Introduction

Prior to the introduction of GST, the Union Government had the power to levy tax on Intellectual property rights (hereinafter referred to as 'IPR' or 'IP rights') if they fell under the ambit of 'service', while the State Governments levied tax if they fell under the ambit of 'sale or deemed sale' of goods. Since the entire system and scope of levy was based on classification of a transaction, either as good or as services, often assessees faced the rigours of double taxation as one single transaction was subjected to both Sales and Service Tax. The pre-GST regime witnessed enormous litigation on classification disputes, which concluded in the Courts looking closely at the transactions to determine the nature and scope for classification as goods or as services.

The introduction of the concurrent levy-based system in GST, attempted to fill the classificational loopholes existing in the earlier regime by insertion of Schedule-II to the Central Goods and Services Tax Act, 2017 which provides for a deeming fiction to treat temporary transfers of IP rights as supply of services. Though GST provides a more comprehensive framework as it fills the gaps prevalent in the previous regime, recent observations of the Supreme Court spring out new unsettled questions of interpretation taking us back to the starting point.

Three-member bench of the Supreme Court in the case of Engineering Analysis Centre of Excellence Pvt Ltd. v. Commissioner of Income Tax - 2021-VIL-37-SC held that the sale of copyrighted products/goods for re-sale amounts to 'sale of goods' as opposed to payment of 'royalty' for transfer of any rights and will be outside the scope of section 9(1)(vi) of the Income Tax Act, 1961. Though the judgment has been delivered in light of the provisions of the Income Tax laws, it has significant implications under GST as well. This article proposes to analyze the same in detail and bring to light the implications of the judgement under GST.

Primer on the nature of IP Rights

Intellectual property ("IP") such as Copyrights, Trademarks, Patents arise from the application of intellect and may be in the form of inventions, designs, literary works, software, processes, books, etc. (MF(DR) circular No. B2/8/2004-TRU dated 10-9-2004). They are intangible in nature when compared with tangible goods as they primarily may or may not have a tangible form. In Vikas Sales Corporation v. CCT - 1996-VIL-07-SC, the Supreme Court held that IP rights are rights in personam and can be transferred. The Court also recognized that such transfer is capable of determination as 'Sale of goods.' IP Rights when transferred may partake the form of either supply of goods or services depending upon the nature of transaction entered between the parties.

Levy of GST on transfer of IP Rights

The GST law unlike its predecessors decoded classification issues by providing comprehensive schedules and definitions for determining classification as a good or a service. Schedule-II enumerates classification of activities as either supply of goods or as supply of services and entry 5(c) by way of a deeming fiction classifies temporary transfer or use or enjoyment of IP to be a 'supply of service.' Permanent transfer of IP rights as 'supply of goods or services' is dependent on the nature, scope, intent and terms of agreement between the parties.

Thus, it can be understood that though IP Rights itself may be a 'good', a license to use or enjoy IP Rights or temporary transfer of IP Rights is a 'service'. The assignment or permanent transfer may be classified as sale of goods or supply of services depending on the nature of transfer.

Further following are the rates on the temporary and permanent transfers of IP Rights as goods/services:

Also, to clear the confusion pertaining on taxation of IP and to obviate litigation, the Department via Press release dated 10.11.2017, proposed a rate of 12% (18% for IT software) for permanent transfer irrespective of whether the transfer amounted to supply of goods or supply of services. Since the rate is the same on both, no serious implications on classification of permanent transfers arise.

Ratio in Engineering Analysis case

Under income tax law, a number of parallel decisions were passed by various High Courts relating to the classification of payments made to a non-resident entity for sale of shrink wrapped/packaged software to distributors and end users in India. The Department contended such income to be Royalty, whereas the Assessees considered the same to be business profits arising out of sale of goods. The full bench of the Supreme Court, putting an end to the conundrum, categorically held that, 'what was licensed by the non-resident supplier to the distributor and sold to the resident end user is merely a sale of a physical object which contains an embedded computer program, and is therefore, sale of goods".

The reason being, the right granted to the distributor is only a non-transferable license to resell computer software and no copyright is being transferred either to the distributor or to the end user. There is per se no 'right to use' or 'right to reproduce' or 'commercially exploit' the copyright in the product given to the distributor, or any 'right to sub-license' or 'transfer' or any 'right of reverse engineering, modification or reproduction' other than the ones permitted by the license to the end user.

