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TMI Blog2019 (9) TMI 1141X X X X Extracts X X X X X X X X Extracts X X X X ..... ndia. The Appellant obtained service tax registration for 'Franchisee Service' and 'Management Consultancy Service' with effect from 24 November, 2005. 3. It is stated that McDonald's India does not operate any restaurant in India. It, however, entered into Franchisee Agreements with local franchisees, namely, Hardcastle Restaurants Private Limited [Hardcastle] and Connaught Plaza Restaurants Private Limited [Connaught Plaza] who operate restaurants in India. As a consideration for its services, McDonald's India receives royalty equivalent to 5 % of the gross sales made by the local franchisees in addition to a fixed location fee of $22,500 to $45,000, each time a new restaurant is opened. The Appellant claims that there is no other consideration flowing to the Appellant, directly or indirectly, from the franchisees, except the said royalty amount and the location fee amount. It is not in dispute that service tax as applicable has been paid by the Appellant on the said royalty and the location fee amount. The Appellant is also providing 'management consultancy' services to McDonald's USA, in terms of a Service Agreement dated 1 April, 1999. 4 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nterest on late payment of Service Tax for franchisee fees to McDonald's USA √ √ √ √ √ 7. According to the Department, the franchisees, apart from remitting franchisee fees and royalty amount were also required to contribute 5 per cent of the gross sale for advertising and promotion of the restaurant system owned by McDonald's USA. Thus, through this contractual obligation, the franchisor was getting an extra consideration in the form of contribution towards advertisement from the franchisees for the promotion of its own brand. It was, therefore, believed that the extra consideration paid by the franchisees to the franchisor would form part of value of taxable service of the franchisor in terms of section 67 of the Finance Act, 1994[the Act] read with the Service Tax (Determination of Value) Rules, 2006[the Act]. It was also believed that there was short payment of service tax due to wrong utilisation of Cenvat Credit, non-payment of service tax on 'Management Consultancy Service' by wrongly claiming it as export, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... COPORATION, a Delaware Corporation ("Licensor" or " McDonald's") and McDONALD'S INDIA PRIVATE LIMITIED, a company organised under the laws of India (" License" ). WITNESSETH: WHEREAS: A. Licensor has developed and operates a restaurant system ("McDonald's System"). The McDonald's System includes proprietary rights in certain valuable trade names, service marks and trademarks, including the trade names " McDonald's" and " McDonald's Hamburgers", designs and colour schemes for restaurant buildings, signs, equipment layouts, formulas and specifications for certain food products, methods of inventory and operator control, bookkeeping and accounting and manuals covering business practices and policies. The McDonald's System is operated and is advertised widely within the United States of America and in certain foreign countries. B. Licensee desires to acquire the non-exclusive right to adopt and use the McDonald's System to promote and develop, in ag ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y which McDonald's USA authorised McDonald's India to grant sub-license to franchisees to operate McDonald's restaurants using the McDonald's System in India, McDonald's India entered into a franchisee agreement dated 27 September, 2004 with Connaught Plaza and a franchisee agreement dated 1 March, 1999 with Hardcastle. The terms of both the agreements are similar in nature and so the relevant terms of the franchisee agreement dated 27 September, 2004 between McDonald's India and Connaught Plaza are reproduced : " FRANCHISEE AGREEMENT THIS AGREEMENT ("Agreement") made as of September, 27, 2004 by and between McDONALD'S INDIA PRIVATE LIMITED, a company organised under the laws of India, with its registered office located at 10, Vasant Lok Community Centre, Vasant Vihar, New Delhi 110057, India ("Franchisor") and VIKRAM BAKSHI, citizen of India, with his registered office at 13A, Jor Bagh, Market, New Delhi, 110003, India, Joint Venture partner and Connaught Plaza Restaurants Private Limited with its corporate office as set forth ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... vides the basis for the valuable goodwill and wide family acceptance of the McDonald's System. Moreover, the establishment and maintenance of a close personal working relationship with Franchisee and Joint Venture Partner in the conduct of Franchisee's McDonald's restaurants business, their accountability for performance of the obligations contained in this Agreement and their adherence to the tenets of the McDonald's System constitutes the essence of this Agreement. (a) The provisions of this Agreement shall be interpreted to give effect to the intent of the parties stated in this Paragraph 1 so that the restaurants operated pursuant to this Agreement shall be operated in conformity to the McDonald's System through strict adherence to Franchisor's standards and policies as they exist now and as they may be from time to time modified; (b) Franchisee and Joint Venture Partner acknowledges his understandings of Franchisor's basic business policy that Franchisor will grant franchises only to those individuals who live in the locality of their McDonald's restaurant, actually own a substantial equity interest in the business of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing and personnel policies. 