OCTOBER 22, 2018

By PR Chandrasekharan, I.R.S. (Retd.)

THE question as to what constitutes supply of goods or supply of services has been the subject matter of dispute in many tax cases and judicial interpretation at the highest level. The perception and the legal position have also changed many times depending on the amendments made in the law in this regard. The advent of Goods and Services Tax (GST in short) with effect from 1st July 2017, has also added new dimensions to these changing perceptions. This is true not only of India but all over the world.

2. In The State Of Madras v. Gannon Dunkerley & Co.,(Madras)- 2002-TIOL-493-SC-CT-LB, the Hon'ble Supreme Court held that ,-

"In a building contract which is one, entire and indivisible, there is no sale of goods and it is not within the competence of the Provincial Legislature under Entry 48 in List 11 in Sch. VII of the Government of India Act, 1935, to impose a tax on the supply of the materials used in such a contract treating it as sale."

3. A similar issue came up for consideration in Associated Hotels of India Limited - 2002-TIOL-65-SC-CT-CB before the Apex Court wherein it was held that "there is no sale when food and drink are supplied to guests residing in the hotel". The  Court  pointed out that the supply of meals was essentially in the nature of a service provided to them and could not be identified as a transaction of sale. The  Court  declined to accept the proposition that the Revenue was entitled to split up the transaction into two parts, one of service and the other of sale of foodstuffs. There were many such decisions of the Supreme Court which had the effect of limiting or restricting the power of the States to levy sales tax in composite transactions consisting elements of both goods and services.

4. To overcome the adverse effect of the judicial pronouncements and to enable the States to levy sales tax on the sale of goods involved in a composite transaction, the Indian Constitution was amended in 1982 vide the 46th amendment by inserting a new clause (29A) in article 366 providing for a 'deemed sale' concept and thereby enabling levy of sales tax. The following six transactions were included in the deemed sale concept.

(i) transfer for consideration of controlled commodities;

(ii) the transfer of property in goods involved in the execution of a works contract;

(iii) delivery of goods on hire-purchase or any system of payment by installments;

(iv) transfer of the right to use any goods for any purpose for cash, deferred payment or other valuable consideration;

(v) the supply of goods by an unincorporated association or body of persons to a member thereof for cash, deferred payment or other valuable consideration;

vi) the supply, by way of or as part of any service, of food or any drink for cash, deferred payment or other valuable consideration.

5. With the advent of GST which provides for concurrent levy of tax on the supply of goods and services by both the Centre as well as the States, the legal treatment of some of the above transactions has undergone further changes. As per Central GST Act, 2017, Schedule II, the following transactions have been treated as supply of services:

"5 (f)  transfer of the right to use any goods for any purpose (whether or not for a specified period) for cash, deferred payment or other valuable consideration.

6. Composite supply

The following composite supplies shall be treated as a supply of services, namely:-

(a)  works contract as defined in clause (119) of section 2; and

(b)  supply, by way of or as part of any service or in any other manner whatsoever, of goods, being food or any other article for human consumption or any drink (other than alcoholic liquor for human consumption), where such supply or service is for cash, deferred payment or other valuable consideration."

Thus in respect of these three transactions which were deemed as "sale of goods" as per Article 366 (29A), the tax treatment has undergone a change and under the GST law, they are treated as services for the levy and collection of tax. Thus the wheel has turned a full circle - from 'service' to 'goods' and now back to 'service'. However, as per entry 1(c) of the said Schedule II,

"(c)  any transfer of title in goods under an agreement which stipulates that property in goods shall pass at a future date upon payment of full consideration as agreed, is a supply of goods."

Thus hire purchase transactions continue to be treated as 'supply of goods'.

6. But what happens when the agreement between the seller and customer, gives an option to the customer to buy or not to buy the goods at the end of the prescribed period - that is, there is no stipulation that the title in goods shall pass at a future date? This question came up for consideration before the Court of Justice of the European Union (CJEU) in Commissioners for HMRC v. Mercedes-Benz Financial Services U.K. Ltd. (MBFS) [in Case C-164/16 decided on 4 October, 2017].

6.1 The case concerned the VAT treatment of a motor vehicle finance agreement called "Agility" offered by MBFS to customers who are undecided as to whether they want to own the car or want to keep open the option to purchase or not. The Agility agreement marketed as a hire purchase contract, offered lower monthly payments than a typical HP agreement and did not cover the full value of the vehicle. It allowed the customer to lease the vehicle for a prescribed period, after which the customer could purchase it subject to payment of a final 'optional purchase payment'. MBFS considered Agility to be a rental agreement with an option to purchase and therefore, treated its supplies as 'services' for VAT purposes. However, HMRC argued that the Agility agreement should be treated as a supply of goods on the ground that a contract where 'in the normal course of events, ownership is to pass at the latest upon payment of the final installment' is a supply of goods. The case was taken to the CJEU by HMRC from the UK Court of Appeal.

6.2 The CJEU took the view that legal certainty requires that lease agreements should be regarded as 'supplies of goods' for levy of VAT only when it can be assumed with certainty that in the normal course of events, at the latest by the end of the agreement term, ownership of the subject matter of the leasing agreement will be transferred to the lessee.

6.3 The CJEU noted that the label attached to a specific agreement for the hiring of a motor vehicle with an option to purchase (e.g. 'finance lease' or 'hire purchase') is not determinative as to whether the supply is one of goods or services for VAT purposes. The Court then set out the tests to determine whether a supply falls to be treated as goods under Article 14(2)(b) of the VAT directive as follows:-

In a contract where the first of the above tests is met but where the transfer of ownership of the goods is not automatic and is one of a number of options available to the customer (other options being to return the goods or extend the hire period), the second test above will not be met. Thus the contract will not fall within Article 14(2)(b) to be treated as a supply of goods. In short, the CJEU ruled that the 'Agility' agreement should be treated as services. If the contracts are classified as supply of services, there is a significant cash flow advantage to the taxpayer since in the case of supply of goods, tax is payable upfront on the whole of the contractual value while in the case of supply of services, tax is payable on a cash received basis.

7. Does the above ruling of the CJEU have any relevance in the Indian context? In my considered view, it does for the following reasons. Let us examine the definitions of a hire purchase agreement under the European VAT directive and under the Indian GST law.

7.1 Article 14(2) of the VAT directive provides that "each of the following shall be regarded as supply of goods:

(a)  ……..

(b)  the actual handing over of goods pursuant to a contract for the hire of goods for a certain period, or for the sale of goods on deferred terms, which provides that in the normal course of events ownership is to pass at the latest upon payment of the final installment;

(c)  …………………"

7.2 Under the Indian GST law, as we have seen earlier, entry 1(c) of Schedule II defines hire-purchase as:

"(c)  any transfer of title in goods under an agreement which stipulates that property in goods shall pass at a future date upon payment of full consideration as agreed, is a supply of goods."

Thus both the definitions envisage transfer of title or ownership of the goods upon payment of full consideration at the end of the period of hire. It does not provide for a situation, where the transfer of ownership is not automatic but is one of the options available to the customer. Therefore, an equipment /financial leasing contract involving goods could be treated as "supply of service" and not as "supply of goods". The CJEU ruling, though not binding on the Indian judicial authorities, will certainly have a persuasive value while considering the position under the Indian GST law.

8. It will be really interesting to see what position the Indian tax administration and the Indian judiciary will take when an identical matter (as in the MBFS case) comes up before them for consideration.

(The author is a former Member (CESTAT) and is presently working as Professor in the National Law School of India University, Bengaluru. The views expressed above are the personal views of the author and do not necessarily represent that of the organization he works for)