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Double taxation in indirect tax law ?
April, 13th 2009

Earlier articles in this column had highlighted the problem with regard to double taxation of a particular transaction under the indirect tax laws that are prevalent in India today. The central problem is with regard to the taxation of a transaction as both a supply of goods as well as a provision of service, with the tax consequence of both the State VAT and the service tax being applicable thereto.

The advent of the Goods and Services Tax (GST) could considerably mitigate, if not all together eliminate, the problem and for this reason alone, its earliest possible introduction is very desirable.

In yet another illustration of the serious challenge faced by taxpayers in regard to double taxation, the Karnataka High Court, in a recent decision in Bharti Airtel Ltd. Vs State of Karnataka (2009-TIOL-99) has held that a particular transaction was chargeable to the State VAT, as a sale of goods, notwithstanding the factual position that it had already been charged to the service tax, as a provision of service.

This decision has taken note of the decision of the Supreme Court in Bharat Sanchar Nigam Ltd. Vs. UOI (2006) 145 STC 91) and nevertheless has come to the above conclusion. In this case, the issue at hand was the taxability of the provision of broadband connectivity by the assessee to its subscribers.

On the particular point of whether the activity of provision of broadband connectivity would at all amount to a supply of goods, as opposed to a provision of service, the High Court considered the technical aspect of the matter in very great detail. It also took note of the decision in the BSNL case (ra) that transfers of the right to use electromagnetic waves or radio frequencies could not be charged to the sales tax or State VAT since they did not constitute goods, for the purpose of Article 366 (29A) of the Constitution of India.

The High Court distinguished broadband connectivity from electromagnetic waves and held that the provision of such connectivity amounted to a sale of light energy and was hence taxable under the Karnataka VAT Act 2003, as a sale of goods. In other words, the Court held that broadband connectivity was essentially the ability to carry data through an optical fibre network whereby light energy was created at the time of commencement of transmission of data/information and was extinguished once the data/information was delivered at the place of intended destination.

The High Court distinguished such energy from electromagnetic waves, which were incapable of abstraction as they traveled through free space from one point to another and were also not extinguished for that reason. Sice broadband was qua the optical fibre network, the properties of goods were attracted to the case in point.

The Court then took up the point that the provision of broadband connectivity to its subscribers had already been charged to service tax. It must be mentioned here that the Union Government was also a respondent in this particular appeal and had argued that the appellants had rightly discharged service tax on the activity and that the Court should, if at all it came to the conclusion that the transaction amounted to a sale of goods, nevertheless hold that the appellants were liable both for the service tax as well as the State VAT.

The appellants argued that they had entered into service level agreements with subscribers in relation to the provision of broadband connectivity and it was clearly demonstrated consequently that the dominant objective and intent was the provision of service.

Hence, even if there was a determination that a sale of goods had taken place, it could only be incidental to the aforesaid dominant objective. Consequently, in terms of the decision in BSNL, the lease rentals received from the subscribers for the provision of broadband connectivity could not be taxed under the VAT laws but could only be taxed under the provisions of the service tax laws.

The High Court took note of the decision of the Supreme Court in State of UP Vs. UOI (2003-TIOL-14) in regard to composite contracts for sales and services. In particular, it took note of the observation therein that an activity could be regarded under one statute as a sale of goods and equally as a provision of services under another statute.

Accordingly, the High Court came to the conclusion that in the case in point, the activity of provision of broadband connectivity did undoubtedly answer the description of sale within the meaning of the Karnataka VAT law and was taxable therein notwithstanding that the same activity was also correctly held to be a service under the Finance Act 1994.

On the dominant nature test, the High Court concluded, based on a scrutiny of the underlying documentation with regard to the recovery of lease rentals from subscribers, that the dominant intent was actually the sale of artificially created light energy and that the provision of infrastructure in the form of the optical fibre network to facilitate the carrying of the data/information, which alone could constitute the service element in the contract, was only ancillary to this intent.

Thus, the Court determined that the dominant nature of the contract was one for sale of goods and rejected the arguments that the dominant nature of the contract was the provision of service. Thereupon, the High Court held that given the inability of separation of the service and sale element in this particular composite contract, the entire consideration received by the appellant from its subscribers towards lease rentals would be chargeable to the VAT. In arriving at this conclusion, the High Court again relied upon the decision of the Supreme Court in State of U.P. vs. UOI (supra).

It can thus be seen that the High Court has come to a conclusion which clearly brings about a double taxation of one transaction to both the goods tax and the service tax, based purely on a determination that the transaction was essentially one for sale of goods and not for provision of service.

The Court has apparently concluded that this determination can be done by each of the two taxing authorities in question and if such respective determinations resulted in a double taxation of a transaction that was an unavoidable legal consequence and that there was nothing improper or illegal as a result.

The central point of the BSNL case regarding the need for taxing entries in the respective statutes for goods and services to maintain exclusivity appears to have been either overlooked or impliedly understood and interpreted in a particular sense.

It was commonly understood subsequent to the BSNL judgement that the dominant nature test in relation to composite contracts other than those specifically covered by Article 366 (29A) could only result in a determination of either a sale of goods or a provision of service and not both.

To be sure, the Supreme Court in the above case did not lay down rules as to how the problem of double taxation could be effectively avoided by a proper application of the dominant nature test by one or the other of the taxing authorities and not by both. Therein lies the problem.

This decision of the Karnataka High Court once again brings to the fore the real and persistent challenge faced by tax payers with regard to double taxation under indirect tax laws of a particular transaction to both the goods and the service tax.

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