Intellectual Property Services in India & Service Tax Regime

ABSTRACT

Moving in an era where the fruits or products of intellect are considered to be at a higher footage than any other form of material wealth , as when the intellectual ideas are converted from ideas to a perceptible form brings huge wealth, this form of intellectual wealth is protected by intellectual property rights/law. In present time the world economies are engaged in transforming themselves into knowledge based economies rather than just being a simple industrial one. Thus, the companies see this intellectual property as an asset capable of generating tonnes of capital & with tax authorities becoming aggressive in auditing, the intellectual property holder aren’t spared & hence fixing liability to pay tax on it. In this article, authors have focussed specifically on service tax imposed on intellectual property services, basis of levying it, its incidence & implications.

INTRODUCTION

With India becoming Mixed Economy in 1991 the foreign investment in India has made strides in the world arena. We are moving towards a period where knowledge and ideas are more valuable than physical property. With widespread internet access, the creation of Intellectual Property (IP) is no longer the citadel of large corporations. Any person can develop value through a copyright, a patentable invention or a trademark.

“The Indian economy is overheated” says the Finance Minister. This comes as a prologue to the fact that the Government of India is bringing more and more sources under the taxation net or is tweaking the existing laws to levy taxes on a number of items/services/incomes, etc. [1] This is being done through changes to existing laws or introduction of new sections in various acts like the Income Tax Act, Central Sales Tax Act, Value Added Tax Act, Profession Tax Act, Service Tax Act, etc.

In a knowledge based economy, business performance & level of economic progress is dependent on development & exploitation of intellectual assets. As IP continues to grow as a wealth creation tool, individuals and corporations will be faced with the challenge of determining the value of the property, and the effect that such property will have on taxes. [2] It would be very surprising if IP is allowed to escape this tax net. Right from tax credits for R & D, through allowances for IP assets the entire cycle of IP creation and use is affected by the taxation system.

THE CONCEPT

The Government of India brought into Indian scenario a new levy of tax on services viz. ‘service tax’ through Chapter V of Finance Act 1994. Today the service tax is levied is applicable on approximately 96 services. But on 10 September 2004 the Government made Intellectual Property Services as taxable service. The Finance Bill (No.2), 2004 Circular No. 80/10/2004 dated 17 September 2004 defines intellectual property as “Intellectual property emerges from application of intellect, which may be in the form of an invention, design, product, process, technology, book, goodwill etc”. It means the definition includes trademark, design, patents & any other similar intangible property.

It’s to be noted that definition of taxable service includes only such intellectual property rights (IPRs) (except copyright) that are prescribed under law for the time being in force. [3] As the phrase “law for the time being in force” implies such laws as are applicable in India, IPRs covered under Indian law in force at present alone are chargeable to service tax and IPRs like integrated circuits or undisclosed information (not covered by Indian law) would not be covered under taxable services. [4] Thus it is clear that the intention of the legislature was to cover those IPRs which were governed by Indian laws & not which aren’t recognised in India. [5]

Prior to the coming in force of the Finance Act, 1994 the transfer of IPRs were held to be taxable service under the clause of ‘consulting engineering services’. As what happened in most parts of the world, happened in India too that most of the companies have technology transfer agreement with other joint venture partners, foreign collaborators, etc. for permitting the use of intellectual property, through transfer of technology transfer or technical know-how as provided in TRIPS by paying them some royalty. This payment of royalty is not considered taxable service was held in Bajaj Auto Ltd. v. Commissioner Central Excise [6] where it was further explained that “Payment of Royalty is not a service. It is rather a profit of the owner for permitting another to use his property. Hence payment of royalty should not be treated as a payment for service. IPR is in nature of property and the right to use IPR is a transaction in property and not consultancy or advice”

Indian companies not being too advanced in technological advancement as the companies are in West or Japan & Chinese, so Indian companies generally enter into agreements with foreign companies to obtain technical know-how. The technical know-how is an intellectual product but whether it would be subjected to service tax or not is yet to be determined. This is because since the Circular [7] has clarified that only those intellectual services would be subjected to service tax on which the legislations are present but as technical know-how is not covered under any IP legislation so it’s not covered under service tax. Also, In case a transfer or use of an IPR attracts cess under Section 3 of the Research and Development Cess Act, 1986, the cess amount so paid would be deductible from the total service tax payable.

TAXABLE SERVICE: WHAT IS IT?

