The Indirect tax judgments that need amends

Some judgments are timeless. For their infinite intellect, the decisions serves as bible for the Courts to come and legislator to penetrate. Some others however need to go with the lapse of time, for that they are not needed anymore or for their inherent flaws.

The present piece examines some of the rulings by the Hon’ble Supreme Court rendered in the context of earlier indirect tax laws, which are in dire need of correction in as much as their extrapolation on the GST code is imminent and the new regime does not need any defective protocol. This means that when we rely on the decision discussed in this article, we need to know that they cannot be relied on fully.

1. The Fiat Ruling[1] – what’s your price?

The Central Excise law had abandoned the ‘normal price’ valuation mechanism in 2000 with the hope that it would be just one of those steps towards the VAT regime. Fiat needed customers, so it sold the manufactured cars at a price below its manufacturing price and paid the corresponding excise duty. The issue before the Court was fairly simple, whether the margin between the sale price and the cost was required to be added to the valuation for the purpose of excise duty or not. The Supreme Court came to a bizarre conclusion that ‘market penetration’ is an additional consideration (in kind) for sale of goods, and the margin had to suffer the extra excise duty.

The rigor of this judgment was corrected by putting necessary provisions in the then Rule 6 of valuation rules[2], for the obvious reasons that even the government was effectively persuaded by the trade of its unreasonableness. The catch in the GST regime is that, although Section 15 of the CGST Act[3] pegs transaction value at the same parameter [sole consideration] as was the case in Central Excise, however, there is no like for like proviso to Rule 6 in the GST valuation rules. This leaves the floodgates wide open, and with revenue needing funds, the next step is for anyone to guess.

The problem with Fiat ruling is not that it deems some reciprocal activity by a recipient as additional consideration, since this is also an acceptable practice in the EU VAT[4], but the fact that an activity [market penetration] prompted by the supplier being treated as an activity done by the recipient is far too exaggerating. The recipient has no clue what is happening, he is not too concerned with Fiat’s cost, he is not obliged to promote the car to any-body. Therefore market penetration, if at all was embedded in the activity done by the supplier and not the recipient. If the principle of Fiat ruling is accepted then every client of Chartered Accountants would become a service provider.

It also needs to be appreciated that under Central Excise the levy was attracted on manufacture and removal whereas in GST it is on supply which happens till the goods are finally sold to the consumer. Further that the concept of “intrinsic value” which was applied in central excise and customs maybe a misplaced concept in GST and focus should be to capture the real transaction value. It is looming that the dispute on the valuation of supply of goods (services) at price lower than manufacturing cost would come before the Apex Court someday apropos GST, and is incumbent upon the Court to modify the Fiat ruling principle to the only recipient induced market penetration and nothing beyond.

2. The Prestige Engineering[5] – who’s the jobber?

The central excise runs through the times when there was an acute imbalance between large and small business segments. While small sector could not be brought within central excises’ purview for its rigors, it was necessary to impose multiple rigors upon the large sector to curb the manipulation. In Prestige Engineering (India) Ltd., the question before the Apex Court was to distinguish ‘job work’ from ‘manufacture’ so that the manufacturers who made the product do not escape excise duty [reckon that job work was exempt, but manufacture was taxable].

The Court while distinguishing ‘job work’ from ‘manufacture’ postulated the formula of goods contributed by the job worker. It was held that the job worker is a person who contributes mainly their labour and skill done with the help of tools, gadgets, or machinery, but can add or apply only minor items.

The judgment made sense back then, a time when job work was a way to avoid excise duty by diverting the profits to an (almost) trader. But the rationale made little sense with the cycle of time[6], and it completely became devoid of continuity once valuation rules were amended[7] to put an ultimate stop to the abusive practices. In today’s environment, the “job work” of Notification No. 119/75-CE is a far cry from what an automotive OEM, a pharmaceutical giant, an in-house power producer, a textile exporter, a developer of real estate or a steel plant maker needs from his job worker.

