M/S Ace Calderys Ltd vs Cst, Bhopal

(Arising out Order-in-Original No. 5 & 28-29/COMMR/ST/ADJ/JBP/2010 dated 26.8.2010 & 29.12.2011 passed by the Commissioner, Customs, Central Excise & Service Tax, Bhopal)

For Approval & Signature :

Honble Mr. Justice G. Raghuram, President

Honble Mr. R.K. Singh, Member (Technical)

1. Whether Press Reporter may be allowed to see the Order for publication as per Rule 27 of the CESTAT (Procedure) Rules, 1982?

2. Whether it would be released under Rule 27 of the CESTAT (Procedure) Rules, 1982 for publication in any authoritative report or not?

3. Whether their Lordships wish to see the fair copy of the order?

4. Whether order is to be circulated to the Department Authorities?

M/s Ace Calderys Ltd. Appellant

Vs.

CST, Bhopal Respondent

Appearance:

Shri Balbir Singh, Sr. Advocate - for the Appellant

Shri Abhisek Singhal, Advocate

Shri Rajeev Tandan, D.R. - for the Respondent

Coram : Honble Mr. Justice G. Raghuram, President

Honble Mr. R.K. Singh, Member (Technical)

F. Order No.52833-52834/2015

Per R.K. Singh:

Appeal is filed against order in original dated 26/08/2010 in terms of which service tax demand of Rs. 4,65,42,505/- was confirmed along with interest and penalties.

2. The facts of the case are as under

The appellant is engaged in the manufacture of branded alumina firebricks and other refractory material. Besides manufacturing the said goods in its own factory, the appellant, it is alleged, granted franchise for manufacture of firebricks of specifications, design and quality prescribed by it to some other small manufacturing units located at Katni. During the period of the demand, as per the figure submitted by the appellant, it was seen that there was a difference between the amount realised on account of sales of the products to its customers and the purchase price actually paid by the appellant to these manufacturing units which manufactured the goods. The adjudicating authority held that this difference reflected the value of the franchise service and confirmed the demand of Rs. 4,65,42,505/- under franchise service along with interest and penalties.

3. The appellant has contended that:

(a) The agreements with various manufacturing units to manufacture the said products on its behalf as per the specifications, designs and quality as directed by it were entered into several years before franchise service became taxable and that while the word franchise or franchisee have been used in the agreement, in substance it is not a franchise agreement and there was no franchise fee prescribed therein,

(b) As per the agreement it gave orders for manufacture (and supply) of firebricks to these manufacturing units which manufactured firebricks as per the specification, design, quality directed by it and consigned them to its customers as per its directions,

(c) The firebricks were manufactured as ordered by it and were consigned to the customers as per its directions but those were solely purchased by it. The manufacturers paid excise duty on the value at which it sold those bricks to its customers. In the invoices issued by these manufacturers, it (appellant) was shown as the buyer and the customers were shown as consignees.

(d) The manufacturers (so called franchisees) were not paying any predetermined amount to the appellant as franchise fee and these so called franchisees were nothing but mere manufacturers who were manufacturing goods on its direction and the goods so manufactured were the property of the appellant and were dispatched as per its direction and the so called franchisees had no right over these goods.

(e) It did not provide any concept of business operations such as know-how, method of operation, managerial expertise, marketing technique, standards of quality control etc to these manufacturers.

(f) The appellant paid the manufacturers as per the agreed purchase rates/terms and conditions of the purchase order and in its books of accounts the amounts paid to these manufacturers is accounted as purchase cost of products and the sale value based on the commercial bills raised on its customers is recorded as value realised on sales. It was issuing sales tax declaration forms for such purchases from these manufacturers and it was also getting sales tax declaration forms from its customers.

(g) The realisation for sales were done by it directly from the customers. The difference between the amount of excise invoice on which the taxes and duties were paid and the purchase price paid to these manufacturer as per the purchase order was termed as incremental/opportunity costs and it did not represent any service charges and the prices mentioned in the manufacturers invoices to it did not represent the sale price but the price only for the purpose of calculating excise duty and sales tax. The manufacturers were only paid the purchase rates as agreed upon.

(h) The sales tax was paid on the entire value and therefore service tax could not be levied on the same amount as has been held by Supreme Court in the case of Bharat Sanchar Nigam Ltd Vs. Union of India - 2006 (2) ST STR 161 (SC),

(I) It did not grant to the manufacturers the right to use its brand-name and these manufacturers were not free to sell the goods got manufactured by it to anybody else except to the appellant and these manufacturers were not allowed to consign these goods to any other person except to those they were directed by it to consign them to.

