The Delhi High Court in a recent judgment titled Sagar Ratna Restaurants Pvt. Ltd & Ors. v. The Value Added Tax Officer & Ors. (WP No. 4453/2013 and 3404/2015) involving various food chains (McDonalds, Bikanerwala alongwith GSK on the issue of Trademark License) held that the amount received by the franchisor by way of franchisee fee under a Franchise Agreement involving use of intangible property is chargeable to service tax and not exigible to VAT.
The dispute in this case was whether the transaction involving use of trademark by the franchisee under the Franchise Agreement can be considered as a transfer of right to use such trademark by the franchisor and consequently the same is to be treated as a deemed sale under Article 366(29A) of the Constitution of India on which VAT is payable under the Delhi VAT law; or as a provision of Service on which service tax is payable.
The Hon'ble Court in this case held that the dominant intention of a Franchise Agreement is to render franchisee service and that the permission to use the trade mark is merely incidental to the bunch of services being provided under the Franchise Agreement. The Hon'ble Court relying on the judgment in the case of Bharat Sanchar Nigam Ltd v. Union of India [(2006) 3 SCC 1] disregarded the applicability of aspect theory on Franchise Agreement stating that the segregation of the terms of the agreement to levy VAT on only specific aspects of it would be inappropriate.
The Hon'ble Court further relying on the decision in the case of Malabar Gold Private Ltd. v. CTO [(2013) 63 VST 496 (Kerala)] (the Hon'ble Supreme Court has admitted Revenue's SLP against this decision vide C.A. No. 5380-5384/2017 after delivery of this judgment) held that for a transfer of the right to use goods to be effective, such transfer of right should be one that the transferee can exercise in exclusion of others; which is not the case in the present appeals and petitions, as the Franchise Agreement only grants a non-exclusive right, retaining the franchisor's right to transfer the composite bunch of services to other parties, apart from it retaining ownership to the same.
Lastly, the Hon'ble Court held that since none of the franchisees are empowered to safeguard violation of the trademark, through enforcement mechanisms, such as filing suits for injunction or damages, therefore, the most important attribute of ownership or transfer (even in the most evanescent sense) is absent.
In nutshell, the ratio of this case is that in case of intangibles, the right to use intangibles does not stand transferred in absence of transfer of title; because the right to defend any infringement vests with the original owner even after permitting the right to use the intangible.
Considering that the Goods and Services Tax ("GST") is likely to come into force from 1st July, 2017 and the transaction involving transfer of right in goods without transfer of title therein are deemed as Supply of Service and transfer of title in goods is treated as Supply of Goods under the GST regime, the industry is expecting that such dispute may not arise.
Note: Our firm argued on behalf of M/s Sagar Ratna Restaurants Pvt. Ltd.
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