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BW Businessworld

Blast From The Past

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If you thought the best way to introduce a product into a highly competitive market space was to price it dirt cheap — below the cost of production — until it captures a considerable market share, think twice. The taxman may be watching.

The government’s tax collection wing is not impressed with the discount business, the way companies sell at a loss, and thereby pay less excise duty on the basis of the low “transaction value” of the product.

The whole array of industries that is coming into the market with new concepts — consumer products, pharmaceuticals, automobiles, or even products for which the research and development costs are high, which the firm intends to recover over a longer period of time — may be in the crosshairs, legal experts feel.

What has caused anxiety among Indian business houses is a recent Supreme Court (SC) verdict supporting the views of the excise department that excise duty should be paid on “actual” cost of a product, and not the discounted price. “It creates great uncertainty for the industry. Particularly when you have new products sold at a loss (introductory price) in the initial stages,” says Vivek Mishra, leader (indirect tax) at PricewaterhouseCoopers India.

The SC verdict was on a specific appeal involving the Commissioner of Central Excise (CCE), Mumbai, and Fiat India. The excise department had asked Fiat to pay more duty on each car of its Uno model that it sold between 1996 and 2001 at a discounted price, which was much lower than its actual assembling cost. This amounted to a tax liability of Rs 360 crore. Soon after the verdict, the excise department is known to have asked several other auto makers to provide details of their actual cost of production for a similar investigation. Other sectors are also under the scanner, industry experts say.

“The revenue authorities will use the Fiat case as a tool to initiate investigations and create a demand for differential excise duty in a large number of cases. While on the facts, the Fiat case is unique, in the sense that the company admittedly resorted to selling cars at a loss over five years to penetrate the market, yet there may not be too many similar cases in industry,” says Ashok Dhingra, partner at law firm J. Sagar Associates. “(However) authorities will blindly apply the Fiat case in each and every case of selling of excisable goods at a loss by assesses,” he adds.
No one is clear about the broad implications of the decision. Does it mean that everything that is sold at a loss can be subjected to a cost-plus valuation? If selling at a loss for five years cannot be allowed, can four years be considered normal practice? Experts have no answers.

Incidentally, arbitrary valuation of excisable goods was a contentious issue for long until the central government amended the excise law around 12 years ago to change the value on which excise duty is levied from “normal price” to “transaction value”.

“The understanding was that duty needs to be paid on invoice value, i.e., the consideration flowing from the buyer to the seller. However, based on this decision, the authorities may (in the future) question the practice of selling the goods at a loss, discount or even a nominal profit and attribute a consideration on account of market penetration, brand building, utilisation of idle capacity and other such factors”, says Pratik Jain, partner, indirect tax and regulatory services at KPMG India.

However, the move may not have an impact on routine discount sales or products where there is a government subsidy. “The ruling will impact only those companies whose prices are linked with the value,” says B. Mukherjee, director (finance) at Hindustan Petroleum.

“Online sale, stock clearance sales, promotional sales or margin-free sales should not be hit by the Fiat case as those are on a different footing. The transactions hit by the Fiat case would be where there is additional consideration for such sale in the form of penetration of the market, undercutting competition, uncompetitive trade practice and factors other than normal business considerations, coupled with long-term sale of goods at a loss,” explains JSA’s Dhingra.

According to him, this decision was neither the result of a legal loophole that got plugged nor one created by the Fiat case. “The decision in the Fiat case is based on a unique set of facts which is an exception to the norm and not settled industry practice. No industry can suffer losses or sell goods at a loss for a continuous period of five years,” he says. If industry players with deep pockets and determination to drive out competition resort to this kind of ambush pricing in the future, they may have to consider the cost of an additional burden of higher excise duty, which may be small change in the entire scheme of things, Dhingra adds.

Experts feel that the Fiat case may result in further clarifications by the Central Board of Excise and Customs (under Section 37B of the Excise Act) or lead to circulars on the manner in which the transaction value will be calculated in future. However, a surge in raids or investigations and valuation audit of industry by the excise authorities is what can happen in the immediate future, they say.

Industry feels that the excise department has always tried to interpret every possible technical loophole in its favour to generate more revenue. “The excise authorities routinely create demand for excise duty on capital subsidy, or sales tax exemption, or sales tax deferral given by the state governments, which are at various stages of adjudication,” Dhingra says.

For instance, he gives the examples of Kinetic Engineering versus CCE and Maruti Udyog versus CCE, where the excise authorities have been demanding additional payments on incentives/subsidies given by state governments.

It’s not the industry alone that is going to be affected by the verdict. The tax authorities will also have to adjust to the new situation. “Tax administration would also be a huge challenge, given the subjectivity involved. The government may need to amend the law to avoid undue hardship for businesses,” says KPMG’s Jain. It is known that leading industry chambers are in the process of assessing the impact and are planning to take up the case with the finance ministry soon.

Meanwhile, Fiat and its erstwhile partner Premier Automobiles are said to be approaching the Supreme Court again through a review petition to see if they can avoid paying the Rs 360 crore as tax liability for the Fiat Uno vehicles that were sold below cost.

(This story was published in Businessworld Issue Dated 05-11-2012)