(j) The manufacturers were selling the manufactured goods to the appellant for which the manufacturers raised invoices on the appellant. In the said invoices, the appellant was shown as buyer and the customer of the appellant whom the goods were ultimately sold by it was shown as consignee. Thus it was sale of the goods by the manufacturers to the appellant for which payment of sale proceed was made by the appellant to the manufacturers. The appellant thereafter raised sale bills on its buyer-customers to whom the goods were consigned and it received payment directly from the customers. In these transactions, there was neither any payment on account of any franchise fees nor of any commission. Whenever manufacturers cleared the goods consigned to its customers, they customers, it paid excise duty on full value of the goods which included the trading profit of the appellant. Once excise duty was paid on this amount, no service tax could be levied on the same amount.

(k) The difference between the amount charged by the manufacturers from the appellant in respect of the goods manufactured by them and the value at which the goods are finally sold by the appellant to its customers was nothing but trading profit of the appellant and does not represent franchise fee.

(l) All the manufacturers have denied the existence of any franchise relationship between them and the appellant.

(m) The demand is time-barred in as much as the 1st interaction in this regard with Revenue took place in 2005 and thus the nature of transactions was in the knowledge of Revenue at least from 2005 onwards and there was no wilful misstatement/suppression on its part. It cited some familiar judgements with regard to invokability of extended period.

(n) Part of the demand is time-barred even on the criteria of (extended) five-year period.

(o) Even if the demand is held to be sustainable, the cum-tax benefit needs to be extended.

(p) The judgement of Skol Breweries Ltd. Vs. CCE, Aurangabad  2014-TIOL-588-CESTAT-Mumbai has decided the issue in its favour.

4. The ld. DR supported the reasoning of the adjudicating authority and added that even the agreement with the manufacturers mentions the words franchise/franchisee. He cited the CESTAT judgement of Delhi Public School Society Vs. CST, Delhi  2013 (32) STR 179 (Tri.-Del.).

5. We have considered the contentions of both sides. The only issue in this case is whether the service, if any, rendered by the appellant to the manufacturers fell under the scope of franchise service. Therefore, it is useful to re-produce the definition of franchisor given in Section 65(48) of the Finance Act, 1994 and franchise defined in Section 65(47) of Finance Act, 1994 as under:

Franchisor means any person who enters into franchise with a franchisee and includes any associate of franchisor or a person designed by franchisor to enter into franchise on this behalf and the terms franchisee shall be construed accordingly.

Franchise means an agreement by which

(i) Franchisee is granted representational right to sell or manufacture good or to provide service or undertake any process identified with franchisor, whether or not a trademark, service mark, trade name or logo or any such of symbol, as the case may be, is involved.

(ii) The franchisor provide concept of business operation to franchisee, including know-how, method of operation, managerial expertise, marketing technique or training and standards of quality control except passing on the ownership of all know-how to franchisee;

(iii) The franchisee is required to pay to the franchisor, directly to indirectly, a fee; and

(iv) The franchisee is under an obligation not to engage in selling or providing similar goods or services kor process, identified with any other person.

The finance Act 2005 has substituted the following definition for expression franchise w.e.f. 16.6.2005.

Franchise means an agreement by which franchisee is granted representational right to sell for manufacture, good or to provide service or undertake any process identified with franchisor, whether or not a trademark, service mark, trade name or logo or any such of symbol, as the case may be, is involved.

A careful perusal of the aforesaid definitions makes it clear that one of the non-derogable conditions to cover any agreement under the scope of franchise is that the franchisee is granted representational right to sell or manufacture goods identified with franchisor.

6. We have perused the representative agreement under which the appellant got the goods manufactured from various manufacturers. The said agreement is reproduced below for the sake of comprehensiveness of the order :

THIS AGREEMENT is entered into between M/s. Associated Cement Companies Limited, Bombay a company incorporated under the Indian Companies Act having its head office at 121 Maharshi Carve Road, Cement House, Bombay and unit called Katni Refractory Works at Katni (M.P.) hereinafter called Party No.1 and M/s. KATNI TILE WORKS, KATNI (MP) a registered partnership firm, through its partner Shri Jashwant Singh Gugalia, Katni hereinafter called the PARTY NO.2 witnesseth :

WHEREAS the Party No.1 is the biggest manufacturers and supplier of firebricks and other refractory products ;

AND WHEREAS Party No.2 M/s. KATNI TILE WORKS, KATNI has agreed to manufacture firebricks on the specifications, design and quality as specified by party no.1 in their purchase orders and has made a request for granting franchise.

