EY Tax Alert. Executive summary

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1 3 June 2014 EY Tax Alert CESTAT rules non-compete fee and trademarks licence fee shall be included while determining the assessable value of the goods, under Central Excise Executive summary Tax Alerts cover significant tax news, developments and changes in legislation that affect Indian businesses. They act as technical summaries to keep you on top of the latest tax issues. For more information, please contact your EY advisor. This Tax Alert summarizes a recent ruling of the Mumbai Bench of the CESTAT, in the case of Godrej Consumer Products Ltd. vs. Commissioner of Central Excise (CCE), Indore 1, on the issue whether non-compete fee and trademarks licence fee received, will be included in the assessable value of the goods manufactured, in terms of Rule 5 of the Central Excise Valuation Rules (Valuation Rules), Based on the factual matrix of the case, the non-compete fee and the trademarks licence fee, were construed to be additional consideration flowing directly or indirectly to the manufacturer from the buyer, and therefore, held to be includible in the assessable value of the goods manufactured, in terms of Section 4(1) of the Central Excise Act (CEA), 1944 read with Rule 5 of the Valuation Rules. On the other hand, it was held that advertisement expenses incurred by the buyer will not be includible in the assessable value, in the absence of a binding stipulation to incur the same, in terms of the agreement between the parties. 1 [TS-181-Tribunal 2014-EXC]

2 Facts and background Godrej Soaps Ltd. (GSL), engaged in the manufacture of soaps, transferred its soap marketing and distribution business to Procter & Gamble Godrej (PGG) by way of a Joint Venture Agreement (JVA). The JVA was entered into between GSL, PGG, Procter & Gamble Far East Inc. (PGFE), Procter & Gamble India Ltd. (PGIL) and Mr. Adi Godrej, on 24 June 1993, w.e.f. from 16 December In terms of the JVA, it was agreed that: The soap marketing business shall be transferred by GSL to PGG for a total consideration of INR 34 crores, which would comprise of the value of the soap business (including goodwill) of INR 17 crores and a non-compete fee of INR 17 crores. In addition, trademarks licence fee of INR 7 crores was also payable by PGG for the assignment of trademarks by GSL. Manufacturing agreement to be signed for the manufacture and sale of soaps to PGG, at an agreed price of cost plus 5%. GSL shall not carry any activity which will be competitive with the activities of PGG and PGFE. Accordingly, other related agreements were also entered into as follows: A manufacturing agreement, dated 22 January 1993, between GSL and PGG, to supply soaps, on a principal to principal basis, for a price to be mutually agreed by the parties from time to time. Non-compete agreement, dated 16 December 1992, between GSL, PGFE and PGG Agreements for assignment of trademarks: GSL assigned their trademark to their holding company, Godrej Boyce Manufacturing Co. Ltd. (GB) vide agreement dated 23 November 1992, for a consideration of INR 6 crores. GB gave the licence to use the trademark to PGG, in terms of the licence agreement between PGG and GB dated 22 January 1993, for a licence fee of INR 7 crores. All the aforesaid agreements, including the JVA, were terminated on 23 July On such termination, these trademarks were reassigned by GB to GSL for a nominal sum of INR 10,000. PGG had also incurred expenses towards advertisement and sales promotion of the Godrej brand. The present case was in pursuance to the directions of the Supreme Court vide its order dated 30 July 2008, wherein the matter was remanded to the Tribunal for fresh consideration. The Tribunal had held that the advertisement charges incurred by PGG shall be included in the assessable value of soaps manufactured by GSL, on the grounds that GSL and PGG were related persons. The Supreme Court set aside the order of the Tribunal as it was based on ground of related parties, which was not taken in the show cause notice. Accordingly, the Supreme Court directed the Tribunal to decide afresh on the issue of inclusion of advertisement expenses, non-compete fees and trademarks licence fees, in the assessable value of soaps. Issues before the CESTAT In terms of section 4(1) of the CEA, read with Rule 5 of Valuation Rules, if price is not the sole consideration for sale, then money value of additional consideration flowing directly or indirectly to assessee from the buyer, over and above the price of goods, will be includible in assessable value for levy of excise duty. Keeping in mind the aforesaid provision of law, the Tribunal had to decide

