Selling is a precondition to manufacture: CENVAT CREDIT FOR SERVICE TAX PAID ON ADVERTISEMENT AND PUBLICITY IS ALLOWALE, IF IT PROMOTES SALE AND THUS MANUFACTURE - Bombay high court

[C.A. DEV KUMAR KOTHARI]

Links:

CENVAT Credit Rules:

M/s. Coca Cola India Pvt. Ltd. Versus The Commissioner of Central Excise, Pune-III [2009 -TMI - 34433 - BOMBAY HIGH COURT]

Article "INPUTS SERVICES- JUDICIAL ANALYSIS" - By Dr. Sanjeev Agarwal.

And various links provided in the above judgments and article and the article below.

Ground realities selling is precondition to manufacture:

Marketing and selling are pre-conditions for manufacture or production:

Practically viewed, selling of any product is essential before its manufacture. Unless a product can be sold, there will be no purpose of manufacture. This is ground reality for success of any business. Therefore, it is always desirable to have a market research to ascertain possibility of acceptance of product and scope of selling the same. Items which are already in market pose less problem then the new products. In case of products which are already in market, the same product with another brand and with some additional features as to attributes, quality, packing and market strategy can be launched with ease. Depending on competitive advantage the new product will capture some of market share of existing manufacturers and shall also create new market. However, in case of an altogether new product, there is need of proper assessment of market for the product. Even after entering the market, there is need of advertisement to retain market share, to gain new market share and to keep the competitive advantage. If a manufacturer has no order or expected orders, he cannot dare to manufacture and keep inventory of products. Therefore, it can be said that the sales promotion and marketing are essential prerequisites for manufacture. When we consider this ground reality, then there is clear case that expenses in connection with selling and sale promotion are essential expenses for manufacture. Therefore, expenses incurred for the same, including any direct and indirect expenses for goods and services are for manufacture of products. Then the inevitable conclusion is that selling and sales promotion are inputs required for manufacture of goods and for rendering of services. Therefore, any tax or duty paid in relation to goods or services for sales or sales promotion should also be eligible for input credit under Central Excise Act, Service tax provisions and VAT as the case may be.    

Recent judgment of Bombay High Court:

In Coca Cola India Pvt. Ltd. vs. CCCE  [2009 -TMI - 34433-BOMBAY HIGH COURT]  the Bombay High Court has considered the provisions relating to levy service tax and allowability of CENVAT credit  in a liberal, broad and inclusive manner. The Court held that expenses incurred by a company for advertising and promoting a brand owned by it would be eligible for input tax credits because such services are 'input services'. This decision has extended the scope of CENVAT credit to a significant extent and will be beneficial for product promotion, consumer benefit etc.

Author feels that the decision recognizes the ground reality of sales promotion being a precondition for manufacture of products.

The taxpayer manufactured raw material (concentrates for beverages)required for manufacture of  carbonated beverages. Carbonated beverages are manufactured by other manufacturers. To promote sale of its own products that is concentrates for beverages, taxpayer advertised the end product that is carbonated beverages. The taxpayer claimed CENVAT credit for service tax paid in relation to advertisement of beverages, which required its products. Thus, by promoting sale of the end product - beverages, the taxpayer created and  maintained market of its own product. This si because sale of concentrates, and other revenue of taxpayer depended on sale of beverages in which concentrates are used.

The Tribunal denied CENVAT credit and taxpayer had to approach the High Court to decide whether advertisement of end products in which product of taxpayer is uses as raw material or intermediate products that is concentrates for beverages is  entitled to avail input credits of the service tax paid on advertising and sales promotion expenses relating to the finished or end  products manufactured by certain other companies (in this case carbonated beverages) which were sold under brands which were owned by the taxpayer.

Technically  and legally the issue  revolved around the correct interpretation of Rule 2 of the CENVAT rules relating to the definition of 'input services' and in particular to the inclusive part of the definition. The relevant part of this Rule is reproduced below with highlights:

Rule 2(1) "input service" means any service:

xxxxx

(ii)………….. and includes services used in relation to setting up, modernisation, renovation or repairs of a factory, premises of provider of output service or an office relating to such factory or premises, advertisement or sales promotion, market research, storage upto the place of removal, procurement of inputs, activities relating to business, such as accounting, auditing, financing, recruitment and quality control, coaching and training, computer networking, credit rating, share registry and security, inward transportation of inputs or capital goods and outward transportation up to the place or removal."