AND WHEREAS the party no.1 has agreed to grant franchisee to the party no.2 on specific condition that they shall manufacture the firebricks on the specifications, design and quality as directed by part no.1 as specified and shall dispatch the firebricks only to such customers of party no.1 as specified in their purchase orders;

AND WHEREAS the party no.2 has agreed to supply the firebricks on the terms and conditions of party no.1 and to the customers of party no.1 alone on the price dictated by party no.1 and shall reimburse the incremental cost to party no.1 as mentioned in the Purchase Order/Annexure by way of payment of opportunity cost.

NOW THEREFORE IT HAS BEEN AGREED BETWEEN THE PARTIES AS FOLLOWS:

(a) That the party no.2 shall dispatch the firebricks to the customers of Party no.1 as per the directions of Party No.1

(b) That the party no.2 shall along with the dispatch of goods, send the invoice-cum-gate pass-cum-despatch advice showing the price as quoted by Party no.1 in their Purchase Order and shall also indicate in such documents besides the Sale Price the leviable sales tax and excise duty separately.

(c) That the Party No.2, franchisee, will send to the Party No.1 a copy of the dispatch Advice-cum-Invoice-cum-Gate Pass in duplicate against the supplies made to the customers of Party No.1 and on the advise and directions of Party No.1.

(d) That the Party No.2 shall not demand, receive or collect any amount towards the supplies from the customers directly. Such amount shall be collected by Party No.2 from party no.1 on production of the dispatch Advice-cum-Invoice-cum-Gate Pass along with a credit note issued in favour of Party No.1 representing the incremental cost to be reimbursed to Party No.1 on account opportunity cost.

(e) That the party no.1, on receipt of the documents mentioned in clause (d) shall deduct the amount of incremental cost as per the credit note and shall pay the balance amount to party no.2

(f) That the party no.1 shall have an absolute right in their discretion to terminate this agreement at any time without assigning any reason and the party no.2 shall have no legal right to dispute/challenge such right and authority of Party no.1.

(g) That in the event of termination of this agreement, the franchisee rights shall automatically stand terminated.

(h) That in the event of termination of this agreement including the right of franchisee, the party no.2 shall have no legal right to sell the product to anyone else but the remaining stock of goods with party no.2 shall be disposed off on the directions of party no.1 at such rate which shall be decided by party no.1. In case of any dis-agreement in the rate for disposal of the remaining stock, the dispute shall be resolved by a sole arbitrator to be appointed by party no.1 and the decision of such arbitrator shall be final and binding on party no.2

IN WITness hereof, the parties above mentioned have executed and signed this agreement on this 25th day of August, 1994 at Katni before the witnesses:

All disputes shall be subject to Jabalpur jurisdiction.

7. At this juncture as the issue involved is interpretation of agreement/contract it is useful to partially quote para 16 & 17 from the CESTAT judgement in the case of Delhi Public School Society (supra) which elucidate the general principles of interpretation/construction of documents.

16.?Before we part with the aspect relating to interpretation of the agreements between the assessee and the other parties, for establishing schools under the brand name, motto and logo of the assessee, a brief analysis of the general principles of interpretation/construction of documents is appropriate.

(a) In Radha Sundar Dutta v. Mohd. Jahadur Rahim - AIR 1959 SC 24; Puzhakkal Kuttappu v. C. Bhargavi and Others - (1977) 1 SCC 17; Ford against Beech - (1848) 11 QB 852; Inntrepreneur Pub Co. Ltd. v. East Crown Ltd. - (2000) 2 Lloyds Rep 611; Investors Compensation Scheme Ltd. v. West Bromwich Building Society - (1998) 1 ALL ER 98 and Hideo Yoshimoto v. Canterbury Golf International Limited - 2000 NZCA 350 the general principles pertaining to construction of documents/contracts were delineated :

Lord Hoffmann in the leading opinion of the House of Lords (with which the other learned law Lords concurred) in West Bromwich Building Society, while observing that almost all the old intellectual baggage of legal interpretation was discarded, summarized the principles by which contractual documents are presently considered, as under :

(i) Interpretation is the ascertainment of the meaning which the document would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract.

