Recently hundreds of show cause notices were issued to equipment manufacturers alleging that drawing/designs supplied to them by the principal manufacturers are additional considerations received by such manufacturers and value of designs/drawings are required to be included in the assessment value of the goods supplied. Such notices threaten the very survival of such manufacturers who manufacture parts for automobile manufacturers.
We need to understand the transaction. Automobile manufacturers gets parts of their vehicles manufactured by vendors. To get the manufacture done as per their specification, they supply drawing/designs to the vendors, free of cost. Using such drawings/designs, the vendors manufacture the items and supply to the automobile manufacturers on principal to principal basis. The vendors are not even aware of value of such designs/drawings. The vendor never gets any right on such drawing/designs. The principal manufacturer has all rights on such drawing and designs; and as such the vendor cannot sold these manufactured goods to any third person without permission from the having rights on such drawing and designs. Hence the goods manufactured by such original equipment manufacturers have limited sale-ability; they can be sold only to the principal manufacturer.
Such arrangements are very common in manufacturing space. A principal manufacturer may have all rights on a trademark, and goods manufactured on that trademark have limited sale-ability; the manufacturer is bound to sale such manufactured goods having trademark of the principal manufacturer to the principal manufacturer only. The question is- should proportionate value of trademark be included in the value of such goods?
Loan-licensing manufacturing is very common in pharma industry. The principal manufacturer holds the rights of trademark, patent etc. on the goods manufacturer by loan licensee. The loan licensee cannot sell such goods to any other person, except to the principal manufacturer. The question is- should value of such trademark/patent be included in the value of such manufactured goods by the loan licensee?
Hundreds of similar examples can be given. All ready made garments are manufactured based on designs supplied by principal manufacturer and donning trademark of principal manufacturer. All food items are manufactured based on FDA approval of principal manufacturer and generally the goods bear their trademark. This paper is an attempt to understand legal provisions to Central Excise Valuation as applicable on such manufactured items.
Valuation Under Central Excise:
Valuation provisions are slightly tricky under Central Excise and hence it has always been a fertile area of tax disputes. Under Central Excise, what was being taxed is “manufacturing activity” but what was being valued is “excisable goods”. Therefore, numerous disputes arose as such and such things are not manufacturing expenses, or post manufacturing expenses etc. In reality, there was no correlation between manufacturing activity which was being taxed, and value of excisable goods at which tax was being computed. For example, some person was doing certain packing activities, amounts to deemed manufacture and he was asked to pay duty on full values of deemed manufactured goods.
“Nature of Tax” and “Measure of Tax” are two different separate things. In Bombay Tyre International [1983 (14) E.L.T. 1896 (S.C.)], the Supreme Court held that it was open to the Legislature to specify the measure for assessing the levy. In the Section 4 of the Central Excise Act, the price charged by the manufacturer on a sale by him represents the measure. Price and sale are related concepts, and price has a definite connotation. The “value” of the excisable article has to be computed with reference to the price charged by the manufacturer, the computation being made in accordance with the terms of Section 4 of the Central Excise Act.
In Acer India [2004 (172) E.L.T. 289 (S.C.)], the Supreme Court held that So far as, the valuation of goods in terms of ‘transaction value’ thereof, as defined in Section 4(3)(d) of the Act is concerned, suffice it to say that the said provision would be subject to the charging provisions contained in Section 3 of the Act as also Sub-Section (1) of Section 4. The expressions “by reason of sale” or “in connection with the sale” contained in the definition of ‘transaction value’ refer to such goods which is excisable to excise duty and not the one which is not so excisable. Section 3 of the Act being the charging section, the definition of ‘transaction value’ must be read in the text and context thereof and not de’hors the same.
The matter was referred to 5-Judge Bench of the Supreme Court and the Court held, in Grasim Industry [2018 (360) E.L.T. 769 (S.C.)],
“We answer the reference by holding that the measure of the levy contemplated in Section 4 of the Act will not be controlled by the nature of the levy. So long a reasonable nexus is discernible between the measure and the nature of the levy both Section 3 and 4 would operate in their respective fields as indicated above. The view expressed in Bombay Tyre International Ltd. (supra) is the correct exposition of the law in this regard. Further, we hold that “transaction value” as defined in Section 4(3)(d) brought into force by the Amendment Act, 2000, statutorily engrafts the additions to the ‘normal price’ under the old Section 4 as held to be permissible in Bombay Tyre International Ltd. (supra) besides giving effect to the changed description of the levy of excise introduced in Section 3 of the Act by the Amendment of 2000. In fact, we are of the view that there is no discernible difference in the statutory concept of ‘transaction value’ and the judicially evolved meaning of ‘normal price’.”
