Karnataka High Court Upholds VAT On Swiping Machine Rentals By Axis Bank To Merchants

The Karnataka High Court has recently upheld the levy of VAT on rental charges collected by Axis Bank for card-swiping machines installed at merchant establishments.

A Division Bench comprising Justice S.G. Pandit and Justice K. Manmadha Rao dismissed a Sales Tax Revision Petition filed by Axis Bank.

“the rental charges collected by the petitioner in respect of EDCT machines constitute consideration for transfer of the right to use goods and are liable to tax under the KVAT Act.”, the court ruled.

The petition challenged the Karnataka Appellate Tribunal's order upholding the reassessment orders for the assessment years 2006-07, 2007-08, 2008-09 and 2009-10.

The bank, apart from its banking activities, provided payment processing services to merchant establishments. These services enabled merchants to accept payments through credit cards, debit cards and other electronic payment instruments.

For this purpose, Axis Bank installed Electronic Data Capture (EDCT) terminals, commonly known as swiping machines, at the premises of merchant establishments. It collected transaction-based charges as well as separate charges towards terminal rental, installation, maintenance and allied charges.

The bank treated the entire consideration received from merchants as consideration towards banking and financial services. It accordingly discharged service tax under the Finance Act, 1994.

However, during proceedings initiated by the Enforcement Wing of the Commercial Taxes Department, it was noticed that the bank had not disclosed rental receipts collected for the EDCT machines as taxable turnover under the Karnataka Value Added Tax Act, 2003 (KVAT Act).

Reassessment proceedings were subsequently initiated. The Assessing Authority held that the rentals collected for the EDCT machines constituted consideration for transfer of the right to use goods and consequently amounted to deemed sales liable to VAT.

The reassessment resulted in VAT of Rs.7,00,198, interest of Rs.5,77,808 and penalty of Rs.70,700.

Axis Bank argued before the High Court that the EDCT machines were merely instruments facilitating its payment processing services. It contended that there was no transfer of the right to use the machines.

The bank also argued that it retained ownership, dominion and effective control over the machines. It retained the right to suspend, disconnect or deactivate the terminals.

Axis Bank further relied on restrictions contained in the Merchant Establishment Agreements. These prohibited merchants from altering, modifying, relocating, assigning or sub-leasing the machines.

The High Court rejected these arguments. It held that the relevant question was not whether ownership of the machines had been transferred, but whether the merchants had been conferred a right to use identified goods.

“The test is not whether ownership has been transferred, but whether the customer has been conferred a right to use identified goods for the purpose for which such goods are supplied.”, the court noted.

The bench observed that the EDCT machines were identifiable and tangible equipment installed at the premises of merchant establishments. They were made available to the merchants for use during the subsistence of the agreements.

It further held that retention of ownership, supervision, maintenance obligations or rights of repossession by the owner did not, by themselves, negate the transfer of the right to use goods.

The Court also rejected the bank's argument that payment of service tax on the entire consideration excluded the levy of VAT. It held that a transaction could contain different elements attracting different levies under different statutes, provided the respective taxing fields were distinct and the statutory requirements were satisfied.

“Payment of service tax on the service component does not, by itself, exclude the power of the State to levy VAT on the sale element, if a transfer of the right to use goods is established.”, it noted.

The bench also distinguished the Supreme Court's decision concerning SIM cards in Idea Mobile Communication Ltd. It held that the EDCT machines stood on a different footing from SIM cards.

The court noted that the EDCT machines were separately identifiable and tangible equipment installed at merchant establishments. The Merchant Establishment Agreement specifically contemplated provision of the equipment and collection of separate rental charges.

Unlike a SIM card, the EDCT machine was not merely an identification device or a passive instrument facilitating access to the bank's service. The merchant establishment was provided possession and operational access to the identified equipment for accepting customer transactions.

The Court also declined to interfere with the interest and penalty imposed under the KVAT Act. It noted that the bank had collected separate rental charges for the EDCT machines but had not disclosed them as taxable turnover.

The High Court emphasised the limited scope of its revisional jurisdiction under Section 65 of the KVAT Act. It found no error of law warranting interference with the concurrent findings of the authorities below.

The court held that the EDCT machines were identifiable goods and that merchant establishments were enabled to use the equipment for their business purposes during the subsistence of the agreements.

The retention of ownership and supervisory rights by Axis Bank did not negate the transfer of the right to use the machines. The Court consequently answered the substantial questions of law in favour of the Revenue and against Axis Bank.

The court dismissed the petition and affirmed the Karnataka Appellate Tribunal's order. 

For Petitioner: Senior Counsel Prakash Shah along with Advocate Mohan Maiya G.Le

For Respondent: Aditya Vikram Bhat, AGA