MUMBAI: Franchise and royalty fees received by Subway Systems India, a group company of the international fast food chain, cannot be subject to value-added tax (VAT) in Maharashtra, according to a recent order of the Bombay high court.
Subway India enters into franchise agreements with third party restaurants (ie, franchisees), permitting them to operate sandwich shops by displaying the trademark ‘Subway’. In return, Subway India receives a one-time franchise fee paid on signing of the agreement and weekly royalty payments linked with the restaurant’s turnover.
Maharashtra state excise authorities sought to impose VAT on such income on the grounds that Subway India had transferred the ‘right to use’ its trademark to the franchisees. Subway India’s contention was that the franchise agreements did not result in a ‘sale’ or transfer of the ‘right to use’ the trademark. The agreements merely permitted the franchisees to display the Subway name and to use certain technologies and methods in preparing the salads and sandwiches. The company was already paying service tax on income received under the agreements.
Even while the writ petition filed by the company, challenging the constitutional validity of VAT levy, was pending before the high court, the company was served show-cause notices aggregating to a VAT demand of Rs 5.3 crore for the years 2006 to 2009 .
“This favourable order, setting aside imposition of VAT, will also help other similar transactions that have been subject to both service tax and VAT liability. Apart from fast food chains, educational and vocational institutions popularly operate under a franchise model,” says Nihal Kothari, executive director at Khaitan and Co, a law firm which represented Subway India.
n Maharashtra, in many cases, even though service tax has been paid, state tax authorities raise VAT demands on the grounds that ‘franchises’ have included within the classification of ‘goods’ for tax purposes under the Maharashtra VAT Act since 2005.
“In this landmark decision, the Bombay high court has laid down the principles for making a distinction between a ‘permissive use’ and ‘transfer of right to use’,” adds Kothari. The former cannot be subject to VAT as there is no element of sale or deemed sale.
The High Court in its order observed that the franchise agreements entered into by Subway India were a classic example of permissive use of goods. The franchisees only had restricted rights to display the name ‘Subway’ or use the dress code during the duration of the agreement. On expiry or termination of the agreement, their rights ended. The franchisees could not sub-franchise their rights, nor was any exclusivity guaranteed to them. Subway India could permit other franchise outlets in the same area, or set up its own outlets.
The Bombay high court also agreed that the situs (place for determining legal jurisdiction for VAT purposes) of the agreements was not in Maharashtra, but in Delhi where Subway India was based.