Custom, Excise & Service Tax Tribunal
Mcdonalds India Pvt Ltd vs Delhi on 25 September, 2019
Author: Dilip Gupta
Bench: Dilip Gupta
CUSTOMS, EXCISE & SERVICE TAX APPELLATE TRIBUNAL
NEW DELHI
PRINCIPAL BENCH-COURT NO.-1
Service Tax Appeal No. 50218 of 2016
[Arising out of Order-in-Original No. DLISVTAX001COM0061516 dated 31.08.2015
passed by the Pr. Commissioner of Service Tax, New Delhi]
McDonalds India Private Limited ...... Appellant
202-206, Tolstoy House,
15, Tolstoy Marg, New Delhi
Versus
Principal Commissioner of Service Tax ...... Respondent
Delhi-I
17-B, I.A.E.A House, IP Estate
M G Marg, New Delhi
APPEARANCE :
Shri S. Thirumalai, Advocate, for the Appellant
Shri Vivek Pandey, Authorised Representative of the respondent
CORAM : HON‟BLE MR.JUSTICE DILIP GUPTA, PRESIDENT
HON‟BLE MR. C.L. MAHAR, MEMBER (TECHNICAL)
DATE OF HEARING: 27 March, 2019
DATE OF DECISION: 25 September, 2019
FINAL ORDER NO. 51264/2019
JUSTICE DILIP GUPTA:
This appeal seeks to assail the order dated 31
October, 2015 passed by the Principal Commissioner of Service
Tax, New Delhi1 on the three Show Cause Notices dated 17
_____________________
1. Principal Commissioner
2 ST/50218/16
August, 2013, 22 May, 2014 and 20 April, 2015 covering the
period from April 2007 to March, 2014. The demand of service
tax of Rs.43,33,31,760/- has been confirmed with penalty of
Rs.43,33,61,756/- and interest of Rs.1,13,86,747/-.
2. The Appellant McDonald‟s India Private Limited2 was
incorporated as a wholly owned subsidiary of McDonald‟s
Corporation USA3 with a view to facilitate development of the
business of McDonald‟s in India. 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 Limited4 and Connaught Plaza Restaurants
Private Limited5 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
_______________
2. McDonald‟s India
3. McDonald‟s USA
4. Hardcastle
5. Connaught Plaza
3 ST/50218/16
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. Till 27 February, 2010 appropriate service tax on the
income earned by the Appellant was discharged. With effect from
27 February, 2010, when an amendment was made in the
erstwhile „Export of Services Rules, 2005‟6 by a Notification dated
27 February, 2010, such services were treated as exports.
Similarly, with the introduction of the „Place of Provision of
Services Rules, 2012‟, with effect from 1 July, 2012, these
services were treated as „exports‟, in conjunction with the Service
Tax Rules, 1994 („Service Tax Rules‟).
5. Post completion of the service tax audit for the
financial years 2009-10 to 2010-11, a Show Cause Notice dated
17 April, 2013 was issued to the Appellant covering financial year
2007-08 to financial year 2011-12. Two more Show Cause
Notices dated 22 May 2014 and 20 April, 2015 covering financial
year 2012-13 and financial year 2013-14, respectively were
issued. The issues raised in the said Show Cause Notices that
arise for consideration in this Appeal are as follows:
_________________________
6. the „Export Rules‟
4 ST/50218/16
a) Non-payment of service tax on advertisement
expenses incurred by the local franchisees on
behalf of the Appellant.
b) Short payment of service tax due to wrong
utilisation of cenvat credit.
c) Non-payment of service tax on „management
consultancy‟ services by wrongly claiming the
same as „export service‟.
d) Interest on late payment of service tax on
franchisee fees to McDonald‟s USA.
6. Details of these four issues covered by the three Show
Cause Notices are tabulated below:
SCN 1 SCN 2 SCN 3
2007- 2008 2009- 2010- 2011- 2012- 2013-
Issue
08 -09 10 11 12 13 14
1. Non-
payment of
service tax on
advertisement √ √ √ √ √ √ √
expenses
incurred by
franchisee
2. Short
payment of
service tax √ √ √
due to wrong
utilization of
cenvat credit
3. Non-
payment of
service tax on
management
consultancy √ √ √ √
service by
wrongly
claiming it as
export
5 ST/50218/16
4. Interest
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, 19947 read with the Service Tax (Determination of
Value) Rules, 20068. 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, and payment of interest on late
payment of franchisee fees to McDonald‟s, USA.
_____________
7. the Act
8. the 2006 Rules
6 ST/50218/16
8. The Appellant filed detailed replies dated 10 July,
2013, 4 July, 2014 and 18 May, 2015 to the three Show Cause
Notices.
9. An Order dated 31 October, 2015 was passed by
Principal Commissioner rejecting the contentions of Appellants.
The demand of Rs. 43,33,31,760/- with interest and penalty of
Rs.1,13,86,747/- and Rs.43,33,61,756/- respectively was
confirmed. The Principal Commissioner relied upon the provisions
of the Indian Contract Act, 1872 and concluded that through a
contractual obligation, the Appellant was getting an extra
consideration in the form of contribution towards advertisement
from the franchisee for promotion of its own brand and not that of
the franchisor. This extra consideration paid by the franchisee to
the franchisor (Appellant) formed part of the value of taxable
service of the franchisor. As regards receipt of export proceeds,
the impugned order states that as per rules and regulations
issued by the Reserve Bank of India, it was obligatory on the part
of the exporter to realize the full value of goods or services within
a stipulated period from the date of exports, which in any case
should not exceed more than one year. The impugned order has
also confirmed the demand of interest on late payment of Service
Tax on franchisee fee submitted to McDonald USA.
7 ST/50218/16
10. We have heard Shri Thirumalai, learned Counsel for
the Appellant and Shri Vivek Pandey learned Authorised
Representative of the Department.
11. In order to appreciate the contentions advanced on
behalf of the parties, it will be appropriate, at this stage, to refer
to the agreement entered into between McDonald‟s USA and the
Appellant, which has been described as the „Master Licence
Agreement‟ as also the two agreements entered into between the
Appellant and the two franchisees, namely, Connaught Plaza and
Hardcastle.
