ORIGIN:
The OEMs manufacture vehicles out of the parts and components (P&C) procured from various suppliers. The P&Cs are customized for every item, such that they require customized Tools and Dies (T&Ds). The building up process of making T&Ds starts with goal setting, it requires Designs, Drawings and Specifications (DDSs) (in paper form or CAD/ CAM), and finally the T&Ds are made through CNCs.
In their investigation and show cause notices (SCNs), the DGCEI (now DG-GSTI) have showcased a position wherein the OEM is incurring expenditure for acquiring DDS from its Group Company (GC) and providing the same to component manufacturers free of cost. The component manufacturers USE the DDS to manufacture T&Ds, and sell the same to OEM. In the case presented by the revenue, the free of cost supply of DDS are amenable to be added in the value of T&Ds as per clause (ii) of Explanation 1 to Rule 6 of the Central Excise Valuation (Determination of Price of Excisable goods), 2000 ('CVR').
Examining the SCN merits:
1. Inapplicability of Rule 6
The valuation under Rule 6 ibid proceeds on the premise that the sale of the manufactured goods between buyer and seller is not on "sole consideration" 1, i.e. the seller is not receiving anything other than agreed price.
The vehicles manufactured by OEMs are unique, the engine of one wouldn't accept the housing of another, the interior of one wouldn't fit the dashboard of another etc. By furnishing DDS to the component manufacturer, the OEMs are only indicating the boundaries, the size, the length, cutting in which the respective P&Cs 2 needs to be accustomed to, they are not furnishing something which is pre-requisite for the very manufacturing of components.
The case is similar to a tailor, stitching shirt from the fabric provided by the customer. The body measurements noted by the tailor could either be on the spot, or the same could be supplied by the customer itself for bulk stitching 3. It cannot be said that tailor required measurement for him to stich shirt. The measurements are sine qua non for the customized stitching, but that doesn't imply that without the same, the tailor can't do the stitching itself. The difference, therefore, is mere customized and non-customized shirts.
The case of T&D vis-à-vis P&C revolves around the fact that T&Ds are absolute necessity for P&Cs, however that's' not the case with DDS vis-à-vis T&Ds. In the latter case, DDS are required only for customizing T&Ds and they are not necessity of T&Ds.
2. Condition for supply - not consideration
An important term that is often coined in for countering the application of "sole consideration" is "condition of supply". The merchandise flowing from the buyer to the seller which is "condition of supply", rather than "consideration for supply" are not includible in the value of goods. The Australian GSTR 2001/6 elaborates on the same;
"83. Many transactions involve exchanging various rights and obligations between the parties to the transaction. In particular, the true character of the transaction may characterise the payment as a condition of the contract rather than the provision of non-monetary consideration……………"
Example 9 - things used in making the supply
91. E agrees to supply services to M at a rate of 100. Under the agreement, E must perform the services on M's premises in Melbourne. M agrees to allow E to use its computer facilities, stationery and safety equipment on M's premises to perform the services. M also agrees to fly E to Melbourne and provide accommodation and meals during the period E performs the services.
92. There is monetary consideration for E's services. The provision of the use of computer facilities, stationery and safety equipment and the transport, accommodation and meals is not part of the price paid for the services as it is not a payment or of value to E in return for his services. They are rather conditions of the contract that go to defining the supply made by E, and are used in providing the services, rather than being supplied to E in return for the services. They do not provide economic value to E in return for his supply. The provision of these things in these circumstances is not consideration in connection with the supply by E. There is no non-monetary consideration for E's supply."
From para 92 above, an inference can be drawn that a condition of sale doesn't provide economic value to the seller in return for his supply. The averment proves true for the automotive component manufacturers also. The DDS are merely pieces of paper/ computer generated files, upon which component manufacturer has to undertake his processing, and not anything of economic value for them.
In Hindustan Polymers vs Collector of C. Ex. 4, the Hon'ble Supreme Court had examined the "necessity"context of an item supplied by the buyer in the manufacturing process to be undertaken by the manufacturer. The Court emphasized that the value of excise duty inextricably tends towards the "value of manufacturing and availability for sale in wholesale market". The value of secondary packing that is supplied by the buyer, which is not necessary for either the manufacturing or making available the product for sale in wholesale market, is not amenable to be added.
In the opinion of author, therefore, the component manufacturers need to arrive at the significance of DDS supplied by the OEM. Most often, component manufacturers have facility to develop T&D on their own and DDS mutely act as specifications only. Relying on the above, the application of Rule 6 ibid may not survive for value addition.
3. Royalty doesn't represent DDS
The most fascinating part of the revenue's investigation is their purported inability to decode the agreement between the OEM and GC. In one case, the Delhi ITAT, after reproducing the relevant parts of the agreement, deduced following arrangement between the OEM and GC;
- The main object of the license agreement is to provide the appellant exclusive right and license to manufacture and sell the licensed product for a specified limited duration.,
- All others rights vested in the license agreement including technology, technical know how and Trade Mark are linked to the core right to manufacture and sell licensed products.