5. ADVERTISING In order to enable Franchisor to protect and preserve its worldwide image as a friendly, clean and wholesome quick service restaurant suitable at all times for families, Franchisee shall use only advertising and promotional materials and programs provided by Franchisor or approved in advance by Franchisor. Neither the approval by Franchisor of Franchisee's advertising and promotional materials nor the providing of such materials by Franchisor to Franchisee shall, directly or indirectly, require Franchisor to pay for such advertising or promotion. Franchisee shall expend during each calendar year for advertising and promotion of the Restaurant to the general public an amount which is not less than five percent (5%) of his Gross Sales (as that term is defined in Paragraph 7) for such year. Franchisor reserves the right to require Franchisee to contribute up to five percent (5%) of its Gross Sales to national and/or regional (in India) advertising cooperatives. Expenditures by F ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... by Franchisee's employees, with the specific indication that the Franchisee is a Franchisee of McDonald's. Franchisee shall submit to Franchisor for approval such receipts, headed paper and business cards prior to their use; (d) ............................... 16. FRANCHISEE NOT AN AGENT OF FRANCHISOR. Neither Franchisee nor Joint Venture Partner shall have any authority, express or implied, to act as agent of Franchisor, or any affiliates for any purpose. Franchisee is, and shall remain, an independent contractor responsible for all obligations and liabilities of, and for all loss or damage to, the Restaurant and its business, including any personal property, equipment, fixtures or real property connected therewith and for all claims or demands based on damage or destruction of property or based on injury, illness or death of any person, directly or indirectly, resulting from the operation of the Restaurant. " (emphasised supplied) 14. Each of the four issues considered in the impugned order shall be dealt with separately. FIRST ISSUE Non-Payment of Service Tax on Ad ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... deration. In this context reliance has been placed on sections 66 and 67 of the Act and the decision of the Supreme Court in Commissioner of Service Tax Vs. M/s Bhayana Builders (P) Ltd.[ 2018 (2) TMI 1325]; (v) Thus, it cannot be said that there is a contractual obligation to advertise the trade names, service marks and trademarks of the franchisor and in the absence of such a direct requirement under the contract, no extra consideration can be attributed to any indirect benefit, which is free and not a direct requirement for the service rendered. Reliance has been placed on the decision of the Delhi High Court in the context of transfer pricing provisions under the Income Tax Act, 1961 in Bausch & Lomb Eyecare (India) Pvt. Ltd. Vs. The Additional Commissioner of Income Tax [(2016) 65 Taxmann.com 141 Delhi]; (vi) The demand which is calculated on the basis of the entire advertising expenditure incurred by the franchisees to fulfil the condition in the franchise agreement with respect to advertising the Restaurant is wholly without any basis and is not in accordan ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rate identity of the franchisee or the 'Restaurant'; (iii) As a separate identity of the franchisee is not possible, the contention that the 'Restaurant' is a separate identity from the McDonald's System is an eyewash. In support of this contention, reliance has been placed on the decision of the Delhi High Court in Delhi International Airport Private Limited Vs. Union of India[2017 (50) STR 275]; (iv) The decision of the Supreme Court in Bhayana Builders would not be applicable to the facts of the present case because the value of the advertising expenses as being not less than 5% of the gross sales is mentioned in the Agreement entered into between the franchisor and the franchisee. This amount would, therefore, form part of the "gross amount charged"; and (v) Likewise, the decision of the Tribunal in Hero Honda Motors and the decision of the Supreme Court in Intercontinental Consultants would not be applicable as the advertisement expense is not a reimbursement and is a part of the service that is provided. This issue has been decided in favour of the Revenue by a Division Bench of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e service marks". In coming to this conclusion the Principal Commissioner placed emphasis on that part of Clause 5 of the agreement that provided that the franchisee "shall use only the advertisement and promotional materials and programmes provided by franchisor or approved in advance by franchisor". The contention of the Appellant that Rule 5 (1) of the 2006 Rules under which the value of non-monetary consideration was determined had been stuck down by the Delhi High Court in Intercontinental Consultants was not accepted for the reason that an Appeal had been filed in the Supreme Court against the decision of Delhi High Court and for the reason that the inclusion of advertisement expenses incurred by virtue of a contract was not the subject matter under consideration before the Delhi High Court. The Principal Commissioner, therefore, placed reliance upon Rule 5(1) of the Rules to determine the value of the nonmonetary consideration. 