12. The Appellant is receiving franchisee service from
McDonald‟s USA and for this purpose a Master Licence Agreement
was executed on 1 January, 1996. The relevant portions of the
agreement are as follows:
" Master License Agreement
This AGREEMENT dated with effect as of the 1st day
of January, 1996 by and between McDONALD‟S
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
8 ST/50218/16
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 agreed locations in India, restaurants in
accordance with the terms and conditions of the license
(the "Restaurants").
C. McDonald‟s is willing to grant License such a non-
exclusive license subject to the terms and conditions
hereinafter stated.
D. McDonald‟s and Licensee agree to enter into non-
exclusive license agreement ("License") on the terms and
conditions hereinafter contained to carry out the
foregoing.
THEREFORE, in consideration of the privilege of
conducting a restaurant business under this License, and
the mutual obligations contained herein, the parties agree
as follows:
................................
2. License Grant and Term Licensor grants to Licensee for the following stated terms the non-exclusive right, license and privilege. (" License"):
(a) to adopt and use the McDonald‟s System in Restaurants to be construed at locations to be mutually agreed upon by the parties hereto in India in accordance with the terms and conditions of this Agreement, and
(b) to advertise to the public that it is a licensee of Licensor, and
(c) to adopt and use, but only in connection with the sale of those food and beverage products which have been designated by McDonald‟s at the Restaurants, the trade names, trademarks and service marks which McDonald‟s shall designate, from time to time to be part of the McDonald‟s System, and
(d) subject to the prior written consent and approval of Licensor to sublicense to approved individuals or corporate entities ("Franchisee" ) the rights conferred on it by this Agreement or to enter into such other arrangement as Licensee deems advisable for the interim operation of any of the Restaurants. Any sublicenses shall contain provisions to the effect that, upon the termination of this Agreement of any reason, the sublicenses shall be deemed to be automatically assigned to Licensor, which hereby accepts such assignment, and Licensor shall be deemed to be substituted for Licensee as Licensor under such sublicenses. Licensee agrees to insert provisions in each of such sublicenses whereby the sublicenses shall acknowledge and agree to such assignment to Licensor. "
9 ST/50218/16
13. In terms of the aforesaid provision contained in the Master Licence Agreement by 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 above ("Franchisee").
Witnesseth:
WHEREAS:
McDonald‟s Corporation, a company organized under the laws of the State of Delaware, United States of America ("McDonald‟s") has developed and operates a restaurants 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", "McDonald‟s Hamburger"
and "McDonald‟s Family Restaurants", designs and color schemes for restaurant buildings, signs, equipment layouts, formulas and specification for certain food products, methods of inventory and operation 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 other countries.
10 ST/50218/16 McDonald‟s India Private Limited is a wholly owned subsidiary of McDonald‟s Corporation and McDonald‟s India Private Limited holds fifty (50) per cent of the capital of Connaught Plaza Restaurants Private Limited.
McDonald‟s has authorised Franchisor to grant franchisee to operate McDonald‟s restaurants using the McDonald‟s System in India.
Franchisee desires to acquire the rights to adopt and use the McDonald‟s System in a restaurant at the location specified in this agreement.
The parties agree as follows:
1. INTREPRETATION The McDonald‟s System is a comprehensive restaurant system for the retailing of a limited menu of uniform and quality food products, emphasizing prompt and courteous service in a clean, wholesome atmosphere which is intended to be attractive to children and families. The foundation of the McDonald‟s System and the essence of this Agreement is the adherence by Franchisee and Joint Venture Partner to but not limited to, serving only designated food and beverage products, the use of only prescribed equipment and building layout and designs; and strict adherence to designated food and beverage specifications and to Franchisor‟s prescribed standards of quality, service and cleanliness in Franchisee‟s restaurants operation. Compliance by Franchisee with the foregoing standards and policies in conjunction with the McDonald‟s trademarks and service marks provides 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 the restaurant and its profits, and who will work full time at their McDonald‟s restaurants business. In the case of companies affiliated with McDonald‟s, Franchisor will only grant franchises to those companies that have a Managing Director who will live in the locality of the McDonald‟s restaurant and who will devote his full
11 ST/50218/16 time and best efforts to the McDonald‟s business. Franchisee represents, warrants and agrees that he actually owns the complete equity interest in this Agreement and the profit from the operation of the Restaurant (defined below), and that it shall maintain such interest during the term of this Agreement except only as otherwise permitted pursuant to the terms and conditions hereof. Franchisee agrees to furnish Franchisor with such evidence as Franchisor may request, from time to time, for the purpose of assuring Franchisor that Franchisee‟s interest remains as represented herein.
2. FRANCHISE GRANT AND TERM
(a) Franchisor grants to Franchisee for the following stated term the right, license, and privilege:
(i) To adopt and use the McDonald‟s System in the restaurants constructed or to be constructed at E-31 and E-32, South Extension, Part II, New Delhi, India ("the Restaurant") and at that location only, and
(ii) To advertise to the public that it is a franchisee of Franchisor, and
(iii) To adopt and use, but only in connection with the sale at the Restaurant of those food and beverage products which have been designated by Franchisor at the Restaurant, the trade names, trademarks and service marks which Franchisor shall designate, from time to time, to be part of the McDonald‟s System.
3. .............................
4. MANUALS Franchisor shall provide Franchisee with the business manuals prepared by McDonald for use by franchisees of McDonald‟s restaurants similar to the Restaurant. The business manuals contain detailed information relating to operation of the Restaurant including:
(a) food formulas and specifications for designated food and beverage products;
(b) methods of inventory control;
(c) bookkeeping and accounting procedures;
(d) business practices and policies; and
(e) other management, advertising 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 12 ST/50218/16 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 Franchisee for national and regional cooperative advertising and promotion (in India) of the McDonald‟s System or to a group of McDonald‟s restaurants which includes the Restaurant, shall be a credit against the required minimum expenditures for advertising and promotion to the general public.
8. ROYALTY
(a) Franchisee shall pay to Franchisor as a royalty five percent (5%) of the Gross Sales from the operation of the Restaurant during the term hereof. The royalty specified herein shall be calculated and shall be paid by Franchisee to Franchisor within five (5) working days after the end of each month.
