Transfer pricing issues under Excise & Customs laws: BMR
Corporate entities are often deemed to be related in terms of excise law if (a) they are interconnected undertakings and / or (b) they have mutuality of interest in the business of each other.
Excise and Customs law are the oldest surviving indirect tax legislations in India. Despite this, till date, valuation methodology to be adopted under both the laws continues to be subject to debate on multifarious issues. These complexities are further aggravated in case of transactions between related group entities.
Ordinarily, corporate entities establish a number of subsidiaries, branch offices, liaisoning offices, etc either in the country of the parent entity or in any other country based on strategic decisions. Such entities may also incorporate affiliates and / or special purpose vehicles for carrying out specific functions or projects. These often have cross shareholdings and enter into monetary transactions with each other for provision of services or supply of goods.
Under excise and customs laws in India, tax as a thumb-rule is payable basis the transaction value that is – actual price paid or payable by buyer to seller. However, in case of transactions between related group entities, lawmakers have laid down special mechanisms for valuation, to ensure that taxes are paid at arm’s length prices. Given the complex provisions regarding valuation under both excise and customs laws, quite often, issues arise with respect to determination of assessable value of transactions between related entities. Lately, there has been a spurt in the number of transactions which are subject to deeper scrutiny by the tax authorities on account of the relationship between such entities, particularly under excise law.
Under excise law, related party transactions are valued on the basis of price at which goods are sold by related party to unrelated buyers. Corporate entities are often deemed to be related in terms of excise law if (a) they are interconnected undertakings and / or (b) they have mutuality of interest in the business of each other. Entities owned or controlled by the same group or company qualify as ‘interconnected undertakings’ and are, therefore, ‘related persons’.
It is interesting to note that even though ‘interconnected undertakings’ are covered under the definition of related persons, valuation methodology for ‘related persons’ does not apply to such interconnected undertakings where ‘mutuality of interest’ does not exist between such entities (other than the situation where the relationship is that of a holding and a subsidiary). This position is supported by a recent ruling of the Mumbai Tribunal in the case of Handy Wires Pvt Ltd vs Commissioner of Central Excise Nagpur TS 226 CESTAT 2015(Mum) EXC wherein it has been held that excise duty is payable on the basis of ‘transaction value’ on sale to interconnected undertaking in absence of relationship in any other manner provided in the definition.
Given the above, in case of interconnected undertakings, valuation issues generally arise when excise authorities raise suspicions that apart from being interconnected, such entities also have ‘mutuality of interest’ in the business of each other. On the other hand, interconnected undertakings deny mutuality of interest and desire valuation on the basis of transaction value.
Interestingly, Indian excise law nowhere defines the phrase ‘mutuality of interest’ and over a prolonged period of time, constituents of mutuality of interest have remained a matter of dispute for the taxpayers as well as the excise authorities. Although judicial authorities on several occasions have interpreted the term ‘mutuality of interest’, no clear principles have so far evolved for establishing mutuality of interest between entities.
Some of the factors which tax authorities typically examine to assess ‘mutuality of interest’ are common holding company, common management or board of directors, incurrence of promotion expenses for seller’s product by buyer, extension of interest free loan to seller, and terms of business such as procurement of raw materials only from approved sources, exclusive sales to buyer, etc. However, none of these factors can independently lead to the conclusion of ‘mutuality of interest’.
In a landmark decision in UOI vs Atic Industries Ltd 1984 (17) ELT 323, the Apex Court laid down the principle that that mere interest of taxpayer in the business of buyer is not enough to establish mutuality of interest. Both the taxpayer and the buyer should have interest in the business of each other. On the other hand, in another landmark decision in the case of Flash Laboratories Ltd v Collector of Central Excise, New Delhi 2003 (151) ELT 241 (SC), the Apex Court held that the taxpayer and the purchaser have mutuality of interest as sixty percent of the products were sold to holding company and remaining forty percent to sister subsidiary and the purchaser was incurring marketing expenses for the products of the taxpayer.
Unlike Atic Industries (supra), the Supreme Court in the case of Flash Laboratories (supra) has held that mere shareholding, bulk purchases and incurrence of promotion expenses by buyer are enough to establish two way interest between the taxpayer and the buyer. This exemplifies that the courts have reached different conclusions with respect to existence of ‘mutuality of interest’ based on very fact specific analysis in each case. This leads to persistent lack of clarity on this aspect.
Another major controversy revolving around excise valuation of related party transactions has been sought to be addressed recently through amendment in excise legislation. Earlier, it was being contested by the taxpayers that excise duty was payable on the resale price of related party only in cases where entire sales were made to such related parties. Time and again, disputes used to arise on this ground with the excise authorities. The Supreme Court in a recent ruling in Commissioner of Central Excise, Hyderabad vs Detergents India Ltd & Another [TS-118-SC-2015-EXC] held that valuation based on buyer’s resale price under the erstwhile relevant rule (applicable for period prior to July 1, 2000) for related party transaction was not correct where only sales to the tune of 10 percent of the production capacity were made to the related entity and remaining to third parties. This was on the basis that the said provision applied only where the sales were predominantly to related entity. With the recent amendment, now the legislation specifically provides that even when goods are partly sold to related persons, resale price of related buyer would apply for excise valuation. It remains to be seen whether the amendment would put this long drawn controversy to rest, or valuation can still sought to be done basis the price of goods sold to independent buyers, in case of part sales to related parties.
Under the customs law, for imported goods, transaction value is allowed to be adopted for valuation in case of imports from related parties, provided the importer can establish that the relationship has not influenced the price at which goods have been imported. Where customs authorities doubt that the value of imported goods have been influenced by relationship between the parties, the valuation is referred to the Special Valuation Branch which then tries to ascertain the veracity of the value declared.
Further, issues may also arise on account of any additional payments (such as royalty for technology, salary to employees deputed abroad, commission for marketing services, etc) made to the related party by the importer. Customs authorities typically deem such payments as ‘condition of sale’ of goods and seek to include the value of such payments in the assessable value of imported goods. While judicial authorities at different levels have delivered numerous decisions relating to these aspects, the litigation on such issues still continues.
Another pain point for the tax payers regarding pricing of inter-company transactions is the inverse relationship between the direct tax and indirect tax consequences. As a result of this, while the direct tax authorities typically seek valuation of inter-company transactions at the lowest price point, the excise and customs authorities are keen on valuation of such transactions at the highest price point.
In case of related parties, it is imperative to understand the peculiarities of provisions relating to related party transactions. It is also critical that the direct and indirect tax positions of the concerned entities vis-à-vis the subject transactions are aligned. Nonetheless, given the complexity of valuation legislations, these issues may not be resolved anytime soon till amendments are carried out in the applicable legal provisions or clear cut principles are laid down. It would also be interesting to watch how related party transactions are dealt with under the impending goods and services tax regime.
