Latest move on service tax on distillers raises concern
January, 02nd 2007
A recent draft circular, put out for public responses/ comments, of the department of revenue in relation to levy of service tax on distillers, under the heading of business auxiliary services, has caused widespread concern.
It is common practice in the liquor industry for the brand name owners, especially foreign ones, to enter into strategic tie-ups with third party manufacturers or contract bottling units (distillers or bottlers), for manufacture of branded liquor.
The reason that it is so is that there are stringent licensing requirements for manufacture and/or sale of liquor in India and only distillers/bottlers who are in possession of such licences are able to manufacture and/or sell branded liquor, regardless of who the brand name owners are. Thus, the distillers/bottlers enter into contract manufacturing activities, whereby they manufacture and sell branded liquor, the brand belonging to the brand name owner, and share proceeds with the said brand name owners.
Alternately, they manufacture branded liquor on job work basis, whereby the brand name owners, at all times, retain title in the manufactured goods.
These arrangements are seen as a win-win for both parties, as the brand name owners are able to realise the benefits of sale of their branded goods in India and the distillers/bottlers are able to utilise fully their manufacturing capacities.
The circular referred to above has taken the view that the activities of blending, manufacturing, bottling and labelling of liquor would amount to provision of business auxiliary services, if carried out on job work basis by the bottler on behalf of the brand name owner. It needs to be stated straightaway that the circular is limited to a situation of job work, whereby the distillers or bottlers do not hold proprietary rights over the branded goods. Consequently, the circular, in terms, does not extend to a situation where such distillers or bottlers carry out such activities, not as job work but as contract manufacturers, involving the sale or the transfer of property in such branded goods. In such a situation, no service tax will be applicable, as per the above circular.
However, the more pressing concern is with regard to whether at all such activities are chargeable to service tax, even if carried out on a job work basis.
The point here is that definition of business auxiliary services under service tax law covers the activities of production or processing of goods for or on behalf of clients, provided that such activities do not amount to manufacture, within the meaning of Section 2(f) of the Central Excise Act, 1944. The circular suggests that since the manufacture of alcoholic beverages falls outside the Union List of the Seventh Schedule of the Constitution of India, the Central Excise Act, being an act of the union, cannot apply to such manufacture at all and purely for that reason, the activities of blending, manufacturing bottling or labelling of liquor, by job workers, would be chargeable to the service tax. This argument that there is no requirement to determine whether such activities amount to manufacture under excise law, qua alcoholic products, appears to be a flawed one. The definition of business auxiliary services extends only to production or processing activity which do not amount to manufacture within the meaning of Section 2(f) of the Central Excise Act. The expression within the meaning would suggest that the appropriate test is whether the activities performed by the job workers constitute manufacture, if the tests which are used under Section 2(f) to define manufacture are met. It cannot be that since alcoholic products are not covered under the Central excise law, the tests under Section 2(f) are not required to be met. As along as the activities carried out by the distillers/ bottlers constitute manufacture under Section 2(f), as per the tests determined there under, no service tax should apply.
Now, the accepted test under Section 2(f), as per several Supreme Court decisions on the point, is that there should be a transformation through the process of manufacture, of a product from one to a commercially distinct another, with its own characteristics, identity and use. If the process does result in such a transformation, the Section 2(f) test is met and manufacture is said to have taken place.
The activities typically performed by the distillers/ bottlers do result in such a transformation. Therefore, such activities cannot be chargeable to service tax, because of the exclusion provided under business auxiliary services to manufacturing activities.
Equally, the principle that service tax ought not to apply, given that an excise tax does apply, albeit at the state level for alcoholic products, instead of at the Central level, as is the case for products other than alcohol, is a relevant one. The idea apparently behind the exclusion for manufacturing activities from the purview of service tax was the avoidance of a double taxation of the same activity, to both the excise tax and the service tax.
The departmental circular will undoubtedly result in this double taxation. This is not desirable. Also, in terms of the recent decision of the Supreme Court in a BSNL case, it is relevant to argue that such double taxation of an activity, to both goods taxation and to service taxation, is impermissible. It is true that the decision was with regard to sales taxation and service taxation but the fundamental principle is equally relevant to the matter under discussion.
There is therefore an urgent need to represent to the government on the matter so that the circular is not formally issued in its present form.
S Madhavan The writer is leader, indirect tax practice, PricewaterhouseCoopers