3 whether the following amounts would be included in the assessable value of the goods manufactured by GSL: Advertisement expenses incurred by PGG, Non-compete fee paid by PGG to GSL, and Trademarks Licence fee paid by PGG to GB Assessee s contentions In respect of the advertisement expenses incurred by PGG, the assessee contended that advertisement expenses incurred by PGG can be included in the assessable value only when there is a legal enforceable contract to incur such expenses. In the absence of such a binding stipulation in the JVA, the advertisement expenses cannot be included in the assessable value. The assessee relied on the Supreme Court (SC) decisions in the cases of Besta Cosmetics 2 and Alembic Glass 3, in support of its contentions. The assessee further relied on the SC decision in the case of Philips India Ltd. 4, wherein it was held that the advertisement expenses incurred by the buyer were not includible in the assessable value as the advertisement has benefitted the buyer also. In respect of non-compete fee, the assessee argued that it was a separate transaction and the fee received had no bearing on the computation of the assessable value. The assessee also placed reliance on the decisions in the cases of Agri More Ltd. 5 and Kwality Icecream 6, wherein it was held that the non-compete fee is not includible in the assessable value. In the context of trademarks licence fee, the assessee argued that they had not received any amount from PGG. It was further contended that it was a transfer of an asset and the trademark had nothing to do with the value of goods sold to PGG. Revenue s contentions In respect of the advertisement expenses, the revenue authorities relied on the SC decision in the case of Bombay Tyre International Ltd. 7, and contended that the said expenses shall be includible in the assessable value. It was further contended that the transaction between PGG and GSL was not on principal to principal basis, as GSL was bound to sell the goods only at a pre-determined profit above cost. As far as non-compete fee was concerned, the revenue pointed out that as per the JVA, PGG paid INR 17 crores as consideration for covenant not to compete, and thus it was an additional consideration, having indirect bearing on the pricing of the soaps. In the context of trademarks licence fee, it was pointed out by the revenue that though GB was not a party to the JVA, the trademark licence agreement with PGG was made co-terminus with the JVA, which shows the nexus between GSL, GB and PGG for trademarks arrangement. Since GB was the holding company of GSL, therefore the additional consideration received by GB from PGG should be included in the assessable value in terms of Rule 5 of the Valuation Rules. 2 CCE vs. Besta Cosmetics [2005 (183) ELT 122 (SC)] 3 Alembic Glass vs. CCE [2006 (201) ELT 161 (SC)] 4 Philips India Ltd. vs. CCE [1997 (91) ELT 540 (SC)] 5 Agri More Ltd. vs. CCE [2004 (64) RLT 762 (T)] 6 Kwality Ice Cream vs. CCE [2002 (51) RLT 895 (T)] 7 UoI & Ors. Vs. Bombay Tyre International Ltd. & Ors. [1983 (14) ELT 1896 (SC)]

4 CESTAT s Ruling Advertisement expenses Comments The Tribunal upheld the contention of the assessee that advertisement expenses incurred by PGG (after the soaps are sold by GSL to PGG), shall not be includible in the assessable value, in the absence of a binding stipulation to incur the same in terms of the JVA. Non-compete fees On perusal of all the agreements, the Tribunal came to the conclusion that all these agreements were an integral part of the JVA and are inseparable, and hence held that, consideration received towards non-compete fees, though under a separate agreement, has definite bearing on entire transaction and would, therefore, be includible in the assessable value of the goods sold by GSL to PGG. The Tribunal also observed that in all the cases relied upon by the assessee, the applicability of Rule 5 of the Valuation Rules was not considered. Trademark licence fees It needs to be examined whether the non-compete fees and trademark licence fees, which have been received in context of the transfer of marketing and distribution business, can be attributed to the manufacturing activity (such as contract manufacturing) while determining the assessable value. Post the decision of apex court in the case of Fiat India 8, wherein transaction value was rejected and provisions of valuation rules were invoked even though there was no additional consideration of money value flowing, directly or indirectly, from the buyer, this CESTAT decision in Godrej case stokes further debate on incremental consideration over and above the price of goods received by the manufacturer. On examination of the factual matrix of the case, the Tribunal reached to a conclusion that the agreements relating to trademarks, were simply a mechanism adopted for routing the payment for the trademarks to GSL through GB. Thus, it was held that the consideration, which was routed through GB, was an additional consideration flowing indirectly from PGG to GSL, and hence, includible in the assessable value of the goods sold by GSL.. Excise duty demand in such cases would create double taxation as Service tax may also be imposed on the same transaction. This is likely to trigger further litigation on valuation of goods. 8 CCE, Mumbai vs. Fiat India Pvt. Ltd. & Anr [2012- TIOL-58-SC-CX]

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