Holding Subsidary relatationship does not mean an arrangement of tax avoidance or tax evasion

“Arrangement” to avoid tax spoken  must be something by which the assessee and the related person “arrange” that the goods are sold at something below the normal price, so that tax is either avoided or evaded by such arrangement

Appeals were filed to determine correct construction of Section 4(1)(a) proviso (iii) and Section 4(4)(c) of the Central Excise and Salt Act as they stood prior to the 2000 amendment of Section 4. Issue raised dealt with the definition of “related person” and the price at which valuation is to take place if sales are made to “related persons” in the course of wholesale trade.

A demand was raised vide show cause notice for the relevant period against the Assessee (‘A’, hereinafter). The demand was later dropped vide order of the Deputy Commissioner and also the appeals filed against the same was dismissed by the Commissioner (Appeals) and CEGAT. By a separate show cause notice, the Commissioner confirmed a demand for the later period and also confiscated land, building, plant and machinery, and further ordered redemption of the same in lieu of confiscation on payment of fine besides penalties imposed. Appeal was filed against the above order by ‘A’ and its holding company ‘S’.

The Technical Member in the above appeals held that during search operations goods from the subsidiary company were cleared from the factory premises at a much lower price as compared to the price at which these goods were sold by ‘A’ in the market to wholesale purchaser. The matter was remanded back for a proper adjudication on facts. The Legal Member, on the other hand decided the issue in favour of ‘A’. Due to difference of opinion, matter was referred to the third member, who held that the price at which the goods were sold should be the basis for determination of the assessable value of the goods, and not the price charged by the latter to their dealers and as also both the concerns cannot be said to be “related” to each other within the meaning of the expression as used in Section 4(1)(a) as no “mutuality of interest” between the two companies could be established. It was held that since both ‘A’ and ‘S’ were found not to be “related persons”, it cannot be said that the former suppressed (in their price lists filed with the department) any “relationship” before the department with an intent to evade payment of duty. Both were adjudged to be not “related persons” within the meaning of Section 4(1)(a) of the Act and accordingly their appeals were allowed while that of the Revenue was rejected.

As the facts further revealed, ‘A’ at the relevant time was a subsidiary of ‘S’ and both were public limited companies. ‘S’s subsidiary companies held 57% of the paid up share capital of ‘A’, making ‘A’ a subsidiary of ‘S’ as understood by the definition of “holding company” and “subsidiary company” contained in the Companies Act, 1956. 90% of the manufacturing capacity of ‘A’ was to manufacture various products for ‘H’ which was then branded with ‘H’ names in small packs. A processing charge was paid by ‘H’ for this job work, and it was clear that different processing charges were paid depending upon the size of the product and the product itself. The excess 10% capacity which was not mopped up by ‘H’ was sold to ‘S’, its holding Company. Various other manufacturers/sellers also sold the same and similar products to ‘S’. A large number of these manufacturers were not subsidiary companies of ‘S’ and had no business relationship with ‘S’ other than the sale of these products. It was pleaded as a fact that the price paid by ‘S’ for the purchase of the same/similar products from the other firms/companies was less than the price paid to ‘A’. It was also pleaded that processing charges of different products were different. 
Revenue contended that both ‘S’ and ‘A’ are related persons within the meaning of Section 4(4)(c) of the Act and stated that some of the factors like advertisement expenses of ‘A’s brands being borne by the ‘S’; processing charges paid by ‘S’ to ‘A’ being less than processing charges paid to ‘H’; employees of ‘S’ and its subsidiaries getting freely transferred from one company to another; depots of ‘S’ and ‘A’ being in the same premises; ‘A’ sending monthly newsletters to ‘S’ showing production, dispatches, purpose, technical problems, quality problems, details of power consumption etc. – and ‘S’ fixing price of ‘A’s products; and unsecured loans being given by ‘S’ to its subsidiary ‘A’. Revenue also argued that the moment there is a holding/subsidiary company relationship, the definition of “related person” under Section 4(4)(c) gets attracted and proviso (iii) to Section 4(1)(a) in turn gets attracted and therefore it is the price at which ‘S’ sells the self same goods to its customers is the price that is to be taken into account on the facts of the present case. On the contrary it was contended that even if both may be holding and subsidiary companies, yet on a true construction of Section 4(4)(c) they are not related persons within the meaning of the definition clause. On a true construction of proviso (iii) to Section 4(1)(a), it is necessary that the assessee must first enter into an arrangement with the related person, which arrangement leads to a price being charged which is lower than the normal price. Further, the proviso only gets attracted when such arrangement is predominantly a sale to or through a related person. There was no arrangement between them which led to any depression in the normal price at which such goods were sold. 

