APPELLATE TRIBUNAL INLAND REVENUE, DIVISION BENCH – I,
ISLAMABAD
FEA No.35/IB/2017
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M/s
Oracle Systems Pakistan (Pvt) Ltd., Suit 306-307, The Forum Clifton, Karachi. |
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Appellant |
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Vs |
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Commissioner
Inland Revenue, |
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Respondent
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Appellant
By: |
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Mr. Asim Ali Zulfiqar, FCA Mr. Muhammad Raza, FCA |
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Respondent
By: |
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Mr.
Imran Shah, DR |
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Date
of Hearing: |
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19.12.2022 |
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Date
of Order: |
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15.01.2023 |
ORDER
M. M. AKRAM (JUDICIAL MEMBER): The
titled appeals have been filed by the appellant taxpayer against Orders in appeal
Nos. ST 524/2017, ST 510/2017, and 138/2021 dated 18.08.2017, 22.08.2017, & 27.10.2021 respectively passed by
the learned Commissioner Inland Revenue (Appeals–I), Islamabad for the
respective tax periods under consideration on the grounds as set forth in the
memos of appeal. The facts of the case and the issue involved in all these
appeals are similar, therefore, all these appeals are being decided through
this common order.
2. Brief facts giving rise to the instant appeals are that the appellant, a private limited company, remained engaged in the supply of hardware and sublicensing of software along with related support services to customers across Pakistan. These business activities were undertaken in terms of a distribution agreement executed between the appellant and foreign group entities. Show cause notices under section 14 of the Federal Excise Act, 2005 (“The Act”) were issued by the concerned Deputy Commissioner Inland Revenue (DCIR) on 12.01.2017, 30.08.2016 and 29.06.2020, respectively for each of the tax periods involved in the subject appeals, which culminated in orders in original passed on 28.02.2017, 31.12.2016, and 23.11.2020 respectively whereby principal amounts of FED demand relating to “franchise services “at Rs 1,378,899,188/-, Rs 556,420,713/-and Rs 316,864,182/- held to be recoverable along with penalties imposed under section 19(1) of the Act and default surcharge under section 8 (to be calculated at the time of payment). Feeling aggrieved, the appellant preferred appeals before the Commissioner Inland Revenue (Appeals–1), Islamabad against the above-mentioned orders in original. The Commissioner Inland Revenue (Appeals-1), Islamabad vides orders in appeal Nos. ST 524/2017, ST 510/2017 and 138/2021 dated 18.08.2017, 22.08.2017 and 27.10.2021 respectively upheld the orders in original. Feeling aggrieved, the appellant preferred appeals before the Appellate Tribunal Inland Revenue. In respect of FE Nos. 35 & 36, this Tribunal earlier passed a combined order dated 06.01.2020 whereby the appellant’s appeals were accepted on jurisdictional grounds (raised through MA(AG) Nos. 99 & 100/IB/2017) relying on the Lahore High Court’s judgment in Hamza Nasir Wire case (2018 PTD 1071). The department filed a reference application (FERA No. 09/2020) against the said order which was decided by the Islamabad High Court vide order dated 19.01.2020 allowing the reference applications on the jurisdictional ground as the judgment of Lahore High Court in Hamza Nasir Wire was subsequently overruled by the Hon’ble Supreme Court of Pakistan in its judgment reported in 2020 SCMR 1822. However, as the original order did not deal with the merits of the case, the matter was remanded back by the Hon’ble Islamabad High Court to this Tribunal for the decision of appeals afresh on merits in accordance with the law.
3. The case came
up for a hearing on 13.12.2022 and 19.12.2022 when the appellant taxpayer was
represented by Mr. Asim Zulfiqar Ali, FCA and Mr. Muhammad Raza, FCA whereas
the department was represented by the learned DR. Mr. Imran Shah. The learned
ARs explained that the appellant’s ultimate parent company is Oracle
Corporation, USA which holds 100% shares of the appellant through its Irish
subsidiary (OCAPAC – NIH1 Company). To explain the issues involved in these
appeals, following the breakup of the FED demands was submitted by the ARs during
the hearing:-
|
DESCRIPTION |
JUNE
2011 TO MAY
2013 |
JUNE
2013 TO MAY
2015 |
JUNE
2015 TO MAY
2016 |
|
(-------------------------
Amount in Rupees ------------------------) |
|||
|
FED on APS
support revenue derived from customers across Pakistan |
183,375,531 |
340,077,677 |
NIL |
|
FED on Sub-license
fee payable in respect of software licensing revenue derived across
Pakistan - June
2011 to May 2015; OCAPAC Ireland - June 2015 to May
2016, OCAPAC Ireland and OFSS Singapore |
373,045,182 |
1,038,821,511 |
316,864,182 |
|
Principal demand of FED |
556,420,713 |
1,378,899,188 |
316,864,182 |
|
Penalty @
5% under section 19(1) of the Act |
27,821,036 |
68,944,959 |
15,843,209 |
|
Total demands as per orders in
original |
584,241,749 |
1,447,844,147 |
332,707,391 |
|
Default
Surcharge under section 8 of the Act, subsequently communicated in recovery
notices |
344,853,094 |
499,309,18 |
171,776,066 |
|
Paid
under protest / recovered from Bank account |
(87,636,262) |
(1,947,153,365) |
- |
|
Balance demand payable |
841,458,581 |
NIL |
504,483,457 |
4. In
relation to the above demands, it was submitted by the ARs that the issue
involved in the first two appeals concern whether revenue earned by the
appellant on account of Advance Product Services (APS) support from its
customers as well as Sublicense Fee (SLF) payable by the appellant to
its overseas associated enterprise Oracle CAPAC Services (OCAPAC)
pursuant to a Distribution Agreement constitute consideration for franchise
services attracted by FED. Regarding the third appeal relating to June 2015 to
May 2016 (i.e. FEA No.15), the ARs informed that a similar fee was payable by
the appellant to another associated enterprise Oracle Financial Services
Software Limited, Singapore (OFSS) in addition to OCAPAC. The ARs
submitted that neither APS support revenue nor Sub-license fee represents
consideration for any franchise services as contemplated under various
provisions of the Act read with orders of the Higher Courts and Appellate
Tribunal on the subject matter. Furthermore, as per ARs, the officers below
have failed to establish a franchise relationship between the parties involved.
