Privatisation Of Airports: Whether A Franchise Service By Airport Authority?

Introduction:

Under selective approach of service tax litigation often
centered around whether a given transaction was one of service apart from the
issue of appropriate classification entry. When the said issue requires
determination based on terms of contract, the importance of reading the terms
of contract as a whole hardly requires any debate. A recent decision covering
this aspect is analysed below:

Facts in brief

In a recently decided set of writ petitions, a division bench
of Hon. Delhi High Court in the case of Delhi International Airport P. Ltd.
vs. UOI 2017 (50) STR 275 (Del) had to examine whether privatisation of
airports done by Airports Authority of India (AAI) under long term Operations,
Management and Development Agreements (OMDA for short) entered into with
consortium led by GMR group and GVK group for Delhi and Mumbai airports
respectively was an arrangement of franchise service. In this case, the dispute
arose when the revenue claimed that upfront fee and an annual fee received by
AAI from the petitioners, Delhi International Airport P. Ltd. (DIAL) and Mumbai
International Airport P. Ltd. (MIAL) was liable for service tax as franchise
service. Under OMDA, DIAL and MIAL undertook the task to design, construct,
operate, upgrade, modernize, finance, manage and develop the respective
airports and in lieu of which AAI granted them various rights interalia,
long term rights to provide aeronautical and non-aeronautical services to
various consumers for a charge. As per the said OMDA, DIAL and MIAL had to pay
an upfront fee as well as revenue share termed as annual fee to AAI. Consequent
upon OMDA, AAI simultaneously leased out all the land along with buildings,
constructions or immovable assets to the petitioners under separate lease deeds
with each petitioner. AAI informed the petitioners post Finance Act, 2007 that
annual fee payable under OMDA was liable for service tax under the
classification entry renting of immovable property service, the annual fee
being consideration for the leasing of immovable property. However, according
to DIAL and MIAL, they had entered into OMDA primarily for grant of various
rights for better operation and management of airports whereas the lease deeds
were separately entered into and only consequent upon OMDA and therefore no
service tax could be paid by them to AAI over and above the amount paid as annual
fee. AAI therefore instructed escrow bankers of the petitioners to block an
amount equivalent to service tax chargeable on the said annual fee. According
to the petitioners, AAI did not render any service to them and annual fee
payable was under OMDA towards grant of rights to develop, finance, operate,
manage and modernize airports. If at all service tax was chargeable on the
annual fee, it would be the liability of AAI from their own revenue share.
Though no notice was issued to DIAL and MIAL, aggrieved by the order of
adjudication passed against AAI wherein liability of service tax was confirmed
under franchise service, DIAL and MIAL filed writ petitions in the High Court
of Delhi.

Case of petitioners, DIAL and MIAL

As per petitioners, upfront fee and annual fees were paid to
AAI as revenue share and not as consideration for any service. OMDA was not a
franchise agreement but a statutory divestation of right in favour of DIAL and
MIAL respectively to build, operate and maintain the airports. Further, both
DIAL and MIAL are joint venture companies wherein AAI itself holds 26% shares.
Also, since there was complete divestation of rights, it could never be a
considered franchise. Both the petitioner companies had to invest their own
funds to build, operate and maintain the airports and consequently get right to
charge various customers for availability of services liable under service tax
as “airport service” and they paid service tax on this service. They ran their
own operation and did not act as franchisee of AAI. They had to pay AAI
specified percentage of gross revenue termed as “annual fee” in addition to an
upfront fee of Rs.150 crore by each DIAL and MIAL. Thus annual fee was not a
consideration for any service but an appropriation of revenue by AAI before
petitioners received any part of the revenue. In order to be attracted under
service tax, the franchisee should be granted representational right and they
did not perform the activity on behalf of AAI. Alternatively if at all service
tax was payable, it would have to be paid by AAI.

