaction, it would be necessary to analyse the relevant statutory provisions as they existed prior to 01.07.2012 and after 01.07.2012. The relevant clauses of the Trademark License Agreement have been reproduced above. Clause-3 deals with grant of license. Under it, the licensor has granted to the licensee an exclusive license to use the Trademark in any manner and during the term of the Agreement the licensee shall not grant to any third party, including any Future Group Companies, the license to use or enjoy the Trademarks in any manner nor will the licensor use or enjoy the Trademark in any manner.

The dispute in the present appeal relates to Trademarks License Agreement and is particularly on the ‘right to use’ component of the Agreement, which is to the extent of 65 per cent and not on the Royalty component, which to the extent of 35 per cent. The respondent contends that on the ‘right to use’ component value, it has regularly paid VAT, as it would amount to a deemed sale under article 366 (29A) of the Constitution and, therefore, no service tax is leviable.

In this connection, it would be pertinent to refer to Entry 54 of List II of the Seventh Schedule to the Constitution. It empowers State to levy tax on sales and purchase of goods. The forty-sixth amendment to the Constitution extended the meaning of “sale or purchase of goods” by giving an inclusive definition to the phrase “tax on the sale or purchase of goods” under article 366(29A) of the Constitution.

It would be seen from the aforesaid that the Constitution empowers the State to levy Sales Tax/VAT on transactions in the nature of transfer of right to use goods, which were earlier not exigible to sales tax as such transactions were not covered by the definition of “sale” as given in the Sales of Goods Act, 1930.It needs to be remembered that the term “transfer of right to use goods” has neither been defined in the Constitution nor in any of the State VAT Acts or Central Sales Tax Act.

It can safely be said that under Sales Tax, there is transfer of possession and effective control in goods, while there is no such transfer of possession and effective control under Service Tax. A perusal of the terms of the Trademark License Agreement dated August 27, 2008 and the Retail License Agreement executed on October 01, 2007 would show that there is a noticeable difference between the two. In the case of the Retail License Agreement only a non-exclusive and non-transferrable license to use the trademark was granted by the respondent to Pantaloon.

Pantaloon also agreed that the respondent would have the right to control the standard and quality of the products. There is also no restriction in granting the license to others during the license period. This agreement is clearly, therefore, outside the purview of article 366 (29A) (d) of the Constitution that defines tax on the sale or purchase of the goods. Service tax would, therefore, be chargeable.

However, in the case of the Trademark License Agreement an exclusive license to use the trademark in any manner during the term of the agreement was granted. Such a license could not be granted to any other person during the period of the agreement. This would clearly fall within the meaning of the phrase “transfer of right to use the goods” and would be covered by article 366 (29A) (d) of the Constitution. Service Tax would, therefore, not be payable. The Principal Commissioner, therefore, committed no illegality in holding that service tax could not be levied on the “right to use” component of the Trademark License Agreement.