Franchise Agreements Are Fundamentally Licensing Agreements, Rather Than Sales Of Goods: Allahabad High Court
The Allahabad High Court held that Franchise agreements are fundamentally licensing agreements, rather than sales of goods.
The Court held thus in a Sales/Trade Tax Revision petition preferred by Commissioner Commercial Tax, U.P. against M/s Pan Parag India Limited.
A Single Bench of Justice Shekhar B. Saraf observed, “Franchise agreements have become a ubiquitous feature of modern commerce, facilitating the expansion of businesses across diverse industries and geographies. However, the tax treatment of franchise agreements poses intricate challenges, with implications for both franchisors and franchisees. Transfer of the right to use a trademark does not necessitate the physical handover or control of the trademark. Instead, it can be affected by authorizing the transferee to use the trademark in accordance with the law. This underscores the intangible nature of trademark rights and their transferability without the need for physical possession. Franchise agreements primarily grant a representational right rather than an exclusive right to sell or manufacture goods, thereby categorizing such transactions as services rather than sales of goods. Franchise agreements are fundamentally licensing agreements rather than sales of goods.”
The Bench added that licensing involves granting permission to use intellectual property rights, whereas sales of goods involve the transfer of ownership of tangible items and understanding this distinction is crucial for determining the appropriate tax treatment for franchise agreements.
Additional Chief Standing Counsel Bipin Kumar Pandey appeared for the revisionist while Advocate Shubham Agarwal appeared for the respondent.
Factual Background -
A commercial tax revision petition under Section 58 of the U.P. Value Added Tax Act, 2008 (UPVAT Act) was filed in this case. The first appellate authority in this matter had concluded that the dealer/respondent had sold his brand name/title under the franchise agreement, and since it is to be considered as a sale, therefore, Value Added Tax (VAT) has to be levied on it. Against such order, the respondent filed an appeal before the Commercial Tax Tribunal.
The Tribunal held that since the franchise of trademark can be transferred to several persons at the same time, it is merely a license to use the goods and not a transfer of the exclusive right to use the goods, and therefore, no VAT can be levied on the same. Therefore, the appellant approached the High Court.
The High Court in view of the above facts noted, “At first glance, franchise agreements may appear analogous to sales of goods, as they involve the transfer of rights and benefits from one party to another in exchange for monetary consideration. However, a deeper examination reveals crucial distinctions that warrant disparate tax treatment. Unlike conventional sales transactions, which involve the transfer of tangible property, franchise agreements primarily entail the licensing of intangible assets, such as trademarks, trade secrets, and proprietary know-how. One of the central aspects of franchise agreements is the grant of intellectual property rights from the franchisor to the franchisee. These rights include trademarks, trade names, logos, and proprietary business methods. Unlike tangible goods, which can be bought and sold outright, intellectual property rights are licensed for use under specific terms and conditions. Another key factor that distinguishes franchise agreements from sales transactions is their non-exclusive nature.”
The Court said that Franchise agreements typically grant franchisees the right to operate a business using the franchisor's brand and system within a defined territory, however, this right is not exclusive, as the franchisor may grant similar rights to other franchisees within the same or overlapping territories. It further noted that Franchise agreements also entail an ongoing relationship between the franchisor and franchisee, characterized by training, support, and ongoing assistance.
“Unlike a one-time sale of goods, which concludes once the transaction is complete, franchise agreements involve continuous interaction and collaboration between the parties. The financial aspects of franchise agreements further underscore their distinction from sales transactions. Franchise fees and royalties are payments made by the franchisee 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 provided by the franchiser”, it observed.
The Court held that the taxation of franchise agreements and sales of goods represents a complex and multifaceted issue that defies easy categorization and while both involve commercial transactions, they embody distinct economic realities and legal considerations that necessitate differential tax treatment.
“By recognizing the unique characteristics of franchise agreements, including the prevalence of intangible assets and the importance of intellectual property, tax authorities can develop nuanced tax policies that promote fairness, efficiency, and compliance. Ultimately, a balanced approach that takes into account the economic substance of franchise transactions and the need to prevent tax arbitrage and avoidance will ensure the integrity and effectiveness of the tax system”, it remarked.
The Court said that the franchise agreement in the case grants a non-exclusive license rather than a transfer of the right to use goods and ss such, the transaction does not attract VAT under the UPVAT Act. It also added that once an activity is taxable as a service, it cannot be taxed as sale/deemed sale of goods.
“It is clear from the factual matrix of the instant case that the respondent herein had received royalty amount from various dealers under the franchise agreement and service tax has been duly paid by it on the same. If these payments have been subjected to service tax, they cannot be recharacterized as the sale of goods to levy VAT or sales tax. The prevention of double taxation is a fundamental principle of tax law. Double taxation occurs when the same income or transaction is taxed more than once by different tax authorities or under different tax regimes. An activity once taxed as a service cannot be taxed again as a sale of goods. This principle is crucial for ensuring fairness in the tax system and avoiding undue tax burdens on taxpayers”, it concluded.
Accordingly, the High Court dismissed the revision petition and refused to interfere with the view of Commercial Tax Tribunal.
Cause Title- Commissioner Commercial Tax, UP v. M/s Pan Parag India Limited (Neutral Citation: 2024:AHC:94356)