9. FRANCHISE FEE. Franchisee shall pay to Franchisor a Franchise Fee for the right to operate the Restaurant in accordance with this Agreement in the amount of the Indian Rupee equivalent of twenty-two thousand five hundred United States Dollars (U.S.$ 22.500.00). Franchisor reserves the right, in case construction of the Restaurant should be abandoned, the lease assigned, or other interest in the premises be relinquished, to terminate this Agreement upon reimbursement to Franchisee of the Franchise Fee.
12. COMPLANCE WITH ENTIRE SYSTEM. Franchisee and Joint Venture Partner acknowledge that every component of the McDonald‟s System is important to Franchisor and to the operation of the Restaurant as a McDonald‟s restaurant, including a designated menu of food and beverage products uniformity of food specification, preparation methods, quality and appearance; and uniformity of facilities and service.
Franchisor shall have the right to inspect the Restaurant at all reasonable times and to take samples of food of non- food items sold therein to ensure that Franchisee‟s operation thereof is in compliance with the standards and policies of the McDonald‟s System.
13 ST/50218/16 Franchisee shall comply with the entire McDonald‟s System, including but not limited to the following:
(a)..........................
(b)...........................
(c) Unless the law otherwise provides, the signs shall only indicate the name "McDonald‟s" with no reference to any other names or entities.
Franchisee‟s name shall appear in the heading of receipts and in the headed paper and business cards used 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 Advertisement Expenses Incurred By Franchisees
15. Learned Counsel for the Appellant made the following submissions :
14 ST/50218/16
(i) From a plain reading of the condition set out in Clause 5 of the agreement and in the light of the definition of the expression "Restaurant" in Clause 2(a)(i) which uses capital "R" as against use of the said expression in other parts of the agreement with small ("r"), it is clear that the intention of the parties was that the advertising required was to be of the "Restaurant" and not the trade names, service marks and trademarks of the franchisor. The fact that advertising is only with respect to the Restaurant (with capital "R") is also evidenced by the advertising pull outs and the invoices of the advertisement agencies which are in the name of the Restaurant and are part of the Appeal paper book;
(ii) While fulfilling the condition of the franchise agreement with respect to Clause 5 of the agreement by way of advertising the Restaurant, the trade names, service marks and trademarks of the franchisor may also appear in such advertisement, but this does not provide any extra consideration to the Appellant;
15 ST/50218/16
(iii) The only condition of the franchise agreement is to require advertisement of the „Restaurant‟ and nothing else. Therefore, there is no legal obligation on the part of the franchisee to include the trade names, service marks and trademarks of the franchisor. Such an unenforceable condition with respect to the trade names, service marks and trademarks of the franchisor cannot be said to provide additional consideration for the purpose of service tax over and above the Royalty payment as per Clause 8 of the agreement, on which service tax has been paid. In support of this contention, reliance was placed on a decision of the Tribunal in M/s. Luminous Electronics Pvt. Ltd. and other Vs. C.C.E. Delhi-II9;
(iv) There is no obligation on the franchisee to incur any expenditure on advertising with respect to the trade names, service marks and trademarks of the franchisor. All that is required and that too as a condition of the contract and not as consideration for the service, is advertisement _________________________
9. 2016 (3) TMI 666 (CESTAT-Delhi) 16 ST/50218/16 of the „Restaurant‟ and, therefore, any indirect result of advertising cannot be called an extra consideration. 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.10;
(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 Tax11;
(vi) The demand which is calculated on the basis of the entire advertising expenditure incurred by ____________________________
10. 2018 (2) TMI 1325
11. (2016) 65 Taxmann.com 141 Delhi 17 ST/50218/16 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 accordance with the provisions of section 67 read with the 2006 Rules;
(vii) The Principal Commissioner has applied Rule 5(1) of the 2006 Rules to determine the true value, though the said Rule was struck down by the Delhi High Court in Intercontinental Consultancy and Technocrafts (P) Ltd. vs. Union of India12, which decision of the Delhi High Court was affirmed by the Supreme Court in Union of India vs Intercontinental Consultants and Technocrats13. In such circumstances, the demand on the basis of the aforesaid Rule is unsustainable;
(viii) The show cause notice refers to Rule 5(1) of the 2006 Rules and, therefore, no other Rule could have been relied upon to sustain the Order, as was observed by the Supreme Court in Commissioner of Central Excise, Bhubaneswar Vs. M/s. Champdany Industries Ltd.14; and __________________________
12. 2013 (38) STR 375
13. 2018 (10) G.S.T.L. 401 (S.C.)
14. 2009 (241) E.L.T. 481 (S.C.) 18 ST/50218/16
(ix) Even otherwise, when a detailed procedure has been prescribed in paragraphs 4.1.5 and 4.1.6 of the Board Circular dated 19 April, 2006 for determination of the value when consideration received is not in terms of money, the Principal Commissioner could not have resorted to best judgment under Section 72 of the Act to include the entire expenses incurred by the franchisees.
16. Learned Authorised Representative of the Department however submitted:
(i) The first part of Clause 5 of the Agreement provides that the franchisee shall use only advertising and promotional material and programmes provided by the franchisor or approved in advance by franchisor. Clause 12(c) of the Agreement provides that the signs shall only indicate the name "McDonald‟s" with no reference to any other name or entity and the name of the franchisee shall appear in the heading of receipts and in the headed paper and business cards used by the employees of the 19 ST/50218/16 franchisee. Thus, the advertisement and promotion of the „Restaurant‟ would result in breeching the aforesaid clauses as the advertisement and promotion of the „Restaurant‟ would not be possible without advertising the McDonald‟s System;
(ii) In view of the provisions of the Clause 12 of the Agreement, the advertisement and promotion that has to be made is of the „McDonald‟s System‟ only and there is no separate 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 India15;
(iv) The decision of the Supreme Court in Bhayana Builders would not be applicable to the facts of __________________
15. 2017 (50) STR 275 20 ST/50218/16 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 the Tribunal in M/s. Subway Systems India Pvt. Ltd. Vs. C.S.T., Delhi- II16 decided on 22 March, 2019.
