The article lays a study into as should Amortization of Tools, Dies, Moulds, Patterns etc. costs be added in the value of finished goods for GST purpose. Example of automobile industry can be taken, the manufacturing of an automobile (say ‘a Car’) is highly complex process and is usually found split among multiple tiers. The ones with the brand name of automobile are the ones who usually do the assembling process are called Original Equipment Manufacturers (‘OEM’), the ones providing parts for assembling are called Tier 1 manufacturers (‘Tier 1’) , and the ones providing sub parts and child parts are referred to as Tier 2 manufacturers and so on.
Manufacturing SKUs out of Dies and Moulds:
The automobile parts (‘SKU’) manufactured by Tier 1 are tailor made for OEM which are to be used as original equipment parts in their finished goods. Accordingly they have to be made in accordance with OEM’s specifications and drawings. For manufacturing specified SKUs, Tier 1 requires Dies and Moulds (‘D&M’).
The term Transaction Value (‘TV’) under Central Excise is a popular one. Almost all of the goods were taxable ad valorem under Central Excise Act, 1944, and the basis of their valuation was TV i.e. the price paid or payable by the buyer, provided certain conditions were satisfied. TV is a fancy word (earlier it was Normal Sales Price). The Central Excise is tax on manufacture, the true valuation factor therefore should be – the value towards manufacturing, TV and NSP are mere proxies of it. To elaborate, if an assessee manufactures a product A which is made of Raw Material X, Consumable Y through use of Capital Good Z, the manufacturing value of Product A shall be the complete value of X, the consumed value of Y and deteriorated value of Z, and some manufacturing profits in making A. It makes no difference if the Material was supplied by the recipient of the goods or the Capital Goods were rented at Nil by the manufacturer. [Ujagar Prints 1989 AIR 516, Empire Industries 1985 (20) ELT 179 (SC), Bombay Tyre International Ltd. 1983 (14) ELT 1896 (SC)].
In the case at hand, the Tier 1 manufactures SKUs out of the raw material procured by them and by use of Capital Goods owned by them. Additionally, the Tier 1 gets the use of D&M for manufacturing the SKUs. Therefore, the cost towards all of these factors should be relevant for arriving at the value for Excise Duty purpose. In the case of M/s Mutual Industries [2000 (117) ELT 578 Tri Del], the assessee had paid excise duty on the consideration received from the buyer, ignoring the value of D&M supplied by the buyer.
The Larger Bench of Hon’ble CEGAT then proceeded to add the value towards D&M (by virtue of Valuation Rules) on the basis that the D&M received by the assessee is an additional consideration in the context of manufacture, hence disqualifying the transaction value/ normal value.
“7…… In the instant case, the price of the finished goods has been fixed between the appellant and the customer. Can one say that the price so fixed is the sole consideration for the sale of the finished product when the mould was supplied by the customer. Without the mould supplied by the customer, which is having substantial value, the product could not have been manufactured. So it is crystal clear that the price of the finished goods was fixed by the appellant and the customer taking into consideration the supply of the mould by the customer. In other words, had the mould not been supplied by the customer, appellant could not have agreed to the price of the finished goods at the price as is evidenced by the contract entered into between them. So, the price of the finished goods fixed in the contract between the parties can safely be taken as not the sole consideration for the sale of the finished product…………..”
The Tribunal observed that since the supplying of D&M has affected the price of goods charged by Tier 1 from OEM, had OEM not supplied D&M, the Tier 1 would have charged a higher price, therefore the monetary price agreed between the parties is not the sole consideration. Once the Value was rejected, the Tribunal invoked Rule 5 of the Excise Valuation Rules, 1975 to add Amortized Value of the D&M for the purpose of arriving at the true manufacturing value. Rule 5 ibid therefore can be said to be a proxy in arriving at the manufacturing value.
The proposition of Amortization of D&M was explicitly incorporated in Valuation Rules of 2000 vide Explanation to Rule 6 [pari materia to Rule 5 ibid]. To sum up, it can be said that Amortization by judicial discipline and by fiction of law tends to arrive at the true value of manufacturing, which was exigible to Excise Duty under the Excise Act.
