The Indian liquor industry, the third largest in world, yields over Rs 30,000 crore in annual revenues for State governments and over Rs 50,000 crore as taxes to the Central exchequer. The industry is, however, highly regulated in terms of constraints on licensing, manufacturing, marketing, storage as well as distribution.

Apart from licensing restraints, the industry faces severe threat of prohibition, high excise and import duties, and restrictions on both advertisements and inter-State movement of products. In short, the industry suffers from over-taxation and over-regulation. This problem is compounded by the fact that alcoholic beverages come under the purview of individual States, with each empowered to frame respective excise laws.

Companies, in order to overcome the capacity issue, enter into strategic tie-ups with third party manufacturers or contract bottling units (CBUs) which have manufacturing licence in their name. Since these CBUs have spare capacity, tie-up arrangements enable companies to get their brands manufactured by these CBUs and meet the demand requirements in various States.

These types of arrangements are legal and are accepted by State excise authorities.

Now, the service tax wing of the Department is trying to get into the world of alcoholic beverages by attempting to tax contract bottling under business auxiliary services. A draft circular issued by the Finance Ministry on October 5, 2006, seeks to levy service tax on processing and bottling activities under business auxiliary services.

Debatable Issues

With reference to the service category of business auxiliary services, although the activities of the contract bottling units may be interpreted as `production or processing of goods for, or on behalf of, the client' and in the case of packing activity services, the bottling activities may amount to `packaging of goods including pouch filling, bottling, labelling', it is required to be clarified that the exemption from `business auxiliary services' or `packaging activity services' to activities that amount to `manufacture' should be extended and/or interpreted to include the manufacture of liquor which is administered by the State Excise laws. The exemption is to the activity of manufacturing, which should include all activities of manufacture.

The draft circular states that the manufacture of alcoholic beverages falls outside the Union List and that the Central Excise Act, 1944 cannot and does not apply to manufacture of alcoholic beverages. Since it is outside the scope of Central Excise law, the activity of making, bottling, packing and labelling of potable alcoholic beverages does not amount to `manufacture' as per Section 2(f) of the Central Excise Act. Accordingly, by virtue of definition and scope of business auxiliary services, such activity of blending, manufacture, bottling or labelling on job-work basis by a distiller in respect of IMFL on behalf of the brand owner would be a taxable service under business auxiliary service. The circular also states that service tax is not an excise duty.

These bottlers, as job workers, do not have any proprietary rights over the goods produced and are paid only job charges by the brand owners who have proprietary rights over goods and who market and the sell the IMFL goods so produced by job works. In such as situation, it is apparent that between the two brand owner and bottler it is the bottler who provides service of bottling (manufacture) and brand owner does not provide any service to the bottler.

Bottling arrangements

It, therefore, appears that if the Government is intending to levy service tax on such bottling arrangements, the service provider (bottler) may have to pay service tax on bottling charges he receives/retains under the agreement. Since the proprietary rights vests is brand owners and they do not render any service, the owners' surplus shall be liable to be taxed in their hands as income-tax only.

It is also a fact that in the case of liquor manufacturing, only State excise duties are paid. There is, therefore, no provision for set off or utilising any Cenvat credit, making the proposed levy discriminatory. Moreover, service tax is to be administered by Central Excise authorities.

Since State excise duties are already paid on these manufacturing activities, service tax, if levied, would amount to double/multiple taxation unless a clear set-off mechanism is laid down and allowed to be set off against State levies, too, if the quantum of service tax payable exceeds to total Cenvat accrued in the purchase of input materials under Central duties. Central Excise and State Excise are two distinct levies/taxes and one duty cannot be set off against the other under the Cenvat Credit Rules, 2004.

Clarification needed

However, in some States, the Central Excise Department is already raking up the issue of payment of service tax on these activities under various service categories.

To make the position clear and remove any doubts, it would be in the interest of the Revenue as well as the manufacturers that a clarification is issued that such manufacturing activities through contract bottling units by the liquor manufacturing companies do not fall under the scope of service tax, being manufacturing operations on which State excise duty is already paid.

Thus these companies generally have multiple tie-ups in each State as per the business demand.

These kinds of arrangements are required as there is a freeze on issue of new licences by the various State Governments, and usage of the existing capacity of the CBU's results in huge savings, as investment in factory and related infrastructure is not required.

Since licensing of new units is still an undecided issue between the Centre and the States so far as jurisdiction is concerned, no fresh licences are available or transferable leading to the need for tie-up with manufacturing units having licence to manufacture liquor. Moreover, buying and selling is not possible as is in the case of consumer products. Also, a prohibition on buyback of products, billing station/seller has to be a distillery and not the brand owner, and need for time bound excise documentation, etc., necessitate the arrangement of manufacturing under a contract.

If the tax is proposed to be levied on bottling/blending part of the contract, then there cannot be a tax on the other part of the contract which is nothing but the share of surplus of the principal on whose behalf such goods are manufactured. This is based on the simple rule that one cannot render service to oneself and that the proprietary rights vests in the brand owners.

The Government should issue a notification/circular clarifying the non-taxability or otherwise of activities relating to the manufacture of alcoholic goods under the licences/contract production from service tax. Sooner the better and it should be done prospectively.

Sanjiv Agarwal
(The author is a Jaipur-based chartered accountant.)