AUGUST 13, 2013

By S K Rajagopalan

VALUATION of the manufactured goods for the purpose of collection of central excise duty has been a thorny issue throughout.More often than not, the department found that the assesses were finding new ways and means to reduce the price of the article declared to the department in order to reduce the incidence of duty on the same. Although the price declared to the department was less, the actual price collected was always more than that. These practices took various shapes such as collection of differential amount in cash by issue of debit notes, supplementary invoices, higher prices collected through depot sales, sales through related and connected companies, collection of extra amounts in the form of 1 st year or 2 nd year warranty charges, Pre delivery inspection charges etc. Further, certain expenses such as advertising, sales promotion etc.were loaded into dealers commission or allowed to be incurred by the dealers on behalf of the manufacturing companies etc. This was nothing but additional consideration allowed to dealers who took up the responsibility of advertising on behalf of the main company.

One of the main modus operandi adopted by the assesseeswas sales through related persons or related companies which thereafter passed on the extra money collected to the parent unit. Another novel modus operandi was in the form of fictitious fixed deposits from the dealers which were never returned to the dealers. The amounts thus collected were pooled into one of the companies situated in one of the metropolitan cities and thereafter transferred to the main manufacturer. Further some companies insisted that the dealers pay a donation of the differential amount to a charitable institution established by the owner or Director of the manufacturing company. Another unit manufacturing ceramic tiles collected the extra amounts in the guise of “tile laying charges” which was never done. In such situation, the price charged in the invoice raised was not the sole consideration for the manufacturer.

To arrest the revenue leakage in such a manner, the department went in for some legislative changes.

The legislative changes inter alia included the amendment of Section 4 of the Central Excise Act which prescribed that when the goods are sold to a related person and where the price is not the sole consideration and the goods are sold by such related persons for a higher consideration, the price at which the goods are sold by such related person was to be treated as the assessable value for the purpose of collection of duty. To achieve this objective, the word “relative” was to have the same meaning attached to it under Section 2 of the Companies Act, 1956 which listed various blood relatives as related persons. These relatives were mainly blood relations of the owner/director of the manufacturing company. Certain companies so arranged the sales of the goods that it was sold by companies held by related persons such as wife, sons, daughters, brothers in law, sisters-in law or the sons or daughters in law of the manufacturers. Such a wide definition borrowed from the companies act could cover the price adopted by such relatives and the leakage of revenue was arrested to some extent.

As already stated, certain companies in order to avoid payment of correct duties which sometimes was of the range of 105% loaded the expenses in the form of warranty charges, dealer commission, sales promotion expenses and advertisement expenses on the account of dealers and thereby shown reduced cost of manufacture and thereby reduced the incidence of duty. To overcome this, the department started loading such expenses on the assessable value for demand of duty after thorough investigation of the nefarious activities indulged in by the assessees. This, many assesses claimed are post manufacturing expenses (PME for short) and cannot be part of the assessable value. Various disputes arose in this regard and SCNs came to be issued. The dispute reached the Apex Court in the form of case of M/s Bombay Tyre International Ltd. Vs. UOI 2002-TIOL-374-SC-CX . The Court, in their judgment decreed that the expenditure towards, advertisement, sales promotion etc., which enhanced the intrinsic value of the product in the market, were to be included in the Assessable value. The trade and commodity discounts which were made known to the customers before sales, freight and insurance etc., have to be excluded from the assessable value. This judgment was a morale booster for the department.

The legislative changes as above lead to several incongruous situations. The department went on demanding duty even when two different units could not be termed as relatives due to the separate corporate identities. This was overcome by the Apex Court [Calcutta Chromotype Ltd. 2002-TIOL-370-SC-CX ] where it was held that if the companies indulged in evasion of duty by hiding themselves under the corporate identities, the corporate “veil” could be lifted to bring out the real intentions behind such creations and the duty escaped could be demanded.

Another important observation of the courts in this regard was that even if the companies are related persons by way of blood relationship, the price adopted by the related person could not be adopted as assessable value unless the department had established the fact of “mutuality of interest” in the business between the parties concerned and the flow of funds from one to another.

The situations as above prevailed till the department was adopting the mode of requiring the assessees to file price lists with the department before clearance of the goods and adopting the price approved by the department. The department was expected to take into account the extra expenses incurred, gains by way of accounting methods such as debit notes and credit notes etc. The department also resorted to provisional assessment of value under Rule 9B of the Central Excise Rules, 1944 and finalization of the same after scrutiny of the annual Balance sheet and statement of accounts of the company including obtaining a Chartered Accountant's certificate.

Finding that several changes made in Section 4 and the judgments given by various courts including the Apex Court did not deter the assesses from resorting to novel methods of undervaluation, Govt. Introduced a major reform in valuation under the Central Excise Act in the year 2000. The old Section 4 was thrown lock, stock and barrel to the dustbin and a new section 4 was introduced in the Finance Act, 2000. A new concept of “transaction value” was introduced. This concept meant that the value adopted in each invoice was the assessable value in so far as the goods involved in that invoice. This concept was earlier practiced for the demand of duty for the items covered under Tariff Item 68 of the erstwhile Central Excise Tariff. Such goods were assessed to duty on the basis of invoice value under notification “120/75”

