In a significant ruling on deemed sale under Article 366(29A)(d) of the Constitution, the Karnataka High Court (Bengaluru Bench) upheld the levy of VAT on rental charges collected by Axis Bank in respect of Electronic Data Capture Terminals (EDCT) installed at merchant establishments, holding that such rentals constitute consideration for transfer of the right to use goods and are liable to tax under the Karnataka Value Added Tax Act, 2003.
The Court applied the principles laid down by the Constitution Bench of the Apex Court in Bharat Sanchar Nigam Ltd., and another v. Union of India [(2006) 3 SCC 1] to hold that the determination of whether a transaction amounts to transfer of the right to use goods depends upon the nature of the goods involved, the contractual arrangement between the parties and the rights conferred upon the user.
The Court further held that the EDCT machines are identifiable goods installed at the premises of merchant establishments, and the merchant establishments were enabled to use such equipment for their business purposes during the subsistence of the agreement. The retention of ownership and supervisory rights by the Bank does not negate the transfer of the right to use such goods.
The Division Bench comprising Justice S.G. Pandit and Justice K. Manmadha Rao observed that Article 366(29A) of the Constitution of India was inserted by the Constitution (Forty-sixth Amendment) Act, 1982, which expanded the concept of sale by including within the ambit of taxation certain transactions which, though not amounting to sale in the conventional sense under the Sale of Goods Act, 1930, involve transfer of certain rights in goods. Clause (d) of Article 366(29A) includes within the expression “tax on the sale or purchase of goods” a tax on the transfer of the right to use any goods for any purpose, whether for a specified period or otherwise, for cash, deferred payment or other valuable consideration, thereby creating a legal fiction by treating transfer of the right to use goods as a sale, notwithstanding that ownership in the goods continues to remain with the owner.
The Court explained that the essential enquiry is whether the user has been conferred a right to use identified goods for the agreed purpose during the period of the agreement, and retention of ownership by the supplier, by itself, would not determine the nature of the transaction, as ownership and the right to use goods are distinct concepts. The Court noted that the test is not whether ownership has been transferred, but whether the customer has been conferred a right to use identified goods for the purpose for which such goods are supplied, and that retention of ownership, supervision, maintenance obligations or rights of repossession by the owner does not, by themselves, negate transfer of the right to use goods.
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The Court further observed that the EDCT machines are identifiable and tangible equipment deployed at the premises of the merchant establishments, and the fact that the equipment operates through the Bank’s banking network does not take away the independent identity of the equipment. The Court rejected the Bank’s contention that the clauses contained in the Merchant Establishment Agreement which restrict alteration, modification, reverse-engineering, tampering, relocation, assignment or subleasing of the equipment negate transfer of the right to use goods, observing that such clauses are normally incorporated in commercial arrangements to safeguard the ownership interest of the supplier and ensure proper maintenance and functioning of the equipment, and the existence of such restrictions does not mean that the user has not been conferred the right to use the equipment during the subsistence of the agreement.
The Court also rejected the Bank’s contention that since it retained the ability to suspend or deactivate the terminals through its network infrastructure, effective control continued to remain with the Bank, observing that retention of supervisory or regulatory control by the owner does not necessarily mean that the right to use the goods has not been transferred. The Court observed that Section 2(29)(d) of the KVAT Act, which is enacted in the backdrop of Article 366(29A)(d) of the Constitution of India, expands the scope of the expression ‘sale’ to include a transfer of the right to use any goods for consideration, and the essential requirements are that there must be identifiable goods, a transfer of the right to use such goods, and such transfer must be for consideration.
The Court further observed that a transaction may contain different elements and may attract different levies under different statutes, provided the respective taxing fields are distinct and the statutory requirements are satisfied, and that payment of service tax on the service component does not, by itself, exclude the power of the State to levy VAT on the sale element, if a transfer of the right to use goods is established.
The Court held that the EDCT machines stand on a different footing, as they are separately identifiable and tangible equipment installed at the premises of the merchant establishments, and unlike a SIM card, the EDCT machine is not merely an identification device or a passive instrument facilitating access to the Bank’s service. The Court further observed that the material on record discloses that the Bank had collected separate charges towards rental of EDCT machines from the merchant establishments but had not disclosed the same as taxable turnover under the KVAT Act, and the Assessing Authority, the First Appellate Authority and the Tribunal have concurrently recorded a finding that such rental charges represented consideration for transfer of the right to use goods.
The Court held that in the absence of any perversity in the findings recorded by the authorities below, the levy of penalty under Section 72(2) of the KVAT Act does not call for interference in exercise of revisional jurisdiction, and the levy of interest being consequential to the determination of tax liability and being statutory in nature, also does not call for interference.
Briefly, Axis Bank Limited entered into Merchant Establishment Agreements and installs Electronic Data Capture Terminals, commonly known as swiping machines, along with connected accessories and printers at the premises of the respective merchant establishments. The Bank collected transaction-based charges known as Merchant Discount Rate or swiping commission, and also collected fixed charges under various heads including monthly terminal rental charges, installation charges, maintenance charges and allied charges in respect of the EDCT machines. The Bank treated the entire consideration received from the merchant establishments as consideration towards banking and financial services and discharged service tax under the provisions of the Finance Act, 1994.
For the assessment years 2006-07, 2007-08, 2008-09 and 2009-10, the Bank filed returns under Section 35 of the KVAT Act and the returns were initially accepted. Subsequently, during the course of proceedings initiated by the Enforcement Wing of the Commercial Taxes Department, it was noticed that the Bank had not disclosed the rental receipts collected in respect of EDCT machines as taxable turnover under the KVAT Act. Accordingly, reassessment proceedings were initiated under Section 39 of the KVAT Act, and the Assessing Authority held that the rentals collected by the Bank in respect of EDCT machines constituted consideration for transfer of the right to use goods and consequently amounted to deemed sale liable to tax under the KVAT Act, and levied tax, interest and penalty under Section 72(2) of the Act. The reassessment proceedings also resulted in levy of VAT amounting to Rs. 7 lakhs, interest amounting to Rs. 5.77 lakhs and penalty amounting to Rs. 70,700/-.
