Dated 09th August 2011
1. – FDI in Multi – Brand retailing is prohibited in India.FDI in single Brand Retailing was, however, permitted in 2006, to the extent of 51%. Single brand retail outlets with FDI generally pertain to high-end products and cater to the needs of a brand conscious segment of the population.Foreign brands enter into exclusive tie-up(s) with Indian entities which, more often than not, are in the nature of Master Franchise / Distributorship/Joint Venture agreements. In context to the exclusive tie – up(s) , especially of the nature of Master Franchise agreements, there prevails a degree of confusion over what implication such agreements has on the issue of Customs Valuation, in terms of related party transactions.
2.- Franchising as a business model is prevalent in many industries. A franchise can be exclusive ,non-exclusive or ‘sole and exclusive’. In Australia, franchising is regulated by the “Franchising Code of Conduct” a mandatory code of conduct issued under
the Trade Practices Act 1974. In theUnited States,franchising is under the legal & administrative purview of the FederalTrade Commission . So far, in India, there are no franchise specific law or regulation.
3. – Accounting Standard (AS) 18 issued by ICAI,is on the subject of “Related PartyDisclosures”. The objective of AS-18 is to establish requirements for
disclosure of related party relationship, and transactions between a reporting
enterprise & its related parties. AS– 18 states that the following are
deemed not to be related parties: A single customer, supplier, franchiser, distributor, or general agent with whom an enterprise transacts a significant volume of business merely by virtue of the resulting economic dependence (clause 4(b) of AS-18). It appears that clause 4(b) of AS-18 is at the root of
the issue of whether or not the transactions between contracting parties in a
franchise agreement are in the nature of related transactions. The implications
of clause 4(b) can only be understood in harmonious reading with clause (3) of AS – 18, which emphasizes over the key concepts of control & significant influence, to establish a relationship between two transacting parties. The concept of control and significant influence have been defined in clause (10) of AS – 18 , which reads as follows:
Control – (a) Ownership, directly or indirectly, of more than one half of the voting power of an enterprise, or (b) Control of the composition of the board of directors in the case of a company or of the composition of the corresponding governing body in case of any other enterprise, or (c) A substantial interest in voting power and the power to direct, by statute or agreement, the financial and/or operating policies of the enterprise.
Significant Influence – participation in the financial and/or operating policy
decisions of an enterprise, but not control of those policies.
4.-Coming to the issue of related party transaction in Customs law , Rule (2)(ii)of the Customs Valuation (Determination of Value of Imported Goods) Rules, 2007,(CVR,2007) reads as follows: For the purpose of these rules,
persons shall be deemed to be “related” only if – i.) They are officers or directors of one another’s business ii.)They are legally recognized partners in business iii.) They are employer and employee iv.) Any person directly or indirectly owns, controls or holds five percent or more of the outstanding voting stock or shares of both of them v.) One of them directly or indirectly controls the other vi.) Both of them are directly or indirectly controlled by a third person vii.) Together they directly or indirectly control a third person or viii.) They are members of the same family. In the Interpretatitive Note to Rule 2(2)(v), of CVR, 2007, it has been stated that for the purposes of these rules, one person shall be deemed to control another when the former is legally or operationally in a position to exercise restraint or direction over the latter.
