Composite arrangement under franchises agreement not liable for TDS as rent

A recent ruling of the Delhi High Court (HC) in the case of CIT v NIIT Ltd. (Taxpayer) [2009-TIOL-533-HC-DEL-IT], on the issue of whether the amount paid by the Taxpayer to the franchisees, pursuant to a franchises agreement (Agreement), can be considered in the nature of rent, for the purpose of tax deduction at source (TDS) under the Indian Tax Law (ITL). The HC held that the Agreement, when read as a whole, indicated that the main intention of the parties to the Agreement, was to carry on the business and share the revenues therefrom and not to let out the premises and infrastructure therein, in isolation. Hence, the payments made cannot be considered in the nature of rent and are not liable for TDS.


Facts of the case


·                                 The Taxpayer is engaged in the business of providing computer education and training, through its own centers and through franchisees.
·                                 The Taxpayer granted limited license to the franchisees for use of its trademark and trade name for the education center. The license was granted for a specified territory with a right to operate the education center, in relation to marketing courses offered by the Taxpayer.
·                                 As per the Agreement with the Taxpayer, the franchisees were providing these courses under the Taxpayer’s license. The franchisees were in charge of bringing together resources such as classroom facilities, equipment, furniture, fixtures, administrative set-up etc., for the purpose of providing computer education and training. The franchisees were responsible for the day-to-day operation and management of the education center, including marketing the course, admitting the students, conducting the classes and performing all other administrative functions relating to the education center. 
·                                 The Taxpayer, as owner of technical information, was to provide the franchisees the relevant courseware and expertise in providing computer education.
·                                 The education center was to run under the Taxpayer’s brand name.
·                                 The Taxpayer and the franchisees agreed to share revenues, based on the number of students enrolled. The Taxpayer collected fees from the students enrolled by the franchisees and shared the same with them.
·                                 The payment of the franchisees’ share was linked to performance-based milestones. For the sake of convenience, the payments were broken into marketing and infrastructure claim.
·                                 For the relevant assessment year, the Taxpayer made payments to the franchisees, without withholding tax. The Tax Authority treated the payments made for infrastructure claims, in the nature of rent for use of assets and infrastructure, which is liable for TDS under the ITL.
·                                 The second appellate authority held that the broad objective of the Agreement was to share the revenue and was not in the nature of hiring of premises and infrastructure thereof and, hence, not liable for TDS. Aggrieved by this, the Tax Authority preferred an appeal before the HC.
Contentions of the Tax Authority


·                                 The Agreement provides for payments made for infrastructure claims, which is in the nature of rent to be liable for TDS under the ITL
·                                  As per the ITL, the definition of rent is wide enough to cover within its ambit any charges paid towards the use of any land, building, furniture etc., either separately or together.
·                                 The relationship between the Taxpayer and the franchisees was in the nature of lessor–lessee.
Contentions of the Taxpayer


·                                 The transaction was in the nature of a partnership, where the parties to an agreement bring in their own contributions and the revenue is shared between them.
·                                 The intention of the parties was to be drawn from the agreement and be inferred accordingly, unless the agreement was a colorable device.
Ruling of the HC


·                                 The HC, affirming the second appellate authority’s ruling, held that the payments made to the franchisees, in the nature of infrastructure claims, cannot be construed as rent under the ITL and, hence, were not liable to TDS.
·                                 The Agreement was a franchises agreement and not a rent arrangement. The relationship between the Taxpayer and the franchisees was not that of a lessor and lessee.
·                                 The agreement is to be read as a whole and cannot be broken up into different components, when the parties to the agreement intend it to be composite.
·                                 The dominant intention and the broad objective of the Taxpayer and the franchisees were to conduct the business and share the revenue therefrom and not to merely hire the premises and infrastructure thereof.
·                                 The revenue shared between the Taxpayer and the franchisees was not a fixed amount but was variable, as it was based on the fees received from the students. No minimum guarantee amount was fixed to be paid to the franchisees by the Taxpayer
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