It is not uncommon for companies launching new products or entering new territories to sell below production cost in an attempt to penetrate the market.

Notwithstanding the commercial ramifications of such pricing, in the light of a recent Supreme Court ruling in the case of CCE, Mumbai vs. Fiat India Pvt Ltd, such special pricing could also entail additional excise duty cost.

Fiat India manufactured Uno cars using CKD/ SKD (completely/ semi knocked down) kits, which were sold to distributors below production cost. Excise duty was paid on the sale price charged from the distributors. During most of the relevant period, excise duty was applicable on the normal price — that is, the price at which the goods were ordinarily sold in the course of wholesale trade to independent buyers, with price as the sole consideration for sale.

From April 2000, the law was amended to levy excise duty on the ‘transaction value’ — that is, the price at which the goods are sold to independent buyers, with price as the sole consideration for sale.

The authorities contended that the price at which cars were sold in the market could not be considered the ‘normal price’, and price is not the ‘sole consideration’.

The matter went up to the Supreme Court, which finally concluded that the price charged by Fiat was not normal, and its intent to penetrate the market constituted ‘extra-commercial consideration’. Accordingly, the Apex Court restored the original order, which seeks to levy excise duty on the basis of cost of production plus a notional mark-up. Further, it held that even under the current ‘transaction value’ regime, such a price cannot be accepted, as price is not the ‘sole consideration’.

The unexpected verdict has surprised industry, which was so far under the belief that authorities could not challenge the sale price for levy of duty so long as the transaction is between independent parties.

Although the ruling is in the context of automobiles, it would be relevant for all industries engaged in manufacturing products that attract excise duty on ‘transaction value’. These include pharmaceuticals, petroleum, chemicals, confectionary and others.

Also, given the similarity in valuation provisions under excise and customs, it wouldn’t be surprising if customs authorities too start questioning the import price if they have reason to believe it is less than the cost of production.

The Supreme Court’s decision leaves many questions unanswered. Isn’t excise duty, like all indirect taxes, a tax on consumption, which should apply on the price recovered from the customer?

Would this not give sweeping powers to excise authorities to question the valuation mechanism adopted by manufacturers? Now, excise authorities would be well within their rights to verify the cost records for any product, to ascertain whether it has been sold below cost of production. This exercise may well be undertaken for past years, and companies may receive demands for the differential duty.

Also, the entire mechanism would introduce subjectivity to the valuation process. So, for instance, what would stop authorities from questioning the percentage of profit on a particular product vis-à-vis the industry benchmark, or the profit made by the same manufacturer on other products?

Given the wide ramifications of this decision, one would expect the Government to find a way of offering relief to the industry. It certainly seems a fit case for a retrospective change in legislation to ensure that so long as dealings are between independent parties, the sale price would not be questioned.

Industry will be keenly monitoring developments in this regard.

(Pratik Jain is Partner, KPMG in India)

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