Though new Section 4 was enacted in the year 2000, no major changes were affected. The Supreme Court held in TVS Motors [2016 (331) E.L.T. 3 (S.C.)] that no major change had been incorporated w.e.f. 1-7-2000 with emphasis on the ‘different transaction value’ from the ‘assessable value’, the essence of valuation principles had not undergone major change and the decisions delivered by this Court with regard to unamended provision on the principle of valuation were still applicable in determining the transaction value under the new provisions of Section 4 of the Act red with Central Excise Valuation (Determination of Price of Excisable Goods) Rules, 2000.
From a careful analysis of these judgments, following proposition of law emerges:
(i) Charging Section and Valuation Section are independent of each other.
(ii) There has been no discernible change in the valuation provision by amendment in the year 2000.
Section 3 of the Central Excise Act is the charging provision, which levy Central Excise Duty on excisable goods. Explanation 1 of Section 2(d) provides that goods include any article, material or substance capable of being brought and sold for a consideration and such goods shall be deemed to be marketable.
Thus “capability of being brought and sold for a consideration” is a basic ingredient of excisable goods. If certain manufactured goods and not capable of being brought and sold for a consideration; these are not excisable goods and no Central Excise duty can be levied.
Excisable Goods Manufactured based on Principal’s Design:
Let us examine the excisable goods manufactured by a manufacturer based on design or drawing, trademark, patent etc. supplied by the principal manufacturer. These excisable goods can be sold only to the principal manufacturer for a consideration. These goods cannot be sold to any other person for a consideration. Thus, there is one buyer for these goods- principal manufacturer. Are these excisable goods being sold to the principal manufacturer? If the answer is yes- excise duty is payable. If these goods are not being sold to the principal manufacturer- no excise duty is payable. It must be understood that goods manufactured in such manner have limited marketability. An excisable goods having limited marketability is required to valued as such, i.e. goods having limited marketability.
Another aspect of drawing. Designs, trademark, patent is that these are inexhaustible resources. When a design or drawing is used in manufacturing process, nothing is lost- drawing or design remains as such. Value of the drawing and design remains as such. Thus, value of drawing/design consumed in the manufacturing process is zero as infinite numbers of articles can be created using the same design and drawing.
Such issue was raised a number of times earlier. In Bharat Forge Limited [2000 (122) E.L.T. 169 (Tri.)], similar issue was raised before the Tribunal, which held,
“The question for consideration in this appeal the includibility in the assessable value of the cost of drawings supplied by customers for forged product manufactured by the respondent, has been settled by the Tribunal in its decision in CCE v. Bharat Forge, in E/776/95-A. The Tribunal said that the assessable value could not include the cost of drawings supplied by customer.
The departmental representative’s contention that, had the drawings not been supplied, the assessee would have been required to incur expenditure in their development which would have then formed part of the assessable value, is not relevant. It is not the department’s case the assessee was doing anything other than make forgings according to the dimension of the customers. It was in other words not engaged in design of the products, which it forged. These designs were made by someone else; the assessee’s work was to make the forgings. We therefore decline to interfere and dismiss the appeal.”
However, in Tata Motors [2009 (237) E.L.T. 147 (Tri. – Kolkata)], a co-ordinate Bench of the Tribunal differed from Bharat Forge (supra) on the ground that new valuation provision has come in force. It is humbly submitted that the Constitution Bench of the Supreme Court has held in Grasim Industry that there is no discernible difference in the principles of valuation, even after 2000 amendment. The Tribunal in Tata Motors has also not pointed towards any discernible difference. It is further to be noted that the order relies solely upon explanation-1 of Rule 6 of the Central Excise Valuation Rules. We shall come later on the rules.
In Commissioner v. Luna Agro Industries [2009 (242) E.L.T. 130 (Tri. – Mumbai)], the Tribunal held that,
“We find that fourteen show cause notices issued to the assessee during 1994 to 1999 purport to add 2% of the value of the goods as design and drawing charges and to recover duty on the additional added value. It is seen that the assessee manufactures the goods as per drawings supplied by the customers. While finalizing the proposal for purchase of these goods, the customers have sent their drawings/designs. Such customers have voluntarily supplied the required drawings/designs etc. Since there is no additional consideration flowing from the customers to the assessee, the cost of such drawings is beyond the scope of Section 4 of the Central Excise Act, 1944. The drawings/designing charges are includible in the assessable value, if incurred by the assessee. In this case, the drawings/designs are supplied voluntarily by the customers, not being the additional consideration, the cost thereof is not includible in the assessable value of the goods. The price of the goods is the normal price negotiated in the course of wholesale trade. It is the correct price at the time and place of removal from the factory. The addition of the amount of 2% of the assessable value for working out the duty liability is totally subjective and imaginary and has no legal basis.”
