Devyani International Limited @APPELLANT @Hash Commissioner of Service Tax Delhi-II @RESPONDENT

Dr. Rachna Gupta, J

Present appeal has been filed to assail Order-In-Appeal No.175/2016-17 dated 10.03.2017.

The facts relevant for the present adjudication, in brief, are as follows;

M/s Deveyani International Limited, the appellant herein, is having service tax registration for providing Restaurant Services, Outdoor Catering Services, Business Auxiliary Services, Franchise Services, Management Consultant Services, Goods Transport Operator Services, Renting of Immoveable Property Services etc. During the audit of appellant’s records, the department observed that the appellant was receiving Franchise Services from M/s Costa International Limited United Kingdom who owns the trade name and trademarks (Costa, vide the Development Agreement dated 28.09.2004. The Franchise Service has also been obtained from M/s International Franchise holding (Labuan) Ltd. Labuan who owns the trade name and trademark “Swensen’s” by virtue of Master Franchise Development Agreement dated 09.12.2009.

Based on the various clauses of the aforesaid agreement, the department observed that franchisee/ appellant, apart from remitting franchisee fee and royalty amount, it has to contributed at least 2% of its gross sale for advertising and promotion of the brand name “Costa” owned by the Franchiser M/s Costa International Limited and Promotion of Brand name “Swenson’s” of M/s International Franchise holding (Labuan) Ltd. Thus, both the Franchisors are getting extra consideration in the form of contribution towards advertisement from the Franchisee for promotion of their own brand instant of appellant incurring it’s own advertisement. Department formed the opinion that the activity of the Franchisee is therefore, taxable as he is providing Business Support Service to the Franchisor, the amount paid by the appellant being the extra consideration spent by the franchisee-appellant on advertisement and promotion of the Brand name of the Franchisor should form the part of the value of taxable service in terms of Section 67 of Finance Act 1994 read with Rule 5 of Service Tax ( Determination of Value) Rules, 2006. The appellant is accordingly, alleged liable to pay the service tax on the amount paid as contribution towards advertisement.

Accordingly, show cause notice No. 152/2012 dated 22.04.2013 has been served upon the appellant proposing service tax amounting to Rs.40,78,339 to be recovered from the appellant along with proportionate interest and the appropriate penalties. The said proposal has been confirmed initially vide Order-In-Original No. 49-50/2016 dated 17.08.2016. The appeal against the said order has been partly allowed. The order of confirmation of tax vis-a-vis the amount paid towards advertisement contribution along with interest has been confirmed. However, the penalty amount has been reduced to 50% for the period from the April 2011 onwards in terms of first proviso to Section 78(1) of the Finance Act. Still being aggrieved of the confirmation of tax demand the appellant is before this Tribunal.

We have heard Shri Dhuruv Tiwari, Advocate for the Appellant & Ms. Jayakumari Authorized representative for the Respondent.

Learned counsel for the appellant has mentioned that the appellant had entered into two separate Franchise Agreement with two overseas franchisors namely Costa International U. K. (herein, after referred as Costa and International Franchise Labuan (herein, after referred as IFHL). In terms of those agreement appellant was paying franchisee fee at the rate of 6% to Costa and at the rate of 3% to Labuan of gross revenue network. The appellant was also paying royalty fees to IFHL at the rate of 5% of gross sales, against grant of development right for operating franchise outlets in India. It is also submitted that appellant was duly discharging its Service Tax liability on such franchise/ royalty fees paid to Costa/ IFHL under reverse charge mechanism (herein, after referred as RCM)

It is further, submitted under these agreements, the appellant was also required to spend at least 2% of Gross Revenue Network in case of Costa and 4% of Gross Sale in case of IFHL towards advertisement and promotion activities. The said amount has wrongly been considered, by the department, as extra consideration being received by Costa/ IFHL in the form of contribution towards advertisement or promotion of the formers brand instead of appellant incurring expenditure on its own wrongly alleging the activity as Business Support Services being provided by the appellant to both the franchisors.

Learned counsel impressed upon that the amount in question is 2%/ 4% of gross network revenue. This term is defined under clause two of the agreements to mean to be an amount towards advertisement of Costa outlets/ IFHL outlets. The meaning of these outlets is defined under agreements to mean retail shops opened and operated by the appellant within the development of area i.e. India. There is nothing in either of these agreements that casts an obligation on appellant to incur expenditure for advertising the brand name, trademarks etc. of Costa/ IFHL. Thus, it is submitted that the indirect result because of the advertisement activity under taken by appellant in India in respect of retail outlets operated by it is wrongly treated as extra consideration flowing from appellant to Costa/IFHL towards franchise services. It is for the reason that out of those advertisement it was appellant himself, who was getting benefitted out of such expenses, the retail outlets being run by appellant himself and not by Costa/IFHL. Decision of larger bench of this tribunal in the case of Bhayana builders Pvt. Ltd. vs. Commissioner of Service tax Delhi reported as 2013(32) STR 49 (Tri. L.B) is relied upon.

