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May, 01 2006

Union Budget 2006-07 Impact on franchising sector

ORGANISED retail is expected to witness an explosive growth in the near future, and we are already observing some unprecedented trends in this sector.

ORGANISED retail is expected to witness an explosive growth in the near future, and we are already observing some unprecedented trends in this sector. Retail is growing at 35 to 40 per cent across urban and semi-urban markets. Retail growth in the coming five years is expected to be stronger than the Gross Domestic Product (GDP) growth, driven by:

  • changing lifestyles
  • strong income growth, supported by favourable demographic patterns
  • extent to which organised retailers succeed in reaching potential consumers towards the bottom of the consumer pyramid
  • consumer credit
  • interests and direct investments

This article takes a look at the recent Foreign Direct Investment (FDI) policy initiatives and the impact of select tax proposals of the Finance Bill, 2006, in so far as it relates to the business of franchising.

FDI liberalisation…. A start

The select initiatives of the government on the FDI front which should influence the retail and franchising growth include:

Allowing FDI up to 51 per cent with prior government approval for retail trade of ‘single brand' products. This is subject to the following conditions:

  • Products to be sold should be of a ‘single brand' only
  • Products should be sold under the same brand internationally, and
  • ‘Single brand' product-retailing would cover only products which are branded during manufacturing

To allow FDI up to 100 per cent under the automatic route in the cash and carry wholesale trading and export trading; and processing and warehousing of coffee and rubber.

The above liberalisation coupled with the franchising route could provide significant opportunities for attracting global brands in India.

Service tax proposals

From the perspective of the franchising industry, the service tax amendments could considerably impact upon the industry. The levy of service tax was introduced on the franchising services vide Finance Act, 2003. This budget proposes:

Increase in tax rate: The rate of this levy is proposed to be enhanced to 12.24 per cent from 10.20 per cent (including education class).

Expansion of the tax net: Fifteen new services have been brought under the tax net. Additionally, the scope of certain existing services is also increased. Some of the relevant ones are, space selling, sponsorships, public relation services, card services and last but not the least, support services for business. Further, the scope of maintenance and repair services and business auxiliary services has been enhanced.

Valuation of services: Hitherto, service tax was payable on services which involved a monetary consideration. This budget proposes to replace the existing valuation provisions with the Service Tax (Determination of Value) Rules, 2006. The draft rules suggest that the value of non-monetary items would also be liable to tax henceforth. However, the question on the method of valuation of such non-monetary items is yet unanswered. These rules could also trigger arguments pertaining to the appropriateness of the value. For example, services provided free of charge in the context of a larger arrangement could be viewed as services provided for non-monetary benefits.

Import of services: Service tax is imposed on a reverse charge mechanism on the Indian company for the foreign technology, know-how, processes, systems, etc., received. The earlier provision on the reverse charge mechanism is proposed to be deleted. Alternatively, a set of Rules Taxation of Services (Provided from outside India and received in India) Rules, 2006, is proposed to be introduced. The proposed rules, insofar as it relates to the franchising services, provide that the same would be taxable in India if such services are received in India for use in relation to commerce or industry, unlike the earlier provision where the taxability was attached to the transaction merely based on the location of the recipient irrespective of where such services are provided/used. While there is not much difference in the levy per se, the impact lies in the mechanism of credit. Under the new rules, it is quite likely that the tax paid on reverse charge mechanism would directly add to the cost of service without any reductions/credits.

Advance ruling: Putting an issue to rest even before it could arise is undisputedly the best of way to manage. The facility of advance ruling is now extended to an issue involving the determination of service tax liability on the service. Thus, the issue on whether the proposed activity would attract the levy of service tax could be addressed well before it is implemented.

Central Sales Tax - A promise missed

In line with the promises made during the previous budget and the suggestions of the Empowered Committee on Value Added Tax, it was envisaged that the rate of Central Sales Tax (CST) would be lowered to 2 per cent. However, there have been no such proposals and the CST rate would continue at 4 per cent.

From a business perspective, the supply chain models would ideally have to remain status quo. It is believed that businesses would have identified a forward looking mix of the supply chain considering the two-year phase out period of CST. The incidence of CST for the envisaged two-year period could in certain circumstances be lower than the cost of re-designing the supply chain.

Central Excise - Feels good

The duty rates on goods such as, footwear, aerated waters, prepared food stuffs, branded ornaments, etc., has been reduced

It is observed that in the past the Foreign Investment Promotion Board has granted approvals for FDI, with a rider that the unit would have to undertake manufacturing activities within a stipulated number of years. The reduction in the rates of duty is believed to give a boost to such manufacturing set ups and other units in India.

Advance ruling now also made possible for determination of excise duty liability on a specified activity.

Vision 2010: Goods & Services Tax - A target

The practice of subjecting both, goods and services, to tax on the same platform is prevalent in a number of countries world over. This tax regime is proposed to be introduced in India too. The Finance Minister has indicated April 1, 2010, as the date for implementation of nationwide Goods & Services Tax (GST). Idealistically, this would embrace central excise, service tax and the tax on sale of goods, viz., VAT.

Custom Duty - Neighbours matter

In advancing the government's declared policy of bringing the custom duty structure closer to that of the ASEAN levels, the peak rate of duty on non-agricultural products is slashed from 15 per cent to 12.5 per cent.

An additional duty of customs @ 4 per cent has been imposed on all goods across the board. This is levied having regard to the sales tax/VAT imposed on the like goods when sold in India. Though, this would be allowed as credit under the CENVAT provisions, this is perceived to impact the cash flows.

Direct Tax - Less tampering is positive

Tax rates: The personal and corporate income tax rates are proposed to be maintained at the same levels of the previous year. The Minimum Alternate Tax (MAT) rate for corporates is proposed to be increased from 7.5 per cent to 10 per cent. As a supportive measure, the period over which the MAT may be availed as a credit has been increased to seven years from five years.

Fringe benefit tax: Much against the desires of the trade and industry, the FBT has been retained though with certain rationalisation measures. Justifying the levy on the principle of equity, the Finance Minister proposed certain rationalisation measures. Relevant ones being:

  • Employer's contribution to approved super annuation fund up to Rs 1 lakh per employee wholly exempt
  • Benefit value on tour and travel expenses reduced from 20 per cent to 5 per cent to all industries
  • Samples to doctors and brand endorsement not to qualify as sales promotion expenses
  • For commuting between office and residence to be kept out of the tax net

In conclusion

We believe that the budget does provide a positive note but not with much support, and leaves us with this quote:

“If you have built castles in the air, your work need not be lost; that is where they should be. Now put the foundations under them.” A statement of Henry David Thoreau quoted by the Finance Minister during the budget speech.

(The authors specialises in tax consulting. The views expressed herein are not that of the publishers.)

The authors can be contacted at: and

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