New disputes in old VAT law: Royalties to overseas entities come back to haunt MNCs

March 30, 2019 1:51 PM

Recently the Maharashtra VAT authorities have issued notices to the multi-nationals across the state and their overseas group companies proposing to demand VAT on the royalty paid for obtaining the licenses to use trademark, technical Know-how and other intellectual property rights.

tax saving, income tax saving, life insurance, Section 80C, section 10(10D), section 80D, taxable income, last minute tax savingThe action undertaken by the VAT authorities has been suspected to arise due to the decision of the Maharashtra VAT tribunal in the case of Merk KGaA Germany.

By Sandeep Sachdeva and Arpitpushp Chaturvedi

Recently the Maharashtra VAT authorities have issued notices to the multi-nationals across the state and their overseas group companies proposing to demand VAT on the royalty paid for obtaining licenses to use the trademark, technical Know-how and other intellectual property rights. The action undertaken by the VAT authorities has been suspected to arise due to the decision of the Maharashtra VAT tribunal in the case of Merk KGaA Germany.

In the aforementioned case, Merk KGaA (appellant), a Germany-based pharmaceutical company had a subsidiary namely M/s. Merk Ltd. in Mumbai. An agreement was entered into between both the companies, which was examined by the tax authorities, and it was concluded that there was a transfer of right to use the trademark and the consideration in the form of a royalty received for such transaction was taxable in the state of Maharashtra. The matter subsequently reached to the tribunal and it has been held that royalty received as a consideration for the transfer of right to use the trademark is taxable under the sales tax laws.

In our view, the said order of the tribunal has not laid down the correct legal position. Even otherwise, the said decision passed in the facts and circumstances of the particular case, ideally, should not be applied to all the assessees in the state. It has been settled by the courts in India time and again that intangible are goods and therefore right to use intangible is covered under the purview of VAT laws.

However, the stand taken by the VAT authorities, while relying upon the Merk decision, should not hold good due to various reasons. The few key contentions are first, the parent companies situated outside India, which have no business in India, cannot be assessed under the provisions of the MVAT Act. Second, the liability of tax in respect of the royalty paid to overseas entities would only arise if the situs of the intangibles is in the state of Maharashtra. Third, the activity of transfer of right to use the intangible has to take place within the state of Maharashtra.

Therefore, there are fair chances to get success in such matters, however, the facts of each case have to be examined independently. The important factors to be considered while determining the taxability of the royalty paid to an overseas entity would be the following:

  • The nature of the agreement between the parties.
  • The place where the agreement has been signed or registered.
  • The place where the relevant trademark and other IPRs have been registered.
  • The place where the transfer of right to use such IPRs has taken place.
  • Whether the company has any business connection/permanent establishment in India.

Thus, it is only upon a determination of all the above relevant factors that the taxability of a transaction can be determined and the same would differ on a case-to-case basis. The VAT department’s knee-jerk reaction to the present matter, in light of the Merk decision, has put a lot of multinationals under huge tax risks. Though so far this issue has been raised in the State of Maharashtra, however, the possibility of VAT authorities initiating the similar proceedings in other states cannot be ruled out completely.

Interestingly, some of the corporates (overseas companies) are contemplating to ignore such notices on the ground that these are beyond the jurisdiction of the VAT authorities in the state of Maharashtra. In our view, taking such a position would lead to passing the ex-parte order which is well within the rights of the VAT authorities. Having confirmed the demand, the VAT authorities can proceed to recover the same from the Indian subsidiaries by invoking the Garnishee provisions inbuilt under the VAT laws.

Therefore, the need of the hour is that the companies should identify the crucial facts of the matter and build the suitable arguments even at the lower stage so that the facts important in the matter are placed on record at this stage itself. In our experience, there is always a challenge to bring new facts on record at a later stage of litigation if these are not taken at the lower level. There is likely chance that the issue in dispute would go to the higher forum given the fact that the whole controversy has arisen due to the tribunal decision. Hence the necessary preparation at the adjudication level would be critical to succeeding at a later stage.

(Sandeep Sachdeva is a Partner and Arpitpushp Chaturvedi is a Senior Associate at Lakshmikumaran & Sridharan Attorneys. Views are the authors’ own.)

Get live Stock Prices from BSE, NSE, US Market and latest NAV, portfolio of Mutual Funds, Check out latest IPO News, Best Performing IPOs, calculate your tax by Income Tax Calculator, know market’s Top Gainers, Top Losers & Best Equity Funds. Like us on Facebook and follow us on Twitter.

Financial Express is now on Telegram. Click here to join our channel and stay updated with the latest Biz news and updates.

Next Stories
1Quarterly Results: IDBI Bank posts Q3 net profit of Rs 378 crore as NII grows
2Enforcement Directorate initiates FEMA probe against Amazon
3Telegram rolls out WhatsApp chat migration tool for iPhone users looking to switch sides without losing conversations