17. According to the Appellant, the agreement requires the franchisee to expend each calendar year a certain amount for advertising and promotion of the Restaurant of the franchisee. The advertisement is for promotion of the Restaurant operated by the franchisee and not for the promotion of the McDonald‟s ___________________________________________
16. Service Tax Appeal Nos. 50099 and 50101 of 2016 21 ST/50218/16 brand trade names, service marks or trademarks. There is no obligation on the part of the franchisee under the agreement to include the trade names, service marks and trademarks of the franchisor. Thus, such an un-enforceable condition with respect to the trade names, service marks and trademarks, according to the Appellant, cannot provide any additional consideration to the franchisor over and above the royalty payment as per Clause 8 of the agreement, on which service has been paid by the Appellant.
18. The Principal Commissioner, however, concluded that through the contractual obligation the Appellant was getting an extra consideration from the franchisee for promotion of its own brand in the form of contribution towards advertisement, which consideration would form part of the value of taxable service of the franchisor. The Principal Commissioner went by what „consideration‟ meant in Explanation (a) to Section 67 of the Act and concluded that the consideration could be in the form of cash, goods or services and non monetary consideration is determined under the 2006 Rules. Thus, since the franchisee, apart from remitting franchisee fees and royalty amount, had also to contribute at least 5 per cent of its gross sale under the agreement for advertising and promotion of the "McDonald‟s System", an extra consideration was paid by the franchisee to the franchisor which would form part of the value of taxable service of the franchiser. The Principal Commissioner did not accept the contention of the Appellant that under the agreement the 22 ST/50218/16 advertisement/promotion was of the Restaurant and not of the trade names, trademarks and service marks of the franchisor because, according to the Principal Commissioner, a perusal of the agreement would unequivocally show that the advertisement was "even for the promotion of the trade names, trademarks and the 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 non- monetary 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 23 ST/50218/16 the Appellant with Hardcastle is similar. The said agreement recognises that McDonald‟s USA has developed and operates a restaurant system called „McDonald‟s System‟. This McDonald‟s System includes propriety rights in certain valuable trade names, service marks and trademarks including the trade names "McDonalds", "McDonalds Hamburger" and "McDonalds Family Restaurant". It also includes the colour schemes for restaurant buildings, signs and equipments, lay outs formulas and specifications for the products. It also recognises that McDonald‟s, USA has authorised the franchisor (the Appellant) to grant franchisees to operate McDonald‟s restaurants using the McDonald‟s System in India and the fact that the franchisee (Connaught Plaza) desires to acquire the right to adopt and use the „McDonald‟s System‟ in a restaurant at a location specified in the agreement.
20. Clause 1 of the agreement describes the „McDonald‟s System‟ as a comprehensive restaurant system for the retailing of a limited menu of uniform and quality food products, emphasizing prompt and courteous service in a clean, wholesome atmosphere which is intended to be attractive to children and families. Compliance by the franchisee with the aforesaid standards and policies in conjunction with the McDonald‟s trademarks and service marks provides the basis for the valuable goodwill and wide family acceptance of the McDonald‟s System.
24 ST/50218/16
21. Clause 2 of the agreement deals with „Franchise Grant and Terms‟ under which the franchisor has granted to the franchisee the right to adopt and use the McDonald‟s System in the Restaurant at South Extension Part-II, New Delhi and the right to advertise to the public that it is a franchisee of the franchisor. The right to adopt and use, but only in connection with the sale at the Restaurant of those and food and beverage products which have been designed by the franchisor have also been granted. Under Clause 4 of the agreement the franchisor has also to provide to the franchisee the business manuals prepared by McDonald‟s for use by franchisee of McDonald‟s restaurants similar to the Restaurant. The business manuals would contain detail information relating to operation of the Restaurant including management, advertising and personnel policies.
22. 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 25 ST/50218/16 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 deals with franchise fee and provides that the franchisee shall pay to franchisor a franchise fee for the right to operate the Restaurant in accordance with the agreement an amount of Indian Rupees equivalent to U.S.$ 22.500.00. Under Clause 12 of the agreement, the franchisee acknowledges that every component of the McDonald‟s System is important to the franchisor and to the operation of the Restaurant as a McDonald‟s restaurant, including a designated menu of food and beverage products. It also requires the franchisee to comply with the entire McDonald‟s System including the requirement that the signs shall only indicate the name "McDonald‟s" with no reference to any other names or entities. It also provides that the name of the franchise shall appear in the heading of receipts and in the headed paper and business cards used by the franchisee. Clause 26 ST/50218/16 16 of the agreement emphasises that the franchisee is and shall remain an independent contractor responsible for all obligations and liabilities
24. It would be appropriate at this stage to analyse the charge against the Appellant in the show cause notice.
25. The show cause notice alleges that since the franchisee has to expend during each calendar year an amount which is not less than 5 per cent of the gross sale for advertising and promotion of the restaurant system owned by Mcdonald‟s Corporation through the contractual obligation, the franchisor gets an extra consideration towards the advertisement from the franchisee for promotion of its own brand, instead of the franchisee, which amount will form part of the value of taxable service of the franchisor in terms of Section 67 of the Act read with Rule 5 of the 2006 Rules. The relevant portion of the show cause notice on this aspect and it is as follows:
"1.7 From the above it appears that the franchisees, apart from remitting franchisee fee and royalty amount as specified above, have to contribute 5% of its gross sale for advertising and promotion of the restaurant system owned by the franchisor i.e. McDonald‟s Corporation. Thus, through contractual obligation, the franchisor is getting extra consideration in the form of contribution towards advertisement from the franchisees for promotion of their own brand instead of assessee receiving the same amount from franchisees and incurs it on advertisement on its own."
[emphasis supplied] 27 ST/50218/16
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 the franchisor."
[emphasis supplied]
27. A perusal of the relevant clause of the agreement would indicate that the show cause notice proceeded on an erroneous interpretation of Clause 5 of the agreement. The show cause notice completely failed to appreciate the distinction that is so clearly maintained in the agreement between a "restaurant" and a "Restaurant". Wherever Restaurant (emphasis on capital „R‟) is mentioned in the agreement, it is in relation to the specific Restaurant run by the franchisees i.e. Connaught Plaza or Hardcastle. Clause 5 of the agreement that relates to „advertising‟ 28 ST/50218/16 provides that the franchisee shall expend during each calendar year for advertisement and promotion of the Restaurant to the general public an amount which is not less than 5% of the gross sale for such year. Thus, what amount has to be spent by the franchisee is for the advertisement and promotion of either the Connaught Plaza Restaurant or the Hardcastle Restaurant and not for advertisement and promotion of the restaurant system owned by McDonald‟s, USA.
