Budget brings vital changes in excise law

SERVICE TAX

Budget 2007-08 has brought about several changes in relation to both, excise rates as well as excise law. This article addresses some of the key issues related to the changes in excise law.

These key changes are in regard to the valuation of excisable goods manufactured as job work, the proposal to charge various categories of IT hardware products to excise duty on the basis of their maximum retail prices (MRPs) and, finally, the introduction of differential duty, based on values, on cement.

The excise valuation rules have been amended to incorporate that, where goods are manufactured by a job-worker on behalf of a principal, the value for payment of excise would be based on the sale value at which the principal sells the goods, as against the earlier provisions which provided that the value would be the cost of raw materials plus the job charges paid to the job worker.

Historically, there were no specific statutory provisions in respect of valuation of goods manufactured as job work and, as a result, there arose numerous disputes in relation to valuation of such goods.

Finally, the matter was settled by the landmark decision of the Supreme Court in the Ujagar Prints' case in 1989, wherein the court held that duty was payable on the cost of goods plus the job worker's charges inclusive of his profit margin. The profit margin of the principal was not therefore charged to tax.

This resulted in a situation whereby the same goods were charged to a higher duty, if manufactured by the principal himself, based on the valuation of such goods at their selling prices, and to a lower duty, if manufactured by a job worker, who had discharged duties on the basis of the principles laid down in the Ujagar Prints case.

This was clearly an anomaly and afforded an opportunity for companies to explore the option of conversion or job work for manufacturing of branded goods. The Budget changes are intended to close this opportunity for tax planning. However, it must be noted that insofar as goods are charged to excise on the basis of their MRPs, in terms of Section 4A of the Central Excise Act, the aforesaid change will have no application and duty will continue to be charged on such goods on the basis of their MRPs.

It must also be noted that the change does not apply to manufacture of intermediate goods as a job work, which will continue to be valued as per the principles laid down in the Ujagar Prints case. Finally, the change will also typically not impact the valuation of goods manufactured by a contract manufacturer under a 'buy-sell' model.

However, there are also some concerns regarding the definition of a 'job work' as contained in the new provisions. The definition has been worded in a manner that it appears to include even those instances where goods are manufactured under contract manufacturing arrangements where typically capital goods, such as moulds or dies, are supplied by the principal to the contract manufacturer, for use in the manufacturing process. It is advisable for the government to appropriately clarify that the definition is not attracted in such situations.

The proposal to include IT products, such as computer and their peripherals, printers, fax machines etc under the various MRP-based valuation provisions is a far reaching step and could be problematic.

Although this system of valuation is similar to that introduced for pharmaceuticals and a host of packaged durables and non durables, the point however is that the aforesaid categories of products are predominately sold only in the packaged form and hence the application of these provisions, which are triggered only if the goods are sold in the packaged form in retail, is understandable.

The problem in relation to the IT hardware category is that the goods which are covered thereunder are sold in the large numbers in unpacked form. This would lead to the industry discharging excise duties on a significant quantum of its production on the basis of the erstwhile valuation provisions, as also discharging duty under the MRP provisions, insofar as the goods are sold in packaged form. This could lead to increased compliance costs.

Also, the products covered under the provisions are sold in diverse channels with differing channel partner dynamics and compensation regimes. Determination of an appropriate abatement percentage in order to arrive at the basis on which the excise duty will be charged on the products will therefore be critical.

The percentage should reflect the actual costs that obtain in relation to marketing and distribution (post-manufacturing expenses) of these goods. It is imperative that the industry and the Government engage in a meaningful discussion so that the abatement percentages, which are at the very core of the discussion, are correctly and fairly determined for the relevant product categories.

Finally, the Budget has become noteworthy, and has assumed a certain degree of notoriety, because of the proposal to differentiate the excise duty structure for cement based on the price at it would be sold in retail. While the measure has been brought in to contain inflation, it is a moot point as to whether the proposal would enable this objective to be achieved. The scheme envisages a reduction in excise duty from Rs 400 per MT to Rs 350 per MT, if the MRP of a 50 kg cement bag is Rs 190 or less, whereas the duty would go up from Rs 400 per MT to Rs 600 per MT if the MRP of the 50-kg cement bag is in excess of Rs 190.

The apparent objective here is to incentivise cement manufacturers to lower their recommended retail prices so that they are able to benefit from the lessor duty outgo and to correspondingly penalise those manufacturers who continue to sell cement in excess of the aforesaid price.

While it is too early to identify the trends, it is a fact that the prices of cement were increased beyond the indicative price of Rs 190 per 50 kg bag. The industry has, of course, finally agreed to hold the price line for a year but the differential excise regime has not influenced pricing decisions. Indeed, the subsequent move of the government to exempt imported cement from customs duties indicates that the differential excise structure has not met the desired objective.

There are other consequences of such a differential excise structure and from a policy standpoint, differential taxes, based on values, are therefore not recommended. It is hoped therefore that this differential excise regime for cement is reconsidered, in the times to come.

The writer is leader, indirect tax practice, PricewaterhouseCoopers