5.-The provisions of AS-18 and Rule 2(2) of the Customs Valuation Rules, 2007, may read differently, but the key concept which emerges in both these provisions to come to the conclusion of related party transactions is “control” .The next logical step is to understand whether in a case specific situation, the franchisee or franchisor exercise control over each other or not. For this a careful examination of clause(s) of appointment/grant, along with franchisee and franchisors obligations as stated in the agreement would have to be undertaken. In an exclusive/sole &exclusive franchise agreement, the franchisor usually grants the franchisee the exclusive right in a defined territory to
sell the ‘’products’’ of the franchisor, and allows the franchisee a non-transferable, limited and non-exclusive rights to use, apply and display, the proprietary marks and other intellectual property of the franchisor, on and in relation to the products and business. By
way of initial obligations, the franchisor typically provides the franchisee,
at the franchisee’s cost and expense, advice and assistance with respect to the setting up the business which also includes general site selection, shop fitting, refurbishment, equipment, layout, décorand signage etc. The obligations of the franchisee may range from:-– To prepare and submit an annual business plan for the approval of the franchisor. The business plan are usually required to address the following : i.) State of the market for products in the territory ii.) Plans for achievement of the sales targets .– To employ a dedicated brand manager for the business, consistent with the brand guidelines set by the franchisor.– To ensure that
all staff engaged in the business receives adequate training, from time to time, to enable them to operate the business in accordance with the policies and the standards required by the franchisor. – Franchisee are also usually required to open the
proposed franchise premises only upon franchisor’s approval.– To use only
materials, equipment and signage to designs and standards specified by
franchisor.– To obtain franchisor’s prior approval before operating through any new distribution channel / location. Etc.,
6.-In the said backdrop of the typical clauses of franchisor and franchisee obligations in an exclusive/sole & exclusive franchise agreement, there remains very little left for imagination to understand the relationship between franchisor and franchisee ,which is
evidently much beyond mere economic interdependence. There is no doubt that in
the given situation as illustrated above the franchisor exercises an amalgamation of control and significant influence over the franchisee, which would lead to a fair conclusion, that the transaction between them are related in nature both as
per AS-18 & the Customs Valuation Rules, 2007.Once the relationship between
the franchisor & franchisee is established, the invoice value declared by the importer(franchisee) at the time of importation of the goods, would be liable to be rejected & re -determined as per the provisions of rule 3(4) of CVR,2007. Theoretically speaking it is possible that the franchisor or franchisee may exercise no control over each other, or where the buyer and seller are related, the invoice value can still be accepted as transaction value, provided that the examination of the circumstances of the sale of the imported goods indicate that the relationship did not influence the price or the importer is able to demonstrate that the declared value of the goods being valued, closely approximates to one of the following values ascertained at or about the same time. (i) The transaction value of identical goods, or of similar goods, in sales to unrelated buyers in India; (ii) The deductive value for identical goods or similar goods; (iii) The computed value for identical goods or similar goods; and that in applying the values used for comparison, due account has been taken of demonstrated difference in commercial levels, quantity levels, adjustments in accordance with the provisions of rules 10 . (rule 3(3)—of CVR, 2007)
7.- The requirement of adjustment in accordance with rule 10 of the CVR
,2007, would merit a close and careful scrutiny even if it is deemed that the
franchisor and the franchisee are not related.Clauses of payment in the franchisee agreement typically pertains to payment of franchise fee which is an annual fee equal to a percentage of net retail sales or gross retail sales of the imported product in the relevant year. The franchise fee may also include a fee in respect of the right to use the intellectual property in context to the product being imported and sold. Many a times such exclusive /sole& exclusive franchise agreements have payment clauses other than franchise fee, which could be of the nature of royalty, service charges ,warehousing charges,consultancy charges etc., In such a situation, if it is apparent that all
such payments are in relation to the imported products and are in the nature of payments made by the buyer which are a condition of the sale for export to the country of importation of the imported goods and/or are in the nature of proceeds of any subsequent resale, disposal or use of the goods by the buyer which accrue directly or indirectly to the seller (Interpretative Notes to rule 10 of CVR,2007),there would be a clear case of adjusting the invoice value of the franchisee for import being affected from the franchisor or franchisor nominated supplier, in accordance with Rule 3(c) of the CVR, 2007, read with rule 10 of the rules ibid , if the said adjustment has not yet been made .The SVB guidelines issued vide Circular No.11/2001 (Cus) of 23.03.2001 prescribes that: SVB is supposed to investigate/ assess cases where there exists a relationship or where any additions could possibly be made where the payments over & above the invoice value are of the nature of royalty & license fee, or where the values of any part of proceeds of any subsequent resale or use of imported goods accrues to the seller or where any other payments are made or are contemplated to be made in future by buyer to the seller as a condition of sale of imported goods. Given the circumstances narrated in the previous para(s) it would be imperative for the importer as well as the department to carefully scrutinize the provisions of a franchise agreement, and arrive at the correct transaction value as per the provisions of CVR, 2007.
This article was recently published on taxindiaonline.com and the views expressed are personal.
SOURCE: GOVT. OF INDIA, MINISTRY OF FINANCE
Disclaimer: please refer to official sources before effecting a decision.