As an alternative argument, the ARs submitted that even if it is assumed that
APS and/or SLF include certain elements of franchise services, there has been
no mechanism provided in the Act or Rules to identify the consideration for
such services in case of a bundled transaction. In any case, as per the AR, it
was incumbent upon the department to assign a value to such services and
exclude the value of products or non-franchise elements. It was alternatively
argued that a subscription fee upto a maximum of USD 12,500 per annum is
prescribed for any person desirous of joining Oracle Partners Network, hence,
even if such services could be classified as a franchise, the incidence of FED
should be restricted to the maximum limit of USD 12,500. It was also submitted
on behalf of the appellant that after the 18th amendment to the
Constitution of Pakistan since the right to collect sales tax on services has
devolved to Provinces, the Federal Government has ceased to have a right to
collect FED on such services. It was further pointed out by the ARs that the
Department has committed certain factual mistakes in all three appeals by not
calculating FED demand on sub-license expense as per respective audited
financials and instead the same was computed on cumulative accounts payable as
of the year-end. Lastly, the imposition of default surcharge and penalty were
assailed being not attributed to any mala fide or mens rea on part of
the appellant.
5. The
learned DR on the other hand supported the orders passed by the DCIR and the
learned Commissioner Inland Revenue (Appeals–1) inter alia by referring to
various aspects of the Distribution Agreement between the appellant and OCAPAC
to substantiate that the relationship between the appellant and OCAPAC is that
of a franchise and consequently, all consideration payable or paid under such
arrangement constitutes fee for franchise services attracted by FED.
6. Upon hearing both
parties at length and after perusing the record, written submissions made by
both parties and other documents made available before us; the following
pivotal questions arise for consideration:-
i.
Whether in the facts and
circumstances of the case, the appellant’s revenue under the head APS Support being
in consideration for a license/sublicense of software and allied services
provided to an end-user could be subjected to FED under the head “franchise
services”?
ii.
Whether in the facts and
circumstances of the case, the consideration paid or payable by the appellant to
its overseas associated enterprises i.e., OCAPAC or OFSS, as the case may be
(hereinafter referred to as SLF)includes in it a consideration for any such
right covered by the term “franchise” as per section 2(12a) of the Act?
iii. If the answer to question No. ii above is in the affirmative, then whether the entire amount paid or payable by the appellant under the head Sub-License Fee could be subjected to the charge of FED under the head “franchise services “as per relevant provisions of the Act?
FED ON APS SUPPORT REVENUE
7. As
per the record and other documents made available to us, it has been gathered
that the appellant is a wholly owned subsidiary of Oracle Corporation USA
(through an Irish holding company – OCAPAC NH1 Company). The appellant is
engaged in the business of providing application licenses, consulting, and
education services on information systems, hardware support, and hardware
sales. The revenue earned by the appellant from its Pakistan-based customers
has been disclosed under different heads in the respective audited financial
statements for the relevant periods viz. Education services, Consulting Services,
Application License Revenue, APS Support, Hardware sales, etc. Out of these
heads, the Department has charged FED on APS Support revenue of the appellant
relating to tax periods 2011 to 2013 and 2013 to 2015. As evident from the
audited financial statements, this head of revenue relates to the provision of
technical support and systems update rights. Explaining the nature of this
item, the ARs submitted that the appellant mainly sublicensed software products
to its customers for which there are software support contracts entitling the
relevant customer to receive software product upgrades, bug fixes, maintenance
releases, and patches. It was further clarified that such services may be
purchased by the customers along with the underlying software (which is licensed
/ sub-licensed by the appellant and revenue there from is recognized under the
head Application License Revenue) or as a stand-alone annual subscription. As
such, it has been emphasized on behalf of the appellant that revenue from APS
support is derived from unrelated end-user customers. The ARs submitted a
sample of underlying ordering documents and invoices for certain transactions
undertaken by the appellant with the end-user customers (such as Askari Bank,
MCB Bank, Mobilink, etc.)
8. On perusal of
the Show Cause Notice dated 30.08.2016 for tax periods June 2011 to May 2013
(relating to FEA No. 36),it is revealed that the Department sought to create a FED
charge on APS support revenue on the following premise:-
“04.
Besides, M/S Oracle System Pakistan (Private) Limited is also engaged in
Franchise / Technical Services in the Country. According to Federal Excise
General Order No. 05 of 2006, dated 05/08/2006:
(iv) In case where the franchiser and
franchisee are both locally based, the liability to deposit the Franchise Fee
or Royalty / Technical Fee is upon the Franchiser;
Contrary to the above, scrutiny of Financial Statements for the period ended May 31, 2012 and May 31, 2013 further reveals that M/s Oracle System Pakistan (Private) Limited is providing Technical Support / Services without charging Federal Excise Duty as per Federal Excise General Order No. 05 of 2006 dated 05/08/2006. As per the Financial Statements of the above-mentioned period, it has been observed that M/s Oracle System Pakistan (Private) Limited have received a Technical Support / Service Fee amounting to Rs 1,833,755,303/-, however, they have failed to charge and pay Federal Excise Duty on account of Franchise Service, Royalty or Technical Fee.”(Emphasis supplied)
Whereas in the Order-in-Original dated 31.12.2016 passed
for the above tax periods, the only rationale for charging FED on APS Support
revenue has been given in para 13 of the order as under:
“Analysis of Financial Statements further reveals that the RP is also providing Technical Support / Services to its Customers for Oracle Products including software and hardware support. This action of the RP, Technical Services clearly fall under the ambit of franchise and are liable to FED in terms of section 3(1)(d) of the Federal Excise Act, 2005 which are enumerated in the first schedule to the Federal Excise Act, 2005”.
The Learned Commissioner Inland Revenue (Appeals) upheld
the levy of FED on APS Support revenue with the following observations on page
no. 4 in his appellate order No. 15/2017 dated 22.08.2017:
“(ii)
For the charge of non-payment of FED on receipt of Technical support/service
fee, according to Federal Excise General Order No. 05 of 2006, dated
05/08/2006:-
“(iv) in case where the franchiser and
franchisee are both locally based, the liability to deposit the franchise fee
or Royalty/ Technical fee is upon the Franchiser.”
In the present scenario, the applicant is a franchiser for the local rendering of technical services and its receipts are liable for charging of FED.”(Emphasis supplied)
It has been observed that the contents of the Show
Cause Notice dated 12.01.2017, Order in Original dated 28.02.2017 and appellate
order No.10/2017 dated 18.08.2017 relating to tax periods June 2013 to May 2015
in FEA No.36 are identical to the above reproduced excerpts.
9. At this
juncture, we deem it relevant to peruse the definition of the franchise as per
section 2(12a) of the Act, which is reproduced as under:-
“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.”
It is clear from the above definition that in order to
fall within the purview of “franchise”, the franchisor has to grant a right to
the franchisee to engage in certain enumerated business activities. There is
nothing in the Show Cause Notices, Orders in Original or in impugned appellate
orders passed by the CIR-Appeals to substantiate as to how the relationship
between the appellant and its customers, being the end-users of software
products, fall within the definition of ‘franchise’ as reproduced above. All
along, the emphasis has been on the fact that the consideration received by the
appellant from its customers on account of APS Support is perhaps in the nature
of so-called technical fees/services and hence, impliedly it has been assumed
by the Officers below that this classification was sufficient to attract FED
under the head franchise services. The Hon’ble Islamabad High Court
in the case of Pakistan Television Corporation Vs Commissioner Inland
Revenue, LTU, Islamabad in Federal Excise Reference No. 04 of
2021 decided on 28.02.2022 inter alia held as under:-
“The
learned ATIR fell into further error, just as did the officers passing the
order-in-original, that fee charged for technical services is a per se ground
to infer a franchise when neither section 2(12a) so prescribes nor is this a
business reality. The name ‘technical fee’ or ‘fee for technical assistance’
are mere convenient labels and no more. For instance, Huawei or Nokia Siemens
charge a technical fee for telecom network support activities to mobile
companies, software companies charge a technical fee for customized software
deployed in networks, a maintenance and operations service provider charges a technical
fee to, say solar power projects, but none of these are franchise relationships
and to infer a franchise as defined in section 2(12a) based on the label given
in a company’s accounts to the fee received for services is tantamount to
rewriting section 2(12a) in its entirety.”