Case of AAI

AAI also contended that there was no franchise agreement in
place and factually DIAL and/or MIAL never claimed that they represented AAI.
The arrangement only allowed private parties to do an activity of profit under
the rights granted by the State. Since the revenue’s case was to bring OMDA
under franchise service, there was no question of examining whether the
arrangement could be construed renting of immovable property as defined u/s.
65(90)(a) of the Finance Act, 1994 (the Act). In response to petitioner’s
contention that if any service tax liability was to be fastened, it would be
that of AAI, they contended that it was a contractual dispute and writ petition
in respect thereof would not be maintainable and more so when there was an
arbitration clause formed part of the contract.

Case of Revenue

Revenue in turn had a case that writ was primarily not
maintainable since alternate remedy was available by filing an appeal with
CESTAT. Further, on merits OMDA reflected relationship between the parties
which squarely falls within the term ‘franchise’ as used in service tax law and
since the term “representational right“ is not given specific meaning in the
Finance Act, 1994 it should be understood in common parlance meaning. OMDA had
various elements of franchise agreement wherein although responsibility of
operating, maintenance and development was with the petitioners, strict
standards were prescribed for performance and the control was retained by the
franchisor. The functions of AAI are so unique that even without any use of
logo or trademark, the function of airport operation remains identifiable with
AAI. Further, on assuming that the transaction between the parties is of lease
of immovable property for carrying out specific purpose, it actually led to
value addition. In such a case, it would be exigible to service tax. The term
‘service’ therefore must be construed in broad sense. In the case where AAI
entered into a franchise agreement for operation, development and maintenance
of airports, there is a significant amount of value addition to the overall
services offered at the airports. Therefore also service tax was attracted on
the annual fees.

Analysis

The Hon. High Court limited its examination to whether or not
upfront fee and annual fee were exigible to service tax under the
classification of franchise service and not renting of immovable property
service since the revenue so contended. Thus, for OMDA to be construed a
franchise, it would have to satisfy requirement of section 65(47) of the Act as
reproduced below:

“Franchise means an agreement by which the franchisee is
granted representational right to sell or manufacture goods or to provide
service or undertake any process identified with franchisor, whether or not a
trade mark, service mark trade name or logo or any such symbol as the case may
be, is involved.”

The above interalia requires that ‘DIAL’ and ‘MIAL’
should have been granted representational right by AAI. The said right would
envisage the franchisee to represent as franchisor and the franchisee could
lose its individual identify. For this, the Court perused in detail certain
relevant clauses of OMDA to ascertain as to what kind of operational rights
were granted by AAI and whether AAI provided any service to DIAL and MIAL.
Reading OMDA as a whole, the Court essentially found as follows:

At the end of the transition phase, the petitioners had to
operate and maintain airports independently and to employ in a phased manner,
increasing number of senior management personnel during transition period so
that at the end of the said period, no employees would continue at the airport.
Joint Ventures were in fact entered into so that functions of AAI under
Airports Authority of India Act could be effectively carried out with AAI to
have 26% stake in the said joint ventures. Petitioners had to prepare a master
plan of development for over 20 year time frame. Petitioners were also given
right to sub-lease or license any part of the airport site to third parties for
the purpose of fulfillment of their obligation under the OMDA. Petitioners
spent their own money for the design, development, construction and
modernisation etc. of the airports. Operation, maintenance and
development is carried out by them in their own right. They have “exclusive
right and authority” to undertake various listed functions and to provide
aeronautical and non-aeronautical services at the airports. Thus it is clear
that the petitioners did not undertake any process identified with AAI. The
sole responsibility is theirs and they perform their operation using their own
policies, techniques and processes. Once the functions of AAI are completely
divested and assigned to petitioners, there does not remain any representation
of AAI by the petitioners. There is no representation right assigned to the
petitioners under OMDA. Annual fee was paid to AAI not because any service was
provided by AAI to petitioners. For the transaction to be taxable there should
be a service provided by AAI to the petitioners. What AAI has done is
entrusting petitioners with some of its functions under the Airports Authority
of India Act. Therefore OMDA does not constitute franchise service.

The Court however left open the issue raised by DIAL and MIAL that
the annual fee was inclusive of service tax or whether the said issue was a
contractual dispute. However, the action of AAI to block the escrow account was
found unsustainable as the categorical stand of revenue was to treat the
transaction as exigible to service tax under franchise service alone.

Conclusion