2015 (4) TMI 710 - AT - Income Tax

Accrual of income - reduction in taxable income - evasion of tax - Shown lesser amount in agreement - Unilateral Modification in Master License Agreement and the Franchise agreement - Held that - All these agreements read with correspondence clearly show that assessee was entitled to USD 22,500 and not USD 45,000 during FY 2002- 03. Ld. Standing Counsel has submitted that there could not be any unilateral amendment to the Franchisee agreement. However, contents of letter dated 8-12-2002, reproduced above, clearly show that the amendment was effective after discussions with reference to license and location fees. A memorandum was accordingly entered into. There was no novation of contract and it was only a change in the payment of fee to assessee. At the outset we may clarify that we are deciding the issue to the extent of entitlement of Franchisee fee as per the Master License Agreement read with JV agreement and Franchisee agreement and the communication relied upon by assessee. We may clarify that we are not giving any finding on the issue relating to assessee's alternate claim on the ground that in any case, no income was assessable in the hands of assessee as the assessee was required to make the payment to McDonald Corporation because this has trapping on TP issues, particularly because there was no permission for remitting the amount prior to 3-2-2004 in respect of new restaurant opened as per letter dated 3-2-2004 of the Under Secretary, Ministry of Finance, available at page 217 of the PB. Ld. Standing Counsel has referred to covenant 26 of the Master License Agreement as well as Franchisee agreement to submit that the modification of the agreement could be only as agreed upon. In this regard we find that the term duly executed in case of Franchisee implies that the same is executed by an officer of Franchiser or its Franchiser director and in case of Franchisee executed by the Franchisee. The communication contained at page 68, in our opinion, confirmed to both the conditions because the same has been addressed to Franchisee by Franchiser. We, accordingly, do not find any reason to interfere with the order of ld. CIT(A) to the extent that since no real income accrued to assessee, no addition was called for. - Decided against the revenue.

Summary

Issues Involved:
1. Validity of the reduction in initial franchise fee from USD 45,000 to USD 22,500.
2. Justification and proof for the reduced franchise fee.
3. Assessment of real income and notional income.

Detailed Analysis:

1. Validity of the reduction in initial franchise fee from USD 45,000 to USD 22,500:
The assessee had entered into a Master License Agreement and a Service Agreement with its parent company, McDonald's Corporation, USA (MDC USA). According to the Master License Agreement, the franchise fee to be charged from the franchisee was USD 45,000. However, the assessee reduced this fee to USD 22,500 through a management decision effective from July 1, 2002, to December 31, 2004, aiming to broaden the restaurant base and strengthen the company's position in India. The AO did not accept this reduction, citing that the assessee did not provide sufficient justification or proof for this change, and the Master License Agreement explicitly stated the fee as USD 45,000. The AO also noted that the assessee merely furnished a copy of a fax letter without any formal amendment to the original agreement.

2. Justification and proof for the reduced franchise fee:
The assessee contended that the reduction in the franchise fee was a strategic decision to increase the sale of McDonald's products and was supported by separate agreements with joint venture companies. The AO, however, observed that the assessee did not provide any substantial evidence or facts to justify the reduction. The AO argued that the reduction appeared to be an attempt to reduce taxable income since the joint venture companies were already showing losses. The AO, therefore, added the difference between the initial franchise fee returned by the assessee and that as per the Master License Agreement, amounting to Rs. 97,81,425/-, to the assessee's income.

3. Assessment of real income and notional income:
The CIT(A) allowed the assessee's appeal, stating that no real income arose to the assessee by the receipt and disbursement of the initial franchise fees, and notional income cannot be taxed. The CIT(A) agreed with the assessee's submission that even if the franchise fee should have been USD 45,000, it was payable to McDonald's Corporation US and would not have been the income of the assessee. The revenue appealed against this decision, arguing that the fee reduction was not valid without a proper resolution and formal amendment to the original agreement. The revenue also contended that the CIT(A) did not consider the true import of the agreement.

The Tribunal considered the rival submissions and the relevant agreements and correspondence. It noted that the assessee had received only USD 22,500, as per the Franchise Agreement dated March 5, 2003, and the communication dated December 8, 2002, confirming the reduced fee. The Tribunal found that the amendment to the fee was effective after discussions and did not constitute a unilateral amendment. The Tribunal also noted that the communication met the conditions for modification as per the Master License Agreement and Franchise Agreement. Therefore, the Tribunal upheld the CIT(A)'s decision that no real income accrued to the assessee, and no addition was called for.

Conclusion:
The Tribunal dismissed the revenue's appeal, affirming that the reduction in the franchise fee was valid and that no real income accrued to the assessee. The order was pronounced in open court on March 18, 2015.