Sale in course of import for Leasing Transactions: Central Sales Tax Act

1.1 In a recently pronounced judgment in the case of Hewlett Packard Financial Services (‘Appellant’) vs The State of Karnataka, The Deputy Commissioner of Commercial Taxes (Audit) (‘Revenue’), the Hon’ble Karnataka High Court dealt with the issue relating to entitlement of VAT exemption by virtue of Section 5(2) of the Central Sales Tax Act, 1956 (‘CST Act’).

1.2 In the given case, the Appellant, for claiming exemption as ‘sale in the course of import under Section 5(2) of the CST Act, entered into a series of transactions outlined below:

1. Appellant entered into a Master Lease Agreement (‘MLA’) for an identified product with its customer in India;

2. After the MLA was signed, the customer placed a purchase order directly on the foreign vendor;

3. As per the purchase order, the product was to be shipped to the customer, but the invoice was issued in the name of the Appellant;

4. The shipping authorization letter was issued by the Appellant to the vendor outside India;

5. After the product was sold to the Appellant, but shipped to the customer, the invoice was raised by the vendor on the Appellant. However, the bill of entry was filed by the customer clearing the product from customs and then taken by the customer to his location;

6. After the product was verified and accepted by the customers, the acceptance certificate was issued by them;

7. When the product was delivered and the customer had unconditionally accepted itas leased to them as per the MLA, a novation notice was issued by the customer, confirming that the purchased documents would remain with the Appellant;

8. Thereafter, the lease schedule was signed by the parties specifying the product under lease as per terms and condition of Master Rental and Finance Agreement (MR & FR).

1.3 The whole idea of this transaction was to import the goods and simultaneously lease it to the customer under the (MLA) though the timing of import and lease was not synchronized in its true sense.

1.4 The above mentioned case deals with the statutory provision of Section 5(2) and the exemption provided thereunder. Section 5(2) of CST Act defines the sale or purchase of goods in the course import and reads as follows:

A sale or purchase of goods shall be deemed to take place in the course of the import of the goods into the territory of India only if-

(a) The sale or purchase either occasions such import; or

(b) Is effected by a transfer of documents of title to the goods before the goods have crossed the customs frontiers of India.

1.5 The Hon’ble Apex Court in its judgement of K. Gopinathan Nair vs. State of Kerala/Cashew Corporation of India vs. State of Karnataka [1997] 105 STC 580 (SC) has clarified the interpretation of “sale in course of import”. The Apex Court held that if following conditions are satisfied, a transaction qualifies as sale in the course of import. The said conditions are as follows:

(a) Sale or purchase actually take place;

(b) Such sale or purchase in India occasions such import, and not vice versa;

(c) The goods must have entered the import stream when they are subject to sale or purchase;

(d) The course of import to be continued till the imported goods reach the local users;

(e) There must be a single sale which itself causes the import or they may appear to be two sale transaction that they are so integrally inter connected that they almost resemble as one;

(f) Direct privity of contract between the Indian importer and foreign exporter.

1.6 The Karnataka High Court in the present case critically examined the transaction and held that:

(a) The Appellant did not place any purchase order on the foreign vendor and the MLA was prior to the purchase order placed by the customer on the foreign vendor;

(b) The parties entered into a lease agreement i.e. MR & FR as supplementary agreement to the MLA after the issuance of acceptance certificate by the customer;

(c) The Appellant is not aware of the goods to be leased out till the purchase order is placed by the customer on the foreign vendor.The right on the goods lies with the end customer till the acceptance certificate is issued by the customer;

(d) It could be seen that the Appellant has not imported the goods from the foreign vendor but it is the end customer purchase order that occasions the sale in the course of import;

(e) The transaction is divided into two legs-

(i) First transaction commences from the import of the goods from the foreign destination and ends with the physical delivery to the end customer; and

(ii) The second transaction started after the acceptance of the goods by the customer followed by the issuance of acceptance certificate and novation notice and ends by signing of the ‘Lease Schedule’.

The factual matrix in the present matter shows there are two independent transactions even though the contracts are back to back which cannot be considered as an integrated transaction in the course of import.

1.7 Generally, as a normal practice, the transaction of sale in the course of import takes place in such a way where a sale between the vendor and customer in India occasions the import from a foreign vendor. Purchase order is placed by the Indian vendor on the foreign vendor and goods are issued to the customer in India. The transaction is so inextricably linked that it seems to be one integrated transaction and not two separate transactions and there is a direct contract or linkage between the Indian importer and foreign exporter.

1.8 The lease agreement was entered between the Appellant and customer after the ownership of the imported goods was transferred by the customer to the Appellant. It is only after, when the goods are in the India territory, there is a transfer of the ownership and entering of the lease agreement. The MLA entered before, severed the relationship of the lessor and lessee wherein the customer is shown as the owner and Appellant is seen as rendering only finance. It is on account of again novation of the contract, where the ownership is transfer by the customer to the appellant and then the lease agreement is entered into which could be seen as the substantial novation of the first agreement.

1.9 Another important consideration in deciding this judgment was the fact that the customer cleared the goods from customs and not the Appellant. Since the customer was a 100% EOU, it was entitled to exemption from customs duty. The contention of the Appellant that he is the owner of the imported goods stands defeated. This view may not hold good in the eyes of law considering that under all EPC contracts, generally the final customer (being allowed customs duty benefit) ends up importing the goods and not the EPC contractor. Yes, for such arrangements the EPC contractor and the customer do enter into a specific contract.

1.10 The High Court finally confirmed the transaction is nothing but ‘sale’ u/s 2(29) of the Karnataka VAT Act and the turnover qualifies as ‘taxable turnover’  and no benefit of the exemption will be available.

1.11 It is quite evident from the case that wordings of the legal contracts and timing of the import and their subsequent lease to the customer was of prime importance in deciding whether such a transaction will qualify as ‘sale in the course of import’ or not.

1.12 To conclude, it is recommended that such leasing transactions which are structured as ‘sale in the course of import’ should be carefully worded in the agreements and the timing of the entire scheme of transactions should be one and inextricably linked to each other.  Any break in the chain of transactions or any change in the sequence of events can be looked upon by the Revenue and Judiciary adversely.

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Nimish GoelAuthored by Nimish Goel , a chartered accountant with more than 12 years of experience and who’s passion is to coach and help young chartered accountants and aspiring students achieve the best in their life. Nimish used to work with EY and PwC in India and has also worked with KPMG in Europe. He now runs his own consulting company and runs a blog www.nimishgoel.com. He can be reached for any queries and issues on his blog. For any professional assistance, he can be reached on nimish.goel@ibadvisors.co. Nimish was assisted by Shivam Khandelwal.

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