Subway Writ Petition – Is taxation on IP Rights Valid?

Subway, the famous American fast food restaurant, has recently taken the indirect tax department to court, alleging that it was forced to pay differential Goods and Services Tax (GST) on services without issuance of any such notice.

Subway Systems India alleged in the writ petition filed in the High Court of Punjab and Haryana that the tax department had issued several summons to their higher management over the taxability of intellectual property rights. The firm also claimed that the tax agency continued to issue summons without following the proper procedure, thereby causing trauma and humiliation.

Hearing Subway’s petition, the High Court held that Subway should be given adequate time to state its case. Subway has been ordered to present all relevant facts, after which the authorities will issue a speaking order to settle the matter. According to legal experts, this means that tax officials will be unable to reclaim any funds until the case is resolved.

The conflict stems from a disagreement about whether intellectual property rights and royalties are taxable.

Taxation of Intellectual Property Rights

The Income Tax Act of 1961 established the definition of royalty. It is any consideration given in exchange for the transfer of all or any rights, including the granting of intellectual property license. It also undertakes a review for the dissemination of any information about the operation of any Intellectual Property or the authorization of the usage of any such property. Section 9 (1) (vi) of the Act has an exhaustive definition of ‘royalty,’ which excludes any consideration that would constitute the recipient’s income charged under the heading “Capital gains.” Whether an intellectual property transfer is a sale or a license depends on whether all of the property’s rights have been transferred. In most cases, a transfer recognised as a sale results in a capital gain or loss and as well as a license to ordinary income.

The royalty is not taxable if it is paid in respect of any right, property, or information used or services provided for the purposes of such person’s business or profession outside India, or for the purpose of creating or generating any income from any source outside India.

Franchising is a business strategy in which one party allows another party to use its branch, business model, brand, and other intellectual property in exchange for a consideration, which is sometimes referred to as royalty payments. In addition, franchising differs from licencing in that licencing is often used to transfer intellectual property rights for commodities, whereas franchising is typically used to extend service-related business models.

When parties sign into franchise agreements, they are transferring the right to use intellectual property rights in exchange for specific payments, such as franchise fees and royalties. The question of whether these payments should be subject to GST has always been debated.

Multinationals including fast food chains, hotels and tech companies that operate in India through franchisee models have come under scrutiny of the tax department and it is challenging the basis of the arrangement and proposing to apply GST on any revenue or royalties earned by the multinationals.

Most multinationals claim that they are neither transferring the brand name nor permitting the Indian firm to use the brand name for eternity, therefore they pay about 12% GST on the amount. According to multinationals, there is a distinction between “right to use” and “transfer of right to use” of a brand name, thus GST rates on royalty income should vary as well. The GST to be paid in the case of “transfer of right to use” is 18%. The tax authority claims that this is merely a jargon to commit tax avoidance.

Intellectual property taxation is complicated by a tangle of fundamental principles and specific rules. Not just individuals but even Courts may find it difficult to comprehend and implement these rules. Currently many multinational franchisees are in the radar of the Tax department. It will be a really interesting interpretation of law to look at once the Court decides whether or not Intellectual Property Rights can be taxed or not.

Author: Saumya Tripathi – a student of Vivekananda Institute of Professional Studies (Delhi), in case of any queries please write back us via email at support@ipandlegalfilings.com  or contact us at IP And Legal Filings.