Furthermore, the Hon’ble Islamabad High
Court in the case of MOL Pakistan Oil and Gas Company
in Federal Excise Reference No. 10/2013 decided on 07.04.2022, also
held that “the onus is on the department to establish the relationship of
franchisee and franchisor in the show cause notice”. There is nothing
mentioned in the show cause notices, orders in original or even impugned appellate
orders to substantiate that the Department had discharged its onus of
establishing the relationship between the appellant and its customers /
end-users to be that of a franchise in terms of section 2(12a) of the Act.
10. Whilst
we are not required to go beyond the show cause notices in the instant case, we
have further observed that the documents furnished before us on a sample basis
for certain customers in relation to APS support services nowhere suggest
conferment of any such right from the appellant to its customers/end-users
which allows or authorizes them to undertake any of the enumerated business
activity as mentioned in the definition of ‘franchise’ as per section 2(12a) of
the Act. The relationship between the appellant and its customers / end-users
is that of a service provider and service recipient who are only given limited
license in the software or computer programs for use in their own business
activity and any subsequent services in the nature of APS Support are primarily
in the nature of after-sales service which is common in many transactions. Under
such transactions, the customers do not obtain or acquire any right to produce,
manufacture, sell or trade in or do any other business activity in respect of
goods or to provide services, or to undertake any process identified with the franchiser.
There has been a plethora of orders passed by this Tribunal as well as
judgments of Higher Courts with regard to FED on franchise services, however,
we are not aware of a single case where a transaction with a customer/end-user
would have been treated as giving rise to the franchise relationship. It is
common in today’s technologically enabled world that every smart phone user is
a licensee of various software and application programs entitled to receipt of
software update patches and other support services under an arrangement with
the software owner or developer. Though most of these cases do not involve
payments from users if there is an element of fee involved in such cases, which
is often the case of various applications and software, the same could not, by
any stretch of the imagination, be treated as consideration for franchise
services so as to attract FED under the relevant provisions of the FED Act.
11. For
what has been discussed above, we hold that in the show cause notices as well
as the orders in original the Department failed to establish the franchisor–franchisee
relationship between the appellant and its customers / end-users which is the
essential pre-requisite to create a charge for FED under the head ‘franchise
services’. Even otherwise, it is unimaginable that by way of providing software
updates/patches and allied technical assistance, the appellant’s customers /
end-users acquire any such right which could fall within the purview of
franchise services. Needless to say, as the Hon’ble Islamabad High Court
held in PTV’s case referred above, all technical fees or royalties are not
necessarily consideration for ‘franchise services’. In arriving at this
conclusion, we are further fortified from the stance of the Revenue itself
taken in tax periods involved in subject appeal bearing reference FEA No.
15/IB/2021 (Tax periods, June 2015 to May 2016) wherein no FED has been
charged on this stream of revenue from end users which amplify that there is a
realization at Revenue’s own end, and rightly so, that no FED is leviable in
such arrangements. We, therefore, answer the question No. 1 in negative and
in favour of the appellant by holding that the consideration received by the
appellant, from the end-user, under the head ‘APS Support’ does not fall within
the purview of ‘franchise services’ and consequently, FED demand alongwith consequential
default surcharge and penalty thereon is held to be deleted.
FED ON SUB-LICENSE FEES (SLF)
12. The second and
third questions, framed as above, are inter-connected. To answer these
vis-à-vis the applicability of FED on SLF, the relevant facts are that the
appellant has entered into two Distribution Agreements with its overseas
associated enterprises i.e., OCAPAC Ireland and OFSS Singapore. Broadly speaking,
under these Agreements, the appellant has been appointed as a non-exclusive
authorized distributor/sub-licensor for Oracle software products and other
allied services (classified as education, consulting, etc.) and consequently
requiring the appellant to pay consideration to these entities as a percentage
of its revenue under the respective heads. The SLF expense charged and recorded
in the audited financial statements for the respective periods is given below:-
|
|
2011-12 |
2012-13 |
2013-14 |
2014-15 |
2015-16 |
|
SLF expense |
1,105,270,614 |
1,837,599,486 |
2,162,985,505 |
2,490,378,015 |
2,944,883,060 |
It was explained by the ARs during the
hearings that the above amount of expense for the first four years relating to
FEA Nos. 35 & 36 relate to OCAPAC Ireland whereas, for the last year
relating to FEA No. 15, the expense amount also includes SLF relating to OFSS
Singapore. The basis of the calculation of SLF amounts is governed by the
respective Distribution Agreements with these foreign associated companies. It
was further pointed out by the ARs that as against the above amounts of SLF
expense for the respective tax periods, the Department has erroneously picked
up the amounts from the Balance Sheet of the appellant under the head ‘payable
to related parties’ which resulted in some duplications for prior periods and
also included certain other heads which did not relate to SLF. This assertion,
when confronted to the learned DR, he candidly conceded on this point and
submitted that the principal issue relating to the classification of SLF as
franchise services chargeable to FED may be dilated upon and decided in the
appeals while this factual controversy may be considered as decided in favour
of the appellant.
