2024 (3) TMI 41 - SC - Income Tax

TDS u/s 194H - commission payable to an agent by the assessees under the franchise/ distributorship agreement between the assessees and the franchisees/distributors - assessee cellular mobile service providers - nature of relationship between a principal and an agent - As per the assessees, neither are they paying a commission or brokerage to the franchisees/distributors, nor are the franchisees/distributors their agents. HELD THAT - In franchise agreements, the supplier or the manufacture, i.e. a franchisor, appoints an independent enterprise as a franchisee through whom the franchisor supplies certain goods or services. There is a close relationship between a franchisor and a franchisee because a franchisee s operations are closely regulated, and this possibly is a distinction between a franchise agreement and a distributorship agreement. Franchise agreements are extremely detailed and complex. They may relate to distribution franchises, service franchises and production franchises. Notwithstanding the strict restrictions placed on the franchisees which may require the franchisee to sell only the franchised goods, operate in a specific location, maintain premises which are required to comply with certain requirements, and even sell according to specified prices the relationship may in a given case be that of an independent contractor. Facts of each case and the authority given by principal to the franchisees matter and are determinative. An independent contractor is free from control on the part of his employer, and is only subject to the terms of his contract. But an agent is not completely free from control, and the relationship to the extent of tasks entrusted by the principal to the agent are fiduciary. As contract with an independent agent depends upon the terms of the contract, sometimes an independent contractor looks like an agent from the point of view of the control exercisable over him, but on an overview of the entire relationship the tests specified in clauses (a) to (d) in paragraph 8 may not be satisfied. The distinction is that independent contractors work for themselves, even when they are employed for the purpose of creating contractual relations with the third persons. An independent contractor is not required to render accounts of the business, as it belongs to him and not his employer. Thus, the term agent denotes a relationship that is very different from that existing between a master and his servant, or between a principal and principal, or between an employer and his independent contractor. Although servants and independent contractors are parties to relationships in which one person acts for another, and thereby possesses the capacity to involve them in liability, yet the nature of the relationship and the kind of acts in question are sufficiently different to justify the exclusion of servants and independent contractors from the law relating to agency. The term agent should be restricted to one who has the power of affecting the legal position of his principal by the making of contracts, or the disposition of the principal s property; viz. an independent contractor who may, incidentally, also affect the legal position of his principal in other ways. This can be ascertained by referring to and examining the indicia mentioned in clauses (a) to (d) in paragraph 8 of this judgment. It is in the restricted sense in which the term agent is used in Explanation (i) to Section 194-H of the Act. We hold that the assessees would not be under a legal obligation to deduct tax at source on the income/profit component in the payments received by the distributors/franchisees from the third parties/customers, or while selling/transferring the pre-paid coupons or starter-kits to the distributors. Section 194-H of the Act is not applicable to the facts and circumstances of this case. Accordingly, the appeals filed by the assessee cellular mobile service providers, challenging the judgments of the High Courts of Delhi and Calcutta are allowed and these judgments are set aside. The appeals filed by the Revenue challenging the judgments of High Courts of Rajasthan, Karnataka and Bombay are dismissed.

Summary

Issues Involved:
1. Liability to deduct tax at source under Section 194-H of the Income Tax Act, 1961.
2. Nature of the relationship between the assessees and franchisees/distributors.

Summary:

Issue 1: Liability to Deduct Tax at Source under Section 194-H
The Supreme Court addressed the appeals concerning the liability to deduct tax at source under Section 194-H of the Income Tax Act, 1961. The Revenue argued that the amount, as per them, is a commission payable to an agent by the assessees under the franchise/distributorship agreement. The assessees, however, contended that they neither pay a commission nor are the franchisees/distributors their agents. The High Courts of Delhi and Calcutta held that the assessees were liable to deduct tax at source under Section 194-H, whereas the High Courts of Rajasthan, Karnataka, and Bombay held otherwise.

The Court examined Section 194-H, which imposes the obligation to deduct tax at source on any income by way of commission or brokerage. The Court clarified that the expression "any person (...) responsible for paying" is a term of art defined in Section 204 of the Act. The Court emphasized that the requirement of a principal-agent relationship has been read into the main section, and the deduction of tax provisions should be pragmatically and realistically construed.

Issue 2: Nature of the Relationship between Assessees and Franchisees/Distributors
The Court analyzed the franchise/distributorship agreements, particularly focusing on the relationship between the assessees and their franchisees/distributors. It was noted that the franchisees/distributors were required to pay in advance the discounted price for the prepaid service products, and their profit consisted of the difference between the sale price received from the retailer/end-user/customer and the discounted price.

The Court highlighted that the franchisees/distributors were not agents of the assessees but acted as independent contractors. The franchisees/distributors were free to sell the prepaid products at any price below the printed price and determined their profits/income. The Court rejected the Revenue's argument that the assessees should periodically ask for information/data from the franchisees/distributors and deduct tax at source, deeming it far-fetched and imposing an unfair obligation.

The Court concluded that the assessees were not liable to deduct tax at source on the income/profit component in the payments received by the distributors/franchisees from third parties/customers. The appeals filed by the assessees were allowed, and the judgments of the High Courts of Delhi and Calcutta were set aside. The appeals filed by the Revenue were dismissed.

Conclusion:
The Supreme Court held that Section 194-H of the Income Tax Act is not applicable to the facts and circumstances of this case, and the assessees (cellular mobile service providers) are not under a legal obligation to deduct tax at source on the income/profit component in the payments received by the distributors/franchisees.