(ii) The background was famously referred to by Lord Wilberforce as the matrix of fact, but this phrase is, if anything, an understated description of what the background may include. Subject to the requirement that it should have been reasonably available to the parties and to the exception to be mentioned next, it includes absolutely anything which would have affected the way in which the language of the documents would have been understood by a reasonable man.

(iii) The law excludes from the admissible background the previous negotiations of the parties and their declarations of subjective intent. They are admissible only in an action for rectification. The law makes this distinction for reasons of practical policy and, in this respect only, legal interpretation differs from the way we would interpret utterances in ordinary life. The boundaries of this exception are in some respects unclear. But this is not the occasion on which to explore them.

(iv) The meaning which a document (or any other utterance) would convey to a reasonable man is not the same thing as the meaning of its words. The meaning of words is a matter of dictionaries and grammars; the meaning of the document is what the parties using those words against the relevant background would reasonably have been understood to mean. The background may not merely enable the reasonable man to choose between the possible meanings of words which are ambiguous but even (as occasionally happens in ordinary life) to conclude that the parties must, for whatever reason, have used the word, words or syntax [Mannai Investment Co. Ltd. v. Eagle Star Life Assurance Co. Ltd. - (1997) ALL ER 352].

(v) The rule that words should be given their natural and ordinary meaning reflects the commonsense proposition that we do not easily accept that people have made linguistic mistakes, particularly in formal documents. On the other hand, if one would nevertheless conclude from the background that something must have gone wrong with the language, the law does not require judges to attribute to the parties An intention which they plainly could not have had. Lord Diplock made this point more vigorously when he said in Antaios Cia Naviera SA v. Salen Rederierna AB, The Antaios - (1984) 3 ALL ER 229 at 233, (1985) AC 191 at 201.

... If detailed semantic and syntactical analyses of words in a commercial contract is going to lead to a conclusion that flouts business common sense, it must be made to yield to business common sense.

17.?In Hideo Yoshimoto, Thomas, J. for the New Zealand Court of Appeal after quoting with approval the restatement of law by Lord Hoffmann in West Bromwich Building Society and noting that the five principles Lord Hoffmann articulated were reiterated and applied by the New Zealand Court of Appeal in Boat Park Ltd. v. Hutchison, referred to a paradigm shift in the interpretative principles noticed by Wigmore [Wigmore on Evidence - 1981-vol. 9, para 2461] and agreed with the observation : The history of the law of interpretation is the history of a progress from a stiff and superstitious formalism to a flexible rationalism; and proceeded to state : The cardinal rule of contractual interpretation must be to ascertain the intention of the parties. To the extent this rule is not implemented, the courts must incur the criticism of failing to give effect to the reasonable expectations of the parties. Surely the parties are reasonably entitled to expect that the courts will strive to ascertain their true intention or, certainly, not to arrive at a meaning of their contract which is at variance with their actual intention. They cannot expect that the judicial exercise of constructing their contract will be buried under a stockpile of excessive formalism.

Lewison [Kim Levison - The Interpretation of Contracts, Sweet and Maxwell, (1989)] refers to a lucid summary of the relevant principles set out in the judgment of Saville, J. in Vitol B.V. v. Compagnie Europeene des Petroles - (1988) 1 Lloyds Rep 574. The approach of the English law to questions of the true construction of contracts of this kind is to seek objectively to ascertain the intentions of the parties from the words which they have chosen to use. xxxxxx

8. It is evident from the agreement reproduced earlier that :

(i) The manufacturers did not have any right to manufacture the goods identified with the appellant except in compliance of the purchase orders of the appellant,

(ii) They also did not have any right to sell those goods to any person except the appellant or even consign those goods to any person except the customers of the appellant and in accordance with the directions of the appellant.

(iii) No payment from the consignees came to the manufacturers. The payment by the consignees was made to the appellant.

(iv) The manufacturers did not pay any amount to the appellant; on the other hand, it was the appellant which paid to the manufacturers for manufacturing those goods as per its purchase orders.

