TaxTMI 
TaxTMI 
2019 (9) TMI 1141
X X X X Extracts X X X X
X X X X Extracts X X X X
....ent 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 Limited [Hardcastle] and Connaught Plaza Restaurants Private Limited [Connaught Plaza] who operate restaurants in India. As a consideration for its services, McDonald's India receives royalty equivalent to 5 % of the gross sales made by the local franchisees in addition to a fixed location fee of $22,500 to $45,000, each time a new restaurant is opened. The Appellant claims that there is no other consideration flowing to the Appellant, directly or indirectly, from the franchisees, except the said royalty amount and the location fee amount. It is not in dispute that service tax as applicable has been paid by the Appellant on the said royalty and the location fee amount. The Appellant is also providing 'management consultancy' services to McDonald's USA, in terms of a Ser....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... 3. Non-payment of service tax on management consultancy service by wrongly claiming it as export √ √ √ √ 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, 1994[the Act] read with the Servi....
X X X X Extracts X X X X
X X X X Extracts X X X X
....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 busine....
X X X X Extracts X X X X
X X X X Extracts X X X X
....nsor 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. " 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 u....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ood 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 adheren....
X X X X Extracts X X X X
X X X X Extracts X X X X
....se 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 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. &nb....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... compliance with the standards and policies of the McDonald's System. 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 al....
X X X X Extracts X X X X
X X X X Extracts X X X X
....p; 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-II[2016 (3) TMI 666 (CESTAT-Delhi)]; (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 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.[ 2018 (2) TMI 1325]; (v) Thus, it cannot be said that there is a contractual obligation to advertise the trade names, service marks and trademarks of the franchisor and in the absence of such a direct requirement under the contract, no extra consideration can be attributed to any indirect benefit, which is free and not a direct requirement for the service ren....
X X X X Extracts X X X X
X X X X Extracts X X X X
....nly 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 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 India[2017 (50) STR 275]; (iv) The decision of the Supreme Court in Bhayana Builders would not be....
X X X X Extracts X X X X
X X X X Extracts X X X X
....bute 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 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 ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....on 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 o....
X X X X Extracts X X X X
X X X X Extracts X X X X
....on 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] 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 Explan....
X X X X Extracts X X X X
X X X X Extracts X X X X
....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 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 ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....lfil 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....
X X X X Extracts X X X X
X X X X Extracts X X X X
....he 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 taxa....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ht, 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 (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 promotion....
X X X X Extracts X X X X
X X X X Extracts X X X X
....nchisor 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 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 wa....
X X X X Extracts X X X X
X X X X Extracts X X X X
....nt. 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 decision of the Delhi High Court in Delhi International Airport also does ....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... 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 nonmonetary consideration was required to be determined under Rule 5(1) of the 2006 Rules. Even if it is assumed that some nonmonetary consideration had been received by the Appellant, then too the same could not have bee....
X X X X Extracts X X X X
X X X X Extracts X X X X
....f 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 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....
X X X X Extracts X X X X
X X X X Extracts X X X X
....edit 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 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....
X X X X Extracts X X X X
X X X X Extracts X X X X
....es, 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. 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.[ 1999 (112) ELT 353 (SC)]. 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....
X X X X Extracts X X X X
X X X X Extracts X X X X
....he 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 c....
X X X X Extracts X X X X
X X X X Extracts X X X X
....e'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 ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....onald's USA are "associated enterprises", in terms of the relevant provisions of the Income Tax Act, 1961. xxxxxxx xxxxxxx xxxxxx 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 ....