FRANCHISE AGREEMENT WILL NOT ATTRACT VALUE ADDED TAX

[Mr. M. GOVINDARAJAN]

Section 65(47) of Finance Act, 1994 defines the term ‘franchise’ as an agreement by which the franchisee is granted representational right to sell or manufacture goods or to provide service or undertake any process identified with the franchisor, whether or not a trade mark, service mark, trade name of logo or any such symbol, as the case may be, is involved. Section 65(48) defines the term ‘franchisor’ as any person who enters into franchise with a franchisee and includes any associate of franchisor or a person designated by franchisor to enter into franchise on his behalf and the term ‘franchisee’ shall be construed accordingly.

In ‘Malabar Gold Private Limited V. Commercial Tax Officer, Kozhikode’ – 2013 (7) TMI 101 - KERALA HIGH COURT the appellant is engaged in marketing, trading , export and import of jewelry, gold ornaments, diamond ornaments, platinum ornaments, watches, etc., under the name of ‘Malabar Gold’. The appellant is a registered dealer for VAT and CST. The appellant is having service tax registration under Finance Act for franchise service.

The Commercial Tax Officer(‘CTO’ for short), Kozhikode issued show cause notice on the appellants on the ground of alleged non payment of VAT on the amount of royalty received from franchisees for use trade mark under Section 6(1) of Kerala VAT Act, 2003. The appellant paid service tax on the royalty amount received from the franchisees. The appellant replied to the show cause notices that the transaction actually attracts service tax along which have been paid by them and it would come under the purview of Kerala VAT Act. Overruling the objections the CTO confirmed the demand of tax along with interest and also imposed penalty.

The appellant filed a writ petition before the High Court against the order of CTO. The Single Judge rejected the contentions of the company and held that the royalty received by the dealer is exigible to tax under Section 6(1)(c) of the KVAT Act. Aggrieved by the said order the appellant filed the present appeal before the Division Bench. The Commissioner of Central Excise also impleaded as one of the party in the appeal. The appellant submitted the following before the High Court:

• The entire legal issues are covered in favor of the company in the light of the binding decision of the Supreme Court in BSNL’s case which interpreted Article 366(29A)(d) and List II Entry 54;
• The nature of transaction is a franchise agreement and the company has different franchisees who have executed similar agreements;
• The terms of the agreement will show that the franchisees can store and sell products and the show room should have the name board ‘Malabar Gold’ as per the design approved by the company;
• The royalty fee being paid the franchisees is a percentage of the annual net profit of the franchisees;
• The payment of service tax as well as VAT are mutually exclusive and hence once the transaction is clearly covered under the relevant provisions for payment of service tax, then it cannot be charged for sales tax or VAT against;
• In the light of the peculiarities of franchise agreement and the concept of ‘right to use goods’ under Article 366(29A) the tests required to satisfy the same as laid by the Apex Court in BSNL’s case are not satisfied here;
• There is no transfer of trade mark to the franchisees in the transaction. The agreement does not permit the franchisees to further transfer the trade mark to a third party or to use it exclusively to the exclusion of the appellant company;
• Once the company takes a decision to withdraw the permission granted to the franchisees to use the trade mark, then the franchisees have to stop using the same;
• There is no absolute transfer in favor of the franchisees and the entire control is vested with the franchisor company;
• In KVAT Act trade mark is not item specifically included among the ‘intangible goods’ mentioned therein and the same is confined to copyright, patent and REP licence;
• The attempt by the Revenue is to rope in Trade mark under item (4) ‘Others’ which cannot be justified;
• The Single Judge did not go into the question whether service tax alone is payable by the company and did not consider the other related legal affairs.

The Commissioner of Central Excise supported the arguments put forth by the appellants before the High Court.   The Revenue put forth the following arguments before the High Court:

• The Commissioner of Central Excise has no role in this case as no decisions has been made against them;
• In the franchise agreement, no service element is provided and therefore the transaction is not eligible to service tax;
• If the appellant has got any grievance regarding the collection of service tax, they will have to challenge it in appropriate proceedings as held by the Single Judge;
• The intellectual property is coming under the definition of ‘goods’ by virtue of many judgments and thus trade mark will also come within the same;
• Clause 18 of the agreement will show that the franchisee is not an agent and is treated as principal itself.   It is therefore that the plea that the franchisee is not having any control cannot be supported;

After hearing both the sides, the High Court analyzed the provisions of the Finance Act, 1994 and Kerala Value Added Tax Act, 2003 and also the agreement entered into between the appellant company and the franchisees. The High Court held that the terms of franchise agreement showed that the appellant retained the right, effective control and possession of their trade mark.   It was not a case of transfer of possession to exclusion of transferor.   Allowing use of trade mark by franchisees on products did not give franchisees effective control of trade mark.   The rights of the franchisees were limited and they were bound to sell products of the appellant company.   Even while franchise agreement with one was in force, the appellant company could use the trade mark on their own and enter into franchise agreement with other parties.   Merely because one of the clauses stipulated that franchisee was not an agent they could not be treated as principal and get other exclusive right. KVAT Act was not applicable as transaction was not ‘deemed sale’ under Section 2(x)(iii) ibid due to non fulfillment of conditions provided in BSNL’s case. The provision of various support services by the appellant company to the franchisees, showed service element and activities stipulated in agreement to be carried by the franchisee, including retailing of various products of assessee and fact that franchisee could stock, exhibit or sell any products only products of assessee, satisfied meaning of franchise in Section 65(47) and 65(105)(zze) of Finance Act, 1994.   Since taxable service was provided to franchisee by franchiser in relation to a franchise, terms of agreement had to be understood in that context. The Supreme Court’s decision in BSNL case supported the appellant, tests laid down in that case were applicable are not satisfied.   There were no deliverable goods at any stage and for that reason also, there was no transfer of right to user at all. The Court reversed the findings of the Single Judge and held that the franchise agreement will not attract the provisions of the KVAT Act.