It was found that not only the related persons had created havoc in the collection of correct duty, but also inter connected undertakings which were created only with the view to undervalue the products of the main undertakings and sell the goods in the market at a higher price and thereby evade central excise duty. “Inter connected undertakings” were already defined under the Monopolies and Restrictive Trade Practices Act, 1969. These companies connected to each other through relatives and associates had formed a cartel and had exploited the customers through pricing of the products and also by preventing others from marketing similar goods and even compelling the customers to buy another unwanted product while purchasing an essential product like LPG connection etc. Since these practices had hampered healthy competition, these companies were subject matter of disputes with the Monopolies and Restrictive Trade Practices Commission (MRTPC) established under the MRTP Act. Revenue Department found that the elaborate definition of “inter connected undertakings” under section 2(G) of MRTP act was a convenient concept for charging theassessees when they indulged in undervaluation by adopting such methods. Therefore, the concept of “inter-connected undertakings” was borrowed from the MRTP Act, 1969 and brought under section 4 of Central Excise Act although the definition depended wholly on the definition of the same under the MRTP Act. This concept was introduced in the new Section 4 of CEA which was brought into effect from 1.7.2000. The definition of the word “relative” was retained as that of same under the Companies Act.,1956.

To delve deeper into the concept of inter connected undertakings one has to look into the wide definition which was prevalent in the MRTP Act. In fact, this is one of the most exhaustive definitions in the Act. It covered the entire gamut of such activities indulged in by the companies in order to form cartels and price control mechanism. It not only covered the undertakings which were controlled by relatives of the main companies but also associates who had stakes in the matter. The entire rules of the game followed by the assessees were covered under this definition. The control of stakes, control of the companies directly or indirectly by directors, partners, trustees, and any other person in this regard was covered. Even direct or indirect control by persons having no direct stakes in the companies was also covered.

In view of the above, the bringing in of the concept of “ inter connected undertakings” into Section 4 of the Central Excise Act, was a needed reform along with the concept of the of the word “relative” under the same section. The department was armed with a new weapon to fight the menace of undervaluation. The reform did not last long. The MRTP Act, from where the definition was brought into CEA, 1944 went into oblivion with the enactment of the new “Competition Act, 2002”. This act was notified in the Gazette on 13.1.2003. Under section 66 of the new Act, the old Act was repealed and the definition of the words “inter connected undertakings” also died a natural death along with the act. This Act was challenged by the stakeholders in the Supreme Court of India and the Apex court gave its clearance to the Act after striking down certain sections. The Act was further notified after effecting amendments in the year 2007. The only change in Section 66 was that the MRTPC was allowed to continue to hear cases filed in it prior to the repealing of the MRTP Act in 2003 while transferring the cases after repeal to the newly established “Competition Commission of India”. The MRTP Act was thus repealed in 2003 itself. It is significant to note that the definition of “inter connected undertakings” was not brought into the Competition Act which was the successor to the MRTP Act, so, it was nobody's case to argue that the definition was an issue alive even after the repeal of the MRTP Act.

The CBEC appeared to have missed this landmark enactment inasmuch as the definition of “inter connected undertakings” under Section 2(g) of the repealed Actcontinued merrily in Section 4 of CEA.The very fact that the whole definition as was available in the dead MRTP Act, was brought verbatim into Section 4 in 2012 proved that it had dawned on the department about the legal vacuum that was existing in the statute from 2003 to 2012.

The sad part of this episode is that the legal vacuum which was too conspicuous by its presence in the Central Excise statute was not at all recognized by the legal luminaries practising Indirect tax laws and brought to the notice of the department. Indeed in case they had done so, the department would have taken immediate action as in the case of the service tax where the major absence of charging section was corrected on the basis of an article in Taxindiaonline.The legal pundits were thus blissfully unaware this lacunae. All of them appeared to be under the impression that the definition of the words “inter connected undertakings” borrowed from the already dead MRTP Act was sufficient to charge the assessee.

For CBEC, it is history repeating itself. CBEC has been studiously following CBDT and followed their footsteps although belatedly. The concept of equal penalty was there in Income Tax Act, much before it was brought into Excise and Customs Acts in the year 1996. Similarly, charging of interest was also borrowed from the Income Tax Act, and was brought into Excise and Customs Act, only in 1996. The Income Tax Appellate Tribunal was established in the year 1963 and the equivalent CESTAT was brought into existence only in 1982. The provisions for Settlement was brought in Income Tax Act, in 1976 and brought into Excise and Customs in the year 1998 only although the proposal was part of Budget Speech in 1992. The Authority on Advance Rulings was brought in Income Tax Act in 1993 and the same concept was brought in by CBEC in Customs and Excise in 1998 only. Further, the above said provisions brought into Customs and Central excise Acts were almost carbon copy of such provisions in the Income Tax Act but for a few changes here and there.

It is high time that the department wakes up to create a separate vibrant legal unit to identify and bring about legislative changes that are imperative and necessary. CBEC has to provide at least correct legal framework for the field officers to follow. No worker can work with imperfect tools. It would be in the best interest of the department if some of the officers who are at the “cutting edge” level of the department are also associated with such an exercise. This core group, like TRU should be a permanent body and should consist of several level officers including those at the cutting edge level. After all, Revenue enactments depend upon various Acts and authorities to implement the revenue provisions to legally and correctly collect the tax due. All the new Acts and the amendments enacted should be brought to this core group to find out the changes made in the original acts and suggest changes in the Excise and Customs and Service Tax Acts. This group should not be big and unwieldy. If that is the case, it would end up resulting in “too many cooks spoil the broth” syndrome.

I hope that the suggestions given above would be taken into account and implemented by the department.

(The views expressed are strictly personal)