Section 65(105) (zzr) of the Finance Act, 1994 defines taxable service as “service provided or to be provided to any person, by any other person, by granting the right or by permitting use or, by the holder of intellectual property right, in relation to intellectual property service”

Thus, the ingredients of this taxable service in general with respect to IP are:

service provided or to be provided to any person, by any other person.

service is provided by granting the right or by permitting commercial use or exploitation of any intellectual property service;

Prior to 2004 the definition of ‘intellectual property service’ under Sec. 65(55b) was:

Transferring whether permanently or otherwise

Permitting the use or enjoyment of any intellectual property right

But after the Circular [8] Sec. 65(55b) was changed as “intellectual property service” means,

(a) transferring, temporarily; or

(b) permitting the use or enjoyment of any intellectual property right;

Thus, it is to be noted that the Circular [9] clarifies it that a permanent transfer of intellectual property right does not amount to rendering of service. On such transfer, the person selling these rights no longer remains a “holder of intellectual property right” so as to come under the purview of taxable service. Thus, there would not be any service tax on permanent transfer of IPRs because permanent transfer of IPR would amount to a sale of IP & thus not attract service tax.

Thus, a temporary transfer or permission to use or enjoy IPR can be classified as transfer of right to use goods, as it involves transfer of right to use movable property. Therefore, a tax on IPR is in pith and substance a tax on transfer of right to use IPR and not a tax on services.

THE INCIDENCE OF SERVICE TAX

Sec. 66 of the Finance Act, 1994 lays down that: There shall be levied a tax (hereinafter referred to as the service tax) at the rate of twelve percent of the value of taxable services referred to in sub-clauses 65(105) (zzr) and collected in such manner as may be prescribed. This provision is quite simple as it tells that when a situation is that where the service provider owning IPR is in India & the service recipient is also in India then the burden of paying the service tax is on the person rendering the service.

The problem of fixing the liability to pay service tax becomes muddling when either the service provider of IPR is outside India or else the recipient is outside India. Thus, the problem is to be determined from two perspectives, firstly, where the IPR service provider is situated outside in India & the service recipient in India & secondly, when the recipient is in India & service provider of IPR is outside India.

Thus, the incidence or burden of liability to pay service tax has to be seen as:

Import of IPRs

Generally the provisions related to liability to pay the tax under the taxing statutes are to be part of substantial law i.e. the charging section in the Act itself but before the introduction Section 66A of the Finance Act, 1994 there was no charging section as such.

Although before introduction of Section 66A in the Act of 1994 there was an Explanation to the definition of taxable service provided in Section 65(105) of the Act which reads as under:

Explanation-For the removal of doubts, it is hereby declared that where any service provided or to be provided by a person, who has established a business or has fixed establishment from which the service is provided or to be provided or has his permanent address or usual place of residence, in a country other than India & such service is received or to be received by a person who has his business, fixed establishment, permanent address or as the case may be usual place of residence in India, such service shall be deemed to be taxable service for the purpose of this clause.

But as discussed above the liability to pay taxes cannot be saddled upon the assessee through an explanation or by way of a rule enacted under the procedural law.

Therefore, after addition of Sec. 66A in the Act of 1994 & introduction of Taxation of Services (Provided from Outside India & Received in India) Rules 2006 with effect from 19 April 2006; Section 66A of the Act should have a conjoint reading with the aforementioned rules.

Section 66 A reads as follows: [10]

(1) Where any service specified in clause (105) of section 65 is,—

(a) provided or to be provided by a person who has established a business or has a fixed establishment from which the service is provided or to be provided or has his permanent address or usual place of residence, in a country other than India, and

(b) received by a person (hereinafter referred to as the recipient) who has his place of business, fixed establishment, permanent address or usual place of residence, in India, such service shall, for the purposes of this section, be taxable service, and such taxable service shall be treated as if the recipient had himself provided the service in India, and accordingly all the provisions of this Chapter shall apply:

Provided that where the recipient of the service is an individual and such service received by  him is otherwise than for the purpose of use in any business or commerce, the provisions of this sub-section shall not apply:

Provided further that where the provider of the service has his business establishment both in that country and elsewhere, the country, where the establishment of the provider of service directly concerned with the provision of service is located, shall be treated as the country from which the service is provided or to be provided.

(2) Where a person is carrying on a business through a permanent establishment in India and through another permanent establishment in a country other than India, such permanent establishments shall be treated as separate persons for the purposes of this section.

Explanation 1. — A person carrying on a business through a branch or agency in any country shall be treated as having a business establishment in that country.

Explanation 2.—Usual place of residence, in relation to a body corporate, means the place where it is incorporated or otherwise legally constituted.

