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Valuation rules should not be invoked, if the transaction is done on arm’s length price even in case of related parties – SC

In the case of Commissioner of Central Excise V/s. M/S. Detergents India Ltd., Supreme Court has held that in case of related party transactions, proviso (iii) of Section 4(1)(a) will not be applicable when there is no arrangement between Shaw the related parties to depress a price which is otherwise at arm's length.
CA Urvashi Porwal
Brief of the Case

In the case of Commissioner of Central Excise V/s. M/S. Detergents India Ltd. & Anr., Supreme Court has held that in case of related party transactions, proviso (iii) of Section  4(1)(a) will not be applicable when there is no “arrangement” between Shaw the related parties to depress a  price  which  is  otherwise  at arm’s length.

Brief Facts

Detergents India Limited (DIL), now Henkel Marketing India Limited, was at the relevant time a subsidiary of Shaw Wallace and Company Limited. Both were public limited companies.  Shaw Wallace’s subsidiary companies held 57% of the paid up  share  capital of  Detergents  India  Limited,  making Detergents  India  Limited  a subsidiary of Shaw Wallace as understood by the definition of “holding company” and “subsidiary company”  contained  in  the  Companies  Act, 1956.  90% of the manufacturing capacity of Detergents India  Limited was to manufacture various products for Hindustan Lever Limited  which were then branded  with  Hindustan  Lever  names  in  small  packs.  A processing charge was paid by Hindustan Lever  Limited  for  this  jobwork, and it is clear that  different  processing  charges  were  paid depending upon the size of the product and the  product  itself.   The excess 10% capacity which was not mopped up by Hindustan Lever was sold to Shaw Wallace,   its   holding   Company. Various other independent manufacturers/sellers also sold the same and similar products to Shaw Wallace and Company.

Various show cause notices were issued alleging that demand of differential duty as the  price  paid  by  Shaw  Wallace  and Company for the purchase of the same/similar products from  the  other firms/companies was less than  the  price  paid  to  Detergents  India Limited.

Contentions of the Revenue

The Revenue contented that Shaw Wallace and DIL are related persons within the meaning of Section 4(4) (c) of the Act and stated that some of these factors are that

  • Advertisement expenses of DIL brands had been borne by  the  holding  Company  Shaw  Wallace;
  • Processing charges paid by Shaw Wallace to DIL is less than processing charges paid to Hindustan Lever;
  • Employees of Shaw  Wallace  and  its subsidiaries were freely transferred  from  one  company  to  another;
  • Depots of Shaw Wallace and DIL were in the same premises;
  • DIL sends monthly newsletters to Shaw Wallace  showing  production,  despatches, purpose,  technical  problems,  quality  problems,  details  of  power consumption etc. – and Shaw Wallace fixes the price of  DIL  products;
  • Unsecured loans of approximately Rs.55 lakhs were given by Shaw Wallace to its subsidiary DIL.

It is  argued  that  all  these  facts would show that Shaw Wallace and DIL were related persons and that the price paid by Shaw Wallace to DIL was a  depressed  price  and  would, therefore fall within proviso (iii) of Section  4(1)(a)  as  it  stood prior to year 2000. The moment  there  is  a  holding/subsidiary  company  relationship, the definition of “related person” under Section  4(4)(c)  gets  attracted and proviso (iii) to  Section  4(1)(a)  in  turn  gets  attracted  and therefore it is the price at which Shaw Wallace and Company sells  the self same goods to its customers that is the price that is to be taken into account on the facts of the present case.

Contentions of the Assessee

 The  assessee contended that even though Shaw  Wallace  and  DIL  may  be  holding  and subsidiary companies, yet on a true construction  of  Section  4(4)(c) they are not related persons within  the  meaning of the definition clause.  Further, on a true construction of proviso (iii) to Section 4(1) (a), it is necessary that the assessee must first enter into an arrangement with the related person, which arrangement leads to a price being charged which is lower than the normal price.

Further, the proviso only gets attracted when such arrangement is predominantly a sale to or through a related person. There is no arrangement between Shaw Wallace and DIL which has led to any depression in the normal price at which such goods are sold.   Also,  since  only  10%  of  the production of  DIL  is  sold  to  Shaw  Wallace,  the  goods  are  not “generally” sold to Shaw Wallace.

Held by Supreme Court of India

 The Hon’ble Supreme court stated that the first thing that  one  notices  on  a  reading  of  Section 4(1)(a), as it then stood, is that a duty of excise is chargeable with  reference to “normal price”, that is to say the price  at  which  such goods are ordinarily sold by the assessee to a buyer in the course  of wholesale trade. The price should be the sole consideration for the sale.  If the buyer is a related person, there is a presumption that a sale to a related person would be at a price which is not the sole consideration for the sale. Further, Proviso (iii) then deals with the price that is to be taken into consideration in case sales are made to related persons.  Three basic ingredients are necessary before proviso (iii) gets attracted:-

  • The first ingredient is that the assessee must “arrange” that goods are sold by him in a particular manner.
  • The second ingredient is that such arrangement must be such that the goods are “generally” sold by the assessee in the course of wholesale trade to or through a related person.
  • Thirdly, such sale need not be to the related person – it can even be through the related person.

The Hon’ble court is of the view that  the  “arrangement”  spoken  of  in  the proviso must be something by which the assessee and the related person “arrange” that the goods are sold at something below the normal price, so  that  tax  is  either  avoided  or  evaded  by  such  arrangement. Secondly, the expression “generally” also shows that such goods must predominantly be sold by the assessee to or through the related person – in mathematical terms, sales that are to or through a related person must consist of at least 50% of the goods that are manufactured and sold. The expression “to or through a related person” again goes back to the “arrangement” and is another way of saying that such  sale  can be effected directly to or indirectly through such related person.  It is only when all three considerations are cumulatively met that proviso (iii) can be said to be attracted.

