CESTAT Chandigarh Sets Aside Service Tax Demand on Franchise Allegation and Vague SCN

Background of the Dispute

M/s Aircom International (India) Pvt. Ltd. filed an appeal before CESTAT Chandigarh challenging the Order-in-Original dated 04.07.2013 passed by Commissioner (Adjudication), Service Tax, New Delhi.

The assessee was engaged in multiple service segments, including:

  • Consulting Engineer services
  • Maintenance or Repair
  • Commercial Training and Coaching
  • Software Development
  • Product Deployment

In the course of its business, the assessee made payments to its U.K. parent entity, M/s Aircom International, U.K., under various heads such as:

  • Licence fee for software
  • Support and maintenance charges
  • Training fee
  • Management fee
  • Out-of-pocket expenses
  • Salary and wages
  • Consultancy charges
  • Repair and maintenance charges

Following investigation based on risk profiling, the Department alleged that the assessee had not discharged service tax under Reverse Charge Mechanism on several categories, including Franchise Service, Maintenance or Repair, Training and Coaching, and other allied services. It was also alleged that the assessee wrongly availed CENVAT credit of Rs.3,90,743/- on invoices addressed to premises that were not registered.

Two Show Cause Notices (SCNs) were issued:

  1. SCN dated 15.10.2009 – covering FY 2003-04 to 2007-08

    • Proposed service tax demand of Rs.1,16,53,293/-
    • Proposed disallowance of CENVAT credit of Rs.3,90,743/-

  2. SCN dated 24.02.2010 – covering FY 2008-09

    • Proposed service tax demand of Rs.2,81,94,672/-

The impugned Order-in-Original confirmed the demands and appropriated Rs.72,34,265/- and Rs.3,90,743/- already paid by the assessee.

The assessee challenged both (a) the classification of services—particularly the tagging of payments as Franchise Service—and (b) the validity and clarity of the SCN dated 22.04.2010.

Assessee’s Arrangements with Parent Company

Under the licence agreement with M/s Aircom International, U.K.:

  • The U.K. entity granted a licence to the assessee to use its software.
  • The assessee supplied the licensed software to Indian customers, often with customization.
  • The assessee provided ongoing support, maintenance and technical assistance to customers in India.
  • Under the revenue-sharing model:
    • 45% of gross receipts from software and related support were remitted to the U.K. parent.
    • In certain cases, 20% of training revenue was also payable to the parent.
  • According to the assessee, these payments were essentially towards purchase/licensing of software and embedded support, and not consideration for Franchise Service.

The Department treated the licence fee and associated remittances as consideration for “Franchise Service” received from the parent company, taxable under Reverse Charge Mechanism.

Department’s Stand on Franchise Classification

Relying heavily on the agreement dated 01.04.2005, the adjudicating authority concluded:

  • The U.K. entity allegedly granted representational rights to the assessee, including:
    • Right to sell the software
    • Right to use trade mark, service mark, trade name and logo
  • The parent supposedly provided:
    • Business concepts and methods of operation
    • Managerial know-how and training
  • 45% of software sale value and 20% of certain training revenues were payable to the parent.
  • On this basis, the Commissioner held that all conditions of “franchise” were fulfilled and that the licence fee shown in the balance sheet represented consideration for Franchise Service.

Tribunal’s Analysis of the Franchise Allegation

The Tribunal examined both the earlier and the later contractual arrangements, particularly the Contract dated 23 October 2008. Clause 19.1 of this contract was crucial. It stated that:

the parties were entering into the agreement as independent parties and that neither party would be construed as the legal representative of the other, unless expressly stated otherwise.

From this clause and the overall contractual framework, CESTAT drew the following conclusions:

  1. No Representational Capacity

    • The assessee could not be regarded as a representative of Aircom International Company, U.K.
    • There was no clear grant of “representational right” to the assessee to act in the capacity of the parent.

  2. Independent Business Identity

    • The assessee had independent dealings with Indian customers under its own contracts.
    • Merely being a licensee/distributor of software did not transform the assessee into a franchisee.

  3. Definition of Franchise/Franchisee Under Finance Act, 1994

    CESTAT referred to the definition of “Franchise” and “franchisee” under Section 65(47) of the Finance Act, 1994, both prior to and after 16.06.2005. The essence of the Tribunal’s reading was:

    • For a relationship to qualify as Franchise, the assessee must be granted a representational right to sell, manufacture or provide services identified with the franchisor.
    • Additionally, there is usually an element of the franchisor exercising significant control over the franchisee’s operations.

  4. Reliance on Reckitt Benckiser (India) Ltd.

    The Tribunal placed reliance on its earlier decision in Rackitt Benckiser (India) Ltd. Vs. Commr. Of C. Ex. & S.T., Panchkula – 2021 (46) G.S.T.L. 41 (Tri. – Chan.). In that case, it was held that: