2006 (3) TMI 1 - SC - Service Tax

Imposition of tax on facilities of the telecommunication services - Nature of the transaction by which mobile phone connections are provided - Activity of giving the connection or activation of the SIM cards - Composite contract - sale Or service or both - States are legislatively competent to levy sales tax on the transaction under Entry 54 List II of the Seventh Schedule to the Constitution - Central Government alone can levy service tax under Entry 97 of List I (or Entry 92C of List I after 2003) - transfer of any right to use any goods by providing access or telephone connection by the telephone service provider to a subscriber - Whether both legislative authorities could levy their separate taxes together or only one of them. Definition of business dealer goods and sale - applicability of res judicata to assessment orders for successive years - expressions telephone and telephony - goods in telecommunication for the purposes of Article 366(29A)(d) - Would the aspect theory be applicable to the transaction enabling the States to levy sales tax on the same transaction in respect of which the Union Government levies service tax. JUDGMENT PER RUMA PAL J. - HELD THAT - In our opinion the essence of the right under Article 366(29A)(d) is that it relates to user of goods. It may be that the actual delivery of the goods is not necessary for effecting the transfer of the right to use the goods but the goods must be available at the time of transfer must be deliverable and delivered at some stage. It is assumed at the time of execution of any agreement to transfer the right to use that the goods are available and deliverable. If the goods or what is claimed to be goods by the respondents are not deliverable at all by the service providers to the subscribers the question of the right to use those goods would not arise. But if there are no deliverable goods in existence as in this case there is no transfer of user at all. Providing access or telephone connection does not put the subscriber in possession of the electromagnetic waves any more than a toll collector puts a road or bridge into the possession of the toll payer by lifting a toll gate. Of course the toll payer will use the road or bridge in one sense. But the distinction with a sale of goods is that the user would be of the thing or goods delivered. The delivery may not be simultaneous with the transfer of the right to use. But the goods must be in existence and deliverable when the right is sought to be transferred. Therefore whether goods are incorporeal or corporeal tangible or intangible they must be deliverable. As we have said Art. 366(29A) has no doubt served to extend the meaning of the word sale to the extent stated but no further. We cannot presume that the Constitutional Amendment was loosely drawn and must proceed on the basis that the parameters of sale were carefully defined. But having said that it is sufficient for the purposes of this judgment to find as we do that a telephone service is nothing but a service. There is no sales element apart from the obvious one relating to the hand set if any. That and any other accessory supplied by the service provider in our opinion remain to be taxed under the State Sales Tax Laws. We have given the reasons earlier why we have reached this conclusion. Thus we answer the questions formulated by us earlier in the following manner (A) Goods do not include electromagnetic waves or radio frequencies for the purpose of Article 366(29A)(d). The goods in telecommunication are limited to the handsets supplied by the service provider. As far as the SIM cards are concerned the issue is left for determination by the Assessing Authorities. (B) There may be a transfer of right to use goods as defined in answer to the previous question by giving a telephone connection. (C) The nature of the transaction involved in providing the telephone connection may be a composite contract of service and sale. It is possible for the State to tax the sale element provided there is a discernible sale and only to the extent relatable to such sale. (D) The issue is left unanswered. (E) The aspect theory would not apply to enable the value of the services to be included in the sale of goods or the price of goods in the value of the service. The writ petitions and appeals are disposed of accordingly. Assent per A.R. Lakshmanan J. HELD THAT - To constitute a transaction for the transfer of the right to use the goods the transaction must have the following attributes a. There must be goods available for delivery; b. There must be a consensus ad idem as to the identity of the goods; c. The transferee should have a legal right to use the goods-consequently all legal consequences of such use including any permissions or licenses required therefor should be available to the transferee; d. For the period during which the transferee has such legal right it has to be the exclusion to the transferor this is the necessary concomitant of the plain language of the statute - viz. a transfer of the right to use and not merely a licence to use the goods; e. Having transferred the right to use the goods during the period for which it is to be transferred the owner cannot again transfer the same rights to others. None of these attributes are present in the relationship between a telecom service provider and a consumer of such services. On the contrary the transaction is a transaction of rendition of service. While the true scope of the amendment may be appreciated by overall reading of the entirety of Article 366(29A) deemed sale under each particular sub-clause has to be determined only within the parameters of the provisions in that sub-clause. One sub-clause cannot be projected into another sub-clause and fiction upon fiction is not permissible. The contract between the telecom service provider and the subscriber is merely to receive transmit and deliver messages of the subscriber through a complex system of fibre optics satellite and cables. Clause 9 clearly interdicts the licensee provided that licensee will not assign or transfer his rights in any manner whatsoever under the licence to third party. It is impossible to contend that the right to use goods assuming without conceding that they are goods which are essential for the rendition of service can never be a transaction or transfer of right to use goods. Nor can the contract between subscribers and licensee viz. service provider be interpreted as involving transfer of right to use goods. It is not possible to interpret the contract between the service provider and the subscriber that the consensus was to mutilate the integrity of contract as a transfer of right to use goods and rendering service. Such a mutilation is not possible except in the case of deemed sale falling under sub-clause (b). Nor can the service element be disregarded and the entirety of the transaction be treated as a sale of goods (even when it is assumed that there is any goods at all involved) except when it falls under sub-clause (f). This will also result in an anomaly of the entire payment by the subscriber to the service provider being for alleged transfer of a right to use goods and no payment at all for service. The licence granted by the Central Government fixes the tariff rates and all are for services. It is therefore unnecessary to deal with the question of delivery of possession which is related only to situs and not to subject-matter of taxation which is a transfer of right to use goods. In the present case as no goods element are involved the transaction is purely one of service. There is no transfer of right to use the goods at all. I am therefore of the view that the imposition of sales tax on any facilities of the telecommunication services is untenable in law.