28. The same mistake has crept in the order of the Principal Commissioner since the said distinction between a „restaurant‟ and a „Restaurant‟ has not been appreciated. It is for this reason that a finding has been recorded by the Principal Commissioner that the Appellant was getting an extra consideration in the form of contribution towards advertisement from the franchisee.
29. As the very basis for recording the finding is based on a misreading of Clause 5 of the agreement, the finding recorded by the Principal Commissioner that the Appellant was getting an extra consideration in the form of contribution towards advertisement from the franchisee, is erroneous.
30. Learned Authorised Representative of the Department has, however, placed reliance upon the decision of the Tribunal in Subway Systems India Pvt. Ltd. to contend that because of the 29 ST/50218/16 Clauses 5 and 12 of the agreement, an additional consideration has been provided by the franchisee to the franchisor, which would form part of the taxable value of service under section 67 of the Act.
31. Reliance placed on the decision of this Tribunal in Subway Systems is misconceived as the agreement between Subway Systems India Pvt. Ltd. and M/s Subway 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.
30 ST/50218/16
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 advertisement of its Restaurant. The amount was not required to be deposited in any fund of the franchisor for advertisement or promotion of the franchisor. Thus, the decision of the Tribunal in Subway Systems will not come to the aid of the Department.
33. What further transpires from the agreement is that there is no obligation cast upon the franchisee to incur any expenditure on advertising the brand name, service marks and trademarks of the franchisor. Any indirect result, because of advertisement cannot, therefore, be called an extra consideration in terms of section 67 of the Act. Unless an amount is charged by the service provider to the service recipient, it does not enter into an equation for determining the value on which Service Tax is payable.
34. A Larger Bench of the Tribunal in Bhayana Builders (P) Ltd. vs Commissioner of Service Tax17 observed that "implicit in the legal architecture is the concept that any consideration whether monetary or otherwise, should have flown or should flow from the service recipient to the service provider ______________________________
17. 2013 (32) S.T.R. 49 (Tri. - LB) 31 ST/50218/16 and should accrue to the benefit of the latter." In the said decision, the Larger Bench made reference to the concept of „consideration‟, as has been expounded in the decision pertaining to Australian GST Rules, wherein a categorical distinction has been made between „conditions‟ to a contract and „consideration‟. It is prescribed under the said GST Rules that certain „conditions‟ to the contract cannot be seen in the light of „consideration‟ for the contract and the fact that the service recipient has to fulfil such conditions under the contract cannot form part of the value of the taxable services that are provided. The impugned order, however, enhances the value of taxable services by adding expenses of advertisement incurred by the franchisees, which expenses have to be incurred because of the condition set out in the agreement.
35. The Supreme Court in the appeal filed by the Department against the aforesaid decision of the Tribunal also explained the scope of Section 67 of the Act both before and after the amendment in the following words :
"12. On a reading of the above definition, it is clear that both prior and after amendment, the value on which service tax is payable has to satisfy 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 32 ST/50218/16 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 necessarily a consideration for the service provided which is taxable under the Act. By using the words "for such service provided" the Act has provided for a nexus between the amount charged and the service provided. Therefore, any amount charged which has no nexus with the taxable service and is not a consideration for the service provided does not become part of the value which is taxable under Section 67. The cost of free supply goods provided by the service recipient to the service provider is neither an amount "charged" by the service provider nor can it be regarded as a consideration for the service provided by the service provider. In fact, it has no nexus whatsoever with the taxable services for which value is sought to be determined."
36. The aforesaid view was reiterated by the Supreme Court in Intercontinental Consultants, wherein it was observed:
"23. Obviously, this Section refers to service tax, i.e., in respect of those services which are taxable and specifically referred to in various sub-clauses of Section 65. Further, it also specifically mentions that the service tax will be @ 12% of the „value of taxable services‟. Thus, service tax is reference to the value of service. As a necessary corollary, it is the value of the services which are actually rendered, the value whereof is to be ascertained for the purpose of calculating the service tax payable thereupon.
24. In this hue, the expression „such‟ occurring in Section 67 of the Act assumes importance. In other words, valuation of taxable services for charging service tax, the authorities 33 ST/50218/16 are to find what is the gross amount charged for providing „such‟ taxable services. As a fortiori, any other amount which is calculated not for providing such taxable service cannot a part of that valuation as that amount is not calculated for providing such „taxable service‟. That according to us is the plain meaning which is to be attached to Section 67 (unamended, i.e., prior to May 1, 2006) or after its amendment, with effect from, May 1, 2006. Once this interpretation is to be given to Section 67, it hardly needs to be emphasised that Rule 5 of the Rules went much beyond the mandate of Section 67. We, therefore, find that High Court was right in interpreting Sections 66 and 67 to say that in the valuation of taxable service, the value of taxable service shall be 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 sub-
section (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 connection, the Appellant had specifically raised a submission before the Principal Commissioner that the 34 ST/50218/16 expenditure on advertisement was in the business interest of the franchisee and not for promotion of McDonald‟s USA and they are as follows :
"They submitted that the local franchisees are required to spend for advertisement and promotion of the restaurants owned, operated and managed by them. It was in the business interest of the franchisee to enhance its sales and accordingly, advertise its products/services. In the present case, the local franchisees, by virtue of the franchise agreement, promote the business which was their own, which they promote. In order to fulfil their obligations under the franchise agreement, the franchisees have to undertake and the franchisor has to ensure that, the franchisees do so, advertising/promotion activities for the products of the franchisees that were local and specific to their business. The advertisement was for the promotion of the restaurants operated by the local franchisees and not for the promotion of the McDonald‟s brand. The clause in the agreement was to lay down certain benchmarks to ensure uniformity of operations and level playing field for all the local franchisees."