Only when the owner of the copyright assigns wholly or in part any of the rights contained in section 14(b) of the Copyrights Act, 1957 i.e., right to reproduce or commercially rent the programme, the assignee of such right becomes entitled to all such rights compromised in the temporary/permanent assignment of copyright; and shall be treated as the owner of the copyright of what is assigned (see section18(2) & 19(3)). In simpler words, a right to reproduce a computer programme or exploit reproduction by sale, transfer of license lies at the heart of the exclusive transfer of copyright.

In the present case, the distributor pays no consideration for any transfer or interest in IP, he is merely selling the medium as goods. Only when the agreement proposes a transfer of copyright or a right to use as understood under the Copyrights Act, 1957, such activity can amount to temporary or permanent transfer.

Implications under GST: Ratio in Engineering Analysis

The decision of the Supreme Court clearly distinguishes between transfer of a copyright and a copyrighted article. A mere right to sell copyrighted goods is different from the licensing of a copyright, as a license permits a right to use or enjoy the IP. Where the medium in which the software is stored is resold by the distributor to the end-user in India, he has no right to use or no title to the IP and the distributor's profit margin is based on resale of the medium the same will be regarded as sale of goods. The line of thought as propounded in the judgment, has opened a new dimension of looking at the two-fold classification currently existing in Schedule II entry 5(1)(c) which will open the pandora box of disputes relating to classification and determination of rates on such copyrighted articles.

It is important to highlight that post introduction of the GST, the Industrial practice followed for the sale of shrink-wrapped/packaged software has been to classify the same as a temporary transfer considering entry 5(1)(c) of Schedule II and to pay tax accordingly.

Now looking carefully at the IP transactions in light of the decision of Supreme Court, even after the introduction of GST classification disputes are likely to arise where person is not engaged in licensing/ assignment of IP rights nor have any right to use such articles but is merely selling the articles loaded with such IP. The Supreme Court observed that the license granted through the End User License Agreements (EULA) in a shrink wrapped/packaged software do not qualify as license in terms of section 30 of the Copyright Act,1957 as they are not transferring interest in any right but are in form of restrictions imposed on use of software which are differentiable from temporary/permanent transfer in GST. In words of the Supreme Court in the said case

"A licence from a copyright owner, conferring no proprietary interest on the licensee, does not entail parting with any copyright, and is different from a licence issued under section 30 of the Copyright Act, which is a licence which grants the licensee an interest in the rights mentioned in section 14(a) and 14(b) of the Copyright Act. Where the core of a transaction is to authorize the end-user to have access to and make use of the "licensed" computer software product over which the licensee has no exclusive rights, no copyright is parted with and consequently, no infringement takes place, as is recognized by section 52(1) (aa) of the Copyright Act. It makes no difference whether the end-user is enabled to use computer software that is customised to its specifications or otherwise."

To sum up, the licence for sale or the use of a product in the absence of proprietary interest cannot be construed as the licence spoken of in section 30 of the Copyright Act, and hence will not constitute transfer under entry 5(1)(c) of Schedule-II. A mere sale of a copyrighted article will not be per se covered under the scope of entry 5(1)c of Schedule-II. The determination of whether an activity amounts to 'transfer' would require some exercise of fact finding, which will vary on a case to case basis so as to understand the nature of the license/right by lifting the veil of the agreement. In a case where there is no temporary/permanent transfer of rights in IP in the article, it will be an outright sale of goods in form of copyrighted article. However, since there is no rate prescribed in the rate notification for sale of copyrighted article, such supplies will find mention under the residual entry taxable @ 18% instead of 12% as applicable on temporary/permanent transfer of IP (other than IT software).

Another aspect was set out in the judgment as under:

". the distributor cannot use the computer software at all and has to pass on the said software, as shrink-wrapped by the owner, to the end-user for a consideration, the distributor's profit margin being that of an intermediary who merely resells the same product to the end-user."

Thus, an important question which will arise for consideration is whether these distributors will fall under the definition of 'intermediaries' under GST instead of being sellers of the copyrighted articles and hence the tax implications might change accordingly.

Conclusion

Though the judgment has been delivered in the context of income tax, the ratio of the SC will have major implications under the GST regime.