Amortization is an accounting concept, it tends to cover the deterioration of intangible assets. The Hon’ble Supreme Court has well worded the concept of Amortization in a brilliant judgment of Moriroku UT India (P) Ltd vs State of Uttar Pradesh [2008 (224) ELT 0365 (S.C.)]. The facts pertains to the assessment of one of Tier 1 Company under the U.P. Trade Tax Act, 1948. The Revenue had sought to impose Sales Tax on the amortization of D&M provided Free of Cost by the OEM on the equal lines of Excise Duty and borrowed the Rule 6 ibid. The Supreme Court noted as follows;
Amortization is a form of Depreciation, applied on the Intangible Asset; Amortization is a principle of accrual based accounting
10. Amortisation, therefore, is an accounting concept similar to depreciation. It is gradual reduction of the value of an asset or liability by a periodic amount. Therefore, depreciation is generally used in the context of tangible assets whereas amortisation is generally used in the context of intangible assets………… (para 10)
……………..Amortisation is a means by which accountants apply the period concept in accrual-based financial statements; income and expenses are recorded in the periods affected, rather than when the cash actually changes hands as it would be inappropriate to expense the entire cost of a facility in the year of its acquisition if its life extends over several years just as it would be equally wrong to expense fully an intangible asset only in the first year (para 10)
The Supreme Court in Moriroku case supra has vividly distinguished the valuation mechanism under Excise Law and Sales Tax Law. It has been unequivocally held that the duty of Excise is leviable on “Value”, and the price has definite connotation for finding value.
Under Section 4, duty of excise is chargeable with reference to the value of excisable goods and “Value” is defined by Section 4. The price charged by the manufacturer on sale by him represents the measure of that value, therefore, in the judgment of this Court in the case of Union of India and Ors. v. Bombay Tyre International Ltd. reported in [AIR 1984 SC 420] it has been held that under the excise law, prices and sale are related concepts. In that judgment, it has been further observed that “price” under the excise law has a definite connotation. …………Therefore, Section 4 of the 1944 Act requires the Department to find out the real value of the excisable article. As stated above, excise law is a tax on value. This is the most important distinction between the excise law and the sales tax law. (para 13)
It was observed that the Sales Tax is leviable on Price and no notional amount can be borrowed into price (para 16)
In case of sales-tax, tax is exigible on real price received or receivable by the dealer in respect of a sale………………….
The important thing to be noted is that “price” is the amount of consideration which a seller charges the buyer for parting with the title to the goods. It comprises of the amount which the dealer himself has to pay for the purchase of the goods, the expenditure, which he is to incur for transporting ………….The cost price of the goods actually paid by him under various heads of accounts would no doubt constitute the consideration for which he would part with his title to the goods. The entire amount of consideration, including the sales tax component, which the purchaser pays, would constitute the price of goods………………….
To this extent, there is no difficulty. The difficulty comes in when by law or by legal fiction the Department seeks to introduce a notional concept as an element of the “real price”. This is particularly important when there is no rule to that effect in the sales-tax law. Even under the definition of turnover in Section 2(i) one has to take into account only the aggregate amount for which goods are bought or sold. It is this aggregate amount which is taxable under Section 3 read with Section 2(i) of the 1948 Act.
It was also noted that measure of Value under Excise Law and Sales Tax Law are based on their taxable event and have to be arrived at keeping in mind the same. For Excise, the measure is Value which is the function of manufacturing costs and manufacturing profits, besides the price agreed between parties can is a good criteria for bringing out true manufacturing value. Comparably, under the Sales Tax, the value for measure is the Real Price, the price again can be used as a basic criteria, however the Price will not necessary be same as the Value of the excisable product.
Therefore, sales-tax or trade-tax under the 1948 Act is leviable on sale, whether actual or deemed, and for every sale there has to be a consideration. On the other hand, excise duty is a levy on a taxable event of “manufacture” and it is calculated on the “value” of manufactured goods.….
Therefore, for sales-tax purposes, what has to be taken into account is the consideration for transfer of property in goods from the seller to the buyer. ………..and in such a case cost of manufacture is irrelevant………….
……..For excise duty purposes, transfer of property in goods or ownership is irrelevant. As stated, excise duty is a duty on manufacture. The provisions relating to measure (Section 4 of 1944 Act read with Excise Valuation Rules, 2000) aim at taking into consideration all items of costs of manufacture and all expenses which lead to value addition to be taken into account and for that purpose Rule 6 makes a deeming provision by providing for notional additions………
One thing that can undoubtedly interpolated from the Moriroku case, is that “Value” is term different for every legislation. The value has to be seen from the point of the levy also, the fiction provided under the law are to be applied keeping in mind the levy. Further, the Excise Rule 6 cannot be summarily borrowed into other Tax statutes just to seek equity.