13. Keeping in
view the above facts, in order to understand the nature of SLF expense, it
would be advantageous to reproduce here relevant excerpts of the Distribution
Agreement between OCAPAC Ireland and the appellant (being referred to as ORASUB
in the Agreement) some of which were also discussed in great detail during the
hearing of the instant appeals.
“ RECITALS
WHEREAS, OCAPAC owns
all rights, title, and interest in, or has been licensed by the developer of
the programs;
WHEREAS, ORASUB desires to promote,
market, distribute, and sublicense the Programs as specified in this Agreement;
WHEREAS, OCAPAC desires to grant ORASUB
a license to promote, market, distribute, and sublicense the Programs as
specified in this Agreement;
…………………………………………………………………………………………………………………………….
…………………………………………………………………………………………………………………………….
ARTICLE 2
LICENSES
GRANTED
2.1 APPOINTMENT AS DISTRIBUTOR
Subject to
the terms of this Agreement, OCAPAC hereby appoints ORASUB as its non-exclusive
authorized distributor for the Programs[1]
to concentrate its distribution efforts within the Territory[2],
with the right to make copies of the Programs of distribution to the public.
2.2 SUBLICENSING LICENSE
2.2.A. End User Sublicensing
OCAPAC
hereby grants to ORASUB a license to market, promote, and to Sublicense the
Programs to Sublicensees in the Territory, under the terms of this Agreement;
a) for use by Sublicensee for its operations on computer systems located in the
Territory, and b) upon approval via the Oracle Group’s international approval
policies and procedures, for use outside of the Territory. ORASUB may also
grant the Sublicensee the right to make copies of the Programs provided that
each copy made by the Sublicensee shall be deemed to be a Sublicense subject to
the terms of this Agreement for which OCAPAC shall be paid a Sublicense Fee.
OCAPAC or its designee shall provide ORASUB with copies of the Program(s) and
Update(s), at the then prevailing Documentation and media Sublicensee price,
for the uses specified herein.
The Sublicensing
license granted by this Article 2.2.A permits ORASUB to:
(i)
make and/or deliver to the Sublicensee an
object code copy of a Program for each Sublicense granted;
(ii)
use the Programs to provide training, Product
Support and Additional Support Services to its Sublicensees and
Subdistributors;
(iii)
use the Programs for demonstration to third
parties;
(iv)
use the Programs for preparing documentation,
marketing, promotional and other materials to further ORASUB’s marketing and
distribution efforts under this Agreement;
(v)
grant trial Sublicenses so that prospective
Sublicensees and Subdistributors may have the opportunity to evaluate the
Programs for a reasonable period of time; and
(vi)
use and reproduce the Programs to the extent
necessary for internal use, safekeeping and archival purposes.
ORASUB may not use the Programs for any
purpose not specified herein without the prior consent of OCAPAC.
…………………………………………………………………………………………………………………………….
…………………………………………………………………………………………………………………………….
ARTICLE 5
FEES AND
PAYMENTS
5.1 SUBLICENSE FEES
5.1.A General Sublicense Fees
In
consideration for each Sublicense of a Program (including any Modifications)
granted by ORASUB or a ORUSB Subdistributor hereunder, ORASUB shall pay a fee
equal to that set out in Part I of Schedule I.
SCHEDULE I
FEES AND
PAYMENTS
Part I General Sublicense Fee
(Article 5.1)
The fee payable by
ORASUB to OCAPAC under Article 5.1 shall equal (a) seventy-seven and eight
tenths percent (77.8%) of the net amount recognized as Program License revenue,
and (b) seventy-seven and eight tenths percent (77.8%) of the net amount recognized
as Support revenue (excluding Additional Support Services Revenue).”
14. We
also reproduce the definition of ‘franchise’ as per section 2(12a) as under:-
“ “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.”
The interpretation of the above definition has been a
subject matter of various orders passed by the Appellate Tribunal as well as
Higher Courts some of which were also cited by both parties during the hearing.
We, however, deem it relevant to refer to a recent judgment of the Hon’ble Islamabad
High Court in the case of Pakistan Television Corporation
in FERA No. 04/2021 decided on 28.02.2022wherein relying on an
earlier judgment of Hon’ble Lahore High Court in the case of Honda
Atlas Car Pakistan (2016 PTD 1328), it was held as under:-
“9.
The ingredients to infer a franchise under section 2(12)(a) of the Act are 5 in
number, namely, (i) authority by the franchisor, (ii) the resultant right
acquired by the franchisee, (iii) the franchised service or product, (iv) the
fee therefor, and (v) the identification of the product or service with the
franchisor. All the impugned orders, however, focus only on the first 4
ingredients, and leave out the most critical ingredient no. (v). Not keeping
the ‘identified with the franchiser’ ingredient as the overriding one leads to
reductio ad absurdum, reducing the myriad business relationships in any
economy, recognized as legally-distinct relationships with distinctly peculiar
characteristics, to one single description, for then the legal doctrines of
agency, construction, charter party, outsourcing, advertising, transportation
and well-nigh all else will be reduced to the singular description of franchise
as they all contain the ingredients (i) to (iv) noted above.”
