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'Transfer Of Right To Use'- The Conundrum Continues!

Published on Thu, Sep 11,2014 | 13:30, Updated at Thu, Sep 11 at 13:30Source : 

By: Rakesh Nangia, Managing Partner, Nangia & Co

'Transfer of right to use' has been an area of eternal litigation in Indirect taxes in India, the primary dispute being whether such transactions attract Service tax or Value Added Tax ('VAT').  In order to appreciate the issue involved, it becomes imperative to understand the genesis of taxation of transactions involving 'transfer of right to use' under Indirect taxes in India.

Sale, including a deemed sale, attracts Central Sales tax/ VAT in India, depending upon whether such sale is an inter-state sale/ intra-state sale. Taxation of 'transfer of right to use any goods' was introduced in 1982 by insertion of sub-clause 29A(d) in Article 366 under the Constitution of India ('Constitution') for defining 'tax on the sale or purchase of goods' [i.e. a 'deemed sale'].  

In 2008, the taxable service category of supply of tangible goods for use ('SOTGU service') was introduced under section 65(105)(zzzzj) of the Finance Act 1994 ('Act'), to bring under the ambit of service tax transactions involving supply of tangible goods (eg. machinery, equipment and other appliances etc.) for use, where the legal right of 'possession' and 'effective control' was not transferred to the hirer.  In other words where a hiring arrangement involves transfer of effective control and possession, VAT is attracted, else, service tax is levied.  

Practically taxation of 'transfer of right to use' is not simple as it appears.  For a transaction to qualify as a 'transfer of right to use' (and be exigible to VAT) it is essential that 'effective control' and 'possession' should be transferred from the hirer to the hiree.  The terms 'effective control' and 'possession' have not been defined either under VAT or Service tax legislation, thereby leaving the interpretation of these terms to the judiciary.  

Various judicial precedents have provided certain guidelines in this regard.  In 1990, the Andhra Pradesh High Court in the case of Rashtriya Ispat Nigam Ltd.  stated that where the owner of the equipment retains the effective control over the equipment, in that case there is no transfer of right to use.

The Supreme Court in 2006 in the case of Bharat Sanchar Nigam Ltd.  inter alia held that in a transaction involving transfer of the right to use the goods:

-    The transferee should have a legal right to use the goods - consequently all legal consequences of such use including any permissions or licenses required therefore should be available to the transferee;
-    For the period during which the transferee has such legal right, it has to be the exclusion to the transferor -this is the necessary concomitant of the plain language of the statute - viz. a "transfer of the right to use" and not merely a license to use the goods; and
-    Having transferred the right to use the goods during the period for which it is to be transferred, the owner cannot again transfer the same rights to others.”

In addition to the above, various other judicial pronouncements have highlighted distinguishing attributes of 'effective control' for determining transfer of right to use, each providing a distinct parameter, some of them being construction of the true nature of contract between the parties, right of usage of the property, ownership of risks and rewards, exclusivity/ non-exclusivity of goods, transfer/ vesting of legal rights and obligations in relation to the goods, intention of the parties etc.

Despite various judicial pronouncements, there is still lack of clarity on as to what should constitute 'effective control' and 'possession' especially in cases involving provision of equipment by an operator to a customer on rental basis, where such equipment is to be operated by the personnel/ manpower of operator. In such cases confusion exists on whether Service tax or VAT should be discharged by the operator on the rentals. Given that the machines are operated by Operator's manpower, it is important to determine whether there is transfer of effective control and possession from the operator to the customer and consequently whether VAT or Service tax should be discharged on the rentals. VAT Authorities in such cases contend that there is transfer of right to use based on various judgments including the decision of the Gauhati High Court in the case of HLS Asia Limited v State of Assam , in which it was held that delivery of physical possession of goods is not an essential pre-condition to determine if the transaction constituted a transfer of right to use goods. However, in 2012, in the case of Aban Loyd Chiles Offshore Limited , the Division Bench of the Madras High Court held that effective control and possession of drilling equipment was not transferred in a case where drilling rigs were operated by personnel of the transferor, as per the directions of the transferee.

Thus the conundrum as to whether a transaction involves transfer of effective control and possession continues even after decades of evolution of this concept and the same is still dependent upon the facts of each case, which each taxing authority (VAT and Service Tax) interprets to its own advantage thereby encouraging litigation.

W.e.f 1 July 2012, a paradigm shift in the taxation of services in India was brought about by way of introduction of the Negative List regime. Under the Negative List regime, the definition of 'service' under section 65B(44) of the Act specifically excludes transfer, delivery or supply of any goods which is deemed to be a sale within the meaning of clause (29A)(d) of Article 366 of the Constitution. Further, as per section 66E(e) of the Act, Transfer of goods by way of hiring, leasing, licensing or in any such manner without transfer of right to use such goods has been defined as a 'declared service'.

Given the confusion surrounding transactions involving transfer of right to use, the industry was hoping appropriate provisions would be introduced regarding the manner of ascertaining whether a transaction constitutes a 'transfer of right to use' or atleast devise a mechanism to reduce litigation on such transactions. However the same does not appear to be the case. Therefore it becomes extremely important that proper guidelines be put in place to determine what constitutes a 'transfer of right to use' (i.e. what constitutes a transfer of effective control and possession) in tangible terms.  However in the current scenario it seems that 'transfer of right to use' would continue to be an area of litigation, resolution of which cannot be delayed till the introduction of the Goods and Service Tax regime in India.


[i] [1990]77STC182(AP)

[ii][2006] 3 STT 245

[iii] (2007) 8 VST 314 (Gau HC DB)

[iv] (2012) 53 VST 89 (Mad HC DB)


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