In a major relief to Mc Donalds, the division bench of the Delhi High Court held that royalty received by the assessee-Company, under Franchise Agreements for the transferring the use of trademark, logo, service marks, brand name etc are not subject to tax under the provisions of the Delhi Value Added Tax (DVAT) Act.
Justices S. Ravindra Bhatt and Justice Deepa Misra also considered the fact that the appellants are already remitting Service Tax for the same and therefore, the Department cannot impose VAT on the same.
The appellant, entered into franchise agreements with various franchisees to allow them to adopt and use the “McDonald’s system”, for the purpose of operating its restaurants in India and received a fixed amount as location fee from the franchisees. Appellant also collected royalty of approximately 5% of the gross sales, from the restaurants operated by the franchisees. They are paying service tax for the entire service fee received by them in connection with the agreement.
For the year under consideration, the VAT authorities held that VAT is leviable on the royalty payment as it constitute consideration for the transfer of rights to use the trade mark “McDonald’s”. They said that appellants had a sale turnover from trade mark and patents, in the form of royalty received from the franchisees, which attracted a levy of sales tax.
The bench noticed that the arrangement in case of the Mc Donald is a composite contract wherein, the trade mark and other services like knowhow, recipe, training, trade secrets, policies, etc. are provided to the franchisee. It was observed that the object of the agreement was to operate a comprehensive restaurant system at the locations specified in the agreement, without an exclusive transfer of right to use the same.
Examining whether the impugned transaction amount to “sale”, the Court said that since the “franchise agreement” evidently intends to make a non-exclusive transfer of the composite system of services that is not limited to the trade mark, but is inclusive of a bunch of services, cannot be treated as goods and hence, VAT cannot be levied on the same.
The bench also observed that “McDonald‟s and the petitioners (Sagar Ratna, and Bikanerwala) are solely engaged in providing franchise services to its franchisees and the same would thus not be liable to VAT under the provisions of the DVAT Act, as the franchise service is expressly a taxable service and cannot be treated as goods.
Diving deeply into the facts of the case as well as the provisions of the franchise agreements, the division bench concluded that, “what was intended to be transferred was not the trade mark, but an entire gamut of services, which includes, inter alia, a guide that educates the franchisees on various aspects of business and conduct to market the business. To segregate the terms of the agreement to levy VAT on only specific aspects of it would be inexact. Moreover, the Appellant and the Petitioners are already paying service tax levied on the franchise agreements, and there can be no overlapping of taxes. The subject matters in List I and List II of the Seventh Schedule to the Constitution are distinct and once a particular service is subject to service tax, it cannot be treated as a sale of goods and subject to VAT. Thus, the definition of “intellectual property” and levy of sales tax on transfer of right to use trade marks, patents and copyrights etc. will not apply in the case of a franchise agreement.”
“For a transfer of the right to use goods to be effective, such transfer of right should be one that the transferee can exercise in exclusion of others; which is not the case in the present appeals and petitions, as the franchise agreement only grants a non-exclusive right, retaining the franchisor‟s right to transfer the composite bunch of services to other parties, apart from it retaining ownership to the same. The ownership in the trade mark, logo, service marks, and brand name is solely vested in Appellant and the Petitioners and has not been transferred; as is clearly manifested in the various clauses of the franchise agreements. The Appellant and the Petitioners grant a non-exclusive license to the franchisees, which can be revoked upon non-compliance of the terms and conditions as stipulated in their franchise arrangement. Clearly, this does not amount to a transfer of the right to use goods”, the bench also added.
Read the full text of the Judgment below.