Section 15 of the GST Act(s) (‘GST Law’), provides for the valuation of taxable supplies under GST. The valuation like the Excise law is based upon Transaction Value. Again, it can be seen that the measure is “Value”, meaning thereby poor “Price” and “Consideration” have definite connotation. True Value of supply of (goods) has to be arrived at by the provisions enumerated by the legislation and the connotation of the words therein using the available aids. Relevant provisions of Section 15 are as below;
15. (1) The value of a supply of goods or services or both shall be the transaction value, which is the price actually paid or payable for the said supply of goods or services or both where the supplier and the recipient of the supply are not related and the price is the sole consideration for the supply.
(4) Where the value of the supply of goods or services or both cannot be determined under sub-section (1), the same shall be determined in such manner as may be prescribed.
Section 15 (1) provides that the value for GST shall be the Price provided (1) the parties are not related and (2) the price is the sole consideration. Déjà vu. On an apparent reading, it seems the very wordings and the very nomenclature of the Excise Law has been incorporated in Section 15(1). However, all caution has to be exercised, as to whether “the sole consideration” as enumerated in Excise Law and as enumerated in GST have same connotations? Or they can be interpreted to mean otherwise? All the logical sense and judicial principles would indicate that there is no departure in the interpretation of the words “sole consideration”. However, we have seen through the Moriroku case that Excise Law tends to cover Value towards manufacturing, which is not the case with Supply.
Supply by its all connotations means to furnish or to provide something, therefore the value has to be skewed towards “Value” of providing or “Value” of furnishing. By all means, what can be the value of furnishing? On this date, any judicial India pronouncement is hard to find, however an ECJ Judgment in case of Banca popolare di Cremona Soc. Coop. arl [C-475/03] provides some guidance into the valuation under VAT as compare to valuation under a production based tax;
“21. Under Article 2 of the First Directive, the principle of the common system of VAT involves the application to goods and services, up to and including the retail trade stage, of a general tax on consumption exactly proportional to the price of the goods and services, whatever the number of transactions which take place in the production and distribution process before the stage at which tax is charged.”[Also Pelzel and others C-390/97, para 21]
“31. In this case, as regards the second essential characteristic of VAT, it must first be observed that, whereas VAT is levied on individual transactions at the marketing stage and its amount is proportional to the price of goods or services supplied, IRAP is, in contrast, a tax charged on the net value of the production of an undertaking in a given period. Its basis of assessment is the difference appearing in the profit and loss account between the ‘value of production’ and the ‘production costs’ as defined by Italian legislation. It includes elements such as variation in stocks, amortization and depreciation, which have no direct connection with the supply of goods or services as such. In those circumstances, IRAP cannot be considered proportional to the price of goods or services supplied.”
In the case above, the Court was concerned with a tax called Italian Regional Production Tax (‘IRAP’) which is chargeable on the productive activities, that whether IRAP being a tax on production was a VAT? The Court on the stand stick of valuation measure, analyzed, that in VAT, the tax is proportionate to the price of the supplies, while in case of IRAP, the tax being based on production factors, would not be parallel to the price. Although this judgment doesn’t explicitly words the valuation measure under a VAT, at the same time it does enunciates the principle that under a VAT, the tax is on the price.
To put into perspective, it’s no secret that “sole consideration” has been disqualified if the D&M are to be supplied by recipient under the Excise. That doesn’t however means that under GST too, it should act as disqualification of Section 15(1). GST is not a tax on manufacture, but on value addition. Following arguments supports the view that use of recipient owned D&M is not an additional consideration;
A. Consideration under GST Law
In Mutual Industries, the Free of Cost supplying of D&M was held as (additional) consideration for the Excise Valuation. It would be imperative to see, if consideration under Section 2 (31) could inhale such “Free supply” under GST Law as well? The consideration is defined as follows;
2. (31) “consideration” in relation to the supply of goods or services or both includes–
(a) any payment made or to be made, whether in money or otherwise, in respect of, in response to, or for the inducement of, the supply of goods or services or both, whether by the recipient or by any other person but shall not include any subsidy given by the Central Government or a State Government;
(b) the monetary value of any act or forbearance, in respect of, in response to, or for the inducement of, the supply of goods or services or both, whether by the recipient or by any other person but shall not include any subsidy given by the Central Government or a State Government:
By the very language, it can be seen that, that the consideration definition has two parts. The “includes” part comprises of two facets viz.