The Hon’ble court referred to the judgement in the case of Union of India v.  Bombay Tyre International Ltd., (1984) 1 SCC 467, it was held that even under Section 4 prior  to  the  1973 Amendment, the wholesale cash price would  consist  of  a  sale  by  a manufacturer in the course of wholesale trade to a  wholesale  dealer, which sale would have to be at arm’s length and in the usual course of business.

The Hon’ble Court clarified that the object of enacting Section 4 is that transactions at arm’s  length between manufacturer and wholesale purchaser  which  yield  the  price which is the sole consideration for the sale  alone  is  contemplated. Any concessional or manipulative considerations  which  depress  price below  the  normal  price  are,  therefore,  not  to  be  taken   into consideration. The arrangements with related persons which yield a price below the normal price because of concessional or manipulative considerations cannot ever be equated to normal price.  But at the same  time,  it  must  be remembered that absent concessional  or  manipulative  considerations, where a sale is between a manufacturer and a  related  person  in  the course of wholesale trade, the transaction being a  transaction  where it is proved by evidence that price is the sole consideration for  the sale, then such price must form the basis for valuation as the “normal price” of the goods.

Where it is proved that the same price is  paid by related persons  as  well  as  arm’s  length  purchasers  (who  are unrelated) for the same goods, in the case of the  former  the  higher price paid by purchasers from the related person would be the price on which excise duty would be calculated which would  be  more  than  the “normal  price”  under  Section  4(1)(a).  Such a   result   is   not contemplated by the amended Section 4(1) (a), which must therefore be read in the manner indicated above.

The Hon’ble court referred the judgement in the case of Flash Laboratories Limited v. Collector of Central Excise, New  Delhi, (2003) 2 SCC 86, wherein the appellant was a subsidiary company of  M/s  Parle Products Limited.  M/s Parle Biscuits Limited is also a subsidiary company of M/s Parle Products Limited.  What was in question in that case was the relationship between two subsidiary companies.   It is clear that the relationship between a subsidiary company and another subsidiary company would not be governed by the second part of Section 4(4) (c).  In  order  that  the  second  part  of  Section  4(4)(c)  be attracted, it must be shown that the related person must either  be  a holding company or a subsidiary company of the assessee. In the facts of that case, the related person, namely, M/s Parle Biscuits Limited was neither a holding company nor a subsidiary company of the assessee i.e. M/s Flash Laboratories Limited. This being the case, this Court held that there must be mutuality of interest between two persons who are both subsidiaries of a particular holding company.

The Hon’ble court referred the judgement in the case of Commissioner of Central Excise Bombay v.  Universal  Luggage Manufacturing Company Limited, (2005)190 ELT 3, this Court found as  a matter of fact that the assessee (holding  company)  was  selling  its products through its wholly owned subsidiary  at  the  same  price  at which it was selling the same goods to other buyers at  arm’s  length, in which the subsidiary company had no role to play.  This  being  the case, this Court agreed with the Tribunal  that  the  price  at  which sales have been effected through the subsidiary, not being a depressed price, would be the price that would be taken into  consideration  for valuation under Section 4(1)(a).

The Hon’ble court stated that Section 4(4) (c) is in two parts. The first part requires the department to apply a de facto test, whereas the second part requires the application of a de jure test. “Relative” is defined in the Companies Act, 1956. The Hon’ble Court further stated that a reading of the definition of “relative” would show that the relative need not be a person who is so associated with the assessee that they have mutual interest in each other’s businesses.   If that were the case, the expression “relative” in the second part would be otiose inasmuch as a relative would be subsumed within “person” in the      first part.  Thus, “relatives” would also be “persons” who are so associated with the assessee that they have a mutual interest in each other’s businesses.  The legislature by application of a de jure test has extended the meaning of “related persons” to include the entire list of relatives per se without more as related persons.   Similarly, holding companies and subsidiary companies by virtue of  the  exercise of control  by  a  holding  company  over  a  subsidiary  company  are similarly included by application of a de jure test.

The Hon’ble Court stated in the present case, the price paid      by Shaw Wallace and Company for the same/similar products as was sold by unrelated entities to it was even lower than the price paid by Shaw Wallace to Detergents India Ltd.  This being the  case,  it  is  clear that on facts here there is no “arrangement” between Shaw Wallace  and Detergents India Limited to depress a  price  which  is  otherwise  at arm’s length.

Shaw Wallace and  Detergents  India  Limited  are  “related persons”  is  made  out  by  their  holding/subsidiary   relationship. However, from this, it does not follow that there is any arrangement of tax avoidance or tax evasion on the facts of this case.  This being the case, proviso (iii) to Section 4(1) (a) would not be applicable.

Further, it would also not be applicable for the reason that there is no predominance of sales by Detergents India Limited to Shaw Wallace. As has been pointed out above, only 10% of its manufacturing capacity has been sold to Shaw Wallace, 90% being sold to Hindustan Lever      Limited.  For this reason also, proviso (iii) does not get attracted.

This being the case, on facts here Section  4(1)(a)  and  not  proviso (iii)  is  attracted  inasmuch  as  on  facts  the  presumption  of  a transaction not being at arm’s length has  been  rebutted.   Revenue’s comparison of price paid by Hindustan Lever to DIL with price paid by Shaw Wallace to DIL is unwarranted as the products sold and processing charges are wholly different. Further, the single most relevant fact, namely, that  Shaw Wallace paid for the same/similar goods to unrelated  suppliers  at  a price lower than the price paid by Shaw Wallace to DIL, has  not  been adverted to at all by the Revenue.

In view of the above, the appeals by Revenue are devoid of merit and are accordingly dismissed.

Categories: Excise Duty
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