Summary

The principal legal question addressed by the Court is the nature of the transaction through which mobile phone connections are provided: whether it constitutes a sale, a service, or a composite of both. This determination is crucial because it governs which legislative authority-State or Union-has the competence to levy tax on such transactions under the Constitution. Specifically, if the transaction is a sale, States can impose sales tax under Entry 54 of List II of the Seventh Schedule. If it is a service, only the Union Government can levy service tax under Entry 97 (or Entry 92C after 2003) of List I. If the transaction has characteristics of both sale and service, the issue arises whether both authorities can levy tax concurrently or if exclusivity applies.

The service providers contend that the transaction is purely a service and that States lack legislative competence to impose sales tax. They argue that the transaction involves no transfer of goods or legal rights to use goods, as prohibited under their licenses granted by the Telegraph Act, 1885. The Union Government supports this position. Conversely, the States assert that the transaction amounts to a deemed sale under Article 366(29A)(d) of the Constitution, thus enabling them to levy sales tax.

Earlier High Court decisions were divided: Allahabad, Andhra Pradesh, and Punjab & Haryana High Courts held against sales tax applicability, while the Kerala High Court upheld sales tax on activation charges as part of the sale price of SIM cards. The Supreme Court had previously overruled the former High Courts in State of U.P. v. Union of India (2003), but the present batch of appeals and petitions called for a larger Bench to reconsider the issues.

A preliminary objection by the States invoking res judicata based on the earlier U.P. decision was rejected. The Court held that res judicata does not bar reconsideration of the issue in subsequent assessment years, especially when the petitioners challenge the precedential value rather than the finality of the earlier decision. The Court distinguished between res judicata and the binding precedential effect of Supreme Court decisions, emphasizing that subsequent Benches of superior strength may overrule earlier decisions.

On the merits, the Court examined the nature of the transaction, the legal framework, and relevant precedents. The key constitutional provision is Article 366(29A), introduced by the 46th Amendment, which defines "tax on the sale or purchase of goods" to include certain deemed sales, such as transfer of the right to use goods. The Court traced the historical development of this provision, noting that prior to the amendment, composite contracts involving goods and services were not subject to sales tax unless the sale element was distinct and dominant, as per the dominant nature test established in State of Madras v. Gannon Dunkerley & Co.

