Service Tax Liability on Technical Knowhow:

A Contentious Issue

 

Apoorva Neral

5^th Year Student, Hidayatullah National Law University, Raipur

 

ABSTRACT:

A service tax is a tax to generate revenue on the transfer of services. Any service provided or to be provided, to a client, by a consulting engineer in relation to advice, consultancy or technical assistance in any manner in one or more disciplines of engineering is called taxable service. This Article pertains to study service tax liability on such technical knowhow. It deals with the notion, construction, legality, underlying principles, and corresponding laws, rules for applicability, and pros and cons of the topic of the present Article. Thus, this article emphasizes and stresses on every aspect of the aforesaid concept giving the best understanding of it. It is analytical and descriptive in nature and doctrinal in approach.

 

INTRODUCTION:

Service tax is said to be the tax of new millennium. The basic idea behind levying service tax is to generate revenue on the transfer of services. There is no specific law to regulate service tax; however, it is currently levied under Finance Act, 1994. There are nearly 109 services specified under Finance Act on which tax is leviable.

 

The present paper is dedicated to study service tax liability on technical knowhow. The taxation on technical knowhow has become a contentious issue due to the inherent ambiguity in the law. The author has concentrated on five different areas. In the first chapter, the author has very briefly discussed the nature of service tax. The second paper throws light on the consulting engineering services. The discussion on consulting engineering is important because the tribunals and courts have several times justified the levy of service tax on knowhow under this head. The author has tried to reflect on the basic nature of this item and the areas covered in this category. The discussion in this chapter will help in studying the various judgments in favor of the authorities justifying the levy of tax under this category.

 

The third chapter of the paper focuses on the nature of technical knowhow. In this part, we have tried to find out whether knowhow has all the characteristics of intellectual property. This study is essential in arguing the levy of service tax under IP services category. In fifth and the last part, we have briefly discussed few decisions given by the courts and tribunals on this issue. The author has tried to bring out the inconsistency in the various decisions.

 

Finally, the purpose of the present study has been to try and find out a solution for the ambiguity in the law.

 

 

NATURE AND SCOPE OF SERVICE TAX

Service tax is said to be the tax of 21^st century. It was first of all introduced in 1994 and ever since it has been increasing its frontiers. Service tax means tax leviable under the provisions of chapter V of Finance Act, 1994. ¹

 

Nature of levy of Service Tax:

There is no “Service Tax Act.” Service tax is imposed under Finance Act, 1994. Section 66 of the said Act is the “charging section” of Service tax. Section 66 provides that there shall be levied a service tax @ 10.30% (including education cess and SAH education cess) w.e.f        24.02.2009. ²

 

Service requires two parties. One cannot give service to itself. ³ Service tax cannot be levied on goods. There are two essential things to be determined in each type of service, first, taxable service and second value of taxable service.

 

Taxable Service:

As per Section 66 of Finance Act, 1994, service tax is payable on ‘taxable service’. Section 65(105) of Finance Act, 1994 defines what is ‘taxable service’. The definition is different for each kind of service.

 

Constitutional Background:

There is no specific entry in union list for service tax. Henceforth, service tax is presently collected under powers of Entry 97 only which reads, ‘Any other matter not included in List II, List III and any tax not mentioned in list II or list III’.

 

CONSULTING ENGINEER’S SERVICE

Section 65(105)(g) of the Finance Act, states that any service provided or to be provided; to be a client, by a consulting engineer in relation to advice,  consultancy or technical assistance in any manner in one or more disciplines of engineering including the discipline of computer hardware engineering but excluding the discipline of computer software engineering, is a taxable service.

 

Further, section 65(31), “consulting engineer” means any professionally qualified engineer or anybody corporate or any other firm who, either directly or indirectly, renders any advice, consultancy or technical assistance in any manner to a client in one or more disciplines of engineering.

 

Widening the scope of “consulting engineer’s service”: way to controversies:

The Courts and tribunals widened the scope of consulting engineer’s service to a large extent. This widening of the term gave way to many controversies. Here we will look at few judicial interpretations which extended the scope of this term.