The expressions 'means' , 'includes', 'activities relating to business' and 'such as' are important to decide the matter therefore the court  considered many  Supreme Court decisions on interpretation on such expressions taking view that the word 'means' was used to denote that what followed thereafter was intended to speak exhaustively and no meaning other than that which was put in the definition could be assigned thereto. And that the word 'includes' when used in the definition, the legislature did not intend to restrict the definition but to expand it and the items expressly included are illustrative and not exhaustive. In other words, use of word includes is intended to make the definition of wide amplitude. The expression 'activities relating to business' has also been considered in expansive manner.

The Court also held that 'activities in relation to business' would cover all conceivable activities that were directly or indirectly related to the functioning of the business and not merely manufacturing. Accordingly the High Court arrived at a clear finding that the definition of 'input services' would have wider amplitude.

The court accepted the plea of the appellants that though they manufactured the intermediate products, the advertising and sales promotion expenses pertaining to brands owned by them were directly linked to and hence had an immediate nexus with the intermediate products since such intermediate products were entirely used in the manufacture of the branded finished products though manufactured by other manufacturers. The advertising and promotion activities were directly beneficial for the said intermediate products as well. Consequently, the fact that the appellants themselves did not manufacture the branded finished products and in fact allowed third parties to manufacture such goods did not detract from the eligibility to credits.

 The Court considered decision of the House of Lords in the context of VAT which had, on similar facts, taken a view that input VAT deduction was admissible to a construction company engaged in the sale of new buildings to prospective customers on fees charged by estate agents who were engaged by the company to assist such prospective customers in valuing and selling their existing houses in order for them to be able to purchase the new houses built by the construction company. The Court also took note of OECD guidelines which had held that the VAT was a consumption tax and equated this with the finding of the Supreme Court decision in All India Federation of Tax Practitioners vs. Union of India [2007 -TMI - 1556 - Supreme Court] which had inter alia laid down  that service taxes were value added taxes and were hence destination based consumption taxes.

The court also took note of the important factual position that the appellants did not claim a deduction towards such advertising and sales promotion expenses in arriving at the value of the intermediate products manufactured for the purpose of the payment of excise duty.

The High Court came to the conclusion that the service tax paid on advertising and sales promotion expenses relating to brands owned by the manufacturer were admissible for input credits and the fact that the appellants did not themselves manufacture the branded finished products and were limited to manufacturing only intermediate products was not germane.

Authors point of view:

As discussed in the preamble, the author feels that sales and sales promotion are essential preconditions to manufacture or production of any product. Therefore, creation and maintenance of market share of any product should be considered as a part and parcel of any business and in case of manufacture or production of any product an essential precondition. Viewed from this angle, it cannot be denied that the sales promotion, advertisement and marketing are integral part and essentials of any activity of manufacturing or producing any type of goods or rendering of services. In case of branded products, or products manufactured under brand or license of brand or patent owner, which are manufactured and / or marketed through others the brand or patent owner advertise the product and brands, the benefit is derived by the brand owner as well s the licensed manufacturer of such brand and patent holder. If the brand owner or patent holder also sell certain crucial material to licensees then sale of such crucial products is also promoted by advertisement of end products in which such crucial products are used. Therefore, the brand owner or patent holder also promote his business by advertising his brands though end products may be manufactured by others.

Another example:

Suppose a patent holder of a particular drug and brand owner of a medicine containing such drug, allow other manufacturers to manufacture the same medicine using certain crucial drug manufactured and supplied by the patent holder. Other manufacturers manufacture such medicine under technical collaborations and supervision of patent holder, and sell the same under the same brand, with marking "manufactured under license from patent holder using …. Drug supplied by patent holder".

In this case the patent holder concentrate on his business of manufacturing patented drug. The medicine is manufactured and sold at several locations. The sale of patented drug in dependent on sale of the medicine in which patented drug is used. The patent holder therefore, advertise the medicine and take efforts to popularize the same. By increasing sale of end product- the medicine, the patented drug is sold. Therefore, the advertisement of patented drug  as well as  the medicine in which patented drug is used  both are equally important for the patent holder. The patented drug has limited number of customers- that is who use the patented drug in formulation and manufacture of medicines under technical collaboration/ license.

Another article by Dr. Sanjeev Agarwal

The readers are advised to refer to a detailed article by Dr. Sanjeeva Agarwal titled "INPUTS SERVICES- JUDICIAL ANALYSIS" hosted on this website in which various other judgments are summarized and links are also provided for relevant provisions and some important judgments.