The Karnataka High Court has held that rental charges collected by banks from merchant establishments for Electronic Data Capture Terminals (EDCTs), commonly known as card swiping machines, constitute consideration for the transfer of the right to use goods and are therefore liable to Value Added Tax (VAT) under the Karnataka Value Added Tax (KVAT) Act.
The bench of Justice S.G. Pandit and Justice K. Manmadha Rao dismissed Axis Bank’s revision petition and upheld the reassessment orders, interest, and penalty imposed by the tax authorities.
The bench concluded that the merchant establishments were granted the right to use identifiable EDCT machines installed at their premises, bringing the transaction within the ambit of a “deemed sale” under Article 366(29A)(d) of the Constitution and Section 2(29)(d) of the KVAT Act.
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The appellant bank, a scheduled commercial bank registered under both the KVAT Act and the Central Sales Tax Act, provides payment processing services to merchant establishments by installing EDCT machines at their business premises. These machines enable merchants to accept payments through credit cards, debit cards, and other electronic payment instruments. Besides earning transaction-based Merchant Discount Rate (MDR) charges, the bank also collected fixed charges such as monthly terminal rentals, installation charges, and maintenance charges for these machines.
The bank treated the entire consideration received from merchants as payment for banking and financial services and discharged service tax under the Finance Act, 1994. However, during an enforcement inspection, the Commercial Taxes Department found that the bank had not disclosed rental receipts from EDCT machines as taxable turnover under the KVAT Act. Consequently, reassessment proceedings were initiated for the assessment years 2006-07 to 2009-10.
The reassessment resulted in a VAT demand of ₹7 lakh, interest of ₹5.77 lakh, and penalty of ₹70,700. Appeals before the Joint Commissioner (Appeals) and the Karnataka Appellate Tribunal were unsuccessful, prompting the bank to approach the High Court.
The bank contended that its arrangement with merchant establishments was essentially a composite contract for rendering payment processing services and that the EDCT machines merely facilitated access to the bank’s electronic payment network. It argued that ownership, dominion, and effective control over the machines always remained with the bank, which retained the power to suspend or deactivate the terminals remotely.
It further submitted that the Merchant Establishment Agreement prohibited merchants from relocating, altering, subleasing, or otherwise dealing with the machines, and required their return upon termination of the agreement. These contractual restrictions, according to the bank, demonstrated that there was no transfer of the right to use goods.
The bank also argued that since service tax had already been paid on the entire consideration received from merchants, the same amount could not simultaneously be subjected to VAT.
The State argued that the EDCT machines were tangible, identifiable goods installed at merchant premises and that separate rental charges were specifically collected for their use. According to the Revenue, merchants enjoyed physical custody and operational use of the machines during the agreement period, satisfying the constitutional requirements for a transfer of the right to use goods.
The State also maintained that payment of service tax on one aspect of the transaction did not prevent the State from levying VAT on the sale element embedded in the same composite arrangement.
The High Court observed that the principal question was whether rental charges collected for EDCT machines represented consideration for the transfer of the right to use goods under Article 366(29A)(d) of the Constitution.
Relying on the Constitution Bench judgment in BSNL v. Union of India, the Court held that the decisive test is whether the customer has been conferred the right to use identifiable goods, and not whether ownership has been transferred. Ownership and the right to use goods, the Court noted, are legally distinct concepts.
The Bench found that the EDCT machines were separately identifiable pieces of equipment installed at merchant establishments and that merchants used them for processing customer payment transactions. Separate rental charges were collected for these machines apart from transaction-based charges, indicating an independent commercial arrangement relating to the equipment.
Rejecting the bank’s reliance on contractual restrictions, the Court held that clauses preventing alteration, relocation, or subleasing merely protected the bank’s ownership interest and did not negate the transfer of the right to use the equipment. According to the Court, what mattered was that merchants were enabled to use the machines for their business throughout the subsistence of the agreement.
The Court also rejected the contention that the bank’s ability to deactivate the terminals meant effective control remained with it. Retention of supervisory powers, maintenance obligations, or ownership does not, by itself, prevent a transaction from amounting to a transfer of the right to use goods, the Bench observed.
The High Court held that payment of service tax does not bar the levy of VAT where a transaction contains a distinct sale element.
The Court observed that a composite transaction may simultaneously attract different taxes under separate statutes, provided each levy operates within its respective legislative field. While service tax applies to the service component, VAT can validly be imposed on the transfer of the right to use goods where the statutory requirements are satisfied.
The Bench clarified that the authorities had not sought to tax the bank’s entire payment processing service but only the rental charges collected specifically for the EDCT machines, which represented consideration for granting merchants the right to use those machines.
The Court distinguished the Supreme Court’s decision in Idea Mobile Communication Ltd., where SIM cards were held to be incidental to telecommunication services. Unlike SIM cards, EDCT machines are tangible, identifiable equipment installed at merchant premises and are subject to separate rental consideration. Therefore, they constitute an independent subject matter capable of attracting VAT as a deemed sale.
Similarly, the Court held that the decision in Indus Towers Ltd. concerning telecom infrastructure was factually distinguishable because, in the present case, merchants were provided identified machines installed at their premises and were enabled to use them directly for processing customer payments.
The High Court also upheld the levy of interest and penalty under Section 72(2) of the KVAT Act. It observed that the authorities had concurrently found that the bank collected separate rental charges without disclosing them as taxable turnover. Since no perversity or legal error was established in those findings, there was no justification for interference in revisional jurisdiction.
Dismissing the revision petition, the Karnataka High Court held that EDCT machines are identifiable goods placed at the disposal of merchant establishments for business use, and the rental charges collected for such machines constitute consideration for the transfer of the right to use goods, making them liable to VAT under the KVAT Act.
The Court affirmed the Karnataka Appellate Tribunal’s order and answered the substantial questions of law in favour of the Revenue, holding that retention of ownership and supervisory control by the bank does not prevent the transaction from being treated as a deemed sale for VAT purposes.
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