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The Conundrum of Excise Duty on Drawings and Designs
Lalitendra Gulani (Palit & Co., Advocates & Solicitors)
Mr. Pallav Palit
‘Death and taxes! There’s never any convenient time for any of them’
- Margaret Mitchell, Gone with the Wind
The indirect tax structure underwent a tectonic shift on July 1st, 2017 with the advent of Goods and Services Tax (‘GST’) regime. The new regime has engulfed the entire spectrum of distinct levies, such as excise duty, service tax and value added tax. As the nation implemented the colossal regime, it was anticipated that new litigation under excise law will douse. However, the revenue recently has raked up a novel issue concerning excise duty on drawings and designs received by automobile component manufacturers from vehicle manufacturers. Before proceedings to the revenue’s assertions, it is pertinent to briefly outline the nature of transaction involved.
A single passenger car is made up of approximately 30,000 parts. The vehicle manufacturers in a bid to increase their efficiency undertake manufacture of only crucial parts, like engine and ECU. The manufacture of the other parts is predominantly outsourced to component manufacturers. The parts manufactured by such component manufacturers can be broadly classified into the following groups.
Group I |
Standard parts, such as nuts and bolts |
Group II |
Parts which are specifically made for a particular vehicle, but do not require any inputs from component manufacturers, such as plastic parts |
Group III |
Parts which are specifically made for a particular vehicle and require technical inputs from component manufacturers, such as gaskets and control arms |
The vehicle manufacturers issue specifications of the parts in form of 2D drawings and 3D models for the parts falling under Group II and Group III.
...The component manufacturers are required to make the requisite parts in line with the specifications received. It has been a standard industry practice that the specifications issued are on a free-on-cost (‘FOC’) basis and no additional value is assigned to the specifications or added to the assessable value of the manufactured part whilst discharging excise duty.
Post the onset of the GST regime, the Directorate General of Goods and Services Tax Intelligence (‘DGGI’) initiated investigations against several component manufacturers supplying parts to Maruti Suzuki India Limited (‘MSIL’). Subsequently, the DGGI issued show cause notices whereby it has sought to impose excise duty on the value of drawings and designs. The grounds taken by the revenue in these notices in support of the demand are summarized below:
- Section 4(1)(a) of the Central Excise Act, 1944 (‘Excise Act’) provides for adoption of transaction value only where the price is the sole consideration. The specifications, whether in form of 2D drawings or 3D models, received by component manufacturers from MSIL on FOC basis, formed additional consideration for sale of the manufactured parts;
- Rule 6 of Central Excise Valuation (Determination of Price of Excisable Goods) Rules, 2000 (‘Excise Valuation Rules’) provides for inclusion of additional consideration for determining the assessable value. The Explanation appended thereto specifically covers drawings and designs as additional consideration;
- MSIL remits a lump sum and running royalty to its parent company, Suzuki Motors, Japan for obtaining these drawings and designs. Thus, the same merits inclusion under Rule 6 of the Excise Valuation Rules for determining excise duty liability; and
- Reliance was placed on the case of CCE v. Tata Motors, 2009 (237) ELT 147 (Tri-Kol.)
It is noteworthy that an identical issue is already pending before a larger bench of CESTAT in the matter of Press Metal Industries, 2019 (4) TMI 322-CESTAT MUMBAI. Considering the pendency of the matter before the larger bench, the adjudicating authorities ought to refrain from confirming the demand before the judgment in above-mentioned matter is delivered. However, as it has been seen in past, the authorities seldom follow the principles of judicial restraint and propriety and have in majority of the cases proceeded to pass adverse orders confirming such demands not being deterred by the pendency of such appeals.
Without prejudice to the arguments assailing the revenue’s eligibility to initiate investigation and issue show cause notice for extended period of 5 years, the authors are of a firm view that demand for excise duty itself is not tenable. Section 4(1)(a) of the Excise Act and Rule 6 of the Excise Valuation Rules are intricately intertwined, inasmuch as the adoption of transaction value is subject to the price being the sole consideration and applicability of rule is subject to the presence of additional consideration. The primary issue that arises for consideration is whether such drawings and designs form consideration in the first place.
There is a sea of difference between a consideration and a condition of contract. While performance of condition is a prerequisite for the execution of contract, viz. in the present context, the manufacture of parts; consideration acts as the incentive for the promisor to undertake the contract.
...In the subject transaction, providing drawings and designs to the component manufacturers by the vehicle manufacturers is a condition prerequisite for the execution of the manufacturing activity but it cannot amount as an incentive for the component manufacturers. This argument can be simplified by way of following example:
A (parts manufacturer) receives a purchase order for supply of certain part to B (vehicle manufacturer) for nil price. For the execution of contract, B issues specification of parts in form of 2D drawing and 3D model. Consequently, A manufactures the requisite part conforming to specifications and supplies the same to B. In such a case, A cannot be said have received any consideration for supply of parts. The 2D drawing and 3D model are only in the nature of instructions and do not act as any incentive for A to enter into the contract.
In the notice, the revenue has further asserted that Explanation appended to Rule 6 creates a deeming fiction treating such drawings and designs as additional consideration. In this regard, it may be noted that Explanation specifically covers only such drawings and designs which are supplied to a manufacturer for use in manufacturing activity. The term ‘Supply’ used in the explanation merits careful consideration. In our opinion, it can be argued that the term ‘Supply’ doesn’t merely imply the physical delivery of drawings and designs but must include generation of some material benefit which is valuable for the recipient.
In the present context, the vehicle manufacturer retains the proprietary interests in the drawings and designs shared with the component manufacturers. Further, it is to be noted that these drawing and designs are confidential information and trade secrets which are privileged in nature shared so that the component manufacturers can produce the parts as per requirements of vehicle manufacturers.
...No rights in favor of the component manufacturers accrue which may be exploited to gain any material benefit. Therefore, the component manufacturer is not deriving any benefit, monetary or otherwise and the vehicle manufacturer remains as the sole beneficiary arising from use of such drawings and designs.
As the nation today transitions to a ‘Good & Simple Tax’ regime (read: GST), the industry is anticipating a scenario where tax liabilities are certain and tax litigation does not erode the value derived from a pre-arranged transaction. The attempt of revenue authorities to impose tax under the erstwhile laws on transactions which were generally accepted to be legally compliant and have become industry’s standard comes as a big surprise.