- Single Package - Royalty in-severable: From the aforesaid extract of the agreement it would also be appreciated that the License Agreement is a single package, for which the consideration in the form of royalty is inseverable.
- Consequently, no part of the royalty can be split and determined for the use of xxx licensed trademarks. The split done by the TPO is arbitrary and wholly without basis.
- Primary intent being technology transfer: The primary intent of the license is transfer of technology and not trademark usage.
- The technology transfer from xxx has allowed the appellant to manufacture certain critical components required for manufacturing these cars and has allowed us to internalize and generate these models locally
Revenue, therefore, seems to have lost sight of the fact that impugned DDS are merely the deliverables of the licensee to manufacture and sell, by the GC to OEM. The Court has explicitly laid out the essence of the agreement as being transfer technology and trademark in consonance.
The royalty paid by OEM on the same to GC may tantamount to taxable service amenable to service tax. It is at this place, a fine line of difference needs to be drawn distinguishing the extra commercial consideration qua excise duty vis-à-vis additional services amenable to service tax. DDS are bare minimum deliverables of the services procured by OEM from GC, they are a separate financial cost for OEM, not inter-linkable with the production of goods.
In Nirulas Corner House Pvt. Ltd. vs CCE 5, the Principal bench of the Tribunal examined a similar issue, wherein the manufacturer was providing tech-transfer services to its franchisee, for lumpsum and running royalties, and paying service tax thereon. The revenue alleged that, such royalties are additional consideration and addable in the sale value of goods by the Appellant to franchisee. The Hon'ble Tribunal held in negative, that tech-transfer and sale of goods are separate activities, and Rule 6 ibid is not invokable.
In the author of the opinion, the DDS is merely an outcome of the services sourced by OEM, and should not be seen as a factor contributing to the manufacturing value of T&Ds.
The allegations of the DG-GSTI are, therefore, unsustainable in law.
4. Jurisprudence
In CCEx & Cus vs Bharat Forge Limited 6, the Mumbai CESTAT relying upon co-ordinate bench decision held that the Appellant was merely making forgings according to the "dimensions" provided by the buyer, and hence the value of dimensions are not to be added as additional consideration.
The Kolkata CESTAT in CCE vs Tata Motors & Ors. 7 8, dissuaded from following the order of Bharat Forge supra, for it being very short and passed in the light of earlier valuation rules. The Tribunal itself though didn't adduce much ground for enhancing the value on account of dimensions other than noting that dimensions are not simple drawings but contains technical details of components.
In Technoweld Alloys (India) Pvt Ltd vs CCE 9, the Appellant argued that, they had not used the drawings provided by the buyer, so as to exclude additional valuation under Rule 6 ibid. The Tribunal, however, held that the contract between the parties stipulates that the manufacturer had to use the drawings provided by the buyer for making goods, hence prima facie the value under Rule 6 ibid is liable to be added. Nonetheless, the Tribunal seemed to principally agree that use is important.
Clause (b) - sub clause (iv) of Rule 10 (1) of Customs Valuation (Determination of Value of Imported Goods) Rules, 2007 is a provision akin to clause (ii) of Explanation 1 to Rule 6 ibid. 10 In the context of "specifications", important tests were formulated in the case of M/s Dabhol Power Company (DPC) by the adjudicating Commissioner of Customs, Pune. The tests were subsequently approved by the Hon'ble Delhi Tribunal 11.
The Appellant DPC had imported plant and machinery for LNG facility from one foreign vendor (EEPC). Another contract was entered with another overseas service provider (EPC) for developing designs and engineering for the plant and machinery. DPC took the plea that service contracts with EPC related only to formulation of specifications, which is separate from drawings and designs required for manufacturing the plant and machinery and fell outside the purview of Rule 10 (1) (b) (iv) 12 ibid. DPC contended that these formulations were to be merely passed on to the manufacturers, relying upon Commentary on GATT Customs Valuation Code13.
The Commissioner ceded that, "while specifications will not form part of the valuation to the extent they are an appropriate way of telling the manufacturer the specifications of what is being ordered, nevertheless it should be deemed of the part of the production process if engineering or drawing goes further."
[Emphasis Supplied]
Analysing the factum of the things, the Commissioner loaded the value of service contracts on the following grounds -
- That specifications were not restricted to merely conveying the design and engineering specifications, but extends further to the very development of equipment.
- The co-ordination between service providers and manufacturers was humongous, that there was continuous review process to arrive at correct designs.
- The manufacturer couldn't make the equipment without the specifications being developed by the service provider.
