M J Antony: Ads for mutual benefit

OUT OF COURT

The Supreme Court has asked excise authorities to recognise legitimate business considerations.

Advertising benefits both the manufacturer and the dealer. Therefore, both spend funds on marketing and publicising products and services. Sometimes the identity of the spender is not clear. This raises problems in computing excise duty on the products. Should the expenditure on sales promotion and publicity paid out by the dealer or distributor be included in the assessable value of the products declared by the manufacturer? This issue came up before the Supreme Court recently in Alembic Glass Industries vs Commissioner of Central Excise.

There was a prolonged strike in the factory of the company which crippled production for some time. It decided to cut down expenditure in areas like labour, packing, inventory and advertising. Darshak Ltd, which was a bulk purchaser of the company's products, then began advertising to boost its sales of goods bought from the company. The excise authorities started investigating the expenditure on publicity and promotion incurred by Darshak.

After the enquiry, the department issued show cause notice to the company accusing it of gradually transferring the expenditure on sales promotion and publicity to Darshak. It wanted to include the amount spent by Darshak in the assessable value declared by the company. It did not accept the objection of the company that all sales were made on principal to principal basis and the two firms were not related. The Customs and Excise Appellate Tribunal confirmed the findings of the revenue authorities on the question of valuation and suppression of facts. It observed that the circumstances showed that it was all a package deal for the revival of the unit and Darshak was helping it in the cost reduction exercise. On appeal, the Supreme Court reversed the finding of the tribunal and set the company free of the liability and penalty.

One of the leading judgements on this issue was delivered by the Supreme Court last year, in Collector of Central Excise vs Besta Cosmetics Ltd. The court held that where advertisement costs were incurred by dealers compulsorily and where the manufacturer had an enforceable legal right against the dealers to insist on incurring such advertising expenditure by the dealers, the advertisement cost could be included in the assessable value. In the latest case, there was no such enforceable legal right. Therefore, the tribunal's view was wrong, according to the Supreme Court.

Some high courts have also dealt with this problem. The Madras High Court, in Standard Electric Appliances vs Supt of Central Excise (1986), pointed out that it was common sense that buyers expect service facilities for the product they've bought from dealers.

So, the consumer is likely to approach the dealer for replacing defective parts of the product. Ultimately, the dealer gets reimbursed for the spare part from the manufacturer. Advertising by the wholesaler or dealer is thus, a well-known method to attract customers. If, as a result of the dealer's advertisement, the demand for the product increased, it could not be taken for granted that the advertising was made for and on the behalf of the manufacturer.

The Bombay High Court, in Union of India vs Mahindra & Mahindra (1989), emphasised the relationship between the parties, being buyer and seller, on a principal to principal basis. The high court observed that the manufacturer and the distributor had mutual interests in increasing the product's sales. The contract between them relating to advertising furthered this desire on their part. It did not affect the real nature of the transaction, which was on a principal to principal basis.

The after-sales service also enhanced the value of the product and the dealer gets to sell more and earn a larger profit due to this factor. Though the product might have been sold in one town, the consumer can benefit from the product's guarantee across India. Therefore, it benefited both the manufacturer and the dealer. In Philips India Ltd vs Collector of Central Excise (1997), the Supreme Court took into account all these factors and ruled that making a deduction out of the trade discount was uncalled for. The court emphasised that while adjudicating matters, the excise authorities would do well to keep in mind "legitimate business considerations".

As early as in 1963, the Supreme Court had stated that the real value could include only manufacturing costs and manufacturing profits and excluded post-manufacturing costs and the profits arising from post-manufacturing operations (Union of India vs Delhi Cloth Mills ). It was reiterated in A K Roy vs Voltas Ltd in 1973. The court ruled in that case that the wholesale price has to be ascertained only on the basis of transactions "at arms length". In the Alembic case, these principles were followed and the court stated that there was no scope for making any addition as done by the excise authorities and upheld by the tribunal. These principles should be the guiding lights for the excise authorities.