19. To appreciate this issue, it will be appropriate to examine the agreement dated 27 September, 2004 entered into between the Appellant and Connaught Plaza. The agreement of the Appellant with Hardca ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... p; Clause 5 of the agreement relates to 'Advertising' and is relevant to the issue under consideration. It provides that in order to enable the franchisor to protect and preserve its worldwide image as a friendly, clean and wholesome quick service restaurant suitable at all times for families, the franchisee shall use only advertising and promotional materials and programmes provided by the franchisor or approved in advance by the franchisor. However, neither the approval by the franchisor of the franchisee advertising and promotional materials nor the providing of such materials by the franchisor to the franchisee would directly or indirectly, require the franchisor to pay for such advertising or promotion. It further provides that the franchisee shall expend during each calendar year for advertising and promotion of the Restaurant to the general public an amount which is not less than 5 per cent of the gross sales. 23. Clause 8 of the agreement deals with 'Royalty'. It provides that the franchisee shall pay to franchisor as a royalty 5% percent of the gross sales from the operation of the restaurant. Clause 9 dea ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... it on advertisement on its own." [emphasis supplied] 26. The Principal Commissioner, after examining the agreement, concluded : "In view of the above, I do not have any hesitation to hold that through contractual obligation, the notice was getting extra consideration in the form of contribution towards advertisement from the franchisees. Now, as regards the aspect whether contribution towards advertisement was an extra consideration or not, I find that Explanation (a) to Section 67 simply states that 'consideration' includes any amount that is payable for the taxable services provided or to be provided. This definition is inclusive and not specific. However, the word 'consideration' has a technical meaning and that needs to be adopted for purpose of Section 67. In the instant case franchisees, apart from remitting franchisee fee and royalty amount were contracted to contribute 5% of its gross sale for advertisement and promotion of the restaurant system owned by the franchisor i.e McDonald's Corporation. Thus, the extra consideration paid by the franchisee to franchisor should form part of the value of taxable service for ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... way Systems International was in different terms than the agreement in this appeal between the franchisor and the franchisee. The agreement in Subway Systems provided that each franchisee was to pay weekly royalty equal to 8% of the gross sales towards also advertising fee of 4.5% of the weekly gross sales as contribution to the Subway Franchisee Advertisement Fund Trust. The Tribunal examined, whether bifurcating the amount of weekly gross sales into payment of royalty and payment towards Franchisee Advertisement Fund would have the effect of excluding the latter value from the transaction value for the purpose of Section 67 of the Act. The Tribunal noticed that this 4.5% of the gross sales was not an expense incurred by the franchisee for advertising its own outlet but was passed on to the service provider under the agreement and, therefore, though a different nomenclature by way of an advertisement fund was given under the agreement, but nonetheless the value was received by the Appellant. 32. In the instant Appeal, as noticed above, the franchisee had to expend not less than 5% of the gross sales in a particular year towards the adver ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sfy the following ingredients : a. Service tax is payable on the gross amount charged :- the words "gross amount" only refers to the entire contract value between the service provider and the service recipient. The word "gross" is only meant to indicate that it is the total amount charged without deduction of any expenses. Merely by use of the word "gross" the Department does not get any jurisdiction to go beyond the contract value to arrive at the value of taxable services. Further, by the use of the word "charged", it is clear that the same refers to the amount billed by the service provider to the service receiver. Therefore, in terms of Section 67, unless an amount is charged by the service provider to the service recipient, it does not enter into the equation for determining the value on which service tax is payable. b. The amount charged should be for "for such service provided" : Section 67 clearly indicates that the gross amount charged by the service provider has to be for the service provided. Therefore, it is not any amount charged which can become the basis of value on which service tax becomes payable but the amount charged has to be neces ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the gross amount charged by the service provider 'for such service' and the valuation of tax service cannot be anything more or less than the consideration paid as quid pro qua for rendering such a service. 25. This position did not change even in the amended Section 67 which was inserted on May 1, 2006. Sub-section (4) of Section 67 empowers the rule making authority to lay down the manner in which value of taxable service is to be determined. However, Section 67(4) is expressly made subject to the provisions of sub-section (1). Mandate of subsection (1) of Section 67 is manifest, as noted above, viz., the service tax is to be paid only on the services actually provided by the service provider." 37. The order has grossly erred in interpreting the franchise agreement, thereby, including the cost of advertisement in the franchise fee received by the Appellant. The amount incurred by the franchisees towards advertisement expenses, cannot, therefore, be said to be 'consideration' paid by the franchisee to the Appellant, as it is the franchisee themselves who are benefitting out of such expenses and not the Appellant. 