The Tribunal concurred with the above view and upheld that specifications were so detailed that they were necessary for manufacturing of equipment. The Tribunal also held that services that had no impact on the production process and are not includible in the value of equipment.
5. Rule of Thumb for loading: Importantly, the Tribunal also held that since entire value of includible services cannot be loaded into the value of goods, as rule of thumb, 50?n be estimated to be relatable to the equipment.
The ruling as above further indicates that, to load value under Rule 6 ibid, it must be established that -
(1) Specifications were absolutely necessary for the component manufacturers to build T&D
(2) The level of interaction between the specification supplier and the manufacturer of T&D also needs to be analysed.
In the opinion of author, if the component manufacturers are able to exemplify that specifications are not absolutely necessary for manufacturing T&D, the application of Rule 6 ibid could be escaped. It also appears that the level of interaction between GC and the component manufacturers is next to nil, therefore, the DPC case supra could be ably distinguished.
6. Absence of valuation mechanism
The demand under SCNs received by component manufacturers is calculated on the basis of "total royalty"paid by the OEM to GC, as a percentage of the cost of material consumed by OEM. The percentage is then applied on the total sales by component manufacturer to OEM, and excise duty is calculated on the same.
In the opinion of the author, the valuation proposed by revenue is erroneous. The royalty paid by OEM to GC is on account of a consolidated license to manufacture and sell. Even if it is assumed for a moment that some proportion is to be applied over DDS, the maximum of which cannot exceed "significance of DDS in the component value". The 100% application of royalty over DDS is grossly unjustifiable.
In Commission of C.Ex. vs Wintac Limited 14, the Bangalore CESTAT had held that where the life of the technical knowhow was perpetual, the valuation cannot be applied over the goods due to lack of proper mechanism.
Moreover, the derivation of value of DDS should be in sync with the technical evaluation of the same. The derivation based on royalty has no legs, inasmuch as DDS are prima facie not qua royalty agreements. Furthermore the DDS may differ from SKUs to SKUs, from one model of vehicle to another etc. Even further, the royalty appears to be perpetual and co-relation with DDS is next to impossible. The ratio of Wintac Limited supra squarely applies in favour the assessees.
7. Non Exclusivity of the DDS
OEMs outsource manufacture of one particular P&C (and its corresponding T&D) to multiple vendors. The DDSs, therefore, are seldom exclusive for a vendor.
Owing to the non-exclusiveness of the DDSs, the component manufacturer may also explore additional ground where it could be contended that DDSs are sunk costs and non-attributable towards the manufacturing value addition at their end.
8. Other grounds
+ Limitation
+ Revenue Neutrality
It is earnestly hoped that the CBIC is consulted on the issue by the authorities concerned and a positive clarification is put out so that the manufacturers heave of sigh of relief and concentrate on their business rather than expend their energies in dealing with ghosts from the bygone era!
(The views expressed are strictly personal.)
1 Rule 6 ibid in such situation stipulates that value of additional consideration flowing directly/ indirectly from buyer to the manufacturer is to be added into the value of goods.
2 T&D are enabler of P&C, so the specifications of T&D are in effect specifications of P&C
3 The customer may have procured the measurement from some other tailor.
4 1989 (43) ELT 165 (S.C.) =2002-TIOL-287-SC-CX-LB
5 2012 (286) ELT 0046 (Tri.-Del.)
6 2000 (122) ELT 0169 (Tribunal)
7 2009 (237) ELT 0147 (Tri. - Kolkata) = 2009-TIOL-241-CESTAT-KOL
8 Also followed in HIND AUTO PVT. LTD. AND ORS. VERSUS COMMISSIONER OF CENTRAL EXCISE & SERVICE TAX, RANCHI, Appeal Nos. EA-241, 244-246/10, E-694/2010 (Kolkata Tribunal)
9 Order No.- STAY ORDER NO.806/12 (Chennai Tribunal) = 2013-TIOL-591-CESTAT-MAD
10 Although customs provisions do not stipulate for qualification of consideration for invocation of Rule 10 i.e. Rule 10 applies in rem
11 Dabhol Power Company vs Commissioner of Customs, Pune 2004 (171) ELT 0354 (Tri. - Del.) = 2004-TIOL-531-CESTAT-DEL
12 Then Rule 9 (1) (b) (iv) of Customs Valuation Rules, 1988
13 By Sherman and Glashoff, published by International Chamber of Commerce
14 2011 (263) E.L.T. 273 (Tri. - Bang.) = 2011-TIOL-296-CESTAT-BANG
This article was published in TIOL at the below link: https://taxindiaonline.com/RC2/inside2.php3?filename=bnews_detail.php3&newsid=36290
Special thanks to CA Madhukar N Hiregange and CA Manish Sachdeva for penning this article. For any further queries/comments please write to manishkumar @hnaindia.com & [email protected]