2025 (12) TMI 716 - AT - Service Tax

No service tax on imported engineering designs; permanent IPR transfer, unrecognized under Indian law, Section 78 penalties dropped

CESTAT set aside the demand of service tax on consideration paid for imported engineering drawings and designs, holding that the transaction constituted a ... Classification of services - Design Services or not - products imported by the appellants in the nature of engineering drawings and designs - time limitation - penalties - HELD THAT:- On careful reading of the statutory provisions, defining the term ‘design services’ and the budget circular issued by the TRU, it would reveal that such services, wherever provided under the instructions of the service recipient or as per his requirements, resulting into creation of a desired design of a product, then such services should fall within the ambit of design service. In the case in hand, as per the contents in the agreements, the appellants had purchased all Intellectual Property Rights (IPRs), consisting of the “Engineering and Drawing Designs” from Group Companies for the purpose of manufacturing of WTGs and their components in the Indian territory. Thus, the ownership and interest in the IPRs for manufacture of WTGs including the “Engineering and Drawing Designs”, vested exclusively with the appellants for exploiting the said IPRs in Indian region. The agreement also provides that the appellants may further license, sell and assign these IPRs to others. Further, it also transpires that M/s. Suzlon Energy GmbH, Germany had also applied for about 75 patent registrations under German laws and had already been granted patent registrations in respect of some of the applications. The transaction in question, arising out of the agreements made by the appellants with their group companies, should not be categorized as a taxable service under the head ‘design services’. On careful analysis of the contents in the agreement vis-àvis the statutory provisions, we express our views that such transactions should appropriately be considered as IPR related services. The Intellectual Property Right service has also been considered in the service tax statute, as a taxable service, as the definition provided under Sections 65(55a), (55b) read with Section 65(105)(zzr) of the Act of 1994. However, the transaction in question, should not be exigible to service tax, firstly for the reason that the right to intellectual property was permanently transferred to the appellants and that on such transfer, the person(s) i.e., the group companies selling these rights, no longer remain as the holder of such intellectual property rights, so as to come within the purview of such taxable service; secondly, the IPR in question was not covered under any Indian law in force. Both the above instances of not conforming to the taxable category under IPR service have also been dealt with by TRU in Circular No. B2/8/2004-TRU dated 10.09.2004. Extended period of limitation - penalties - HELD THAT:- The onus to prove the indulgence of the appellants into the fraudulent activities, having the intention to evade the government revenue, which lies with the department, has not at all been substantiated. Accordingly, the extended period of limitation cannot be invoked for confirmation of the adjudged demands on the appellants. Similarly, penalties imposed on the appellants under Section 78 of the Act of 1994 cannot also be sustained, in the absence of any evidence, being adduced by the adjudicator that the appellants had really indulged into the activities of fraud, collusion etc., or had contravened the statutory provisions, with the intent to evade payment of service tax. There are no merits in the impugned order, insofar as it has confirmed the adjudged demands on the appellants - the impugned order is set aside - appeal allowed. 1. ISSUES PRESENTED AND CONSIDERED (1) Whether the import and acquisition of technical know-how in the form of 'engineering drawings and designs' under product development and purchase agreements constituted 'design services' under Section 65(36b) read with Section 65(105)(zzzzd) of the Finance Act, 1994, so as to attract service tax under reverse charge. (2) Whether the department was justified in invoking the extended period of limitation under the proviso to Section 73(1) of the Finance Act, 1994, for recovery of service tax, interest and imposition of penalties. 2. ISSUE-WISE DETAILED ANALYSIS Issue (1): Taxability under 'design services' Legal framework (a) Section 65(36b) of the Finance Act, 1994 defines 'design services' as including services provided in relation to designing of furniture, consumer products, industrial products, packages, logos, graphics, websites and corporate identity designing and production of three-dimensional models. (b) Section 65(105)(zzzzd) defines 'taxable service' as any service provided or to be provided to any person, by any other person, in relation to design services, excluding services by interior decorators and fashion designers. (c) TRU Budget Circular No. 334/1/2007-TRU dated 28.02.2007 clarifies that 'design services' cover design activities other than fashion designing and interior decoration, such as design of furniture, aesthetic design, consumer or industrial products, logos, packaging, and production of three-dimensional models. (d) TRU Circular No. B2/8/2004-TRU dated 10.09.2004 clarifies: (i) only IPRs covered under Indian law are chargeable under IPR service; (ii) permanent transfer of IPR does not amount to rendering of service, as the transferor ceases to be the holder of IPR. Interpretation and reasoning (e) The agreements between the foreign group entities and the appellants expressly provide that the foreign entities 'sell and transfer' to the appellants all their rights (including Intellectual Property Rights), title and interest in the products (technical know-how, engineering drawings and designs, documentation, improvements) for manufacturing WTGs in India. (f) The agreements stipulate that:   (i) the transaction is one-time transfer of technical know-how/patent for the Indian territory;   (ii) the appellants become the 'absolute owner' of the products and associated IPR for India, with liberty to license, sell or assign such rights further;   (iii) the foreign entities retain rights only for territories outside India. (g) Pricing and payment clauses provide a composite 'consideration for the Product(s) along with all rights (including Intellectual Property Rights)' based on cost plus profit, covering all direct and indirect costs of producing the products. No separate or earmarked price is stipulated for any design activity as an independent service. (h) The Court held that levy of service tax presupposes existence of: (i) a service provider; (ii) a service recipient; and (iii) consideration for provision of service. Under the agreements, the relationship between the parties is of seller and buyer of