Some Transactions Fall Between Service Tax And Vat
Some transactions fall between service tax and VAT
September, 15th 2008
A recurring challenge in indirect taxes is that of double taxation of a single transaction. The challenge comes
about because a particular transaction is both deemed to be a supply of goods, in terms of the State sales tax/value added
tax definitions, as also a provision of services, under the central service tax law.
The Supreme Court, in its decision in Bharat Sanchar Nigam Ltd Vs UOI [(2006) 145 STC
91], had of course held that double taxation was impermissible and that transactions could only be charged to one of the
two taxes and not to both.
An equally important challenge however is the prospect of double non-taxation in that a transaction is neither
charged to the State VAT nor to the central service tax. Of course, pure services which are currently outside the ambit of
service tax law and which are unrelated to the supply of goods are not charged to any indirect taxes at all at present but the
challenge is really with regard to those transactions which are intended to be taxed but which not charged to either the VAT
or the service tax as a result of the wordings of the underlying provisions contained in the respective statutes and their
interpretation by the Courts.
One such challenge was with regard to the taxation of the transfer of the right to use tangible goods. Now, it is an
obvious point that the relevant tax in relation to such transactions of goods would be the sales tax or VAT. Prior to the 46th
Amendment to the Constitution of India in 1983, only the outright sales of goods were chargeable to the sales tax. It was
only subsequent to this landmark amendment that several categories of ‘deemed sales’ of the kind described thereunder
were also charged to the State sales tax law.
One such category of deemed sales related to the transfer of the right to use goods. Consequently, while there was
no sale of goods, in that property and ownership in goods was never transferred, nevertheless transfers of the right to use
such goods were brought within the ambit of the sales tax.
This has led to a spate of litigation on what constitutes a transfer of the right to use, in order for the sales tax to
apply. In a landmark case, the Andhra Pradesh High Court in Rashtriya Ispat Nigam Ltd. Vs. CTO 
43 STL 67) held that in terms of the particular contractual agreement under reference, the effective control and
possession of the machinery that was used in the execution of the contracted works continued to remain with the person
who supplied the machinery for the purpose.
In the instant case, it was the company which was the owner of the project in question that had supplied the
machinery in order for the contractor to put up the works.The Court held that there was no transfer of the right to use the
machinery in the complete absence of passage of control over the economic benefit of the property.
Following this decision, several other high courts have held to similar effect that unless there was transfer of
effective control over the goods, the sales tax or VAT laws cannot apply. Two recent decisions in this regard have been by
the Allahabad High Court in Commissioner of Trade Tax Vs. UPSRTC 16 VST 226) and
Commissioner of Trade Tax Vs. Nand Transport Co.  16 VST 381).
It is therefore settled that in the absence of any transfer of the right to use the underlying goods, the VAT laws will
not apply. Such transactions were therefore outside the purview of the goods tax and were equally outside the purview of
the service tax as well.
However, the recently introduced definition of the service of supply of tangible goods is intended to address this
particular matter of the double non-taxation of a transaction which was intended to be taxed but was not so taxed, as a
result of the above case law. This new definition states that any service in relation to supply of tangible goods including
machinery, equipment and appliances for use, without transferring the right of possession and effective control thereof,
would be charged to the service tax.
Since such a transaction does not, in terms, amount to a transfer of the right to use goods, the idea is to charge it to
the service tax since the goods tax in the form of the VAT cannot apply. The key expression in this definition is ‘without
transferring the right of possession and effective control’. This expression is almost entirely extracted out of the above
decisions of the Courts on sales tax and the endeavour is quite clearly to tax such a transaction to the service tax.
The issue of whether a transaction where the right of possession and effective control is not transferred is taxable
under service tax law has been discussed in relation to certain other definitions of taxable services as well, such as ‘rent a
cab’ operator services as well as ‘intellectual property services’. In relation to rent a cab operator service, the key words are
with regard to the ‘renting of a cab’.
In a situation where cab services are procured without the control and possession of the cab being transferred to
the user, the question was whether the definition would apply at all. As regards intellectual property services, the issue is
slightly more complicated as it extends not only to temporary transfers but also to transactions whereby the use or
enjoyment of an intellectual property right is permitted.
There have been several instances where the application of these other definitions has been seriously disputed, in
the absence of a ‘transfer’ of the underlying goods. However, with the introduction of the definition of supply of tangible
goods services, it clearly is the position that in all such instances the service tax will now apply. The VAT will not apply
and thus only the one indirect tax will be charged.