GST is expected to deal with the dual taxation issue over time, but there has to be clarity in the interim
Intellectual property (IP) such as patents, copyrights and trade secrets and software are classified as intangible property. They are considered intangible because they are totally divorceable from the tangible property in which the intellectual element is embodied. IP law and taxation has been the subject of considerable development, globally and in India, over the past years. From a global perspective, absent any differential tax treatment, most VAT/GST implementing countries are agnostic to characterisation of intangibles. That said, from the perspective of defining tax jurisdictions as well as compliance procedures, intangibles have been accorded the status of services internationally. On the other hand, levy of indirect tax on intangibles in India has always been a matter of dispute, and that dispute is far from being settled.
Under the existing indirect tax laws, intangibles can be taxed under service tax or VAT depending on whether the transaction qualifies as one in services or goods, respectively. However, in certain cases, considering the ambiguity surrounding chargeability of service tax by the Union government and VAT by respective state governments on intangibles, the industry has been playing conservative and discharging both VAT and service tax. This paradox stems from the fact that constitutionally, while the Union government can levy tax on intangibles only if it qualifies as services, the state governments can levy tax on it, if it qualifies as sale/deemed sale of goods. Since, intangibles form a substantial portion of the net worth of many businesses, both the Union and state governments see it as a low-hanging fruit as far as tax revenue collections are concerned.
Following the landmark Supreme Court judgment in the case of TCS, the state governments have been levying VAT on canned/branded/packaged software. Internationally, too, canned/packaged software are classified as goods in several jurisdictions. However, temporary transfer or permit of use or enjoyment of IPR and designing, upgrading, adapting, implementing activities, etc, related to software have been classified as service for levy of service tax.
The dual taxation of intangibles appears to be on the rise. Coupled with this, is the lack of clarity in the tax treatment of emerging digital instruments such as cloud offerings, e-vouchers, e-wallets, etc. In a dynamic business environment, several emerging transactions and business models—for instance, franchisee arrangements, user rights, licenses, entitlement certificates, carbon credits, etc— continue to grapple with uncertainty.
This tug of war between the Union and state governments, to collect tax on transfer of intangibles, is expected to end with introduction of Goods and Service Tax (GST) wherein both the Union and state governments would be allowed to collect tax equally on the same transaction.
With GST close to becoming a reality, it is time that the Union and the state governments come to a common ground regarding their respective jurisdictions as far as taxation of intangibles is concerned. The issue seems to be within the radar of the drafting committee for GST laws. The draft Model GST law issued in June 2016 specifically excluded intangible property from the definition of goods and included it under the definition of services (much in line with the international experience/ practice). This position was however undone in the November 2016 version of the Model GST law. While intangibles per se may be classified as goods, business transactions concerning intangibles are mostly in the nature of licensing/non-exclusive rights to use/exploit commercially. Given this, such transactions could still be effectively taxed as services (with exceptions).
Further, activities related to information technology software, presently classified as declared service, have been expressly declared as supply of service under the model GST law, thereby, bringing back the age-old dilemma whether supply of software is a supply of goods or of services.
Intangibles, being one of the most disputed indirect tax subjects, require clarity, particularly when we are looking forward to a big leap in the indirect tax regime via the implementation of GST. Though GST may not resolve the issue immediately, it must settle the issue over time. With each goods and service supply required to be reported as per the applicable code under the GST regime, the need is to wait and watch whether the government notifies intangibles under the goods codes (HSN) or service codes (SAC). One more aspect where the government should come out with clear guidance without leaving room for ambiguity is the place of supply for transactions in intangibles, clearly identifying the taxing jurisdiction for various transactions.
With increasing economic relevance of intangibles, clarity in taxation of intangibles can boost the growth prospects of the Indian economy. While the Union government’s quick action on moving towards “one nation, one tax” is quite visible, it remains to be seen what initiatives it takes towards fixing the issue the multi-billion-dollar intangibles segment faces.
With inputs from Poonam Harjani, director, and Dhiraj Agarwal, associate director, BMR & Associates LLP
The author is leader (indirect tax), BMR & Associates LLP.
Views are personal