[emphasis supplied]
39. This contention was not accepted by the Principal Commissioner and the finding is :
"The agreement entered with the franchisees were inter alia, as under
Franchise Grant and Term :
(a) Franchisor grants to Franchisee for the following stated term the right, license, and privilege :
(i) to adopt and use the McDonald‟s system in the restaurant constructed or to be constructed at E-31 and E-32, South Extension, Part-II, New Delhi, India ("the Restaurant") and at that location only, and
(ii) to advertise to the public that it is a franchisee of franchisor, and 35 ST/50218/16
(iii) to adopt and use, but only in connection with the sale at the Restaurant of those food and beverage products which have been designated by Franchisor at the Restaurant, the trade names, trademarks and service marks which franchisor shall designate, from time to time, to be part of the McDonald‟s system.
A perusal of the above unequivocally 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 trademarks as also the design and colour schemes for restaurant building, signs and equipment layouts. It is a comprehensive system providing a limited menu of uniform and quality food products with emphasis on prompt and courteous 36 ST/50218/16 service in a friendly, clean, wholesome atmosphere. The franchisee was granted the right to adopt and use the McDonald‟s System in the Restaurant. The franchisor also provided the business manuals prepared by McDonald‟s USA for the use by the franchisee. It is not in dispute that the Appellant on its own does not run a restaurant. It has granted Connaught Plaza and Hard Castle the right to run and operate the Restaurant.
41. It is in this context that the terms of Clause 5 of the agreement, which relates to advertising, have to be interpreted. Clause 5 provides that in order to enable the franchisor to protect and preserve its worldwide range as a friendly, clean, wholesome, quick service restaurant suitable at all time for families, the franchisee shall only use the promotional materials and programs provided by the franchisor or approved in advance by the franchisor. The advertisement cannot be said to be for the benefit of any restaurant run by the Appellant because the Appellant does not run any restaurant. Any advertisement by the franchisee would enure to its own benefit since the advertisement would result in increase in the number of customers coming to the Restaurant. Merely because the agreement requires the franchisee to use only advertising and promotion materials and programs provided by the franchisor or approved in advance by the franchisor would not mean that the advertisement is for the benefit of the franchisor. As the first part of clause 5 of the 37 ST/50218/16 agreement indicates, the reason why only such promotion materials and programs as provided by the franchiser are required to be used by the franchisee for advertisement is to protect and preserve the worldwide image of the franchisor as a friendly, clean and wholesome quick service restaurant suitable at all times. Customers come to the Restaurant run by the franchisee because the Restaurant is using the McDonald‟s System and the sale at the Restaurant is only of those food and beverages products which have been designed by the franchisor. The Restaurant, in terms of the Clause 12 of the agreement, has to be on the pattern of the McDonald‟s restaurant 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 38 ST/50218/16 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 advanced by the Appellant that McDonald‟s India was a subsidiary of McDonald‟s USA and had been set up to promote and develop the restaurant business in India. McDonald‟s India has only granted licenses to Connaught Plaza and Hardcastle to operate and manage the restaurants in India. It was imperative for the franchisees to adopt the "McDonald‟s System" which contains a set up of guidelines and procedure for running the restaurant.
44. Learned Authorised Representative of the Department, however, submitted that the advertisement and promotion of the Restaurant is not possible without breaching Clause 12(c) or Clause 5(first paragraph) of the agreement. According to the learned Authorised Representative of the Department, Clause 12 of the agreement provides that the Restaurant has to operate as a McDonald‟s restaurant and thus the advertisement and promotion has to be of the McDonald‟s system only. The first paragraph of Clause 5 of the agreement also provides that the franchisee shall use only advertising and promotional materials provided by the franchisor. Thus, Clause 39 ST/50218/16 12 and the first paragraph of Clause 5 of the agreement dominate the second paragraph of Clause 5 of the agreement and there is no separate identity of the franchisee or the Restaurant. In this connection, reliance has been placed upon the decision of the Delhi High Court in Delhi International Airport.
45. It is not possible to accept the contention of the learned Authorised Representative of the Department. Clause 12 and Clause 5 of the agreement are very clear. The first paragraph of Clause 5 of the agreement emphasises why it would be necessary for the franchisee to use only the promotion materials and programmes provided by the franchisor for the advertisement. The second part of paragraph 5 of the agreement requires the franchisee to expend during each calendar year for advertising and promotion of the Restaurant to the general public an amount which is not less than 5% of the gross sales for such year. Clause 12 of the agreement acknowledges that every component of the McDonald‟s System is important to the franchisor and to the operation of the Restaurant as a McDonald‟s restaurant. Clause 12(c) further stipulates that signs shall only indicate the name "McDonald‟s" with 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 40 ST/50218/16 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 been seen that the advertisement is for the benefit of the franchisee. This aspect has already been analyzed in the earlier paragraphs. This apart, Clause 16 of the agreement provides that the franchisee is, and shall remain, an independent contractor.
47. The Appellant had raised a contention before the Principal Commissioner that the show cause notice did not give cogent reason as to why the advertisement expenses would be part of the franchisee fee and they are as follows :
"They contended that the Notice does not make any cogent reasons as to why the advertisement expenses incurred by the franchisee were part of the franchisee fee paid by the franchisee to the Noticee. The onus was on the Department 41 ST/50218/16 to bring about a positive allegation in the SCN detailing the reasons supporting the allegation based on law and facts. The SCN suffered from the infirmity of neither being supported with the help of law and or facts for the purpose of the said allegations in the notice."
48. This contention was also not accepted by the Principal Commissioner and the finding is :
"The Show Cause Notice has termed expenses incurred on advertisement as an extra consideration by virtue of contract on record. „Consideration‟ means everything received or recoverable in return for a provision of service which includes monetary payment and also consideration of non-monetary nature or deferred consideration as well as recharges between establishments located in a non-taxable territory on one hand and taxable territory on the other hand. Non-monetary consideration essentially means compensation in kind. The non-monetary consideration also needs to be valued for determining the tax payable on the taxable service since service tax is levied on the value of consideration received which includes both monetary consideration and money value of non-monetary consideration. The value of non-monetary consideration is determined as per section of the Act and the Service Tax (Determination of Value) Rules, 2006."