 

In Bharat Sanchar Nigam Ltd. and others v. Union of India⁴, the SC held that, the consulting engineer’s services includes not only advisory assistance involving cerebral activity of professional but also implementation of their advice and no distinction can be made between the two. It would also include training of personnel, software support, operation/maintenance, emergency support, technical consultancy, etc. In Nokia (I) Pvt. Ltd. v. CCE⁵, the tribunal was of the opinion that the expression ‘consulting engineer’ cannot be understood narrowly. However, in Bharat Fritz Werner v. DCCE⁶, the tribunal stated that mere supervision, inspection and training is not consulting engineering service. 

 

TECHNICAL KNOWHOW AS INTELLECTUAL PROPERTY

Technical knowhow means a body of accumulated knowledge and experience in any technical field for doing or executing a particular activity. Knowhow is commercially valuable knowledge. It may or may not be trade secret, may or may not be patentable. However, it’s very difficult to define knowhow.

 

The difficulty in defining knowhow has led to the difficulty in its legal protection as well. Knowhow can vary from a “trick of trade” to a very large collection of drawings and instructions manuals dealing with the running of a large plant.  The expression “knowhow” essentially means practical and useful information and is secret. However, in Stephenson Jorden and Harrison Ltd. v. Mcdonald and Evans⁷, lord Evershed observed “knowhow seems to me to indicate something quite different from secret and confidential information. It indicates the way in which a skilled man does his job and is an expression of his individual skill and experience…..in practice the best result is obtained not merely by following all the directions from the book, but the way in which the experienced man carries out those directions.”

 

Again in BE. GELB Consultancy Services v. CCE⁸, the CESTAT observed that an agreement which envisages provision of technical know to manufacture automotive chains and ancillary equipment for the purpose, is in the nature of intellectual property and intangible. The tribunal confirmed that technical knowhow is intellectual property. Likewise, in Modi-Munidpharma Private Limited v. CCE, Meerut⁹, the tribunal noted that an agreement for the right to use the knowhow for the manufacture of certain medicines will be covered by the definition of “Intellectual Property rights” service as defined in section 65 (55a) of the Act. There are differences as to whether technical knowhow is a part of intellectual property rights or not but it is crystal clear that knowhow has sufficient characteristics to be considered as an intangible property.

 

Trade Secret:

Article 39 of TRIPS stipulates that undisclosed information, often treated with synonymous with trade secrets, can be protected as provided for in Article 10 bis of the Paris Convention. However, TRIPS does not define trade secret. Trade secret is generally accepted as the information that is not accessible to the persons other than those to whom it is divulged, has commercial value because it is secret, and the owner of the secret has every intention to treat it as secret. ¹⁰ For instance, process details, drawings, compositions, formulae, business models and information on inventions on which patent applications have not been filed or even those which may not qualify for patents would also be treated as trade secret. ¹¹

 

The nature and methodology to protect trade secret differ from country to country. In many countries it falls under privacy laws, in others under unfair competition and in yet others under breach of contracts, trust or confidence. ¹²

 

Protection of Trade Secret: A study of Existing Laws in USA and India

In USA, Uniform Trade Secret Act (Hereinafter “UTSA”) regulates unauthorized commercial use of a trade secret by a third party. Apart from that, a federal law, the Economic Espionage Act 1996 (Hereinafter “EEA”)   gives the attorney general sweeping powers to criminally prosecute a person for appropriating trade secrets. The EEA has provisions for punishing both provider as well as the receiver of unauthorized trade secrets. ¹³

 

Even though India is obliged to adhere to WTO, there is absolutely no law to protect trade secrets apart from the normal recourse to breach of contract provisions. Henceforth, there is no law regarding Intellectual property rights which governs trade secret.

 

Legal protection of knowhow varies from country to country. However, unlike copyright, patents and trademark, one cannot get exclusive legal right of protection on knowhow by registration.