It is further submitted that Rule 5 of service tax determination of value rules has also, wrongly been invoked. The said rule has already been struck down by Hon’ble Delhi High Court in the case of Intercontinental Consultants and Technocrats Pvt. Ltd. vs. Union of India reported as 2013 (29) STR 9 (Del.). Finally, the impugned show cause notice is alleged being barred by time. The appellant had no intention to act dishonestly, nor has engaged in any suppression by wilful means with intent to evade payment of tax. The extended period has been wrongly invoked. The order is liable to be set aside on this ground as well. Decision, in the case of Uniworth Textiles Ltd. vs Commissioner of Central excise, Raipur reported as 2013(288) ELT 161 SC is relied upon. With these submissions the order under challenge is prayed to be set aside and the appeal is prayed to be allowed.

While rebutting these submissions, learned DR for the Department has reiterated the discussion and findings given in order-in-original as well as the impugned order/ order-in-appeal. It is submitted that the amount spent by the appellant towards advertisement and promotional activity is rightly held to be the part of the consideration for Franchisee Service paid by the appellant to the franchisor. Admittedly, the amount paid to towards Franchise Service is taxable amount. There is nothing either of the agreement to show that the said amount is not for the promotion of the franchisor’s business.

Learned AR further submitted that period involved in the present case is pre as well as post negative list (Section 66(D) of Finance Act). For the period prior introduction of negative list on 01.07.2012 classification of service was relevant factor. Admittedly, the service in question is Franchise Service which is admittedly, taxable. The appellant has wrongly bifurcated the amount as contrary to the clauses of the agreements entered into with both the overseas franchisors. Hence, there is no infirmity in confirmation of the demand. With respect to period beyond post negative list, apparently the Franchise Service do not fall in negative list of Section 66 (D) of Finance Act. The service is taxable. The amount received for such taxable service is liable to service tax hence. Since, the providers are outside India appellant is liable to pay service tax on the said amount under RCM. The entire demand confirmed is therefore, liable to sustain. With these submission the appeal is prayed to be dismissed. Learned DR has relied upon the decision in the case titled as M/s Subway System India Pvt. Ltd. vs. CST Delhi-II reported as 2019 (25) G.S.T.L 465 (Tri. Del.)

Having heard the rival contentions of both the parties, perusing the entire record of the appeal memo including both the Franchise Agreements, we observe that the moot question of adjudication is as follows;

Whether, the amount spent by the appellant (2%/4% of the gross net revenue) towards advertisement and promotion of the Costa/IFHL outlets operated by the appellant is an amount of consideration in terms of Section 67 of Finance Act 1994 read with rule 5 of service tax (determination of value) rules 2006 being includable in the value of Franchise Services received by the appellant from overseas franchisors.

To adjudicate the same we, foremost have to look into Section 67 of the Finance Act. This Section talks about valuation of taxable services for charging service tax. The provision defines consideration to include any amount that is payable for the taxable services provided or to be provided. The expression considerations was decided by Hon’ble Supreme Court in the case of Sonia Bhatiya vs. State of U. P. And others reported as AIR 1981 as see 1274 in reference to U. P. Imposition of ceiling on land building Acts 1961. Since, the Act was not defining consideration its meaning as defined from expression in Section 2(d) of the Contract Act 1872 for consider with a reference to its meaning in Black’s law dictionary it was held that the consideration means a reasonable equivalent for other valuable benefit passed on by the Promisor to the Promissee or by the transferor or by the transferee.

Section 67 of the Finance Act defines this concept as any consideration whether monetary or otherwise should have flown or should flow from the service recipient to the service provider and should accrue to the benefit of the later. The larger bench of this Tribunal in the case of Bhayana Builders (Supra) has held:

A Larger Bench of the Tribunal in Bhayana Builders (P) Ltd. vs Commissioner of Service Tax [2013 (32) S.T.R. 49 (Tri. -LB)] observed that "implicit in the legal architecture is the concept that any consideration whether monetary or otherwise, should have flown or should flow from the service recipient to the service provider and should accrue to the benefit of the latter. In the said decision, the Larger Bench made reference to the concept of 'consideration', as has been expounded in the decision pertaining to Australian GST Rules, wherein a categorical distinction has been made between 'conditions' to a contract and 'consideration'. It is prescribed under the said GST Rules that certain 'conditions' to the contract cannot be seen in the light of 'consideration' for the contract and the fact that the service recipient has to fulfil 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.

