Whether when franchisees conduct learning classes as per agreement with assessee, payment made in this regard is covered by the provisions of Sec 194C - NO, rules Delhi HC

THE issues before the Bench is - Whether when franchisees conduct learning classes as per agreement with assessee, payment made in this regard is covered by the provisions of Sec 194C and whether in the case of a contract for the carrying out of any work as is envisaged by Section 194C, there cannot be any use of a person’s trade name or goodwill or knowhow by the other. And the answers go against the Revenue.

Facts of the case

Applicability of TDS on payment made by assessee to its franchisees u/s 194C - The assessee provides its services across the country through education centres run by the assessee itself or by its franchisees. While completing the assessment, the AO noted that the assessee had debited a sum of Rs.6,38,64,018/- to the profit and loss account as payment made to franchisees. On a perusal of the agreement between the assessee and one of its franchisees, which was apparently taken as a specimen agreement, the AO took the view that the payment made by the assessee came within the provisions of Section 194(C) of the Act as a payment made for carrying out a work in pursuance of a contract and accordingly the assessee ought to have deducted tax from the payment at the applicable rates. He further took the view that since the assessee failed to deduct the tax as contemplated by Section 194C, the amount cannot be allowed as a deduction in view of the embargo placed by Section 40(a)(ia).
2009-TIOL-533-HC-DEL-IT). The Tribunal agreed with the assessee’s contention that the payment was not made by the assessee to the licensee/franchisee for any work and therefore neither Section 194C nor Section 40(a)(ia) was applicable. The AO was accordingly, directed to allow the payments.

On cross appeals by the assessee and the Revenue, the High Court held that,

The assessee’s submission was that the agreement was not a pure and simple agreement for carrying out any work within the meaning of Section 194C, that it was an agreement for permitting the payee to utilize the name and copyright of the assessee in the study material and in running the coaching centres, that there were mutual rights, duties and obligations envisaged by the agreement, that a holistic appraisal of the agreement would show that it is a business arrangement and contemplates a sharing of the profits from the business between the assessee and the franchisee, that the franchisee was neither a contractor nor a sub-contractor for carrying out any work for the assessee and that in these circumstances the assessee was not responsible for deducting any tax u/s 194C. It was therefore submitted that the Section 40(a)(ia) was not applicable and the payment should be allowed as a deduction in computing the business income of the assessee.

The submissions were not accepted by the AO. He held that the words “any work” appearing in section 194C were defined in an inclusive manner. He opined that the agreement entered into between the assessee and the franchisee was a contract enforceable in law and it is in the nature of a service contract. According to the AO, the assessee and the franchisee cannot be said to be partners in any business. He also relied on the Clause in the agreement that the entire fees were collected from the students by the franchisee and deposited in the bank account of the assessee, which militated against the claim of the assessee that the arrangement was a composite arrangement providing for mutual duties and obligations. He also negatived the assessee’s claim that the parties to the agreement were not acting as agents for each other. According to him the franchisee was acting on behalf of the assessee as he was using the trade name of the assessee for providing education to the students. For these reasons, the AO held that Section 194C read with 40(a)(ia) applied. He accordingly, disallowed the payment of Rs.6,38,64,018/-. For the same reasons he disallowed the payment made by the assessee in the AY 2006-07.

The CIT(Appeals) dismissed the assessee’s appeals. The Tribunal, after noting the various clauses of the agreement, held that the tenor and purport of the various terms of the agreement were that it was not a case where the licensee was doing any work for the assessee even within the wider meaning of the term “any work” as defined in Section 194C or the meaning of the word “work” as understood in common parlance. According to the Tribunal it was only a case of the assessee running a study centre through various licensees or franchisees and sharing the profits with them. It opined that the agreement has to be read as a whole and on doing so it became clear that the agreement is not for making any payment to the licensee for any work done for the assessee and that it was a case of sharing of fees for carrying out respective obligations under a contract. In coming to this conclusion the Tribunal referred to the judgment of this Court in CIT v NIIT Limited (

++ the assessee is undoubtedly in the business of imparting coaching or learning for the purpose of competitive examinations such as those conducted by the IIT, IIM etc. It has developed expertise in the same which has fructified into some kind of a knowhow or a trademark or trade name or reputation. It is noteworthy that the income declared by the assessee was Rs.4,80,26,060/- for the AY 2005-06 and Rs.6,84,27,841/- for the AY 2006-07. The income declared by the assessee itself is an indication of its success and popularity in the field. It is not therefore surprising that others wanted to associate themselves with the assessee’s business. It is equally understandable that the assessee was willing to enter into some arrangements with such persons so that the learning centres, as they are called in the agreement, can be opened in several places of the country with the blessings or association of assessee for the mutual benefit of all the parties concerned. Such arrangements are not uncommon in the business world which is a well known fact. These are loosely called “franchisee agreement”. In the agreement entered into by the assessee in the preset case, the words “licensor” and “licensee” are used respectively to denote the assessee and the franchisee, who has associated itself with the assessee’s success story and has opened learning centres using the trade name of the assessee. The substance of the agreement however, is that it is a business arrangement under which both parties hope to benefit. It would be myopic to view the agreement divorced from the nature of the assessee’s activities and the business realities;

