The Customs, Excise & Service Tax Appellate Tribunal has clarified a long-standing ambiguity in the intersection of sales tax and service tax regimes, holding that payment of VAT on the hire of machinery conclusively establishes a deemed sale under the Constitution, thereby excluding the transaction from service tax liability under the category of Supply of Tangible Goods for Use Services.
Background & Facts
The Dispute
The appellant, M/s The Mining & Engineering Corporation, provided site analyser machines to clients on a hire basis, charging fees for usage and paying VAT on such transactions. The Revenue contended that these transactions constituted taxable services under the category of "Supply of Tangible Goods for Use Services" under Section 65(105)(zzzzj) of the Finance Act, 1994, and demanded service tax, interest, and penalty for the period 2007-08 to 2012-13.
Procedural History
- 2012: Department initiated investigation based on intelligence regarding non-payment of service tax on machine hires.
- 2013: Appellant filed declaration under the Voluntary Compliance Encouragement Scheme (VCES) declaring tax dues of Rs. 80,25,500.
- 2014: Show-cause notice issued demanding service tax of Rs. 1,28,28,267, alleging suppression of true dues.
- 2016: Commissioner confirmed demand and imposed penalty under Sections 77 & 78 of the Finance Act, 1994.
- 2016: Appeal filed before the Tribunal.
Relief Sought
The appellant sought quashing of the demand, interest, and penalty, arguing that the transaction was a deemed sale under Article 366(29A)(d) of the Constitution, and therefore outside the scope of service tax. It further contended that the demand was barred by limitation and that the penalty was imposed without application of mind.
The Legal Issue
The central question was whether the hire of site analyser machines, accompanied by payment of VAT, constitutes a deemed sale under Article 366(29A)(d) of the Constitution, thereby excluding it from the scope of taxable service under Section 65(105)(zzzzj) of the Finance Act, 1994.
Arguments Presented
For the Appellant
The appellant relied on multiple precedents including Express Engineers & Spares Pvt. Ltd., Lindstrom Services India Pvt. Ltd., and MSPL Limited, arguing that the transfer of possession and effective control to the hirer, coupled with payment of VAT, established a deemed sale under Article 366(29A)(d). It cited Circulars dated 23-8-2007 and 29-2-2008, which explicitly state that payment of VAT indicates a transaction is treated as sale of goods, and service tax cannot be levied on such transactions. It further argued that the VCES declaration was accepted in part, and imposing full penalty was arbitrary.
For the Respondent
The Revenue contended that the appellant had suppressed true tax dues by declaring only Rs. 80,25,500 under VCES, while actual dues were over Rs. 1.28 crore. It argued that the appellant retained control over maintenance and provided operators, thereby satisfying the criteria for STGU service. It relied on the literal interpretation of the service tax provision and dismissed the relevance of VAT payment as irrelevant to service tax liability.
The Court's Analysis
The Tribunal undertook a detailed statutory and constitutional analysis, distinguishing between "transfer of right to use" and "transfer of possession and effective control." It emphasized that Section 65B(44) of the Finance Act excludes from the definition of service any transaction deemed a sale under Article 366(29A)(d). The Court then applied the five-fold test laid down in Bharat Sanchar Nigam Ltd. v. Union of India to determine whether a transfer of right to use had occurred.
"To constitute a transaction for the transfer of the right to use the goods, the transaction must have the following attributes: (a) goods available for delivery; (b) consensus ad idem; (c) legal right to use including permissions; (d) exclusion of transferor during the period; (e) no re-transfer by owner."
The Tribunal found that the appellant’s contracts with clients satisfied all five attributes: specific machines were identified, clients had exclusive control, issued operational instructions, bore fuel and maintenance costs, and required passes for machine movement. Crucially, the appellant had paid VAT on these transactions, which the Tribunal held was not merely incidental but a conclusive indicator of the transaction’s nature as a deemed sale.
The Court further relied on Circulars issued by the Department itself, which explicitly state that "payment of VAT on a transaction indicates that the said transaction is treated as sale of goods" and service tax cannot be levied on such transactions. The Tribunal rejected the Revenue’s argument that retention of maintenance responsibility indicated control, distinguishing between custody and effective control as clarified in Rashtriya Ispat Nigam Limited and Great Eastern Shipping Company Ltd.
The Tribunal also dismissed the limitation argument, noting that the VCES declaration tolled the limitation period, but held that the penalty under Section 77(2) was inapplicable since the transaction was not a service at all, and the demand was based on a misinterpretation of law.
The Verdict
The appellant won. The Tribunal held that the hire of site analyser machines, accompanied by payment of VAT, constitutes a deemed sale under Article 366(29A)(d) of the Constitution and is therefore excluded from the scope of service tax under Section 65(105)(zzzzj). The impugned order was set aside, and the demand for service tax, interest, and penalty was quashed.
What This Means For Similar Cases
VAT Payment Is Conclusive of Deemed Sale
- Practitioners must treat payment of VAT on hire of machinery as conclusive evidence that the transaction is a deemed sale under Article 366(29A)(d).
- Service tax authorities cannot impose service tax on such transactions even if control elements appear ambiguous.
- Any demand for service tax on VAT-paid hire transactions is legally unsustainable.
Control Must Be Effective, Not Custodial
- Retention of maintenance, provision of operators, or technical support does not negate the transfer of effective control if the hirer directs usage, bears operational costs, and has exclusive possession.
- The distinction between "custody" and "possession and control" must be rigorously argued using precedents like Rashtriya Ispat Nigam Limited and Great Eastern Shipping.
- Contracts should clearly define the hirer’s right to operate, direct, and exclude the owner from interference.
VCES Declarations Do Not Validate False Disclosures
- While the Tribunal accepted the appellant’s VCES filing as a basis to examine the nature of the transaction, it did not validate the declared amount.
- Practitioners must ensure VCES declarations are accurate; false declarations may still attract penalties under Section 78, but only if the underlying transaction is a taxable service.
- This case confirms that if the transaction is not a service, no penalty can be imposed under service tax provisions.