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:

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 the value of taxable services. Further, by the use of the word "charged", it is clear that the same refers to the amount billed by the service provider to the service ser Therefore, in terms of Section 67, unless an amount is charged by the service provider to the service recipient. It does not enter into the equation for determining the value on which service tax is payable.

The amount charged should be for "for such service provided” : Section 67 clearly indicates that the gross amount charged by the service provider has to be for the service provided. Therefore, it is not any amount charged which can become the basis of value on which service tax becomes payable but the amount charged has to be necessarily a consideration for the service provided which is taxable under the Act. By using the words "for such service provided” the Act has provided for a nexus between the amount charged and the service provided. Therefore, any amount charged which has no nexus with the taxable service and is not a consideration for the service provided does not become part of the value which is taxable under Section 67. The cost of free supply goods provided by the service recipient to the service provider is neither an amount "charged" by the service provider nor can it be regarded as a consideration for the service provided by the service provider. In fact, it has no nexus whatsoever with the taxable services for which value is sought to be determined."

Reverting to both the agreement in question we observe following to be the relevant clauses.

(A) Agreement with COSTA. Promotion and Advertising 13. Franchisee's Local Advertising Expenditure

13.1 The Franchisee shall be responsible for the advertising and promotion of the COSTA OUTLETS within the Development Area and shall spend at least two per cent (2%) of Gross Network Revenue on advertising and promotional activities

13.2 The Franchisee shall report annually at the same time as if submits the business plan required under clause 9.3 on its expenditure under clause 13.1 in the previous 12 months, including details of advertising and expenditure as reasonable required by Costs.

13.3 Costa will provide criteria for advertising and promotion which if observed will not require any consent from Costa, except in relation to artwork and design for advertising which must always be approved prior to their first use by the Franchisee. All other advertising and promotional activities, programmes and materials and media proposal to be used or conducted by the Franchisee shall be subject to the prior written approval of Costa.”

(B) Agreement with IFHL

“3. Fee

3.1 In consideration for the foregoing grant of rights, the Developer shall pay to Franchisor a one time Territory Exclusivity Fee. The Territory Exclusivity Fee shall be non-refundable and shall be deemed to be fully earned upon execution of this Agreement. 3.2 The Territory Exclusivity Fee shall be paid by the Developer to the Franchisor in the manner stipulated in Appendix 2.

3.5 The Developer acknowledges and agrees that it shall be required to pay the Royalty Fee, as well as the Advertising Contribution, for any Shoppe opened pursuant to the rights granted to it hereunder, as set forth in Appendix 2, and otherwise accordance with the terms of the Individual Franchise Agreement. 3.6 During the Initial Term, the parties agree that a Royalty Fee as set forth in Appendix 2 equal to five (5) % of the total Gross Sales from each Shoppe shall be due and payable on a monthly basis by the Developer to the Franchisor, unless otherwise agreed in writing between the parties. The parties expressly acknowledge that the Royalty Fee at the rate of five (5) % of Gross Sales from each Shoppe is currently the legally permissible royalty fee rate that can be remitted overseas to the Franchisor in accordance with the rules and regulations of the Reserve Bank of India and other applicable Indian laws, and the parties expressly agree to strictly comply with such rules, regulations and laws.

3.7 The Developer further acknowledges and agrees that it shall be required to pay the Franchisor in India an ongoing monthly fee of 1% of Gross Sales of each Shoppe through possible payment mechanism or alternative solutions as agreed by the parties in good faith including, without limitation, payment for the Franchisor's marketing and advertisement support and advice or payment of the Franchisor's expenses in India.”

A bare perusal of the above indicates that the Appellant was required to pay royalty fees to IFHL against the award of franchise under Clause 3 on which Service tax is duly discharged by the appellant under reverse change mechanism. The Appellant was required to spend at least 4% of the Gross Sales, i.e. the gross income arising from the conduct of franchise business of Appellant operating at retail sale outlets. As per the definitions of Advertising Contribution, Gross Sales, Business Shoppe etc. under of the Agreements. It is clear that the amount of advertisement, on which Service tax demand has been confirmed, was spent by Appellant for the advertisement of retail outlets operated by it in India and not for the advertisement of restaurant system owned by Costa/ IFHL. There is nothing contained in the Agreement that casts as obligation on Appellant to incur expenditure for advertising the brand name, trademarks, etc. of Costa/ IFHL. Thus, it is submitted that any indirect result because of the advertisement activity undertaken by Appellant in India in respect of retail outlets operated by it. cannot be treated as extra consideration flowing from Appellant to Costa/ IFHL towards Franchise Services. Since, it is the Appellant who was benefitting out of such expenses and not Costa/ IFHL. The amount in question cannot be the consideration paid by appellant for receiving any taxable service (Advertisement/Business Support Services) from the Costa/IFHL. Admittedly, Costa/ IFHL do not run any retail outlet in India on their own and it was in the business of Appellant to enhance its sale by undertaking advertisement activity. Merely because the brand name, trademarks, etc. of Costa/ IFHL appear in the advertisement, it can not be called taxable service of BSS. Consequently the question of extra consideration following from Appellant to Costa/ IFHL does not arises. Hence, the advertisement amount spent by Appellant is not includible in the taxable value of Franchise Services by treating the same as non-monetary consideration under Section 67 of the Finance Act as is held by the adjudicating authority in the OIO in the present case. Thus, the findings in impugned order are apparently wrong.