products/IPR, not of service provider and service recipient. (i) It was found that the appellants had not engaged the foreign entities to design industrial products as per their specifications or requirements for a fee; rather, the foreign entities had already developed the designs and technical know-how, and then sold/transferred the same (with IPRs) to the appellants. (j) The Tribunal distinguished two situations:   (i) Where A engages B to create a design as per A's requirement for an agreed consideration, such activity is 'design service';   (ii) Where B has already created a design and transfers the rights in that design to A, the transaction is not 'design service' but a transfer of intellectual property, appropriately falling within the realm of IPR-related services. (k) In the present case, the ownership of the engineering drawings and designs originally vested with the foreign group companies; only territorial rights for India were transferred to the appellants, as confirmed by a subsequent letter of the foreign entity and supported by patent applications under German law. (l) On a conjoint reading of the statutory definition of 'design services' and the TRU circular, the Court held that 'design services' contemplate provision of design work carried out on the instructions or as per requirements of the recipient, resulting in creation of a desired design. A mere sale or permanent transfer of already-developed designs and associated IPRs does not fall within this taxable category. (m) The Court held that the impugned transaction is more appropriately classifiable as IPR-related activity, but noted that even under 'IPR service' it would not be taxable because:   (i) there was permanent transfer of IPR, so the transferor ceased to be 'holder of intellectual property right', as clarified by TRU Circular No. B2/8/2004-TRU;   (ii) the IPR in question (patented/designs under German law) was not covered under any Indian IPR legislation, while taxable IPR service is confined to IPRs prescribed under Indian law. (n) The adjudicating authority's attempt to artificially bifurcate the composite consideration into an alleged component for design services was rejected, as there is no statutory mechanism or contractual basis for such bifurcation. Conclusions (o) The import and acquisition of engineering drawings and designs under the product development and purchase agreements do not constitute 'design services' under Section 65(36b) read with Section 65(105)(zzzzd) of the Finance Act, 1994. (p) The transactions are in the nature of permanent transfer of IPRs, not liable to service tax under 'IPR service' either, in view of permanent transfer and absence of coverage under Indian IPR laws as clarified by TRU Circular No. B2/8/2004-TRU. (q) The service tax demands confirmed under the head 'design services' are unsustainable on merits. Issue (2): Invocation of extended period of limitation and penalties Legal framework (r) Section 73(1) of the Finance Act, 1994 permits issuance of show cause notice within one year from the relevant date for non-levy, short-levy, non-payment, short-payment or erroneous refund of service tax. (s) The proviso to Section 73(1) extends the limitation to five years where non-levy, non-payment, short-levy, short-payment or erroneous refund is 'by reason of' fraud, collusion, wilful mis-statement, suppression of facts, or contravention of statutory provisions with intent to evade payment of service tax. (t) The Court referred to judicial interpretations (in the context of pari materia provisions under Central Excise and Customs) holding that: (i) expressions like 'suppression' must be read ejusdem generis with fraud, collusion etc., and connote deliberate conduct to evade duty; (ii) 'mis-statement' and 'suppression' must be 'wilful' and with intent to evade duty; (iii) extended limitation is an exception and the burden to establish ingredients of the proviso lies on the department. Interpretation and reasoning (u) The first show cause notice dated 15.12.2011 covered the period 01.06.2007 to 30.09.2010 and was issued beyond the normal limitation, expressly invoking the extended period under the proviso to Section 73(1). (v) The Court noted that the entire basis for initiation of proceedings emerged from departmental audit of the appellants' records, which were maintained in the ordinary course and produced before the authorities. (w) The appellants had: (i) filed Bills of Entry declaring import of designs and drawings; (ii) obtained assessment and clearance of consignments by customs at nil duty under applicable exemption notifications; (iii) paid R&D Cess on the imported technical know-how, treating the same as IPR-related import. These facts were within departmental knowledge. (x) The Court found that the dispute turns on interpretation of complex legal provisions-whether the transactions constitute import of goods, design services, or IPR services. Earlier, the Tribunal had itself taken the view (in the appellants' own case and in another case) that such imports were to be treated as 'goods' and not liable to service tax, a view later reversed by the Supreme Court. (y) In such a context of genuine interpretational doubt, the Court held that non-payment of service tax cannot be equated with fraud, collusion, wilful mis-statement or suppression of facts with intent to evade tax. (z) It was specifically recorded that there was no material or evidence brought on record by the adjudicating authority to substantiate allegations of deliberate non-disclosure or intention to evade tax. The findings imputing knowledge of law and intention to 'defraud' were not supported by any concrete evidence. (aa) The fact that the appellants paid R&D Cess on the technical know-how was considered corroborative of their bona fide belief that the transactions amounted to IPR-related import, not taxable 'design services'. (ab) As the proceedings originated from audit of regularly maintained records and the department was not shown to have discovered any concealed activity or external information, the essential pre-conditions for invoking the extended period were held to be absent. Conclusions (ac) The extended period of limitation under the proviso to Section 73(1) of the Finance Act, 1994 was not available, as the department failed to establish fraud, collusion, wilful mis-statement, suppression of facts, or contravention with intent to evade payment of service tax. (ad) Even assuming taxability, any demand would be confined to the normal limitation period; however, since the demand itself fails on merits, no recovery survives. (ae) Penalties imposed under Section 78 (and consequential penalties) are unsustainable in the absence of evidence of fraudulent intent or wilful suppression; they are liable to be set aside. (af) Overall, the impugned order confirming service tax, interest, and penalties is set aside, and the appeals are allowed on both merits and limitation.