Allahabad High Court On Taxation Of Franchise Agreements

In the light of the case of Commissioner Commercial Tax, U.P. at Lucknow v. M/S Pan Parag India
Limited, the Allahabad High Court addressed and answered some pertinent questions related to
levying of VAT on franchise agreements.

The First Appellate Body had previously ruled that since Pan Parag had “sold” its brand name under
the franchise agreement, this should be considered a sale and therefore subject to VAT.
However, the Commercial Tax Tribunal ruled that since the franchise of a trade mark can be
transferred to several persons at the same time, it is only a license to use the goods and not a
transfer of the exclusive right to use the goods.

Before the High Court, the Commissioner submitted that since franchise or trademark falls within
the meaning of transfer of right to use the goods, VAT can be levied even if service tax has been paid.
The Court noted that the Finance Act of 1994 made a distinction between the transfer of the right
to use a trademark and its assignment.

Licensing agreements, which grant the franchisee limited rights to use a trademark or business
concept, are clearly demarcated from the direct transfer or sale of trademarks, it noted.
“This distinction is crucial for tax purposes because it determines the nature and extent of the tax
liability for the parties involved”, said the Court.

The Court also looked at the decisions on taxation of franchisees by the Delhi High Court and the
Kerala High Court and against this backdrop, Justice Shekhar B. Saraf noted that franchise
agreements generally grant non-exclusive rights to use trademarks and business systems.
“The non-exclusive nature of these rights ensures that the franchisor retains control and can license
the same rights to multiple franchisees, strengthening the licensing framework rather than a
complete transfer. The retention of ownership and control by the franchisor or licensor ensures that
the transaction remains within the scope of service tax rather than sales tax”, the Court explained.

In this particular case, Pan Parag had received royalties from various dealers under the franchise
agreement and subsequently paid service tax on the same.
Hence, rejecting the review plea to levy VAT on franchise agreement, the court observed, “If these
payments are subject to service tax, they cannot be re-characterized as sale of goods for the
purpose of collecting VAT or sales tax. Avoiding double taxation is a fundamental principle of tax
law.”

However, the Court noted that franchise agreements have become a ubiquitous feature of modern
commerce and stated that their tax treatment poses complex challenges.

“Unlike a one-time sale of goods, which ends once the transaction is completed, franchise
agreements involve ongoing interaction and cooperation between the parties. The financial aspects
of franchise agreements further underline the difference with sales transactions. Franchise fees and
royalties are payments that the franchisee makes to the franchisor in exchange for the right to use
the franchisor’s brand and system. These payments are not for the purchase of goods, but rather for
the ongoing support and benefits the franchisor provides,” the court further said.

Welcoming the decision, many industry experts demand separate law framework for franchising.
“It’s time that India gets a proper and a separate framework of law for franchising, like many foreign
countries. Franchisees’ interests must be safeguarded at all cost. And if both franchisors and
franchisees are paying their respective taxes and fees, there is no question of burdening them with
extra taxes like the VAT”, opines Dr. Chackochen Mathai, Founder and CEO, Franchising Rightway.

Sounding a word of caution to the budding entrepreneurs, Seema Jhingan, Senior Partner,
LexCounsel, Law Offices, adds, “Individuals venturing into entrepreneurship must pay attention to
the contractual rights and obligations assumed, exclusivity of territorial rights granted, non-
exclusivity of license to use intellectual goods, training, marketing and promotional support, and
ongoing assistance by the franchisor to the entrepreneur, royalty obligations and the tax
implications thereof. In practical terms, clarity in agreements not only mitigates the risk of
ambiguity of rights and liabilities but also assists in mapping of obligations to minimize future
disputes.”