We draw our support from the decision of this Tribunal in the case of Macdonald’s India Pvt. Ltd. vs. Principal Commissioner of Service Tax Delhi (1) reported as 2019(30) GSTL J-51 (Tri.-del) wherein it was held that the condition of the Franchise Agreement is to require of the advertisement of the “Restaurant” and nothing else. Irrespective that while so advertising the trade names / service marks and trademarks of the Franchisor appear in the advertisement but it being the indirect benefit to the franchisor, the value of such advertisement cannot be called as the amount of consideration for receiving Franchise Services. The facts of present case are identical to the case of, Macdonald’s case. We find no reason to differ from those findings Similar have been the findings in the case of Delhi High Court in the case of Baush and Lomb Eye Care India Pvt. Ltd. vs the Additional Commissioner of income tax reported as 2016 (65) taxmann.com 141 Delhi.

Apparently and Admittedly, the appellant is paying service tax under RCM with respect to royalty fee and even on advertisement fee for advertising the trade name of Costa/IFHL. The amount in question is an amount for advertising the Costa/ IFHL outlets which are operated by appellant for its own Business Department has not produced anything to falsify these observations. Hence, the amount is question is an amount towards promotion of appellant’s own outlets in this arrangement presence of the two people to Constitute Service rendered by one & received by another is are missing vis-a-vis the promotion the promotional activity for the appellant operated outlets. Hence, we hold that the said amount has wrongly been included in gross value towards franchise service received by the appellant from the two overseas Franchisors. The confirmation of demand of service tax on this amount is therefore, liable to be set aside.

We also, observe that the said demand was proposed vide show cause notice dated 22.04.2013 for the period from 2007-08 to 2011-12 while invoking the extended period of limitation. But we find no evidence of any positive act of the appellant which may be called as an act of suppression or of wilful mis-statement committed with and intent to evade payment of tax. The Commissioner (Appeals) himself has reduced the penalty to the extent of 50% of the tax. While drawing our support from the decision of Hon’ble Supreme Court in the case titled as Uniworth Textile (Supra), as relied upon the appellant, we hold that extended period has been wrongly invoked while issuing the SCN. The SCN is therefore, held bared by time.

The show cause notice is also held to have wrongly invoked. Rule 5 of the Valuation Rules, 2006 as the said Rule has already been held ultra vires by Hon’ble High Court Delhi in the case on Intercontinental (Supra). it has been hold as follows:

The illustration 3 given below the Rule amplifies what is meant by sub-rule (1). In the illustration given, the architect who renders the service incurs expenses such as telephone charges, air travel tickets, hotel accommodation, etc. to enable him to effectively perform the services, The illustration, therefore, says that these expenses are to be included in the value of the taxable service. The illustration clearly shows how the boundaries of Section 67 of Finance Act, 1994 are breached by the Rule. Sub-section (4) of Section 67 which enables the determination of the value of the taxable service "in such manner as may be prescribed is expressly made subject to the provisions of sub-section (1). The thread which runs through Sections 66, 67 and 94, which empowers the Central Government to make rules for carrying out the provisions of Chapter V of Finance Act, 1994 is manifest, in the sense that only the service actually provided by the service provider can be valued and assessed to Service Tax. We are, therefore, undoubtedly of the opinion that Rule 5(1) of the Rules runs counter and is repugnant A to Sections 66 and 67 of the Act and to that extent it is ultra vires. It purports to tax not what is due from the service provider under the charging Section, but it seeks to extract something more from him by including in the valuation of the taxable service the other expenditure and costs which are incurred by the service provider "in the course of providing taxable service". What is brought to charge under the relevant Sections is only the consideration for the taxable service. By including the expenditure and costs, Rule 5(1) goes far beyond the charging provisions and cannot be upheld.

With these observations we hold that show cause notice is time bared and is vague also. The demand based on such show cause notice is not sustainable. Resultantly, we hereby set aside the order-in-appeal/ the order under challenge. Consequent, thereto, the appeal stands allowed.

(Pronounced in the open Court on 05.12.2024)