Today’s there is very little for a job worker [in connivance with the Principal] to make any attempt to avoid taxes[8], more so when the job work activity is itself amenable to tax. It is therefore needed for every smaller Court to distinguish Prestige Engineering in every job work dispute ruling in favour of a transaction being a job work unless mala fides are established till the Apex Court ultimately quash the whole basis. The AARs may follow suit afterward[9].

3. Associated Cements – the intangible shoot

In Associated Cement Companies Ltd.[10], a customs duty case, the Apex Court held that as and when an intangible information or advice is put on a media, whether paper or diskettes or any other thing, then it becomes goods. Further considering the scheme of customs valuation ruled it was observed that the value of product inter alia includes its intellectual value. Accordingly, the value of the collaboration contract [essentially the value of services] was added in the value of drawings/ diskettes. Expectedly, in TCS case, the status quo of intangible software was also confirmed as goods.

Without going into the potential infirmities in the decision its general acceptance paves the way for several distortions. The WTO’s moratorium on non-imposition of customs duties on electronic transmissions gets effectively defeated so long as the source code is not importable otherwise through a disk/ media. With respect to levy of GST, there is a dichotomy as to permanent transfers of intangibles, namely where situs falls, if at all those are to be considered as supply of goods.

The policy distortions aside, the judgment also could open a back door entry for the inclusion of services charges that are not includible by virtue of Rule 10 (1) (e) of the Customs valuation rules for the mere reasons that they could be associated with a physical media.[11] Luckily, there is a positive Chennai Tribunal ruling[12] holding that charges for post importation activity are not includible distinguishing the ACC case. To collate and put an end to all associated issues relating to intangibles, the judgments need to be modified, of in GST valuation issues said to be differentiated so as make the tax environment definitive, rather than speculative.

4. GS Auto International[13] – parts of the vehicle

The Central Excise Tariff schedule got revamped upon the adoption of HSN in the year 1986. The next 15-20 years were supposed to be a transition phase for the classification related disputes. Coincidently, the Tribunal orders[14] of classification of nuts and bolts in the context of the old schedule and new schedule were clubbed together and combined order was passed in G.S. Auto International Ltd. case. The Apex Court first resolved the conflict between entries in the old schedule based on commercial parlance test (relying upon its previous judgments). In the rhythm however, even under the new schedule, the classification of parts of the vehicles was modeled on the basis of “sole or principal use” test.

The classification of goods as parts or accessories of vehicles is subject to three exclusions [1] specific coverage in other chapter/ headings [2] not solely or principally usable with the vehicles [3] not covered by the schedule otherwise. The Court confirmed the classification of nuts and bolts (and alike) only on the basis of 2^nd test.

Over the years, the Tribunals[15] and even the Apex Court[16] understood the correct choreography of HSN vis-à-vis parts and accessories. Unfortunately, however, GS Auto decision was never specifically distinguished or over-ruled. When the central excise duty rates became homogenous for the competing chapters, the field formations succumbed to indolence, but the rate structure in GST[17] has surely rekindled their interest.

The GS Auto International decision never made sense, not then, not now. The parts conflict rests on strength of the sector, in the wisdom of the government, a car consumer needs to pay GST @ 28%, and therefore the parts that are required for manufacturing of car should also be taxed at 28%. But, what if that part is not car specific but can be used in a variety of machines, that part should be ousted from CTH 8708, and crucially that’s what the whole job of exclusion tests is. It is therefore hoped that when-ever GS Auto decision is reviewed, or a similar dispute reaches the Courts, it would be over-ruled to the extent relevant to the new schedule.

5. ITC Limited – the ceremonious challenge to assessment

The decision is fairly new as compared to the others listed herein, but deserves attention for it being too contagious in the realm of taxes. Before the year 2011, the judgment in Priya Blue Industries Ltd.[18] held the field wherein for any refund of the customs duty, the importer was required to challenge the assessment. In the year 2011, the Customs Act turned to self-assessment and the government thought it fit to delete “in pursuance of an order of assessment” in Section 27 of the Customs Act, 1962.

However such amendment was not found convincing by the Apex Court in ITC Limited[19] wherein it was held that even a self-assessment is an assessment and so long it is not challenged, the refund cannot be preferred straightway. The cardinal principle of the judgment stemmed on the premise that provisions of refund are more or less in the nature of execution proceedings and the officer adjudicating the refund is not competent to make a fresh assessment.

