Levy of Federal Excise Duty on Franchise Services

Levy of Federal Excise Duty on Franchise Services Automotive Case Laws Commercial Constitutional Law Federal Excise Duty Franchise Government Duties Knowledge - Constitutional Law Lahore High Court Litigation & Arbitration Solutions - Constitutional Law Tax Mrs. Justice Ayesha A. Malik in her judgment has decided the issue regarding levy of federal excise duty on franchise services in Writ Petition No. 9491 of 2006.

1. Through this petition, the Petitioner has challenged the levy of federal excise duty on the Petitioner for the franchise services provided to the Petitioner under its License and Technical Assistance Agreement dated 01.04.1994 between the Petitioner and Honda Japan.

2. Briefly the facts of the case are that the Petitioner is engaged in the business of manufacture and sale of Honda automobiles. The Petitioner entered into a License and Technical Assistance Agreement (“Agreement”) with Honda Motor Company Japan, a corporation registered under the laws of Japan, with its principal office in Tokyo Japan. In terms of the Agreement, the Petitioner has been granted a license to assemble, manufacture and sell automobiles using the Honda patent. The Petitioner also receives technical assistance to use the Honda patent to manufacture and sell Honda automobiles in Pakistan. The Respondents have levied federal excise duty under the Federal Excise Act, 2005 (“Act”) on the franchise services received by the Petitioner under the Agreement. The Petitioner is aggrieved by this levy, hence this Petition.

3. Learned counsel for the Petitioner argued that the Petitioner does not receive any franchise services under the Agreement, hence is not liable to tax under the Act. Learned counsel explained that “franchise” is defined under Section 2 (12a) of the Act whereas “services” is defined under Section 2 (23) of the Act. He argued that in terms of the definition of the two words, the Petitioner does not receive any franchise service which can be taxed under the Act. He argued that there is a contractual arrangement with Honda Japan whereby the Petitioner has been granted a license to assemble and sell Honda automobiles using the Honda patent and its Know How. He argued that in terms of Section 3 (1) (d) of the Act no services are being provided to the Petitioner by Honda Japan which are subject to the levy of Federal Excise Duty. It is the case of the Petitioner that the use of a patent under the Agreement is not a service but is use of a movable property which cannot be called a service. He argued that Honda Japan is the owner of the patent and merely shares its technical knowledge so as to protect its patent and ensure standardization of its product. Further argued that the Agreement is not an agreement for services but in fact is an agreement for permission to use the patent of Honda Japan which is not a taxable service. Hence, the levy of federal excise duty on the so called services provided by Honda Japan to the Petitioner is ultra vires to the Constitution, the Excise Rules and General Order No.4. Reliance has been placed on Dr. M.B Ankalsaria v Commissioner of Wealth Tax, Karachi (1992 SCMR 1755), Diamond Food Industries Limited v Joseph Wolf GmbH & Co. and another (2004 CLD 343) and Amin Textile and others v. Federation of Pakistan and others (2002 CLC 1714)

4. On behalf of the Respondents it was argued that under the Agreement, the Petitioner is provided franchise services which are subject to federal excise duty under Section 3 of the Act. It is their case that the relationship between Honda Japan and the Petitioner is such that the Petitioner is allowed to use the patents, design and other proprietary rights of Honda Japan to manufacture and sell Honda automobiles in Pakistan. Under the Agreement, Honda Japan provides the Petitioner all its secret technical information, its Know How, data, formulae including designs, drawings, standards, specifications, technical record, manuals, material lists and direction maps. The grant of this technical assistance is a service for the purposes of the Act and without this service the Petitioner cannot manufacture Honda automobiles in Pakistan. Further argued that furnishing of all technical assistance and Know How is a service which is subject to the tax. He argued that it is not movable property of the business of the Petitioner as Honda Japan’s provision of technical Know How and assistance to the Petitioner is a service which enables the Petitioner to manufacture, assemble and sell vehicles.

5. Heard and record perused.

6. The Petitioner has challenged the levy of federal excise duty on the franchise services provided under the Agreement on the ground that it does not receive franchise services from Honda Japan. Section 3 (1)(d) of the Act levies federal excise duty on services provided in Pakistan, including services which originate outside of Pakistan but provided in Pakistan. Franchise services are provided in Table II of the First Schedule of the Act as item No.11. Franchise is defined in Section 2 (12a) of the Act as follows:

“Franchise” means an authority given by a franchiser under which the franchisee is contractually or otherwise granted any right to produce, manufacture, sell or trade in or do any other business activity in respect of goods or to provide service or to undertake any process identified with franchiser against a fee or consideration including royalty or technical fee, whether or not a trade mark, service mark, trade name, logo, brand name or any such representation or symbol, as the case may be, is involved.”

Services have been defined in Section 2 (23) of the Act as follows:

“Services” means services, facilities and utilities leviable to excise duty under this Act or as specified in the First Schedule read with Chapter 98 of the Pakistan Customs Tariff, including the services, facilities and utilities originating from Pakistan or its tariff area or terminating in Pakistan or its tariff area.”

The Respondents FBR then issued General Order No.4/2006 which provided the manner in which assessable value of the franchise services could be determined for levy of excise duty on the franchise fee or technical fee or on royalty. In terms of the definition given the word “franchise services” means the services facilities and utilities provided in the First Schedule. Franchise is the right to produce, manufacture, sell or deal in any product or business or service for a fee or consideration including a technical fee or royalty. Therefore, a franchise agreement will grant the franchisee the right to operate its business in the name and style of the franchisor’s business. So in essence it is a way to do business. A franchise agreement allows the franchisee the right to use the mark or patent of a franchisor for a royalty or fee. The franchisee must ensure that the goods or services maintain the uniformity and standard of the franchisor’s goods or services. The franchisor provides the technical assistance and the Know How to protect its mark or patent so as to ensure uniformity in quality. Therefore, a franchisor shares its business model with all relevant details so that the franchisee can use the patent, logo or mark of the franchisor and maintain the standard, style, quality and look of the product or services provided, as if it is given by the franchisor itself. The franchisor must grant the franchisee the right to use its patent or mark or logo, that is its intellectual property, to the extent necessary to operate the franchisee business. In addition to this the franchisor also provides the assistance and Know How in support of the business and helps to solve problems along the way. Therefore, franchising is a business relationship between the parties where the franchisor services and facilitates the business of the franchisee within defined parameters.

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