It thus comes out loud and clear that the manufacturers did not have any representational right to manufacture goods identified with the appellant. Indeed the appellant did not provide any service to these manufacturers nor did the manufacturers make any payment to the appellant for any service. The flow of payment was from the appellant to the manufacturer which would not have been the case had the appellant provided any service to the manufacturers. Merely because the words franchise and franchisee have been used in the agreement between the appellant and the manufacturers does not ipso facto mean that as per that agreement franchise service was rendered. As elucidated in para 7 above, whether franchise service has been rendered as per the said agreement has to be ascertained from the actual context, intent and content of the agreement. As has been analysed, no part of the agreement gives the slightest support to the contention that it gave representational right to the manufacturers to manufacture goods identified with the appellant. As a consequence notwithstanding the presence of words, franchise/franchisee, therein, the said agreement miserably fails to qualify as franchise agreement. The judgement of CESTAT in the case of Delhi Public School Society Vs. CST, New Delhi  2013 (32) STR 179 (Tri.-Del.) is not relevant to the present circumstances. In that case the franchisee had representational right to render service identified with Delhi Public School Society and also that judgement dealt with totally different facts and circumstances.

9. We have seen some of the invoices issued by the appellant as well as the manufacturers. We find that the manufacturers have issued invoices where the goods were shown to be sold to the appellant and the consignee is the person to whom the goods were consigned as per the direction of the appellant. The appellant in turn sent the invoice to the consignee- customer in which the total value shown was the aggregate of the value of the goods plus various taxes shown in the invoice of the manufacturer raised on the appellant. From this it is evident that as far as the manufacturer is concerned the goods were sold to the appellant and were consigned only to those persons whom the appellant directed the manufacturer to consign them to. The manufacturer did not have any right to sell these goods directly to any customer in the market. The goods were manufactured and consigned by these manufacturers as per the purchase orders placed by the appellant in which it indicated the name of the consignee but there was no direct contact between the manufacturers and the consignee either with regard to placing of orders or with regard to payment for the goods. The payment for the goods by the consignee- customers was made to the appellant and appellant, in effect, paid to the manufacturers the amount agreed upon for manufacturing those goods. It was only a financial mechanism that because the manufacturers invoices raised on the appellant showed the value of the goods at which the appellant sold the goods to the customers so as to pay due excise duty and sales tax thereon but as the manufacturer was entitled to receive only the amount agreed upon between the appellant and the manufacturer for manufacture of goods the manufacturer also issued a credit note of an amount which represented the difference between the value of the invoice and the amount which the manufacturer was entitled to receive for manufacturing those goods as a result of which the appellant was enabled to pay to the manufacturer only that amount which was agreed upon between the appellant and the manufacturer for manufacture of those goods while the transactions as per invoices also got squared off. Thus, the actual transactions are also in conformity with the agreement and clearly support the analysis/inference in the preceding para.

10. We find that CESTAT in the case of M/s Skol Breweries Ltd. (supra) involving similar circumstances has held as under :

8. Having considered the rival submissions, we find that as per the agreement between the parties, the risk of manufacture and sale lies with the appellant in respect of the Foster Brand beer got manufactured by it from FIPL. It is evident from the contract that FIPL is only responsible for bottling, packing and dispatch as per the specification, terms, formula etc. as laid down by the appellant. Further FIPL is bound to charge the price from the notified Identer of the appellant as fixed by the appellant. Only for the risks associated with the manufacturing process fastened on FIPL (CBU), it cannot be said that as FIPL is responsible for proper quality, quantity and timely production, they are providing Franchise Service and/or IPR Service. Further taking notice of the definitions which are reproduced below:-

47. Franchise means an agreement by which Franchisee is granted representational right to sell or manufacture good or to provide service or undertake any process identified with franchisor, whether or not a trademark, service mark, trade name or logo or any such of symbol, as the case may be, is involved.

(48) Franchisor means any person who enters into franchise with a franchisee and includes any associate of franchisor or a person designed by franchisor to enter into franchise on this behalf and the terms franchisee shall be construed accordingly.

From the aforementioned definitions, it is crystal clear that in the facts and circumstances, no services have been provided by the appellant to FIPL under the classification of Franchise Service and IPR service.

Although the said judgement clearly supports the case of the appellant, we hesitate to drawn support there-from as we are unable to discern any guiding analysis/principle/ratio therein. However, as our independent analysis in the preceding paras unequivocally brings out, the agreements entered into by the appellant with the manufacturers were not in the nature of franchise agreements and the appellant did not provide franchise service to the manufacturer.

11. In the light of the analysis above, we declare that the appellant did not provide franchise service and the impugned demand is not sustainable. Accordingly, we set aside the impugned order in original and allow the appeal.

(Justice G. Raghuram)

President

(R.K. Singh)

Member (Technical)

RM

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