++ on a careful consideration of the issue, it would not be possible to view the agreement as a contract for carrying out any work by the franchisee. The terms of contract show that the arrangement consists of mutual obligations and rights. It is not a simple case of an agreement under which a person is engaged to carry out any work for the other. The essence of the contract appears to be one under which the trade name or reputation or knowhow belonging to the assessee in the business of running learning centres, where students are coached for writing competitive examinations, is permitted to be made use of by the franchisees in different places for a monetary consideration. In the case of a contract for the carrying out of any work as is envisaged by Section 194C, there cannot be any use of a person’s trade name or goodwill or knowhow by the other. The contract envisaged by the Section would be one under which one person merely renders certain services to the other person for consideration. It is no doubt true that the word “work” has been defined in a broad and inclusive manner in the Section. Nevertheless its essential feature remains the same namely that it should be a work carried out by one person for another. The terms of the contract between the assessee and its franchisees in the case before us do not satisfy this condition. The income tax authorities have erroneously interpreted the contract as one for carrying out a work by the franchisee for the assessee. It is not a simple case of the assessee engaging certain other person to conduct the learning centres for which they were to be paid. The agreement is much more complex and reflects a business arrangement, as opposed to a simple contract for carrying out a work. The agreement provides for the supervision and control by the assessee of the manner in which the learning centres are conducted by the franchisees. The records and books of account as also the premises from which the learning centres are carried on are subject to inspection and audit by the assessee. The materials for the learning centres are to be supplied by the assessee for which separate charges are to be paid by the franchisee. It is essentially a case of the assessee permitting its goodwill/knowhow/trade name to be utilized by the franchisees;

++ in consideration of the assessee permitting the use of its trade name by the franchisees for the purpose of running the learning centres, the franchisee/licensee is obliged to pay recurring franchise fees to the licensor at 25% of the net revenue which means gross revenue and the service tax as applicable. This is in addition to the non-refundable deposit to be made by the licensee with the assessee. The fees are to be collected by the licensees/franchisees from the students for and on behalf of the assessee. Strict control is exercised by the assessee over the collection and deposit of the fees. The licensee is bound to deposit the collections received on a particular day directly into the licensor’s bank account on that day itself. Any collections made after the banking hours shall be deposited at the commencement of the banking hours on the following working day for the bank. The licensee is to issue receipts on behalf of the licensor. The clause has been incorporated into the agreement only as a measure of exercising control over the collections made by the licensees and it does not in any manner discredit the claim of the assessee that the contract is not one for carrying out any work. Both the parties-the assessee and the licensees-have entered into this arrangement only in their mutual interest and for mutual gains. It is a simple case of the assessee permitting the use of its trade name or reputation by the licensees for a consideration. There are several other clauses in the contract which have been incorporated in the interest of both the parties to the contract. They ensure proper compliance of the arrangement and the mutual rights and obligations. These clauses have been included only to protect the interest of both the sides and to ensure smooth functioning of the business arrangement;

++ the income tax authorities have not been able to show clearly how the contract between the assessee and the franchisees can be interpreted to be one for carrying out any work by the licensees. They have failed to appreciate that merely because some work is to be carried out by the licensees in conducting the learning centres it cannot be said that the agreement embodies a contract for carrying out a work;

++ a perusal of the extended definition of the word “work” given in clause (iv) of the Explanation below section 194C shows that it covers a simple case of engaging a person to render services of the kind mentioned in the definition. Otherwise every composite transaction which also has an element of work will be covered. Clause (e) is illustrative that this is not the intention of the legislature. A case of an arrangement under which both sides have joined together by mutual arrangement and to share the profits of the joint enterprise carried on by them is not covered by the definition. They mutually undertake the profit making activity with a stipulation to divide the gains of their collective efforts. The work is undertaken jointly by them for third parties who pay consideration which is shared. Parties do not work for each other. Therefore, the mere fact that the definition of the word “work” is an extended or inclusive definition does not automatically justify the conclusion of the income tax authorities that the activities carried on by the licencees of the assessee in running learning centres amount to the carrying out of any work for the assessee in pursuance of the contract;

++ For the above reasons, it is held that the conclusion arrived at by the Tribunal cannot be disturbed. The Tribunal was right in law in holding that the provisions of Section 194C and section 40(a)(ia) are not applicable to the facts of the case.