The consequences of the judgment could be chaotic [1] it forces ceremonious filing of the appeal, when the merits can straight away be considered in the refund proceedings [2] the tightened limitation period for the importer [3] threatening the very existence of show cause notice limitation at department’s end[20]. There would be anarchy if the ratio of this judgment is applied in the GST context, therefore better that a larger bench make amends this decision.

6. SAIL – the time loop

Some debates just do not end, no matter what regime they answer to, always stuck in the time paradox. The upward price revision of a sold commodity does attract additional tax. But does it also attract the interest for the time gap, the question was answered by the 3 member bench of the Supreme Court in Steel Authority of India Limited[21] after reference from a 2 member bench which doubted an earlier 2 member bench judgment decision.

What followed was a lengthy discussion on the historic treatment under the VAT regime of the issue, the inter-relationship between removal and assessment, etc. But the majority logic of the upholding the leviability of interest on excise duty on time gap (via supplementary invoices) was compared with the provisional assessment. It was held that if the provisional assessment of excise duty calls for interest upon finalization thereof, why regular assessment be given any special advantage. The “unforeseen-ability test” in J K Synthetics decision and the “crystallization test” in the income tax judgments was held not applicable.

The decision casts serious doubts on the small sector which for real operate on ‘interest equivalent margins’, and to the misery, the field formations are not only imposing a penalty on interest component but also invoking the larger period of limitation for the excise regime demands. A decision so formed after already being doubted is unlikely to be reviewed but it is for the bare minimum to distinguish the same in GST context. In the words of Lord Mansfield, the law should follow the trade and not vice versa as the law needs to serve the creators of wealth.

7. Ind-swift Laboratories – the interest saga

In Ind-swift Laboratories Limited[22], the Supreme Court reversed the order of the Punjab & Haryana High Court which had read down the word “or” as “and” in the context of erstwhile Rule 14 of the Cenvat Credit Rules[23]. In essence what it meant that interest on Cenvat Credit can be sought even for the period when wrong Cenvat Credit was ‘unutilized’.

A revenue favourable judgment often results in opening up of the callbook, draft a template show cause notice and book the assessee on the plank of the judgments. The ironic thing about the judgment was that it emanated from the facts Cenvat Credit on fake invoices. The Hon’ble Karnataka High Court in Bill Forge Pvt. Ltd.[24] smartly distinguished the judgment in bona fide cases where the incorrect Cenvat Credit was reversed before being utilized.

To illustrate Cenvat Credit of INR 100 availed on 01 Jan 2009 [1] In the first situation it was discovered that such Credit is irregular, therefore it was reversed on 1 May 2009, and till such time such credit was not utilized at all [2] In the second situation the Credit was utilized for payment of output excise duty in the clearances of March 2009. The first situation is covered by Bill Forge and the assessee need not any interest on INR 100, but the second situation is covered by Ind-swift laboratories and the assessee cannot seek interest waiver for the period between Jan to Mar, even when such credit remain unutilized.

Both the judgments operate in separate fields and the issue is likely to resurrect in as much as Section 73 and 74 of the CGST Act has used pegged the irregular availed ITC in pre 17 March 2012 viz. “availed or utilized” apropos ITC under GST. With that in mind, the Ind-swift judgment in the GST context needs better distinguishing features like bona fide and mala fide purchases, the technological/ portal deficiencies, the ITC taken under protest, etc. Those relying on the proviso to Section 50 (1) of the CGST Act may have to re-think given such proviso do not appear to cover the factual position of irregular ITC, but of course, Patna High Court decision in Commercial Steel Engineering Corporation[25] may be fruitful to refer to.

8. Acer India Limited – parallel to transaction value

The transaction valuation method is a mystique, it’s not a definition of valuation in its classical sense but more of a context in which an acceptable valuation abide. While certain qualifications [related party, sole consideration] are specifically given which rules out a value from being transaction value, certain other qualifications are explicated by the Courts.