38. In this connec ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... quivocally bore that advertisement was even for the promotion of the trade names, trademarks and service marks. The very wording of the contract that "Franchisee shall use only advertising and promotional materials and programs provided by Franchisor or approved in advance by Franchisor. Neither the approval by Franchisor of Franchisee's advertising and promotional material nor the providing of such material by Franchisor to Franchisee shall, directly or indirect, require Franchisor to pay for such advertising or promotion". negates the defense point that advertisement was for the own business promotion of the sub licensee. Accordingly, the defense submissions in this regard do not merit consideration." 40. Though the Principal Commissioner reproduced Clause 2 of the agreement, but drew an incorrect inference from the said clause of the agreement as the conclusion drawn is that the advertisement was for promotion of the trade names, trademarks and service marks and not for the business promotion of the franchisee. It is clear that McDonald's System includes proprietary rights in certain valuable trade names, service marks and trademark ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... which have only designated menu of food and beverage products of the McDonald's System. Even the sign boards have to indicate the name "McDonald's" with no reference to any other name or entities. It was imperative for the franchisee in terms of the agreement to adhere to the 'McDonald's System' consistent with the McDonald's brand across India. 42. It was, therefore, in the business interest of the franchisee to enhance its sale by causing advertisements. The advertisement, therefore, was for promotion of the Restaurant operated by the franchisee and merely because the trade names, service marks, trademarks of the franchisor also appear in the advertisement, no extra consideration flows to the franchisor. The order of the Principal Commissioner, therefore, suffers from a fundamental error as it rejects the contention of the Appellant that the advertisement was for the business promotion of the franchisee. 43. It needs to be remembered that the Principal Commissioner has not recorded any finding, nor could he have, that McDonald's India is also running restaurants. The Principal Commissioner completely misunderstood the submission advan ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ith no reference to any other name or entity. It is, therefore, not possible to accept the contention of the learned Authorized Representative of the Department that the advertisement of the Restaurant would result in breach of either Clause 12(c) or clause 5(first paragraph). The decision of the Delhi High Court in Delhi International Airport also does not help the Department as the facts were entirely different. Paragraph 58 of the judgment, on which reliance has been placed by the Authorised Representative of the Department, is as follows: "58. A representational right would mean that a right is available with the franchisee to represent the franchisor. When the Franchisee represents the franchisor, for all practical purposes, the franchisee loses its individual identity and would be known by the identity of the franchisor. The individual identity of the franchisee is subsumed in the identity of the franchisor. In the case of a franchise, anyone dealing with the franchisee would get an impression as if he were dealing with the franchisor." 46. It is Clause 5 of the agreement that requires the advertisement to be issued and it has be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... some non-monetary consideration had been received by the Appellant towards the advertisement made by the franchisee, which nonmonetary consideration was required to be determined under Rule 5(1) of the 2006 Rules. Even if it is assumed that some nonmonetary consideration had been received by the Appellant, then too the same could not have been determined under Rule 5(1) of the 2006 Rules. Rule 5(1) of the 2006 Rules was struck down by the Delhi High Court in Intercontinental Consultant, which judgment was upheld by the Supreme Court. 50. Section 67 of the Act deals with valuation of taxable services for charging Service Tax. Sub-section (1) of section 67 provides that where Service Tax is chargeable on any taxable service with reference to its value, then such value shall, where the provision of service is for a consideration in money, be the gross amount charged by the service provider for such service provided or to be provided by the service provider. It is, therefore, clear that only such amount is subject to Service Tax which represents consideration for provision of service and any other amount which is not a consideration for provision of service c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... bursable claims which were included in the gross value. The Supreme Court noted that Rule 5 does bring within its sweep the expenses which are incurred while rendering the service and are reimbursed and, therefore, what was required to be decided was whether section 67 of the Act permits subordinate legislation to be enacted as was done by Rule 5. It needs to be noted that prior to 19 April, 2006, in the absence of a Rule, the valuation was required to be done as per the provisions of section 67 of the Act. The Supreme Court noticed that the charging section 66 provides that there shall be levied Service Tax @ 12% of the value of taxable services referred to in the sub-clauses of Section 65 and collected in such manner as may be prescribed. Thus, the Service Tax is on the "value of taxable services" and, therefore, it is the value of the services which are actually rendered which has to be ascertained for the purpose of calculating the Service Tax. It is for this reason that the Supreme Court observed that the expression "such" occurring in section 67 of the Act assumes importance. It is in this context that the Supreme Court in paragraph 26 observed that the authority has to find ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... enses for adopting McDonald's Restaurant system provided by the Noticee. xxxxxxx xxxxxxx xxxxxx 3. The assertions to the effect that the franchise services received by the Company and the management consultant's services rendered by the Company, were so inextricably linked, that, one cannot be rendered/received in the absence of the other in no way implies that Franchisee service will qualify for an input service used for providing Management Consultancy services by virtue of definition of Input Services as discussed." 