(a) Value Added Tax- Transfer Of Technical Know How- Sale- Liable To Vat.
(b) Value Added Tax- Frenchise Agreements- Not A Transfer Of Right To Use- Not A Sale- Not Liable For Vat, Schedule Entry C-39 of The Maharashtra Value Added Tax Act, 2002.
Facts
i) The Petitioner Monsanto India, a joint venture company of Monsanto Investment India Private Limited (“MIIPL”) and the Maharashtra Hybrid Seeds Co. Monsanto India developed and commercialized insect-resistant hybrid cotton seeds using a proprietary “Bollgard Technology”, one that is licensed to Monsanto India by Monsanto USA through its wholly-owned subsidiary, Monsanto Holdings Private Limited (“MHPL”). This technology is further sublicensed by Monsanto India to various seed companies on a non-exclusive and nontransferable basis to use, test, produce and sell genetically modified hybrid cotton planting seeds. In return for this technology, Monsanto India received trait fees based on the number of packets of seeds sold by the sub-licensees. These sub-licensing agreements, with almost 40 seed companies, were the transactions in question. The petitioner paid service tax on these transactions and did not paid vat. The department levied vat on these transactions treating transfer of technical knowhow as sale liable to vat. The petitioner file writ petition before the Bombay High Court.
ii) In other case the petitioner Subway was granted a non-exclusive sub-license by Subway International B.V. (“SIBV”), a Dutch limited liability corporation to establish, operate and franchise others to operate SUBWAY – branded restaurants in India. This non-exclusive license was granted to SIBV itself by Subway Systems International Ansalt, which in turn was granted such a license by Doctor’s Associates Inc., an entity that owns the proprietary system for setting up and operating these restaurants. These restaurants serve sandwiches and salads under the trade mark ‘SUBWAY’. The agreement includes not only the trade mark SUBWAY, but also associated confidential information and goodwill, such as policies, forms, recipes, trade secrets and the like. Typically, Subway enters into franchise agreements with third parties, under which it provides specified services to the franchisee. In return, the franchisee undertakes to carry on the business of operating sandwich shops in Subway’s name. The agreement only provides for a very limited representational or display right, and the franchisee cannot transfer or assign these exclusive rights to any third person. Subway also reserves the right to compete with these franchisees in the agreement. Under this agreement, Subway received two kinds of consideration, one being a one-time franchisee fee which is paid when the agreement is signed; and the second is a royalty fee paid weekly by the franchisee on the basis of its weekly turnover. Under these agreements, the franchisees have no more than a right to display Subway’s intellectual property in the form of marks and logos, and a mere right to use such confidential information as Subway discloses and as prescribed by the franchise agreement. Since September 2003, Subway was paying service tax to the Union of India on the consideration received by it from the franchisees. The vat department took the view that this consideration should be subject to VAT and passed the orders levying tax, interest and penalty against which the Subway filed writ petition before the Bombay High Court.
The High Court disposed both writ petitions by common order.
Held
(a) In first case the High Court held that the first question is whether there is a ‘transfer’ within the meaning of Article 366(29A)(d) the answer is yes. It is true that the essence of a ‘transfer’ is the divesting of a right or goods from transferor and the investing of the same in the transferee, and this is what Salmond on Jurisprudence and Corpus Juris Secundum both say. The seeds embedded with the technology are, in fact, transferred. Monsanto India is divested of that portion of the technology embedded in those fifty seeds and those were fully vested in the sub-licensee. It is not correct to say that the effective control of the ‘goods’ is with Monsanto India. The effective control over the seeds, and, therefore that portion of the technology that is embedded in the seeds, is entirely with the sub-licensee. That sub licensee is not bound to use the seeds (and the embedded technology) in accordance with Monsanto India’s wishes. Monsanto India cannot further dictate to the sub-licensee what he or it may do with these technology-infused seeds. The sub-licensee can do as it wishes with them. It may not use them at all. It may even destroy the seeds. Once the transaction is complete, i.e., once possession of the technology-imbued seeds is effected, and those seeds are delivered, Monsanto India has nothing at all to do with the technology embedded in those fifty seeds given to the sub-licensee. At no point does Monsanto India have access to this portion of the technology. In other words, the transfer is to the exclusion of Monsanto India. Further, the High Court held that the Monsanto India sub-licensing transaction could only be a service in one circumstance, i.e., if the seed companies gave Monsanto India a bag of seeds to mutate and improve with the Bollgard Technology which would, thereafter, be returned to the seed companies. That might perhaps be a service contract. Accordingly, the High Court held that it is a clear case of sale of goods liable to tax (Vat).
