2011 (5) TMI 590 - HC - Income Tax

Franchisee Discounts as Indirect Commissions: Tax Implications

Bharti Cellular Ltd. Versus Assistant Commissioner of Income-tax, Circle-57, Kolkata

The Court determined that the relationship between the assessee and franchisees was that of principal-to-agent, not principal-to-principal, based on ... Pre-paid Sim cards and rechargeable Coupons - liability of TDS u/s 194H - Commission or franchisee - Assessee in default - Held that:- It is settled principle of law that merely because some terms and conditions and restrictions having been imposed in the agreement, the relationship between principal to principal is not changed and varied - in this case that the transaction in case of pre-paid Sim cards, and rechargeable Coupons, sufficient stocks are to be kept by franchisee, and then the same are to be sold to the retailers at a rate stipulated by the assessee at ₹ 324 and the retailer is allowed to sell it to the ultimate customer at the maximum price again fixed by the assessee, say at ₹ 330, the assessee is to realize lesser rate say at ₹ 317 per Sim card from franchisee. Thus discount of ₹ 7 is given. Therefore after selling all the Sim cards and Pre-paid Coupons to the retailers the franchisee is to make payment of sale proceeds to the assessee after deducting a discount of ₹ 7 per Sim card. Thus this receipt of discount at the rate of 7 is in real sense commission paid to the franchisees. Hence all the trappings of liability as agent, of the franchisee towards assessee subsists, there has been indirect payment by the assessee to the franchisee of the commission and the same is attractable under section 194H - Decided against the assessee Issues Involved:1. Relationship between the assessee and the franchisee: Principal-to-Principal or Principal-to-Agent.2. Applicability of Section 194H of the Income-tax Act, 1961 to the discount allowed by the assessee to the franchisee.Detailed Issue-Wise Analysis:1. Relationship between the Assessee and the Franchisee: Principal-to-Principal or Principal-to-AgentThe core issue in this case was to determine whether the relationship between the assessee and its franchisees was that of a principal-to-principal or a principal-to-agent. The assessee contended that the relationship was principal-to-principal, as evidenced by the clauses in their agreement, particularly clause 16.2, which suggested that the franchisee operated independently. The assessee relied on judgments from the Supreme Court in Bhopal Sugar Industry Ltd. v. STO and the Gujarat High Court in Ahmedabad Stamp Vendor Association v. Union of India to support their argument that the relationship was principal-to-principal.However, the Assessing Officer and the Tribunal found that the relationship was principal-to-agent. This conclusion was based on the observation that the franchisees were essentially acting on behalf of the assessee, collecting information and passing it on, and receiving a fixed percentage of commission disguised as a discount. The Tribunal emphasized that the true relationship must be determined from the nature of the contract, its terms, and conditions, rather than the terminology used by the parties.The Court agreed with the Tribunal's interpretation, noting that the agreement's clauses, when read in their entirety, indicated a principal-to-agent relationship. Key clauses highlighted included:- Clause 4.1: Franchisee's obligation to act in the interest of both BML and the subscribers.- Clause 4.3: Confidentiality and security measures dictated by BML.- Clause 4.4: Adherence to BML's policies and pricing.- Clause 4.8: Ownership of pre-paid cards remained with BML.- Clause 8.1: BML's control over pricing and payment terms.These clauses collectively demonstrated that the franchisee had no free choice and was heavily regulated by the assessee, reinforcing the principal-to-agent relationship.2. Applicability of Section 194H of the Income-tax Act, 1961 to the Discount Allowed by the Assessee to the FranchiseeSection 194H of the Income-tax Act, 1961, mandates the deduction of tax at source on any income by way of commission or brokerage. The explanation to this section includes any payment received or receivable, directly or indirectly, by a person acting on behalf of another person for services rendered.The assessee argued that the discount given to the franchisees did not constitute commission and therefore did not attract Section 194H. However, the Assessing Officer and the Tribunal disagreed, viewing the discount as an indirect form of commission. The Court supported this interpretation, noting that the franchisees received a discount (e.g., Rs. 7 per SIM card) which, in essence, was a commission for their services in selling the SIM cards and pre-paid coupons.The Court referenced the Supreme Court's explanation that in a contract of sale, title passes to the buyer upon delivery for a price, making the buyer the owner. However, in this case, the franchisees did not gain ownership of the pre-paid cards, and their activities were tightly controlled by the assessee, aligning with the characteristics of an agency relationship.The Court also considered similar judgments from the Delhi High Court in CIT v. Idea Cellular Ltd. and the Kerala High Court in Vodafone Essar Cellular Ltd. v. Asstt. CIT, which concluded that such discounts were indeed commissions subject to TDS under Section 194H.Conclusion:The Court concluded that the relationship between the assessee and the franchisees was that of a principal and agent. Consequently, the discount allowed to the franchisees was an indirect form of commission, attracting the provisions of Section 194H. The Court affirmed the Tribunal's decision and directed the Assessing Officer to ensure that any unpaid taxes by the franchisees were recovered, with interest levied as per the law. The appeal was thus disposed of, upholding the Tribunal's judgment.