IP Taxation: Know-how, Consultancy and Service Tax

As part of my promised initiative to broaden the scope of my cogitation on the blog, I intend to share my thoughts on IP taxation given my interest in taxation. Apart from the obvious need to understand IP taxation, taxation in general helps to bring greater clarity to our perception of what constitutes IP. I had written on this topic elsewhere in 2010, and this post is a slightly modified version of it.

One of the decisions I would urge our readers to read is IFFCO v. Commissioner of Central Excise ((2007)7VST 6 CESTAT) delivered by the Customs, Excise and Service Tax Appellate Tribunal (CESTAT) on whether all know-how is intellectual property.

The primary issue in this case was the applicability of the definition of “Consulting engineer” in Section 65(31) of the Finance Act, 1994 to an arrangement entered into between Indian Fanner Fertiliser Co-operative Limited (IFFCO) and Haldor Topsoe of Denmark as per Rule 2(1)(d)(iv) of the Service Tax Rules (substituted vide Notification No. 12 of 2002 dated August 1, 2003 having effect from August 16, 2002).

The question that needed to be addressed here was, whether Topsoe rendered engineering consultancy services to IFFCO? If yes, IFFCO was liable to pay service tax under Chapter V of the Finance Act, 1994 for such consultancy services in addition to penalties under the Act.

The facts leading to this issue were as follows:

1. IFFCO entered into 4 agreements with Topsoe for licensed use of Topsoe’s technology for redesigning and modifying the operation of its ammonia and urea plants at Aonla (U.P.) to make the plants more energy efficient.

2. In a statement given under Section 14 of the Central Excise Act, 1944, IFFCO disclosed that it had received taxable services worth approximately Rs.4.22 crores. The tax liability for this amount worked out to approximately Rs.34 lakhs. In addition to this, IFFCO paid an R&D cess of approximately Rs.19.5 lakhs under the R&D Cess Act, 1986. IFFCO could avail an exemption of service to the extent of the R&D cess paid, therefore, the net service tax liability would be approximately Rs.14.5 lakhs.

3. However, IFFCO argued that it was not liable to pay even Rs.14.5 lakhs since the arrangement between IFFCO and Topsoe (hereinafter “the transaction”) was one for transfer of know-how, and not for rendering technical consultancy services. According to IFFCO, the technical consultancy provided by Topsoe was integrally connected to the transfer of technology and that such integral assistance was not within the scope of the definition of “consulting engineer” under the Act.

4. The Commissioner of Central Excise held the contrary and served a show cause notice on IFFCO demanding payment of service tax with interest and proposing imposition of penalties under Sections 76 and 77 of the Finance Act.

5. IFFCO appealed to the Customs, Excise and Service Tax Appellate Tribunal (CESTAT)

IFFCO’s (Appellant) Arguments

As mentioned earlier, IFFCO contended that the transaction was one for transfer of know-how/intellectual property which could be sold or licensed. This “know-how” was a bundled package of technical information and technical assistance, and therefore, was not a service as envisaged under the Act. To make its case, IFFCO drew attention to the nature of arrangement between Topsoe and itself.

According to IFFCO, if Topsoe were a mere consultant, then IFFCO would not need to take a license for use of such technology; instead, it would have purchased the title to the technology as one whose development was commissioned by IFFCO for its use. Further, Topsoe had sought performance guarantee, which IFFCO argued proved that the transaction was not for provision of consultancy services because consultant engineers did not seek such guarantees.

IFFCO relied upon Navinon limited v. Commissioner of Central Excise where the levy of service tax was set aside on an agreement for technical know-how, expertise and services on grounds that it did not attract the definition of a “consulting engineer”. IFFCO added that since the technical-how had been received in tangible media, they constituted “goods” and therefore, the transaction was a mere purchase of imported goods.

 Besides the fact that no separate payment was made for technical assistance, IFFCO argued that such assistance was incidental and therefore was not in the nature of “consultancy”. IFFCO also submitted that since the development of technology had occurred outside India, there was no service provided in India. To support this argument, Carborundum v. Commissioner of Income Tax (Supreme Court) was cited where it was held that where advice was received from abroad, the fact that the advice was used in India did not render the advice amenable to service tax in India.

Commissionerate’s (Respondent) Response and Ruling of the Tribunal

It was argued by the respondent that the definition of “consulting engineer” included feasibility study, pre-design study/project report, basic design engineering, detailed design engineering, trouble-shooting and technical services including establishing systems and procedures for an existing plant, etc. Since all such services were actively provided for in the transaction between the parties, the respondent argued that the transaction was amenable to service tax.

Having heard both the parties, the Tribunal undertook a detailed perusal of the clauses in the agreements. It observed that although the transaction was primarily for transfer of know-how, at several places in the agreements technical assistance had been provided for. Also, the parties had agreed upon on a method of calculation of the payments to be made for such services on a man-day basis.

Further, contrary to IFFCO’s contention that no service had been provided in India, the Tribunal noted that such technical assistance was meant to be provided at the plants situated in India. Such services included an elaborate study of the plant, which obviously couldn’t have been undertaken without visiting the site in India. It was pointed out that technical assistance of this nature found specific mention in the definition of “consulting engineer”.

From paras 16-20 of the decision, the Tribunal explained in detail the meaning of know-how. It observed thus in para 19:

“”know-how” is a parcel of closely-held information relating to industrial technology, sometimes also referred to as trade secret which enables its user to derive commercial benefit from it. “Know-how” as an intellectual property, would mean a proprietary series of practical, non-patented knowledge, derived from the owner’s experience and tests, which is secret, substantial, and identified…. “Know-how” must be described in a sufficiently comprehensive manner in order to verify whether it meets the secrecy and substantiality criteria.”

In other words, according to the Tribunal, know-how which was out in the public domain and which did not need special knowledge or training for it to be put to use was not intellectual property.

The Tribunal observed that there was no denying that the transaction between the parties primarily dealt with transfer of know-how/intellectual property; the factum of provision of technical assistance by Topsoe to IFFCO proved this further. That said, such technical assistance was not subsumed within the know-how and fell squarely within the definition of “consulting engineer”.

The Tribunal took a middle path between the arguments of IFFCO and that of Commissioner of Central Excise; it held that neither was the transaction completely one for transfer of know-how nor was it entirely for provision of services. It was for both; also, the agreements envisaged two separate methods of payment for each of the components. Therefore, since only a portion of the outstanding tax liability of Rs.14.5 lakhs was for technical assistance, only such portion could be recovered from IFFCO. The approach of the Tribunal does seem reasoned and reasonable.

One of the issues that this decision also raises and partly addresses is- what is the “situs” of a service? I mean, where exactly is a service truly rendered? How would that question be addressed in the context of an opinion rendered by a foreign entity to an India-based party? I’ll address this issue in the next post.