By TIOL News Service

ERNAKULAM, JULY 01, 2013: THE Kerala High Court, in a landmark important decision dealt with the issue of overlap of Service Tax and VAT and held that VAT cannot be demanded on consideration received under franchisee agreement. The High Court relied on the Apex Court decisions in the case of BSNL and another v. Union of India and others 2006-TIOL-15-SC-CT-LB, Tata Consultancy Services v. State of A.P - 2004-TIOL-87-SC-CT-LB and Imagic Creative Pvt. Ltd. v. Commissioner of Commercial Taxes (2008-TIOL-04-SC-VAT), to arrive at this conclusion.

However, most importantly the High Court distinguished three Division Bench decisions of the Kerala High Court, namely, Mechanical Assembly Systems (India) Pvt. Ltd. v. State of Kerala, Jojo Frozen Foods (P) Ltd. v. State of Kerala and Kareem Foods Pvt. Ltd. v. State of Kerala. The Court held that these decisions were rendered prior to introduction of Franchisee services under service tax in Year 2003 and hence the issue of Service Tax was not before the Court and hence are distinguishable. The High Court also referred to the decision of Bombay High Court in Commissioner of Sales Tax v. Duke & Sons Pvt. Ltd and the decision Madras High Court in S.P.S. Jayam and Co. v. Registrar, Tamil Nadu Taxation Special Tribunal, wherein both the High Courts had held that Royalty received for allowing use of Trade Mark would be liable to Sales Tax as ‘right to use Trade Mark'. The Court distinguished these decisions on the same reason that these were rendered prior to Year 2003. The High Court also distinguished the decision of the AP High Court in Nutrine Confectionary Co. Pvt. Ltd. v. State of Andhra Pradesh on facts.

The appellant is a private limited company engaged in marketing, trading, export and import of gold and diamond Jewellery. The appellant entered into franchise agreements, by which the appellant had permitted the Franchisees to use of the Trade Mark of the appellant. In return the appellant receives royalty and paid Service Tax of 10% / 12% on the royalty. However, the department of Commercial Taxes contended that royalty would attract VAT as per the decision in Mechanical Assembly Systems (India) Pvt. Ltd. v. State of Kerala and demanded VAT @ 4% on royalty.

The appellant replied stating that the transaction is one of rendering Taxable Services under Finance Act, 1994 and that the appellant had already paid Service Tax of 10 % / 12% and accordingly, the transaction would not attract VAT. The appellant relied on the decision of the Supreme Court in Imagic Creative Pvt. Ltd. v. Commissioner of Commercial Taxes, wherein it was held that once a transaction is specifically covered under Service Tax, then the said transaction cannot be charged to Sales Tax / VAT again. However, the respondent confirmed the demand of VAT. Aggrieved against the assessment Order the appellant filed writ petition in the Kerala High Court. The single judge dismissed the Writ Petition holding that the transaction is liable to pay VAT notwithstanding the fact that the appellant had paid Service tax . Aggrieved thereby, the appellant preferred writ appeal.

The High Court examined the Franchise agreement and analyzed Franchise Services under Section 65(105) (zze) of the Finance Act, 1994 in terms of the definition of the terms franchise and franchisor under Sections 65(47) and (48) of the Finance Act, 1994 and held that the Franchise services would get covered under the Finance Act, 1994.

The High Court also examined the Franchise agreement from the perspective of VAT and found that even while the franchise agreement is in force, the company could use the trademark on their own and could enter into franchise agreement with other parties. Thus the Court found that the effective control is with the appellant Company during the term of the agreement and hence the test transaction failed the test of ‘right to use' under VAT.

Further the Court held that that there are no goods which are deliverable at any stage as per the test laid down by the Apex Court in paragraphs 78 and 79 of BSNL's case and also found that during the period in question the franchisee is having the right, it is not to the exclusion of the franchisor.

The Court held thus.

‘37. In the light of the above tests, if the franchise agreement in this case is analysed, it can be seen that it is only a licence to use the Trade Mark and the transfer of its use is not to the exclusion of the transferor.

48. ………..Herein, it cannot be said that there are goods deliverable at any stage which is the test laid down by the Apex Court in paragraphs 78 and 79 of BSNL's case (supra) and for that reason also, there is no transfer of right to user at all. Coupled with the same, is the fact that during the period in question the franchisee is having the right, it is not to the exclusion of the franchisor and as it is seen that even during the period during which the transaction is going on, the franchisor can again transfer the right to others, the tests laid down in sub paragraphs (d) and (e) under para 97 of BSNL's case (supra) are not satisfied. Accordingly, we allow the appeals reversing the judgment of the learned Single Judge and hold that the franchise agreement will not attract the provisions of the KVAT Act.'

(See2013-TIOL-512-HC-KERALA-ST)