[emphasis supplied]
49. In the first instance, as noticed above, the Appellant did not receive any consideration for advertisement made by the franchisee in terms of Clause 5 of the agreement. The Principal Commissioner, therefore, fell in error in concluding that some non-monetary consideration had been received by the Appellant towards the advertisement made by the franchisee, which non- monetary consideration was required to be determined under Rule 5(1) of the 2006 Rules. Even if it is assumed that some non- monetary consideration had been received by the Appellant, then 42 ST/50218/16 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 cannot be subjected to service tax.
51. Section 67 of the Act was considered and explained by the Delhi High Court in Intercontinental Consultants. The Appellant therein was providing consulting engineering services. It received payment not only for the services provided by it but was also reimbursed for the expenses incurred by it on air travel, hotel stay, etc. It paid Service Tax on the amount received by it for services rendered to its clients but did not pay any Service Tax in respect of expenses incurred by it which were reimbursed by the 43 ST/50218/16 clients. A show cause notice was issued to it to explain why Service Tax should not be charged on the gross value including reimbursable and out of pocket expenses. The provisions of Rule 5(1) of the Rules were resorted to for this purpose. A Writ Petition was filed challenging the vires of Rule 5 as being unconstitutional as well as ultra vires the provisions of section 66 and 67 of the Act. The Delhi High Court accepted the said contention and declared Rule 5 to be ultra vires the provisions of section 66 and 67 of the Act. The High Court noted that both the amended and the un-amended section 67 authorized the determination of value of taxable services for the purpose of charging Service Tax under section 66 as the gross amount charged by the service provider for such services provided or to be provided by him in a case where consideration for such service is money. The High Court placed emphasis on the words "for such service" and took the view that the charge of Service Tax under section 66 has to be on the value of taxable service i.e. the value of service rendered by the assessee and the quantification of the value of service can, therefore, never exceed the gross amount charged by the service provider for the service provided by him. On that analogy, the High Court opined that the scope of Rule 5 goes beyond the scope of section 67 which was impermissible as rules could be framed only for carrying out the provisions of Chapter 5 of the Act. In taking this view, the High Court observed that the expenditure or cost incurred by the service provider for providing the taxable 44 ST/50218/16 service can never be considered as the gross amount charged by the service provider "for such service" provided by him.
52. In the Appeal filed by the Department, the Supreme Court noticed the various reimbursable 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 what is the gross amount charged for providing "such" taxable services and so any other amount which 45 ST/50218/16 is calculated not for providing such taxable service cannot be a part of that valuation as the amount is not calculated for providing "such taxable service." This, according to the Supreme Court, is the plain meaning attached to section 67 either prior to its amendment on 1 May, 2006 or after this amendment and if this be so, then Rule 5 went much beyond the mandate of section 67. The Supreme Court, therefore, held that the value of material which is supplied free by the service recipient cannot be treated as "gross amount charged" as that is not a "consideration" for rendering the service. The Appeal filed by the Department was, therefore, dismissed.
SECOND ISSUE Short payment of Service Tax due to wrong utilisation of cenvat credit
53. The relevant observations of the Principal Commissioner on this issue are as follows :
"1. As regards the issue related to allegation of "Short payment of Service Tax due to wrong utilization of Cenvat Credit", I find that the department‟s case basically rest on the premise that the Noticee availed and utilized CENVAT credit of service tax paid by them for import of franchisee service under reverse charge mechanism under section 66A of Finance Act, 1994. CENVAT credit of service tax paid on import of service was allowed subject to the condition that the service should fall within the definition of input service given under sub rule 2(1) of CENVAT Credit Rules, 2004. Franchisee service was not an input service used for providing Management Consultancy services inasmuch as the franchisee service imported by them were used for providing further 46 ST/50218/16 franchisee service to the sublicense for adopting McDonald‟s Restaurant system provided by the Noticee.
xxxxxxx xxxxxxx xxxxxx
2. Here, I find that Franchisee service imported by the Noticee has nothing to do with the Management Consultancy service provided by the Noticee to their parent company. Franchisee service is not an input service used for providing Management Consultancy services inasmuch as the franchisee service imported by them has been used for providing further franchisee service to the sublicenses 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, 200418 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 repairs of a factory, premises of provider of output service or an office relating to such factory or premises, advertisement or sales promotion, market research, storage upto the place of removal, procurement of inputs, activities relating to business, such as accounting, auditing, financing, recruitment and quality control, coaching and training, computer networking, credit rating, share registry, and security, inward transportation of inputs or capital goods and outward transportation upto the place of removal."
_________________
18. the Cenvat Rules 47 ST/50218/16
55. The Appellant has paid service tax under reverse charge as required by section 68(2) of the Act on the import of franchise service from the McDonald‟s USA in terms of the Master License Agreement. In terms of the said agreement the Appellant was granted the license to adopt and use the "McDonald‟s System" in restaurants in India and was also given the power to sub- license the rights conferred under the said agreement. Pursuant to such a power reserved under the said agreement, the Appellant had sub-licensed the McDonald‟s System to the franchisees Connaught Plaza in Delhi and Hardcastle in Mumbai. The Appellant had taken cenvat credit on reverse charge payment and utilized the same for payment of service tax on the export of „management consultancy‟ services by the Appellant from India to McDonald‟s USA in terms of the agreement dated 01 April, 1999. This payment of service tax was made in view of the condition under the Export of Service Rules, 2005 that required service to be delivered out of India for use outside India. This provision was subsequently altered with effect from 02 February, 2010. The issue is, therefore, restricted to the period 2007-08 to 2009-10 in the first show cause notice dated 17 August, 2013 and does not arise under the subsequent show cause notices.
48 ST/50218/16
56. The conclusion drawn by the Principal Commissioner is that the import of franchise service has nothing to do with the „management consultancy service‟ provided by the Appellant to McDonald‟s USA and, therefore, is not an input service is not correct. Firstly, there is no one-to-one correlation for the utilization of input service as long as the same qualifies as an input service in terms of Rule 3(1) of the Cenvat Rules as held by the Supreme Court in Collector of Central Excise, Pune vs Dai Ichi Karkaria Ltd.19. 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 Delhi20 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 _______________________
19. 1999 (112) ELT 353 (SC)
20. 2014(33) STR 96 (Tri. Delhi) 49 ST/50218/16 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 franchise on which service tax is paid on the royalty payment charged to the Restaurants. The franchisee services received by the Appellant and the „Management Consultant‟ services rendered by the Appellant, are so inextricably linked, that, one cannot be rendered/received in the absence of the other. Where, on the other hand, the Appellant is receiving franchisee services from McDonald‟s USA to set up the franchise business in India, at the same time, the Appellant is also providing consultancy to McDonald‟s USA, in order to effectively carry out and supervise the franchise business. Accordingly, to state that, the franchise service could not be termed as an input service, for management consultancy is against the spirit of the CENVAT Credit mechanism.