In Acer India Limited[26], the Hon’ble Supreme Court [3 member bench] was sieged of a situation where computer loaded with operational software was sold to the customer. The assessee prepared invoice for loaded computer [100], deduced value towards software [10] and charged excise duty on 90 because the software was non-dutiable. The Apex Court held in favour of the assessee observing that ‘10 is the value of non-dutiable goods’ and transaction value [Section 4(3) (d) of the Excise Act] is subject to levy [Section 3 of the Excise Act].

The remark was disputed by 2 member bench in Grasim Industries Ltd., for being contrary to another 3 member bench judgment in Bombay Tyre International[27] and matter was referred to 5 member bench to resolve the controversy. The 5 member bench in Grasim Industries Ltd.[28] reconciled the judgments by holding the ratio of Bombay Tyre that “valuation is not subject to levy so long there is a reasonable nexus between the two”, however at the same time holding that Acer India judgment is not contrary in as much as valuation qua non-dutiable goods can be excluded from the composite transaction value.

The conclusion is that the judgment in Acer India persists qua transaction value and a deserving case would definitely face the dichotomy of Acer India and Section 8 (a) of the CGST Act [composite supply]. A children’ crayon kit [9608 – 12%] with incidental coloring textures [4903 – Nil] is sold as a package and may qualify as a composite supply under Section 8 (a) with 12% GST on the entire package.

The catch is that Acer India judgment permits deduction of valuation towards non-taxable goods and charging of 12% GST on the entire package directly hits this judgment. The question of bifurcating point between Section 15 (2) (c) of the CGST Act and Section 8 is already a vexed issue and this judgment boils fuel to the fire. Simply put, Acer India judgment seems to have no place in GST, but before it gets mis-utilized (before the Tribunals), it needs to be distinguished.

9. Bharat Pest Control – transferring the consumables

The Apex Court in Larsen & Toubro Ltd. [29]articulated the meaning of transfer of property goods ‘in some other form’ in a works contract to be so expansive such that it includes all those goods which even ceased to be chattels while being attached or embedded to earth.

But as the case with works contract is over the years, the controversy just never ends. In Bharat Pest Control[30], the Gujarat High Court held that ‘in some other form’ must the bare minimum be transferred, if the property in goods is not at all transferred such as the case of consumables, the provisions of works contract are not attracted. However, the Supreme Court in revenue’s appeal[31] nixed the question of whether the property in consumables at all constitutes the transfer of property in goods, and instead assuming that property in goods is transferred went on quote paragraphs from L&T case supra.

The ratio in Bharat Pest Control lacks confidence in as much as the status quo of consumables as transferable goods was not deciphered but merely assumed. In fact, the misconception of “consumables vs transferrable goods” in a variant form is traceable to judgment in Rainbow Color Lab[32], where photography services were held as not works contract. The decision which was subsequently over-ruled in BSNL judgment[33] but again on the pretext of irrelevancy of dominant intention post 46^th Constitutional Amendment, without actually deciphering the real issue. Recently in a controversial ruling in MIOT Hospitals Ltd., [34]the Madras High Court also succumbed to this farce, but the silver lining is the Delhi High Court judgment in VPSSR Facilities[35].

Unlike all the judgments quoted as above Bharat Pest Control directly hits the works contract definition in Section 2 (119) of the CGST Act to the extent of the meaning of ‘some other form’, and is a dangerous precedent. This judgment hits the entire road/ building repairs activity, remember S. No. 3 (iv) of rate notification for concessional rate, only covers ‘works contract’ and not ‘service simpliciter activities [construction, erection, commissioning, installation, completion, fitting out, repair, maintenance, renovation, or alteration]. To resolve the controversy once and for all, the judgment needs correction.

10. 20^th Century Leasing Finance Corpn. Ltd. – need of a better situs

In 20th Century Finance Corpn. Ltd.[36], the question arose as to the fixation of jurisdiction apropos levy of sales tax when there was conflict between the competing legislatures as to the right to tax transfer of right to use machines. The Court expounded certain principles with respect to situs [1] the legislature can by deeming fiction and fix the situs of the taxable event [2] where the taxable event is also a matter of general law (sale of goods), then situs should be determined as per that general law [3] where the taxable event is a deeming fiction (transfer of right to use the goods), and the goods are available for delivery then situs is where such transfer happens viz. where the contract is executed.

