Khaitan & Co. scores victory for Subway in Maharashtra VAT claim over franchise agreements

In a judgment delivered last week, the Bombay High Court’s SC Dharmadhikari and GS Patel JJ held that the Maharashtra government had incorrectly claimed sales tax over transactions covered under the franchise agreements involving Subway restaurants in India. .These franchise agreements not only cover the use of the “Subway” trademark but also goodwill and confidential information such as recipes etc. As the High Court’s judgment notes,.“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 2003, Subway had been charged service tax on the consideration it received with respect to the franchise agreements. However, from November of 2014 onwards, the government claimed that Subway was in fact liable to pay sales tax on the same. The revenue department, represented by special counsel VA Sonpal, would argue that both, “trademarks” and “franchise” agreements were covered as goods under the Maharashtra Value Added Tax Act since 2005..Rejecting this contention, the Bombay High Court held that, .“The agreement between Subway and its franchisees is not a sale, but is in fact a bare permission to use. It is, therefore, subject only to service tax. In our opinion, 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.”.However, the court also clarified that,.“We do not mean to suggest that 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).….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.”.Subway Systems, which challenged the imposition of sales tax, was represented by senior counsel DB Shroff, briefed by Khaitan & Co. The Khaitan team consisted of Nihal Kothari, Hormaz Daruwalla and Prajakta Menezes..As per a Khaitan press release,.“This landmark judgment has laid down principles for making distinction between a “permissive use’ and “transfer of right to use”. This judgment will provide much needed relief not only to Subway but also to other similar arrangements which are currently facing double taxation under service tax as well as VAT.”.The judgement was passed in a batch of two petitions that had been tagged together. The other petition, which did not succeed, involved a tax dispute involving Mahyco Monsanato. The company was represented by senior counsel N Venkatraman, who was briefed by PDS Legal. The PDS team included Arun Jain, Jas Sanghvi and Shilpi Jain..Read the complete text of the judgment below.