54. Sub-rule 2(1) of CENVAT Credit Rules, 2004 [the Cenvat Rules] is as follows : "Input service means any service,- (i) used by a provider of taxable service for providing an output service: or (ii) used by the manufacturer, whether directly or indirectly in or in relation to the manufacture of final products and clearance of final products, upto the place of removal, and includes services used in relation to setting up, modernization, renovation or r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ]. Secondly, the definition of input service during the period prior to 1 August, 2011 included "activities relating to business" as an eligible item for purpose of the definition of input service under Rule 2(l) of the Cenvat Rules. A Division Bench of the Tribunal in KPMG v/s Commissioner of Central Excise, New Delhi[2014(33) STR 96 (Tri. Delhi)] held:- "Input service has been defined illustratively and not restrictively; illustratively and not exhaustively as comprising inter alia enumerating services. A restriction has been incorporated on the availment of Cenvat Credit only with effect from 1 August, 2011 and this is subsequent to the period of dispute." 57. The observation of the Principal Commissioner that the franchise service received by the Appellant, even though inextricably linked with the export of 'management consultancy' cannot be called input service is thus without any basis. A bare perusal of the export agreement dated 1 April, 1999 would show that the Appellant is to report to the overseas service recipient on the functioning of the McDonald's System by way of improvements and this is also required for the business of local fran ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in convertible foreign currency has been received against such exports shown in ST-3 returns for the period 2010-11 and 2011-12. They vide letter dated 18-12-2012 submitted that they have not issued any export invoices and have not received any convertible foreign currency against such export. xxxxxxx xxxxxxx xxxxxx 4. However, at this juncture it is necessary to examine the defence submissions in its right perspective. The submissions in this regard are discussed below:- (i) (a) In relation to the receipt of export consideration, they submitted that the conditions, as applicable to the taxable service category of management consultancy, to qualify as exports were, as follows: The recipient of the taxable service is located outside India. The consideration for the taxable service is received in convertible foreign exchange. They contended that there was no dispute about the fact that, the services were rendered by McDonald's India to McDonald's USA, which was an entity located outside India. It was also not in dispute ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... iod of one year from the date of export of services. 63. In the first instance, there is no time limit in Rule 3(2) of the Export Service Rules, 2005. Thus, any time limit prescribed by the Reserve Bank of India would not debar exporter from receiving remittances for the services even after one year. What has, therefore, to be examined is whether the Appellant received any remittances thereafter. This has not been examined in the impugned order. The matter, therefore, needs to be remitted to the Principal Commissioner for examining this issue and thereafter recording a finding. FOURTH ISSUE Interest on late payment of Service Tax on franchisee fees to McDonald's USA 64. The relevant observations of the Principal Commissioner on this issue are as follows : "1. As regards the issue related to Interest on late payment of Service Tax, I find that on scrutiny of ST-3 returns for the period 2007-08 to 2011-12 it unearthed that although McDonald India were accruing and receiving franchisee fees from its franchisees on the monthly basis but they booked the same in the ledger of McDonald Corporation, USA in the month of Se ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... der section 66 of the Act is in respect of service provided or to be provided and it is only from 1 July, 2011 that the Point of Taxation Rules, 2011 were brought into force. Therefore, for the period 2007-08 to 2010-11, the tax payment is linked to the receipt in cash. The same was the position with respect to payments made till 10 May, 2008 to overseas associated enterprises. From 10 May, 2008 passing of book entries was also regarded as payment made to associated enterprises. 67. The Principal Commissioner has accepted the position that there is no loss to the exchequer, but failed to appreciate that the date of entry in the books of account and payment to the overseas entity for the franchisee fee are on the same day. Therefore, applying the relevant Rule 7 of the Point of Taxation Rules, 2011, the tax has to be remitted on the date of payment or entry in the books of account, whichever is earlier. In the instant case, the date of entry and payment to overseas entity are on the same day. There is, therefore, no delay and the reasoning given by the Principal Commissioner to the effect that since the payment of franchisee fee from the local entitie ..... X X X X Extracts X X X X X X X X Extracts X X X X
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