In the context of GST, the situs dispute is foreseeable on two counts [1] Taxability of the transaction on the counter-argument of taxability being extra-territorial [2] Distribution of tax between the States, which State gets fruity of GST component. Needless to say, that place of supply is defective rules at least to the extent of intangible goods which unlike the services, do not have a residuary clause for place of supply[37]. In the case of permanent assignment of IPR/ Duty credit scrips[38], different courts have used different principles[39].

The judgment still prevails on first principles, but its precedent value seems to have lost under GST in as much as POS has replaced the ‘outside the state’ and ‘inter-state principles’. The situs determination principle of the 20^th Century may or may not be a good one depending upon what the IPR turns out to be, goods or services. On the other hand mobilia sequuntur personam doctrine was used by a South African Court in place of supply dispute concerning permanent extinguishment of incorporeal rights[40], however, the US Courts have rejected this principle in the sphere of taxation statutes. It is therefore important that before things get awry, the Court to go down the helm of 20^th Century Finance Corp. and re-calibrate the situs principle with the place of supply rules.

11. Dharmendra Textiles and Rajasthan Spinning – a lethal combination

In Dharmendra Textile Processors[41] (D’s case) the larger bench [3 members[42]] of Supreme Court held that in a case involving short paid taxes on account of fraud, wilful misstatement, and suppression cases (mala fide) is mandatory penalty mens rea is irrelevant and penalty is imposable as stipulated in Section 11AC of the erstwhile Central Excise Act, 1944. A subsequent 2 member bench in Rajasthan Spinning & Weaving Mills[43] (R’s case) clarified the penalty is only invokable where elements of mala fide are established and not in all cases.

The Court in R case also went on to peruse the submission of Mr. Chandrashekharan, the then ASG, in D’s case. Two arguments were pressed by the ASG in his submissions (1) that mens rea was irrelevant and (2) quantum of penalty was fixed, the Court in D’s case had only concurred with the first argument, with no dicta on the second argument. In R’s case, however, after relying upon the ASG submissions (in D’s case) which were contrary to the submission of revenue on the first argument, the Court also upheld the second argument i.e. that there was no discretion for reduction of penalty in mala fide was upheld even when the same was not even the point of reference.

The twin judgments have been taken granted for in multiple subsequent decisions by various high courts[44]. In fact, the point has been again referenced before the Supreme Court[45], with decision pending. The brunt of these judgments would be seen in E Way Bill default cases, where even venial breaches attracts mandatory 100% penalties. The High Courts have recognized the venial breaches and have waived the penalties altogether, however, the question relating reduction of penalty commensurate to extent of breach is left open.

Years ago, the Apex Court in its very own words had observed that penalty for failure to perform a statutory obligation is a matter of discretion of the authority to be exercised judicially and on a consideration of all the relevant circumstances. Even if a minimum penalty is prescribed, the authority is justified in refusing to impose the penalty, when there is a technical or venial breach of the provisions of the Act or where the breach flows from the bona fide belief act of offender[46].

Section 129 of the CGST Act suffers from a grave infirmity in as much as it enforces a mandatory penalty of 100%/ 50%, even when the EWB lapses are venial or technical and in that regard, the twin judgments definitely need a re-visit, if not for cases couched by Section 74 of the CGST Act.

Conclusion

There is little left for a person to do when the final remedy before the Apex Court is exhausted which at present takes an inordinate period of time. And for that very reason, the sentinel has rarely let us down. More than once, it has rescued the individual against the State. The great jurist Benjamin N. Cardozo once said that few rules are so well established that they may not be called upon any day to justify their existence. But if they do not function, they are diseased and they must not propagate their kind. Truly does, in their own time the supreme judgments served their purpose, but with time glowing (and glooming), they must be step aside and pave way for better ones of their kind.

Thank You
Manish Sachdeva
[email protected]