Keeping
in view the above principles, one can fairly deduce from the above-referred
excerpts of the Distribution Agreement that there are multiple authorizations
and rights granted by OCAPAC to the appellant with regard to products and
services clearly identified with OCAPAC. Hence, the arrangement between the
parties could be implied to fall within the purview of ‘franchise’ in so far as
conditions (i), (ii), (iii), and (v) laid down in the above judgment. It was
further emphasized by the ARs during the hearing that the status of the
appellant is that of a ‘distributor’ which is distinct from ‘franchise’.
However, we have noted that there is a specific definition of ‘distributor’ in
section 2(8) of the Act which read as under:-
“
section 2(8) “distributor” means a person appointed by a manufacturer in or
for a specified area to purchase goods from him for sale to a wholesale dealer
in that area.”
The
underlying concept of a distributor is purchasing and selling of goods from a
manufacturer to the next person in the supply chain. In the instant case, the
act of acquiring the software on license from OCAPAC and its subsequent
sub-licensing to the customers / end-users cannot be equated as the purchase
and sale of goods as the Distribution Agreement itself unequivocally stresses
that the ownership in such programs or software products always remain with
OCAPAC. Furthermore, it was noted that such software is claimed by the
appellant to be acquired by way of downloading from the internet and not on any
tangible medium such as CDs, hard disks, etc. Since the arrangement of the
appellant with OFSS Singapore is also similar hence our findings above squarely
apply on the same as well. Accordingly, in our view, the appellant does not
qualify to be a distributor for the purpose of the provisions of the Act and
consequently, that could not be the basis to exclude its relationship with
OCAPAC and OFSS from the ambit of the franchise. Further, it is always the
substance which is to be seen and consider rather than the form. Reliance may
be placed on the judgments titled Habib Insurance Co. Ltd Vs
Commissioner Income Tax, Karachi, (PLD 1985 SC 109) and Commissioner
of Income Tax Vs Gammon (Pak) Ltd, Karachi, (1966) 14 Tax 304
(Kar). We, therefore, answer the question No. ii in the affirmative and against
the appellant.
15. We now revert
to the third question i.e. whether the entire amount paid or payable by the
appellant under the head Sub-License Fee / SLF to OCAPAC / OFSS could be
subjected to the charge of FED under the head ‘franchise services’ as per
relevant provisions of the Act. To answer this question, let's first peruse
certain relevant provisions of the Act. As per the definition of ‘franchise’
given in section 2(12a) as reproduced above and analysed by the Hon’ble
Islamabad High Court in PTV’s judgment, it is essential that
whatever right or authority has been granted by the franchisor to franchisee
there has to be a consideration or fee for the same which could have any
nomenclature such as royalty, technical fees, etc. As such, the nomenclature of
consideration is not relevant but the existence of consideration for the right
or authority subsisting in the contractual or other arrangements between the
parties is essential. The rate of FED applicable on ‘franchise services’ is
given at entry 11 of Table II of the First Schedule to the Act which is
prescribed as ten percent of the charges. Section 12 of the Act
deals with the determination of value for the purposes of duty which is
reproduced as under:-
“12.
Determination of value for the purpose of duty.- (1) Where any goods are
liable to duty under this Act at a rate dependent on their value, duty shall be
assessed and paid on the basis of value as determined in accordance with
sub-section (46) of section 2 of the Sales Tax Act, 1990, excluding the amount
of duty payable thereon.
(2)
Where any services are liable to duty under this Act at a rate dependent on the
charges therefore, the duty shall be paid on total amount of charges for the
services including the ancillary facilities or utilities, if any, irrespective
of whether such services have been rendered or provided on payment of charge or
free of charge or on any concessional basis.”
For excisable goods, the valuation for the purpose of
assessment and payment of duty is linked with section 2(46) of the Sales Tax
Act, 1990 which inter alia contains a detailed methodology for arriving at a such
value even in case of transactions between related parties or determination of
value by a Valuation Committee comprising of members from Board and Trade where
there is a sufficient reason to believe that the value of a supply has not been
correctly declared in the invoice. For excisable services, the duty is to be
paid on the total amount of charges for the services including the ancillary
facilities and utilities which implies that there has to be a nexus between the
charges and services. The provision further clarifies that this basis has to be
adopted irrespective of whether such services have been rendered or provided on
payment of a charge or free of charge or on any concessional basis. It is
pivotal to compare the language of section 12(2) of the Act with section 4(3)
of the repealed Central Excise Act, 1944 which read as under:-
“(3) Where under this Act any
services, facilities and utilities are subject to duty at a rate dependent on
the charges therefor and—
(a) any
such services, facilities or utilities are, in any case, rendered or provided
free of charge or at a concessional rate, the duty shall be levied and
collected on the amount which would have been charged for such services,
facilities and utilities had they not been rendered or provided free of charge
or at a concessional rate.