As regards plea of petitioner for transfer of the amount paid as service tax from the Consolidated Fund of India to the Consolidated Fund of State of Maharashtra, the High Court did not give any direction and left it to Monsanto India to adopt suitable proceedings in this behalf, and left their contentions open to the necessary extent.
(b) It is not true that the eligibility of Vat is to be determined by the State, and therefore it could levy sales tax on a transaction which already attracts service tax. The decisions in BSNL, Imagic Creative, and Associated Lease Finance are exactly on this. Service Tax and Sales Tax are mutually exclusive of each other. The agreement between Subway and its franchisees is not a sale, but it is in fact a bare permission to use. It is, therefore, subject only to service tax. The fact that the agreement between Subway and its franchisee is limited to the precise period of time stipulated in the agreement is vital to Subway’s case. At the end of the period of the agreement, or before in case there was any breach of its terms, the right of the franchisee to display the mark ‘Subway’ and its trade dress, and all other permissions would also end. This is what sets this agreement apart from the case of Monsanto and its sub licensee. There, the seed companies could do as they pleased with the seeds; they could alienate or even destroy them. In Subway’s case, there are set terms provided by the agreement which have to be followed. A breach of these would result in termination of the agreement. There is no passage of any kind of control or exclusivity to the franchisees. In fact, this agreement is a classic example of permissive use. It can be nothing else. For all the reasons in law and fact that the sub-licensing of technology in Monsanto is held to be a transfer of right to use, this franchising agreement must be held to be permissive use. It does not mean every franchise agreement will necessarily fall outside the purview of the amended MVAT Act. There is conceivably a class of franchise agreements that would have all the incidents of a ‘sale’ or a ‘deemed sale’ (i.e., a transfer of the right to use). Black’s Law Dictionary defines a franchise, in the context of a commercial transaction as: “The sole right granted by the owner of a trade mark or a trade name to engage in business or to sell a good or service e in a certain area”.
On facts, the High Court found that the Subway franchise does not meet these tests. There is no such exclusivity. The agreement itself says that Subway may itself open and operate its own outlets in direct competition with the franchisee. The agreements themselves expressly contemplate that Subway may create further franchisees in the very area in which these franchisees operate. The franchisee cannot unilaterally sub-franchise. The right of transferability is extremely restricted and it is impossible without Subway’s control throughout. Similarly, if there is no requirement of having to cease display and use or return the intangible property at the end of the franchise agreement’s term, then the transaction might arguably be a sale. Exercises in co-branding or sub-branding, where one party franchises its mark on a territorially-restricted basis and allows the franchisee to combine it with its own or other marks may also well have an element of sale. Similarly, where a dealership for, say, automobiles, has a territorial exclusivity, then it may amount to a franchise. The Subway franchise model has none of these elements. The so-called ‘system’ is controlled by Subway and it is exclusive to Subway. At the end of the franchise term, it cannot be used. The agreement gives Subway deep and pervasive control and dominion over the franchisee’s daily operations, without, at the same time, ceding to the franchisee the slightest hint or latitude in what it may do with the permitted marks and technology. This is, therefore, diametrically opposed to the Monsanto model, for Monsanto India has no control whatever in what its licensee does with the BT-infused donor seeds; that licensee may choose not to use them at all. There is also no question of any ‘return’ or ‘cessation’ to Monsanto India. Thus, viewed from any perspective, and on the facts of the case, the Subway franchise agreements does not have any of the necessary elements of a sale or a deemed sale.
Equally, the High Court rejected any general proposition to the effect that anything that is nothing but a service can be artificially converted into or treated as a sale merely by the insertion of an omnibus clause in a state-level taxing statute. To accept this argument, one would have to accept that the State Legislature can encroach upon the legislative powers of the Union in respect of items in the Union List simply by inserting such amendments that would by some process of fiscal and legal alchemy convert a pure service into a sale. The introduction of the word ‘franchise’ in the amended MVAT Act by way of a notification will have to be read to mean those franchises that can reasonably and plausibly be construed to have the effect of a sale; it cannot be widened to include agreements styled as ‘franchise’ agreements simply because of the nomenclature. Presumably, what the Legislature intended was to include only those franchise agreements that involved a transfer of the right to use or some other aspect of a deemed sale as defined under Article 366(29A) of the Constitution. The Subway’s franchise agreement grants to the franchisee nothing more than mere permissive use of defined intangible rights. It is therefore a service, and is not amenable to VAT .
Accordingly, the High Court disposed both writ petitions.