 

IP SERVICES UNDER FINANCE ACT, 1994

The Finance act, 2004, explicitly included “Intellectual Property services” other than copyrights under the purview of service tax under Clause 9.1 of the Act. The definition of taxable service includes only such IPRs (except copyright) that are prescribed under law for the time being in force. IPRs covered under Indian law in force at present, alone are chargeable to service tax and IPRs, like integrated circuits or undisclosed information (not covered by Indian law) would not be covered under taxable services. It is clear that if there is no clear mandate of the legislature the government cannot charge service tax on any IP which is not covered under the Indian law for the time being in force. ¹⁴

As it has been discussed above that technical knowhow has not been defined as such anywhere and there is ambiguity regarding its definition. Henceforth, service tax knowhow cannot be levied under the head of IP services in India.

 

COURTS/TRIBUNALS APPROACH TOWARDS SERVICE TAX LIABILITY ON TECHNICAL KNOWHOW

1.         Technical Know-How is Not Exigible Under Engineering Consultancy

In BE. GELB Consultancy Services v. CCE¹⁵ the CESTAT observed that when IP services were brought under the net of service tax without altering the scope of “Consulting engineer services” the new impost covers an activity hitherto not exigible to service tax under the head of consulting engineer. A transaction in intellectual property along with the right to manufacture the licensed product is totally different from the technical assistance rendered by an engineer or a firm of engineers. Apart from this the tribunal also observed that technical knowhow is in the nature of intellectual property and hence cannot be taxed under consulting engineer service. Similarly, in Motherson Automotive Tech and Engg. v. CCE¹⁶  the tribunal observed that the appellant did not receive engineering consultancy when it receive technical knowhow in exchange for a lumpsum payment or payment of royalty.

 

2.      Introduction of new entry for the purpose of levy of TAX PRESUPPOSES that it was not covered by any of the pre-existing entries.

 

In Diebold systems (P) Ltd v. CST¹⁷, the tribunal was of the opinion that in the ever widening scope of service tax the introduction of a new item to the list of taxable services is just an addition, and not a subtraction from a pre existing entry. Thus this new entry pre-supposes that it was not covered by any pre-existing items. Similarly in Glaxo Smithkline Pharmaceuticals noted the same observation. In this case, certain service rendered by the company was found to be in the category of “Business Auxillary service” as claimed by them and not “Management consultancy” as claimed by revenue. Business Auxillary Service was introduced in 2003 when the Management consultancy service already existed. The revenue noted that the definition of management consultancy services remained the same even after introduction of Business Auxiliary service and hence was taxable service. However, the tribunal rejected the plea of revenue. If we closely review the judgment of tribunal in these two cases we come to the conclusion that since IP services were introduced after consultancy engineer services it pre-supposes the fact that IP services did not exist in any other item before that. This also makes clear that technical knowhow being an intellectual property cannot be taxed under consultancy engineer services.

 

3.      Taxation of Technical Knowhow Under Intellectual Property Services Category

The most strange situation arises when tribunal levy tax on the transfer of technical knowhow after accepting it as intellectual property. In Modi-Munidpharma Private Limited v. CCE, Meerut¹⁸, the tribunal made this mistake again. In this case the appellant acquired right to use technical knowhow developed by M/s Mundipharma, for the manufacture of certain medicines for which annual payment of royalty was made to M/s Mundipharma. Appellant argued that there is no law governing knowhow as an intellectual property. The definition of intellectual property includes only those intellectual property rights which are protected by nay Indian law. It was further argued that as per circular No. 80/10/2004-S.T. dated 17.9.04, any intellectual property , not specially covered by any law in India, is not covered under Service tax provisions.

 

However, the tribunal observed that since there is no permanent transfer of knowhow and the appellant received only the right to use the knowhow developed by M/s Mundipharma, it will be covered under the definition of “intellectual property rights” services. It is submitted that tribunal was wrong in upholding the decision of CCE to levy tax on technical knowhow under intellectual property rights service category.

