'Distributor Not Agent, Independent Contractor': Supreme Court Elaborates Law On Agency

While deciding the question of cellular mobile service providers' liability to deduct tax at source under Section 194-H of the Income Tax Act, 1961, the Supreme Court recently summarized aspects that must be kept in mind by Courts while examining whether principal-agent relationship exists in particular case.

The factors/aspects enunciated by the Bench of Justices Sanjiv Khanna and SVN Bhatti, after referring to Section 182 of the Contract Act, 1872, are as follows:

“(a) The essential characteristic of an agent is the legal power vested with the agent to alter his principal's legal relationship with a third party and the principal's co-relative liability to have his relations altered.

(b) As the agent acts on behalf of the principal, one of the prime elements of the relationship is the exercise of a degree of control by the principal over the conduct of the activities of the agent. This degree of control is less than the control exercised by the master on the servant, and is different from the rights and obligations in case of principal to principal and independent contractor relationship.

(c) The task entrusted by the principal to the agent should result in a fiduciary relationship. The fiduciary relationship is the manifestation of consent by one person to another to act on his or her behalf and subject to his or her control, and the reciprocal consent by the other to do so.

(d) As the business done by the agent is on the principal's account, the agent is liable to render accounts thereof to the principal. An agent is entitled to remuneration from the principal for the work he performs for the principal.”

For an overview of the matter, click here.

Notably, dealing with the case, the Bench also made some observations with respect to the status of franchisee and distributor agreements. Distinguishing the legal position of a distributor from that of an agent, it said that a distributor does not act as a communicator or creator of a relationship between the principal and a third party.

"The legal position of a distributor, it is to be generally regarded as different form that of an agent. The distributor buys goods on his account and sells them in his territory...the distributor in such cases is an independent contractor...An independent contractor is free from control on the part of his employer, and is only subject to the terms of his contract. But an agent is not completely free from control, and the relationship to the extent of tasks entrusted by the principal to the agent are fiduciary."

Insofar as franchisee agreements are concerned, it was opined that there is detail and complexity involved in the relationship between a franchisor and the franchisee, which perhaps distinguishes franchisee agreements from distributorship agreements. However, notwithstanding the strict regulation of a franchisee's operations, the relationship in a given case may be that of an independent contractor.

"There is a close relationship between a franchisor and a franchisee because a franchisee's operations are closely regulated...[Franchisee agreements] may relate to distribution franchises, service franchises and production franchises. Notwithstanding the strict restrictions placed on the franchisees – which may require the franchisee to sell only the franchised goods, operate in a specific location, maintain premises which are required to comply with certain requirements, and even sell according to specified prices – the relationship may in a given case be that of an independent contractor".

Whilst equating franchisees/distributors to independent contractors, the Bench went on to say that, "independent contractors work for themselves, even when they are employed for the purpose of creating contractual relations with the third persons". It further noted that an independent contractor is not required to render accounts of the business, as it belongs to him and not his employer.

Distinguishing between power and authority, the Court expressed that when a person gives authority to another person to do the acts which bring the law of agency into play, then, the law vests power with the agent to affect the principal's legal relationship with the third parties.

Bringing independent contractors out of the purview of 'agency', it explicated that the term 'agent' should be restricted to one who has the power of affecting the legal position of his principal. It was also underlined that the concept of agency under Explanation (i) to Section 194-H is contemplated in a restricted sense.

"Although servants and independent contractors are parties to relationships in which one person acts for another, and thereby possesses the capacity to involve them in liability, yet the nature of the relationship and the kind of acts in question are sufficiently different to justify the exclusion of servants and independent contractors from the law relating to agency."

On the facts of the case, the Court observed that the franchisees/distributors were free to sell the prepaid products of assessees at any price below the price printed on the pack and therefore determined their profits/income.

In response to the Revenue's submission that the prepaid SIM cards remained property of the assessees without transfer of any title etc. to the franchisee/distributor, the Court concluded that the distributors/franchisees were operating under certain contractual obligations but the same did not reflect fiduciary character of the relationship, or that the business was being done on the principal's account.

Case Title: Bharti Cellular Limited v. Assistant Commissioner of Income Tax and Another, Civil Appeal No. 7257 of 2011 (and connected matters)

Citation : 2024 LiveLaw (SC) 176

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