A.1. Bhayana Builders’ Analogy
Without going into the contours of “in respect of” etc., there has to be an act or forbearance. In the case at hand, there is no need to divulge in the second facet, when there is lack of satisfaction of first facet. The Larger Bench of Hon’ble CESTAT in case of Bhayana Builders [2013 (032) STR 0049 (Tri. – LB)], has held that the consideration is something that benefits the supplier.
“6 (v)…………..Implicit in this legislative architecture is the concept that any consideration whether monetary or otherwise should have flown or should flow from the service recipient to the service provider and should accrue to the benefit of the later.”
Even if it has be construed that the “Free supplies” are “for the inducement of” supplies, these Free supplies are precursory not “act or forbearance” for the benefit of the supplier. These could be called “condition of supply” vis-à-vis supplier, these are passed on to supplier for supply but not passed on to supplier for supplier (his own benefit).
The term “for the benefit of supplier/ promisor”, is a superlative character for the “consideration”. The lack of benefit in the payment/ act/ forbearance, fails even the general definition of consideration for a supply. [Bhayana Builders quoting the Hon’ble Supreme Court from Ku. Sonia Bhatia v. State of U.P: and Others – AIR 1981 SC 1274]
“8. (i)………..the inescapable conclusion that follows is that ‘consideration’ means a reasonable equivalent or other valuable benefit passed on by the promisor to the promise or by the transferor to the transferee.”
“8. C. …………..There could be no dispute that free supplies by the recipient for use in construction services have a nexus; and an integral nexus for that matter with the construction activity. The essential question is however whether such free supplies by the recipient would constitute consideration accruing to the economic benefit of the service provider so as to be includible in the “gross amount charged” for the service provided”
A.2. Condition for supply than Consideration for Supply
It’s already noted that SKUs are based on specific drawings, they are In-fact, D&M specific. In almost certainty, “Type A” D&M can only bring to existence “Type A” SKU “Type B” D&M cannot make “Type A” SKU. Therefore to bring “Type A”, SKU, the Tier 1 needn’t but has to resort to “Type A” D&M, meaning thereby, regardless of its position otherwise, the use of D&M is least of all a “condition/obligation of supply” of SKU. The condition of supply not consideration. Australian GST Ruling namely GSTR 2001/6: Non-Monetary Consideration, concurs with same;
“83. Many transactions involve exchanging various rights and obligations between the parties to the transaction. In particular, the true character of the transaction may characterise the payment as a condition of the contract rather than the provision of non-monetary consideration……………”
Example 9 – things used in making the supply
91. E agrees to supply services to M at a rate of 100. Under the agreement, E must perform the services on M’s premises in Melbourne. M agrees to allow E to use its computer facilities, stationery and safety equipment on M’s premises to perform the services. M also agrees to fly E to Melbourne and provide accommodation and meals during the period E performs the services.
92. There is monetary consideration for E’s services. The provision of the use of computer facilities, stationery and safety equipment and the transport, accommodation and meals is not part of the price paid for the services as it is not a payment or of value to E in return for his services. They are rather conditions of the contract that go to defining the supply made by E, and are used in providing the services, rather than being supplied to E in return for the services. They do not provide economic value to E in return for his supply. The provision of these things in these circumstances is not consideration in connection with the supply by E. There is no non-monetary consideration for E’s supply.”
A.3. Disparity of Valuation in Model 1 to Model 2
On a closer look into Model 1 and Model 2, a major difference can be seen. Suppose in the Model 1 the price of SKU offered by Tier 1 is INR 100 per SKU, while in Model 2, the Tier negotiates, a consolidated price of INR 140 per SKU instead of charging separately for the D&M manufactured by them. Call we call it disparity? And proceed to load the value of D&M into SKU under Model 1, so as to bring into parity with Model 2?
It would be another day when we will find the logic of disparity via-a-vis Excise Law, but the same cannot be found under GST. Nope! Even if there is, disparity cannot be the singular to load the value of D&M. The Court in Bhayana Builders supra, unequivocally disapproves the same relying on Bombay Tyre International supra and Nitdip Textile Processors [2011 (273) ELT 321(SC)] [para 8 (ix)].
All the above leads to reasonable belief that the consideration fails to cover the free supplies of D&M by the OEM to Tier 1 for manufacturing SKUs and therefore TV can be accepted distinguishing the ratio of Mutual Industries on change of law and circumstances.