A co-ordinate bench took a different view in Simplex Engineering and Foundary Works [2016 (343) E.L.T. 458 (Tri. – Del.)] and held,
“The appellant is manufacturing engineering goods which are as per the specification of the customers. In the cases where the customers had not supplied the drawings and designs, the appellant prepared the drawings and designs. The dispute is in this case where the drawings and designs of the goods were supplied by the customers. Accordingly, the point of dispute is as to whether in the cases where drawings and designs have been supplied by the customers, whether the same are to be treated as additional consideration and their value is includible in the assessable value of the goods in terms of Rule 6 of the Central Excise Valuation Rules, 2000 according to which where the assessable goods are sold in the circumstances specified under clause (a) of Section 4(1) of the Act except the circumstance where price is not the sole consideration for sale, the value of said goods shall be deemed to be the aggregate of such transacting value and the amount of money value of any additional consideration following directly or indirectly from the buyers or assessee. Explanation-I to Rule 6 explains that among other things, the value of tools, dies, moulds, drawings, blueprints technical charges and similar items used in the production of such goods which was supplied by the buyer are to be treated as additional consideration. Since in this case the goods being manufactured by the appellant are Customs made and as per the requirements of each customer, for determining the value of the goods manufactured for a particular customer, the price of the goods supplied to other customers cannot be applied. In these circumstances, we are of the view that in the cases where the goods were manufactured by using the drawings supplied by the customers, the value of the drawings would have to be included in the assessable value of the goods.”
It is humbly submitted that the Tribunal started with wrong proposition. It started with the proposition that “in the cases where the customers had not supplied the drawings and designs, the appellant prepared the drawings and designs”.
Excisable goods manufactured by drawings and designs owned/supplied by principal manufacturer has limited marketability. The manufacturer cannot sell these goods to any person. On the other hand, excisable goods manufactured by drawing/designs developed by manufacturer himself has wider marketability. In view of these, these goods are different from each other and cannot be compared.
In a number of cases, the Tribunal took the view that such charges are not includible in the value of goods. In Eastman Crusher [2008 (224) E.L.T. 86 (Tri. – Kolkata)], the Tribunal held that designing charge not relates to excisable goods manufactured and supplied by appellants, but relates to whole structure of which parts are only made by them, such charges cannot be included in assessable value. In Staffield System [1996 (87) E.L.T. 510 (Tribunal)], the Tribunal held that designing charges are not includible. In Maharashtra Scooters [2009 (246) E.L.T. 209 (Tri. – Mumbai)], the Tribunal held,
“It is also seen that the price is agreed and contracted between the assessee and their customers. The assessee have not recovered anything over and above the price contracted. There is no allegation regarding flow back of any additional consideration from the customers to the assessee. We find that the addition of the amount of 2% of the assessable value for working out the duty liability is totally subjective and imaginary and has not legal basis.”
Section 4 of the Central Excise Act:
As there are contradictory judgments of the Tribunal on the issue, we need to examine Section 4 of the Central Excise Act. Section 4(1) of the Central Excise Act reads as,
“(1) Where under this Act, the duty of excise is chargeable on any excisable goods with reference to their value, then, on each removal of the goods, such value shall –
(a) In a case where the goods are sold by the assessee, for delivery at the time and place of the removal, the assessee and the buyer of the goods are not related and the price is the sole consideration for the sale, be the transaction value;
(b) In any other case, including the case where the goods are not sold, be the value determined in such manner as may be prescribed.”
Further, the Section 4(3)(d) defines transaction value as,
“Transaction value” means the price actually paid or payable for the goods, when sold, and includes in addition to the amount charged as price, any amount that the buyer is liable to pay to, or on behalf of, the assessee, by reason of, or in connection with the sale, whether payable at the time of the sale or at any other time, including, but not limited to, any amount charged for, or to make provision for, advertising or publicity, marketing and selling organization expenses, storage, outward handling, servicing, warranty, commission or any other matter; but does not include the amount of duty of excise, sales tax and other taxes, if any, actually paid or actually payable on such goods.”
