AUGUST 10, 2009

By Dinesh Kumar Agrawal, CA & Former IRS

PRODUCTION or processing of goods for or on behalf of a client as defined under section 65(19) of the Finance Act, 1994 (“Finance Act”) falls under the category of ‘Business Auxiliary Service’ (“BAS”) and taxable under section 66 of the Finance Act read with section 65(105)(zzb) thereof. However, any activity amounting to manufacture within the meaning of section 2(f) of the Central Excise Act, is excluded therefrom. This exclusion has been modified by the Finance Bill, 2009 to state that it would apply only if the activity results in manufacture of ‘excisable goods’. Both the words/phrases i.e. ‘manufacture’ and ‘excisable goods’ have been assigned same meaning as defined under section 2(d) and (f) of the Central Excise Act, 1944 (“Central Excise Act”).

The Board vide circular No.334/13/2009 TRU dated 6 July 2009 has clarified that even if a process of manufacture is undertaken for the client, but the resultant product does not fall under the category of excisable goods, such as alcoholic beverages, the service tax would be attracted.

Till now, any activity amounting to ‘manufacture’ within the meaning of section 2(f) of the Central Excise Act was excluded from the purview of service tax. The Board vide circular No.249/1/2006 CXA, dated 27 October 2008 has clarified that 'manufacture' and 'excisable goods' are two independent concepts and that it is not necessary that a process amounting to manufacture within the meaning of section 2(f) of the Central Excise Act should always result in emergence of an excisable goods and vice versa. A process amounting to manufacture under section 2(f) but not resulting in emergence of an excisable product was excluded from BAS, thus, just because the Central Excise Act does not extend to the manufacture or production of alcoholic beverages meant for human consumption, it cannot be said that the term 'manufacture' used in BAS would also not cover the process of making the said product, namely, alcoholic beverages.

The Central Government by amending the definition of BAS has created a nexus between manufacture and emergence of excisable goods. Now, all contract manufacturers of alcoholic beverages and medicinal and toilet preparations containing alcohol, opium, Indian hemp and narcotic would be exigible to service tax as these goods are not excisable goods under the Central Excise Act.

With the enactment of Finance Act in the year 1994, the Central Government derived its authority from the residuary Entry 97 of the List I of Schedule 7 (“Union List”) of the Constitution of India (“Constitution”) for levying tax on services. The legal backup was further provided by the introduction of Article 268A in the Constitution vide Constitution (Eighty eighth Amendment) Act, 2003 which stated that taxes on services shall be charged by the Central Government and appropriated between the Central Government and the States. Simultaneously, a new Entry 92C was also introduced in the Union List for the levy of service tax. Entry 84 of the Union List empowers the Central Government to levy duties of excise on tobacco and other goods manufactured or produced in India. Entry 51 of the List II of Schedule 7 (“State List”) of the Constitution empowers State Governments to levy duties of excise on the alcoholic liquors for human consumption, opium, Indian hemp and other narcotic drugs and narcotics goods manufactured or produced in the State and countervailing duties at the same or lower rates on similar goods manufactured or produced elsewhere in India.

Article 246 of the Constitution provides that the Parliament has exclusive power to make laws with respect to any of the matters enumerated in the Union List and the Legislature of any State has exclusive power to make laws for such State or any part thereof with respect to any of the matters enumerated in the State List. Accordingly, section 3 of the Central Excise Act creates a charge of central excise duty (“CENVAT”) on all excisable goods produced or manufactured in India. Further, section 3 of Medicinal and Toilet Preparations (Excise Duties) Act, 1955 [“MATP”] creates a charge of excise duty on medicinal and toilet preparations containing alcohol. All State Governments of union of India has enacted state laws to levy state excise duty on potable alcoholic liquors, opium, Indian hemp and other narcotic drugs and narcotics goods. For example, section 105 of the Bombay Prohibition Act, 1949 (“Bombay Act”) levies a excise duty or countervailing duly on import, export, transport, possession, manufacture or sale in or from the State on alcoholic liquor for human consumption, intoxicating drug, hemp, opium and any other
specifies excisable article.

It is worth mentioning that processes amounting manufacture within Central Excise Act are excluded from BAS, as these process are chargeable to CENVAT. However, in the amended provision, processes amounting manufacture within State laws and liable for state levies will be exigible to service tax. Similarly, processes amounting manufacture within MATP and liable for excise levies thereunder will be exigible to service tax.

At this point it is relevant to examine the State laws which levies state excise duty on potable alcohol. In terms of section 2(25) of the Bombay Act, ‘manufacture’ includes every process whether natural or artificial by which any liquor or intoxicating drug is produced, prepared or blended and also redistillation and every process for the rectification, flavouring, or colouring of liquor or intoxicating drug.

In catena of cases, the Supreme Court has held that processes resulting into emergence of a new article with a distinctive character and use amounts to manufacture. References can be made to Union of India v. Delhi Cloth & General Mills (2002-TIOL-12-SC-CX-LB) Tungabhadra Industries Ltd. v. Commercial Officer Kurnool, [(1961) SCR 14], Deputy Commissioner of Sales Tax v. Pio Food Packers, (2002-TIOL-67-SC-CT), Sterling Foods v. State of Karnataka, [(1986) 3 SCC 469], Kailash Nath v. State of U.P. [8 STC 358], Deputy Commissioner Sales Tax v. Sadasivan [42 STC 201], Swan Bangle Stores v Assistant SalesTax Officer, 25 STC 122], Stale of Andhra Pradesh v. Sri Durga Hardware Stores [32 STC 322]. Further, the Supreme Court has held that wherever law provides extended definition of manufacture, all such processes declared as manufacture in the respective law will be considered as manufacture.

Excise duty is levied upon goods manufactured or produced (Entry 84 of the Union List and Entry 51 of the State List). Incidence of tax is, therefore, manufacturing, which is a valued added tax. On the other hand, service tax, as per amended provision, is also on production although on behalf of a client. Incidence of tax in this case is, therefore, manufacturing which is again a value added service. Therefore, there are two distinct levies on same activity i.e. manufacture. In both the cases, incidence of tax falls on manufacturer.

The Parliament derives its power from the Constitution to legislate with respect to any matters enumerated in Entries 1 to 97 of the Union List. Before exclusive legislative competence can be claimed for the Parliament, the legislative incompetence of the State Legislature must be established. The Parliament cannot legislate on matters enumerated in the State List and the State Legislature can not legislate on matters enumerated in the Union List. In the present case, the Parliament seems to be legislating on a subject enumerated at Entry 51 of the State List for which State Legislature alone is competence to legislate.It is evident that the Parliament is neither competent to legislate on matters pertaining to the production, manufacture, possession, transport, purchase and sale of intoxicating liquors [Entry No 8 of the State List] nor competent to impose tax on any process amounting to manufacture or production of potable alcoholic liquor. The proposed impost is ultra vires to the constitution and on challenge by the liquor manufacturer likely to be declared so by the High Courts. Levy of service tax on manufacturing of Medicinal and Toilet Preparations will amount to double taxation on same incidence of manufacture and therefore it is also likely to be declared ultra vires to the Constitution of India.

(The author works with Khaitan & Co)

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