58. The finding of the Principal Commissioner on this issue, therefore, cannot be sustained.
50 ST/50218/16 THIRD ISSUE Non-payment of Service Tax on „Management Consultancy‟ services by wrongly claiming the same as export service
59. The relevant observations of the Principal Commissioner on this issue are as follows :
"1. As regards the issue related to non-payment of service tax on Management Consultancy Service by wrongly claiming it as Export, I find that the department‟s case basically rest on the premise that the Management Consultancy service will be qualified for Export of Services when payment of such service is received by the service provider in convertible foreign exchange. As the payment has not been received, the department concluded that the Services are not Export of Service.
2. I find that the Noticee has been providing Management consultancy services to its parent company McDonald, USA and discharging service tax liability upto 27-02-2010. However, w.e.f. 27.2.2010, after amendment in Export of Services Rules 2005 made vide Notification No. 6/2010-ST dated 27.2.2010, they claimed their service i.e. Management Consultancy service as export of service in terms of Export of Services Rules, 2005.
xxxxxxx xxxxxxx xxxxxx
3. In the instant case I find that the Noticee was asked to furnish export invoices raised by them for provisions of service and FIRCs to substantiate that payment 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.
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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:-
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(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 that the taxable service of management consultancy was rendered by the Company to McDonald‟s USA. With reference to the export consideration, though, the Company admits that, the same is yet to be received and is expected to be received shortly, yet, there was no stipulation with respect to the time limit in the said Rules as regards receipt of consideration. In other words, till the time the consideration was considered good and recoverable/receivable by the management of the Company the services continue to qualify as exports and the allegation that, the services cannot be said to be exported, was beyond the scope of law. Accordingly, in light of the above, the benefit of export of services was appropriately claimed by the Company.
I do not find any force in the above arguments for the reason that the Hon‟ble Apex Court has spelt out the law that the conditions of an exemption notification has to be strictly followed. Further the argument that, there was no stipulation with respect to the time limit in the said Rules as regards receipt of consideration is not correct because as per Rules and guidelines issued by the Reserve Bank of India it is obligatory on the part of the exporter to realize the full value of goods or services within a stipulated period from the date of exports which in any case does not exceed more than one year.
52 ST/50218/16 In view of the same I do not found any merit in Noticee‟s argument."
[emphasis supplied]
60. The relevant Rule 3(2) of Export Rules is as follows :
"3. Export of taxable service -
(1)............
(2) The provision of any taxable service specified in sub-rule (1) shall be treated as export of service when the following conditions are satisfied, namely:-
(a) -------- [omitted]
(b) payment for such service is received by the service provider in convertible foreign exchange. "
61. Rule 3(2) of the Export of Service Rules 2005 states that provision of any taxable service to qualify as export has to satisfy the condition that payment for such services is received in convertible foreign exchange.
62. While examining the reply of the Appellant, the Principal Commissioner has relied upon the requirement contained under the Reserve Bank of India Regulations that require the export proceeds to be realized within a period 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 53 ST/50218/16 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 September and March of every year which caused delay in the payment of service tax.
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2. It is on record that franchisee had paid franchisee fees to the franchisor on a monthly basis, but the act of booking the same in the ledger of McDonald Corporation, USA in the month of September and March of every year had caused delay in the payment of service tax. Accordingly, Interest on late payment of Service Tax is rightly demandable.
xxxxxxx xxxxxxx xxxxxx
3. However, I find that on the issued related to allegation of Interest on late payment of Service Tax, the Noticee submitted that in terms of the License Agreement, entered into between McDonald‟s India and McDonald‟s USA, the Company was liable to remit franchise fee to McDonald‟s USA 54 ST/50218/16 on a monthly basis. However, as a matter of administrative convenience and mutual understanding, the same was being accrued on a yearly basis and accordingly, service tax was discharged as and when the expenditure was accrued under the taxable category of „franchise service‟. McDonald‟s India and McDonald‟s USA are "associated enterprises", in terms of the relevant provisions of the Income Tax Act, 1961.
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4. I do not find any force in the above agreements for the reason that above stated administrative convenience and mutual understanding was contrary to the agreement on record. In absence of any documentary evidence to substantiate the "administrative convenience and mutual understanding", I find it to be intentional and deliberate to delay the payment of tax."
65. The Principal Commissioner grossly erred in comparing the two tax payments namely those in respect of local franchisees under forward charge and those in respect of overseas payment of franchisee fee under the reverse charge. The former is under section 66 of the Act while the latter is under section 66A of the Act during the relevant period.
66. Forward charge under 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 55 ST/50218/16 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 entities is on monthly basis, the same should be the basis with respect to the remittances to the overseas associated enterprises is not correct. As stated above, the forward charge and reverse charge cannot be equated for the charge of interest as these are governed by different set of Rules. Therefore, the interest claim that was confirmed for the entire period deserves to be set aside.
68. Learned Counsel for the Appellant also submitted that the extended period of limitation as contemplated under the proviso to Section 73 of the Act could not have been invoked.
56 ST/50218/16 The demand made in Issue No. 1, 2 and 4 has been set aside. With regard to Issue no. 3, the matter has been remitted to the Principal Commissioner to decide it afresh. Thus, it is not necessary to examine the issue relating to limitation, at this stage.
69. Thus, for all the reasons stated above, the impugned order, insofar as it confirms the demand of Service Tax in regard to Issue Nos. 1,2 and 4 deserves to be set aside and is set aside. With regard to Issue no. 3, the matter is remitted to the Principal Commissioner to pass a fresh reasoned order in the light of the observations made above. The Appeal is, accordingly, allowed to the extent indicated above.
(Pronounced in the Court on 25 September, 2019) (JUSTICE DILIP GUPTA) PRESIDENT (C.L. MAHAR) MEMBER (TECHNICAL) Golay