The Section is very clear. Section 4(1)(a) is applicable and transaction value if the value, if following conditions are satisfied,
(i) There is a sale.
(ii) At the time and place of removal.
(iii) Buyer and seller are not related.
(iv) Price is the sole consideration.
Transaction value shall include any amount that the buyer is liable to pay to, or on behalf of, the assessee, by reason of, or in connection with the sale, whether payable at the time of the sale or at any other time.
Before proceeding to Rules, we have to understand that rules cannot increase the ambit of sections legislated by the Parliament. Rules are required to be read within the meaning os the section itself. Explanation (1) of the Rule 6 of the Valuation Rules reads as,
“For removal of doubts, it is hereby clarified that the value, apportioned as appropriate, of the following goods and services, whether supplied directly or indirectly by the buyer free of charge or at reduced cost for use in connection with the production and sale of such goods, to the extent that such value has not been included in the price actually paid or payable, shall be treated to be the amount of money value of additional consideration flowing directly or indirectly from the buyer to the assessee in relation to sale of the goods being valued and aggregated accordingly, namely : –
(i) Value of materials, components, parts and similar items relatable to such goods;
(ii) Value of tools, dies, moulds, drawings, blue prints, technical maps and charts and similar items used in the production of such goods;
(iii) Value of material consumed, including packaging materials, in the production of such goods;
(iv) Value of engineering, development, art work, design work and plans and sketches undertaken elsewhere than in the factory of production and necessary for the production of such goods.”
The provision is required to be read in conjunction of definition of transaction value- and any amount can be added only when the buyer is liable to pay the to or on behalf of the assessee. Thus, design charges can be included in the value of excisable goods, only when the buyer has paid the amount on behalf of the assessee. When the buyer pays the amount on his own, and do not transfer such design to the assessee, value of such design charges cannot be included in the value of excisable goods.
Reading Explanation-1 of the Rule 6 of the Valuation Rules, independently of Section 4 amounts to increasing the ambit of “transaction value” as defined by the Parliament. This is not permissible. In Luna Agro Industries [2009 (242) E.L.T. 130 (Tri. – Mumbai)], the Tribunal held that
“It is seen that the assessee manufactures the goods as per drawings supplied by the customers. While finalizing the proposal for purchase of these goods, the customers have sent their drawings/designs. Such customers have voluntarily supplied the required drawings/designs etc. Since there is no additional consideration flowing from the customers to the assessee, the cost of such drawings is beyond the scope of Section 4 of the Central Excise Act, 1944. The drawings/designing charges are includible in the assessable value, if incurred by the assessee. In this case, the drawings/designs are supplied voluntarily by the customers, not being the additional consideration, the cost thereof is not includible in the assessable value of the goods. The price of the goods is the normal price negotiated in the course of wholesale trade. It is the correct price at the time and place of removal from the factory. The addition of the amount of 2% of the assessable value for working out the duty liability is totally subjective and imaginary and has no legal basis.”
In the above quoted judgment, the Tribunal has considered the ambit of Section 4 of Central Excise Act and in view of this author, explains the correct position of law. Even in case of Simplex Engineering, the Tribunal starts with the proposition In the cases where the customers had not supplied the drawings and designs, the appellant prepared the drawings and designs. Thus, the preposition is that it is responsibility of the assessee to prepare the designs. When it is responsibility of the assessee to prepare the designs, and buyer pays for such design- the transaction shall fall within the definition of transaction value as “paid on behalf of the assessee”. When developing drawing or designs is not a responsibility of the assessee, but it is responsibility of the buyer itself- it cannot be said that such amount has been paid on behalf of the buyer and such amount cannot be added in the value of excisable goods.
In view of these, following principles of law emerges;
(i) Central Excise Valuation Rules ought to be read within the ambit of Section 4 of the Central Excise Act.
(ii) Explanation-1 of Rule 6 of the Central Excise Valuation Rules is required to be read with the definition of transaction value given under Section 4(3)(d) of the Central Excise Act.
(iii) Value of design/drawing charges can be added in the assessable value only when preparing such design is responsibility of the manufacturer and payment for such design is made by the buyer.
(iv) In cases where the contract is manufacture of goods, based on design/drawing supplied by the buyer, value of such design/drawing cannot be added in the assessable value.
[The author is Managing Partner of Rajesh Kumar and Associates. The author may be contacted on email@example.com]