 

Again in Eicher Private Ltd. v. CCE, Indore¹⁹, the question was whether the technical knowhow in the form of drawing and design will be covered under consulting engineer service. The appellants relied upon the decision in M/s Indian Farmers fertilizers Co-operative ltd. v. CCE²⁰, in which it was held that the transfer of licensing rights in respect of technical knowhow are not covered under consulting engineer services. However, the tribunal observed that there is no consideration regarding transfer of technical knowhow which was to be kept confidential. There is consolidated amount of consideration in respect of the service provided by the service provider and it cannot be said that in each drawing and design is only in respect of technical knowhow.

 

Hero Cycles Ltd. v. CCE, Ludhiana²¹, is yet another case in which the tribunal upheld the decision of CCE to levy tax on the technical knowhow under IP services category. In this case, the national Bicycle industries, Japan was engaged in the production and sale of bicycle parts and thereof. The appellant entered into contract to receive technical knowhow for production of cycles and parts thereof. As per the agreement, the appellants were receiving part designs, frame designs, parts assembled design etc.  The tribunal held that this agreement showed that the applicants were receiving the intellectual property right in respect of designs for manufacture of parts of cycles.

 

CONCLUSION:

 Taxation of intellectual property has always been a contentious issue. The cloud over the taxation of technical knowhow has still not been cleared. Firstly, it’s very difficult to define knowhow because of its complicate nature. The problem in defining knowhow is the crux of whole dispute regarding the service tax liability on technical knowhow. However, as we have already discussed that technical knowhow is different from technical assistance and hence cannot be taxed under consulting engineer services. In these circumstances, any authority should not levy tax for transfer of knowhow under the heading of consulting engineer service. Such taxation will be outside the purview of the said item.

 

Secondly, the question which comes after this conclusion is whether technical knowhow can be taxed under “IP services” category? The answer to this question is little bit difficult. First, technical knowhow can be put only in the category of trade secret. Second, even if we assume that technical knowhow will come under the purview of confidential information or trade secret there is no law to regulate that. Although India is obliged to follow WTO but it has not come up with any legislation to protect confidential information or know how. Since, IPR s covered under the Indian law are only chargeable to service tax, technical knowhow being not protected by any law is not liable to service tax.

 

SUGGESTIONS:

1)      India should enact laws regulating technical knowhow. The knowhow is becoming very crucial these days. The joint venture companies are mostly applying knowhow in their business pursuit and there is constant transfer of knowhow from one company to another. Therefore, it is necessary to define knowhow as well as to protect it.

2)      Technical knowhow cannot be taxed under Consulting Engineer Services.

3)      Government should clarify that under the new definition of intellectual property services technical knowhow cannot be taxed until and unless there is law regulating it in India.

 

 

REFERENCES:

1.       As per S. 65(95) of Finance Act, 1994.

2.       During the period 11.5.2007 to 23.2.2009, it was 12.36%.

3.       Rolls Royce Indus Power v. CCE, 2004 STT 573.

4.       2001 CTR 346 (SC).

5.       (2006) 3 STT 209.

6.       (2007) 6 STT 73.

7.       (1952) 69 RPC 10.

8.       Appeal No. S/93/2006/MAS, January 2, 2009.

9.       2008 12 STR 189.

10.     M.D.Nair, Protection of Trade Secrets/undisclosed information, published in Journal of Intellectual Property Rights, ( Vol. 7, Nov. 2002), p. 527.

11.     Ibid.

12.     Ibid.

13.     Ibid.

14.     K.D.Raju, Intellectual Property Taxation: Need for Comprehensive Policy and Law in India  published in Journal of Intellectual Property Rights, (Vol. 13, Nov. 2008), p. 568.

15.     Appeal No. S/93/2006/MAS, January 2, 2009.

16.     MANU/CC/0440/2008.

17.     2008 (9) STR 546.

18.     2008 12 STR 189.

19.     2008 10 STR 65.

20.     2006 INDLAW CESTAT 1506 (Tribunal).

21.     2009 14 STR 113.