B. Unlike under Excise Law, the D&M do not escape Tax under GST
The Excise duty is leviable on manufacture, however payable on removal, so when there is no removal, there is no tax. Under the analogy of Model 2 above, the Tier 1 would manufacture D&M, transfer the title to OEM, but retain the same in their factory and won’t pay Excise Duty. Even if the D&M exhausted their life and rendered useless, then also there was no Excise Duty since they were used in the manufacture of other excisable goods vide Notification No 67/95-CE. In effect these D&M got complete exclusion from the Excise Duty. To correct such anomaly, the excise duty had charged on D&M via SKU. Therefore there was a necessity under Excise Law to provide for inclusion of value of D&M as Amortization.
However, under GST, the transfer of title from Tier 1 to D&M is exigible to tax as an independent supply, therefore there is no need to unnecessary incorporate the amortized value of D&M and tax it twice in the grab of SKU.
C. No specific provision providing for Amortization
Wonder why the value of D&M was added as Amortization Rule i.e. Rule 6 of Excise Valuation Rules, 2000 and not under the comparable value rule viz. Rule 4. The only foreseeable reason can be, that SKUs are tailor made, one of its kind and gets extinct very quickly, therefore there is clear lack of comparable value for an SKU. Explanation 1 to Rule 6 explicitly called for Amortization method of such cases. However, there is no such provision for Amortization under the GST Rules for Valuation. It may be indicate of the intent of the legislative authority to intentionally not incorporate amortization. It may also be noted that, a provision in the Model GST Law June 2016 had sought to add the value of free supplied goods by the recipient in value, however in subsequent Models and Final Law, the clause was omitted, leading to another indication that intent is not to cover the same. The provision is quoted under Section 15 (2) (b) of the Model Law;
(b) the value, apportioned as appropriate, of such goods and/or services as are supplied directly or indirectly by the recipient of the supply free of charge or at reduced cost for use in connection with the supply of goods and/or services being valued, to the extent that such value has not been included in the price actually paid or payable;
Asides from the proposition of “sole consideration” above, there is another provision that can be contemplated to gauge if value of Free Supplies be added in value of SKUs for GST purpose. Section 15 (2) clause (b) is quoted below;
15. (2) The value of supply shall include–
(b) any amount that the supplier is liable to pay in relation to such supply but which has been incurred by the recipient of the supply and not included in the price actually paid or payable for the goods or services or both;
Before moving forward, a closer look at who is “liable to pay”, should be necessary. Liable to pay is a, “contractual term” i.e. to become liable to pay, one has to enter into contract or be a part of contract in some capacity. Furthermore, there should be an express or implied onus on the one to be “liable to pay”. In express contract, if one person is specified to pay, then he is liable to pay, and if his liability has been paid by someone else, then the payment needs to be added to value under clause (b) above. However, in case by an express clause, it is inserted that “supplier” is not liable to pay, there will be no occasion to go into Section 15 (2) (b) whatsoever.
The plethora reaches to one and only conclusion, re-imbursements are being made liable to tax. However, re-imbursements are taxable only when there is a conjunctive supply, mere reimbursements may not be subject to tax. Nevertheless, re-imbursements are absolutely nowhere to be found in either of the Model 1 or Model 2. In Model 1, the OEM is liable to pay towards the cost of D&M, the Tier 1 is not privy to the liability of D&M. While in Model 2, the value of D&M is part of separate supply between Tier 1 and OEM, and is anyways offered for tax as part of that supply.
Another way of looking at Section 15 (2) is that all the clauses contained therein are “determined value”, if they are to be added, they are to be added as such, No function can be applied over the value of determined value. However, in the peculiar case present, the D&M covers multiple consignments usually over 2 – 3 years [say 50 lots]. Factually, the value of D&M is qua contract of SKUs than qua Lot of SKU. Should a single determined value be added to either of the lot? If it was to be spread over 50 lots, the value would lose its primary character. Amortization, therefore should never be covered by the operation of clause (b), simply because the provision doesn’t empower spread of value.
It can be safely summed up that, Valuation for a VAT/GST is different from the Valuation of Production based tax. Although Section 15 (1) carries the transaction value from the Excise, it doesn’t carry the flawed “manufacturing value”. The Valuation in GST should be structured on “Price”, more or less mimicking State VAT Acts, since GST tends to capture the events which Central Excise Act was not able to and hence was forced to act upon the proxy valuation rules. Sole consideration also needs a level up from the one prevailing under Excise, the proxies should be minimum. And out of all, Amortization should not be there under GST.