The Court held that the 46th Amendment created specific fictions of deemed sales in defined categories-works contracts, hire purchase, catering contracts, etc.-but did not broadly alter the meaning of "goods" or permit arbitrary splitting of composite transactions. The dominant nature test continues to apply to transactions not covered by Article 366(29A). The Court emphasized that the word "goods" retains its established legal meaning, including tangible movable property and certain incorporeal rights, provided they satisfy attributes such as utility, capability of being bought and sold, and capacity for transfer, delivery, and possession.

Applying these principles to telecommunication, the Court analyzed whether electromagnetic waves or radio frequencies constitute "goods." It concluded that electromagnetic waves are merely the medium of communication, not goods themselves, as they are intangible, non-deliverable, non-storable, and not marketable. The signals transmitted are generated by subscribers and do not involve transfer of goods. The Court rejected the States' contention that the entire telephone system, including wiring and exchanges, constitutes goods, distinguishing prior electricity cases where electrical energy was held to be goods. The Court found the analogy inapposite because telecommunication involves transmission of messages, not transfer of physical goods or energy as goods.

The Court further held that for a transfer of the right to use goods under Article 366(29A)(d), goods must be available and deliverable at the time of transfer. The mere provision of access or telephone connection does not amount to transfer of possession or control over goods. The license conditions under the Telegraph Act prohibit transfer or assignment of rights, reinforcing that the transaction is a service. The Court rejected reliance on the earlier decision in State of U.P. v. Union of India to the extent it held that telephone connections and accessories constituted goods, finding that decision erroneous on this point.

Regarding SIM cards, the Court recognized that whether they are goods subject to sales tax depends on the factual question of whether they are sold to subscribers or merely provided as part of the service. The Kerala High Court's decision to include activation charges in the sale price of SIM cards was found to be premature and erroneous in applying the aspect theory to value inclusion. The Court remanded this issue for determination by the assessing authorities, emphasizing that if SIM cards are merely incidental to service, they are not taxable as goods.

The Court addressed the aspect theory, which allows different aspects of a transaction to be taxed by different authorities if within their legislative competence. It held that while the theory permits overlapping taxation of distinct aspects, it does not authorize States to include service value in the sale price or vice versa. The Court stressed the need for maintaining exclusivity and mutual respect between State and Union taxing powers under Articles 246 and 286.

On the question of inter-state sales, given the finding that electromagnetic waves are not goods, the Court found the issue academic and left it unanswered.

The Court concluded that telecommunication services are essentially services, not sales of goods, except for tangible goods such as handsets and possibly SIM cards if sold separately. States may tax such goods but cannot levy sales tax on the service component or on deemed sales not covered by Article 366(29A). The Union Government alone has competence to levy service tax on telecommunication services. The Court allowed the appeals of service providers, set aside contrary decisions, and remanded issues concerning SIM cards to the assessing authorities.

The concurring opinion reaffirmed these conclusions, emphasizing the attributes necessary for a transfer of the right to use goods-availability of goods for delivery, consensus on identity of goods, legal right to use, exclusivity of such right, and prohibition of multiple transfers. It found these absent in telecommunication service contracts. The concurring Judge underscored the integrity of the license under the Telegraph Act, which prohibits transfer or assignment, and held that the transaction is a composite service contract not amenable to disintegration into sale and service for taxation purposes.

In sum, the Court established that:

- Electromagnetic waves and radio frequencies are not "goods" for sales tax purposes.

- The provision of telecommunication services does not involve transfer of the right to use goods as contemplated by Article 366(29A)(d).

- The transaction is predominantly a service contract, with any sale element limited to tangible goods like handsets or possibly SIM cards.

- States cannot levy sales tax on the service component of telecommunication; only the Union can levy service tax.

- The aspect theory does not permit States to include service value in sale valuation or vice versa.

- Earlier decisions holding telephone connections and accessories as goods are overruled to the extent inconsistent.

- Issues relating to SIM cards require factual determination and are remanded.

- The principle of res judicata does not preclude reconsideration of the issue in subsequent assessment years or by a Larger Bench.

- The dominant nature test continues to apply to composite contracts except where Article 366(29A) creates specific deemed sales.

This judgment clarifies the constitutional demarcation between State and Union taxing powers in the context of telecommunication, emphasizing the service nature of telecommunications and limiting State sales tax to tangible goods sold separately.