According to the Rules, under the circumstances enunciated in the previous paragraph, the recipient of the service would be considered to have rendered the service himself. Hence where the IPR holder is situated outside India and where the recipient of the service is situated in India, the liability to pay service tax is on the recipient of service. With respect to IPRs, the Government of India has exempted an amount which is equivalent to the amount of cess paid towards the import of technology from being paid. [11]

Export of IPRs

If the IP related service is rendered by a person resident in India and the recipient of the service is situated outside India, the tax liability would be governed by the provisions laid down in Export of Services Rules, 2005. Prior to these rules, the service provider was under an obligation to prove export by showing that the consideration received was convertible foreign exchange. This notification was rescinded on introduction of the Export of Services Rules 2005. Post enactment of these rules the services are classified as: [12]

Services provided in relation to immovable properties situated outside India

Services physically carried out, partly or wholly, outside India

Services in respect of which the recipient of the service is located outside India & delivered outside India

IP service falls in the abovementioned third category & according to Export Service Rules 2005 the IP holder has to fulfil condition viz. the provision of service should be to a person situated outside India if it is in relation to business & commerce & if it is not in relation to business & commerce then the recipient outside India at the time of receiving the service. [13]

GLIMPSE OF GLOBAL TAX REGIME OF INTELLECTUAL PROPERTY SERVICES

United Kingdom

In recognition of importance of IP to business, the Government has introduced a new regime for the taxation of IP and other intangible assets. The tax treatment of these assets follows Generally Accepted Accounting Principles (GAAP) with income, expenditure and amortisation relating to intangibles being treated as revenue. With respect to intangible assets acquired before 1-4-2002, the tax treatment will continue to follow the ‘old’ regime for the taxation of intangibles, so long as these assets are owned by their existing owners. [14] A person who resides in the UK and carries on trade, which involves the exploitation of IP, is taxable upon any sums which he receives from such exploitation whether or not they are received in the UK. It would also include lump sum payments made for the grant of a licence to exploit the right or for the total or partial assignment of the right or as compensation/damages for infringement because any sum which a trader derives from carrying on of his trade is income.

United States of America (USA)

The tax treatment of IP does not follow the GAAP in the United States of America (hereinafter referred to as ‘U.S.’). On the contrary, the treatment of intangible assets has been set out in the U.S. Tax Legislation. Tax deductions are available for U.S. tax purposes for all the IP assets. Transfer of IP by persons situated in the U.S.A. to foreign corporations is taxed in the U.S.A. The U.S.A. generally taxes the world income of the companies incorporated in the U.S.A. [15] Foreign corporations with no business activities in the U.S.A. are subject to tax on payments of certain categories of income like dividends, interest or royalties from sources in the U.S.A. Sec. 197 of the Internal Revenue Code allows the amortization of any intangible asset which is acquired after 9-8-1993 and which is held in the conduct of trade or business

Other Countries [16]

The tax treatment of IP in Germany follows the GAAP. Germany is a relatively high tax jurisdiction with profits being taxed at a corporate income tax rate of between 38% and 40%. In Ireland, generally no tax deductions are available with respect to acquired IP. The legislation provides for tax exemption for income derived from ‘qualifying patents’, where the holder of the patent resides in Ireland. Stamp duty is however not levied with respect to transfer of IPRs in Ireland. The tax treatment in the Netherlands follows the GAAP. The cost of internally generated IP is fully tax deductible on an accrual basis.

CONCLUSION

Service tax is levied by the Central government on specified services. Service tax is not payable on export of services subject to fulfilment of prescribed conditions. Conversely, services received in India are taxed in the hands of the recipient. The rate of service tax is 12 percent, together with education cess at two percent i.e. 12.24 %. [17] Governments over the world seek to provide ‘tax benefits’ to foster innovation and this is testament to the fact that IP plays a vital role in the development of the economy. One of the by-products of socio-economic policy for development in many countries is the acceptance of ‘fiscal dirigism’ in tax laws. [18]

The issue as to whether the transfer of know-how would fall within the ambit of service tax has been the subject of unending debate/ argument in courts. With services pertaining to IP being made a taxable service, whether or not the transfer of know-how would be subject to service tax had remained unclear, until recently.

Also, intellectual property rights are deemed as intangible properties & most states in India hold these intangible properties as liable to sales tax/value added tax. [19] In case a right to use trademarks or patents is granted by an entity outside India to an entity in India, the same would be subject to service tax under Intellectual Property services. The contracts in such a case would be considered as executed outside India as the transferor signs the contract outside India. However, state VAT authorities have contended that such a right to use would also attract VAT as use of the same is in India. This contention is against the Supreme Court decision in 20th century case, wherein, for intangibles, it has been held that transfer of right to use takes place where the agreement is executed. The dual applicability of VAT, as well as service tax would increase the cost of operations in transfer of technology cases between MNCs established in India. [20]

The above lacunae in indirect taxes regime lead to only one conclusion that Goods & Services Tax (GST) is the ultimate solutions for businesses in India. The Central and State governments need to be sensitive to the concerns of the knowledge based industries like software industries, pharmaceutical industries, etc which in the recent years have become the standing pillars of the Indian economy. So, it must be ensured that taxes do not affect the competitiveness amongst the companies and the larger social concern of benefit sharing of IP services e.g. life saving drugs through transfer of technology to companies & ultimately to masses at least cost which is one of the main objectives of Convention on Biodiversity (CBD) 1992 must be kept in mind.