The Court held that the “arrangement” spoken of in the proviso must be something by which the assessee and the related person “arrange” that the goods are sold at something below the normal price, so that tax is either avoided or evaded by such arrangement. Secondly, the expression “generally” also shows that such goods must predominantly be sold by the assessee to or through the related person – in mathematical terms, sales that are to or through a related person must consist of at least 50% of the goods that are manufactured and sold. The expression “to or through a related person” again goes back to the “arrangement” and is another way of saying that such sale can be effected directly to or indirectly through such related person. It is only when all three considerations are cumulatively met that proviso (iii) can be said to be attracted. The object of enacting Section 4 is that transaction at arm’s length between manufacturer and wholesale purchaser which yield the price which is the sole consideration for the sale alone is contemplated. Any concessional or manipulative considerations which depress price below the normal price are, therefore, not to be taken into consideration. Arrangements with related persons which yield a price below the normal price because of concessional or manipulative considerations cannot ever be equated to normal price. But at the same time, absent concessional or manipulative considerations, where a sale is between a manufacturer and a related person in the course of wholesale trade, the transaction being a transaction where it is proved by evidence that price is the sole consideration for the sale, then such price must form the basis for valuation as the “normal price” of the goods. 

Section 4(4)(c) is in two parts. The first part requires the department to apply a de facto test, whereas the second part requires the application of a de jure test. A reading of the definition of “relative”, as defined in the Companies Act would show that the relative need not be a person who is so associated with the assessee that they have mutual interest in each other’s businesses. If that were the case, the expression “relative” in the second part would be otiose inasmuch as a relative would be subsumed within “person” in the first part. Thus, “relatives” would also be “persons” who are so associated with the assessee that they have a mutual interest in each other’s businesses. The legislature by application of a de jure test has extended the meaning of “related persons” to include the entire list of relatives per se without more as related persons. Similarly, holding companies and subsidiary companies by virtue of the exercise of control by a holding company over a subsidiary company are similarly included by application of a de jure test.

‘A’ had argued that the price paid by ‘S’ for the same/similar products as was sold by unrelated entities to it was even lower than the price paid by ‘S’ to ‘A’. This being the case, it was held as clearly on facts there is no “arrangement” between ‘S’ and ‘A’ to depress a price which is otherwise at arm’s length. ‘S’ and ‘A’ are “related persons”, which is made out by their holding/subsidiary relationship. However, from this, it does not follow that there is any arrangement of tax avoidance or tax evasion on the facts of this case. This being the case, proviso (iii) to Section 4(1)(a) would not be applicable. Further, it would also not be applicable for the reason that there is no predominance of sales by ‘A’ to ‘S’. In the instant case, only 10% of its manufacturing capacity was sold to ‘S’, 90% being sold to ‘H’. For this reason also, proviso (iii) does not get attracted. This being the case, on facts here Section 4(1)(a) and not proviso (iii) is attracted inasmuch as on facts the presumption of a transaction not being at arm’s length has been rebutted.

[CCE, Hyderabad vs. M/s. Detergents India Ltd. & Anr.]
(SC, 08.04.2015 – Civil Appeal Nos. 9049-9051 of 2003)