(b) the
amount with reference to which the duty shall be levied shall be the total
amount charged for all services, facilities and utilities provided or rendered,
including charges for supplies or merchandise therewith.”
On a
comparison of the above provisions, one can safely deduce that under the
repealed Act, there was a concept of an implied open market / fair market value
for a service provided free of charge or at a concessional rate whereas no such
concept is expressly catered for in section 12(2). In fact, the provisions of
section 2(46) of the Sales Tax Act, 1990 are also applicable only in the case
of excisable goods and not on excisable services.
16. In the exercise of the powers conferred upon
the Federal Government, Rule 43A was promulgated through SRO 561(I)/2006 dated
June 5, 2006, prescribing Special procedure for payment of Federal Excise duty
on franchise fees or technical fee or royalty under a franchise agreement.
Sub-Rule (2) of the said procedure lays down as under:-
“(2) The duty shall be paid by the franchisee, or as the case may be, the head office of the franchisee, at the rate of ten percent of the value of taxable service, which shall be the gross amount or the franchise fee or the deemed franchise fee or technical fee or royalty charged by the franchiser from the franchisee for using the right to deal with the goods or service of the franchisee.”
It is evident from the above
that even for special procedure relating to the collection of FED on franchise
services, the value of taxable service has been kept very specific to the
amount charged by the franchiser from the franchisee for using the right to
deal with the goods or services of the franchisee. With regard to the term ‘deemed
fee’ it appears that the legislature is empowered to prescribe the same in
certain specific cases for instance as has been done for the beverage industry
through General Order No. 5/2006 dated 05.08.2006 wherein it was suggested that
in the absence of any consideration, franchise fee can be assumed as 5% of the
imported concentrates in case of bottlers. Similarly, under the erstwhile General
Order No. 04/2006 which was repealed by the Order No. 05 of 2006, deemed
franchise fee was taken as higher of the actual amount remitted by the
franchisee or 5% of net sales. Similarly, under the Sindh Sales Tax Act on
Services, as amended by the Finance Act, 2017, the deemed franchise fee is
taken as 10% of the net sales of franchisees in certain cases.
17. Keeping in view the above, when we examine the contents of the
Agreement between OCAPAC and the appellant, Article 5.1 of the Distribution
Agreement defines that “In consideration for each Sublicense of a Program
(including any Modifications) granted by ORASUB or a ORUSB Sub-distributor
hereunder, ORASUB shall pay a fee equal to that set out in Part I of Schedule I
”viz. 77.8% of net revenue from specified heads. Under the Agreement with
OFSS, this percentage is prescribed as 96.5%. These are the amounts which are being
disclosed in the audited financial statements of the appellant as Sublicense
fee under the head “cost of services”. Other than this consideration as agreed
between the parties under a written contract, there is no separate
consideration payable from the appellant to OCAPAC / OFSS as a consideration
for any right to deal in Oracle goods or services (viz. in the instant case the
sublicenses issued by the appellant to its customers / end-users). It is an
undisputed fact that the aggregate consideration between the appellant and its
associated enterprises is the one as per Agreements which include ‘right /
authorization being franchise’ and ‘cost of acquisition of Oracle products/programs
and other allied services’. It is an undisputed position that the contracts
between the parties are not a ‘sham’ nor the department has anywhere contended
that such contracts are colourable arrangements aimed to avoid any fiscal
liabilities. In such cases, where there is no dispute with regard to the
genuineness of the contract between the parties, it is important to follow the
principles laid down by the Hon’ble Supreme Court of Pakistan in its
landmark judgment of Siemens AG, reported as 1991 PTD 488
wherein their Lordships held that “when two contracting parties agree
to do something by a mutual valid contract or intend doing so, and it is not
prohibited by Islam, a third party, like the Income Tax Department or for that
matter the Court has no power to modify either the contract or with what they
intended to do with it.”It was further concluded in the said
judgement that “under the present Constitutional set-up the Courts are
bound to apply in preference to the contrary so-called accepted rules of
interpretation under the other jurisprudential concepts and the fiscal laws are
no except in this behalf, the income tax authorities cannot change the nature
of the contract intended by the parties thereto, under the pretext that the
rule of interpretation of fiscal law in this behalf, is different.”
Applying these principles to the instant case, we are mindful of the fact that unless
there is an established fact that a contract between the parties is sham or
colourable device to avoid payment of taxes or duties, it’s not permissible for
the Department or this Tribunal to alter the character of consideration agreed
between the appellant and its associated enterprises to be in relation to
Sublicenses (being the cost of acquiring software and other services) and not
for any such right which falls within the purview of franchise services.
18. We would also like to mention here that it is not uncommon that under the contracts, parties agree for a composite consideration in relation to a bundle of rights or products and services being the subject matter of such contract. However, when it comes to creating a charge of tax or duty on such consideration with regard to any particular right or item being part of such a composite or bundled transaction, the legislature is required to prescribe a specific method or procedure as it has done for beverage industry or as prescribed in section 2(46) of Sales Tax Act, 1990 with regard to the mechanism of assessment through Valuation Committee. In the instant case, there is no enabling provision or Rule which allows the tax authorities to dissect the consideration between the cost of services i.e. sublicense or so-called franchise rights embedded in the same transaction. Even the FBR’s General Order No. 06/2006 which has been all along relied upon by the Department to justify the charge of FED in the instant case, only deals with one case of a bundled transaction i.e. relating to the beverages industry where the price being paid for the purchase of concentrate might have included a deemed franchise fee or consideration. In the absence of any specific rule or provision which could justify a similar dissection of consideration in case of a bundled consideration applicable in the instant appeals, we are handicapped to sustain the FED levied by the Department on the entire amount of SLF. In relation to such related party transactions or arrangements between associates, all fiscal laws generally have enabling provisions to determine the pricing or value of a transaction on an arm’s length basis. For instance, in Income Tax Ordinance, 2001, provisions of section 108 require the transactions between associated parties to be on an arm’s length basis which is an internationally recognized standard for which there are well-defined methods prescribed by Organization for Economic Cooperation and Development as also adopted in Chapter VI of Income Tax Rules, 2002. Similarly, in Sales Tax Act, 1990, a specific provision in the form of section 25AA was inserted through Finance Act 2010 to empower tax authorities to determine the transfer price of taxable supplies between the persons as is necessary to reflect the fair market value of supplies in an arm’s length transaction. The said provision was further amended by Finance Act, 2021 to have an enabling provision for the Board to prescribe Rules in this regard. We are unable to find any parallel provisions like these in the FE Act or Rules which could allow the tax authorities to determine the transfer price for excisable services in relation to a related party transaction. Whilst the Board is suggested to frame specific Rules in this regard for determination of consideration in case of composite or bundled transactions especially those between related parties / associated persons as is done by other legislatures or as per best practices adopted in other countries, in the interim, it would be proper that the matter is remanded back to the tax authorities for determination of the element of consideration relating to franchise services embedded in SLF. In such determination, the tax authorities are expected to follow the generic principles relating to the arm’s length standard.
19. It would also be pertinent to mention here that during
discussion, learned AR appearing to represent the appellant, apprised us that
the software is not physically sold to its ultimate clients in Pakistan, rather
the same is downloaded online, and in order to have full authority to use the
downloaded software, the ultimate clients need to have a license for which they
also have to pay a predetermined amount to APS (the franchisee in Pakistan).
APS after issuance of the license provided by the OCAPAC or OFSS (the foreign
franchiser), collects the amount from ultimate clients and after deducting
almost 22%, remits 78% to the franchiser. The department has raised FED demand
against the entire amount of SLF considering it to be paid to OCAPAC or OFSS,
on account of franchise services. However, on the other hand the department has
also acknowledged in their written correspondence with the appellant that they
have been engaged in ‘sale of software’, which is perhaps not correct. We
understand that the appellant is not selling software, but rendering some
services as per agreement (as discussed above), while he remits 78% of the
amount received from ultimate clients, to the franchiser. Department has also
not successfully explained before us whether any Sales Tax or Income Tax demand
has been raised against the appellant on the 22% retained by him. Hence,
foregoing in view, we answer the third question in negative, and remand back
the case on to the department for determination of the component of SLF
attributable to the franchise services (if any) strictly in accordance with the
arm’s length principle accepted and applied under OECD guidelines for income
tax matters. The Department is also directed to take into consideration the
parallel cases including arrangements of OCAPAC / OFSS with other unrelated or
independent persons.
20. Having answered the above questions, we do not need to engage
ourselves in other alternative grounds relating to the applicability of FED on
services after the 18th amendment to the Constitution of Pakistan, calculation
mistakes, justification of default surcharge and penalty, etc. We expect that
in case the remand back proceedings result in any agreed amount of FED relating
to franchise services under the aforesaid contracts, the issues relating to
calculation errors and other duplications would be resolved mutually by the
parties.
21. This order consists of (24) pages and each
page bear my signature.
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Sd/- |
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Sd/- (M. M. AKRAM) JUDICIAL MEMBER |
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(MUHAMMAD IMTIAZ) ACCOUNTANT MEMBER |
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CERTIFICATE U/S
5 OF THE LAW REPORT ACT
This
case is fit for reporting as it settles the principles highlighted above.
(M. M. AKRAM)
JUDICIAL MEMBER
[1] Defined in clause 1.14 of the Agreement as “Unless otherwise
specified by OCAPAC, “Program(s)” shall mean all software programs specified,
or expected to be included, in the Price List, including Updates. “Program(s)”
shall include (a) the object code computer software program, (b) any modified
version of such program, and (c) Documentation. “Programs” shall include
Modifications. Certain Programs’ utilities may not be available in all
operation system environments.
[2] Pakistan
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