APRIL 01, 2009

By CA Dinesh Kumar Agrawal, Ex-IRS

''THE electronics and telecom sectors merit special attention. On 217 Information Technology Agreement (ITA) bound items, the duty is required to be brought down to nil. Consequently, to provide a level-playing field to the domestic industry, I propose to remove the customs duty on specified capital goods and all inputs required for the manufacture of ITA bound items”

The Union Finance Minister on 28 February 2005 announced on the floor of the parliament while presenting union budget for the year 2005-06. He was implementing the Ministerial Declaration on Trade in Information Technology Products (ITA) concluded at the Singapore Ministerial Conference in December 1996. The ITA provides for participants countries to completely eliminate duties on IT products covered by the Agreement. At that time, Finance Minister could not have visualized that this exemption will be a cause of great embarrassment to the premier Indian investigation agency namely Directorate of Revenue Intelligence (DRI).

Recently, Bombay High Court in the case of Vodafore Essar v Union of India [2009-TIOL-117-HC-MUM-CUS] castigated DRI in the following words:

“In these circumstances, we are clearly of the opinion that in the present case, the conduct of the DRI officers is not only high handed but it is in gross abuse of the powers vested in them under the Customs Act. It is apparent that the DRI officers in utter disregard to the order passed by the Commissioner of Customs (A), Mumbai have forced the petitioners to pay the amount by threat and coercion which is not permissible in law. Thus, the conduct of the DRI officers in the present case in collecting the amount from the petitioners towards the alleged differential duty is wholly arbitrary, illegal and contrary to law. Having terrorised the petitioners with the threat of arrest, it is not open to the DRI officers to contend that the amount has been paid by the petitioners voluntarily. We strongly condemn the high handed action of the DRI officers in totally flouting the norms laid down under the Customs Act in relation to reassessment proceedings and purporting to collect the amount even before reassessment. We hope that such incidents do not occur in the future.”

Besides passing severe strictures, High Court also imposed costs on the Government. The controversy evolves around the classification of telecom grade Optical Fibre Cables (“OFC”). Exemption Notification No 24/2005-Cus dated 1 March 2005 exempts goods falling under Chapter Heading 854470 and all goods imported for the manufacture of final product falling under Chapter Heading 854470. As per HSN, OFC made up of individually sheathed fibres whether or not assembled with electric conductors or fitted with connectors are classifiable under Chapter Heading 854470 whereas OFC other than those of heading 8544 are classifiable under Chapter Heading 900190.

In recent past, telephonic communication was carried across the globe by electrical signals along copper wire cables. With the advent of internet and spread of telephone facility, there was a demand for higher bandwidth i.e. capacity to carry the amount of information, which the copper wires could not fulfill. Optical fibres offer huge communication capacity and therefore nowadays widely used for telecommunication purpose. Optical fibers, thinner than a human hair, can carry huge data across the globe at the speed of light. OFC are laid under the land and sea, overhead and also used for networking of the computers. There is no doubt that OFC are backbone of the information technology and therefore should have been one of the most eligible candidates for the ITA concession.

Sadly, the destiny of OFC for exemption is not determined by the end use but by the classification. As stated above, OFC will enjoy exemption only if it is made up of individually sheathed fibres. Generally, OFC is made of a central strength member around which dual-coated optical fibers forms the main core which is filled with jelly. This main core is covered with inner and outer sheath of HDPE and Nylon. The core of the entire controversy is whether dual-coated optical fibers are individually sheathed or not or in other words whether coating can be considered as sheathing or not.

Explanatory Notes to Heading No. 85.44 states that sheathes are usually of different colours to permit identification of the fibres at both ends of the cable. Optical fibres are used mainly in telecommunication because of their capacity for transmission of data is greater than that of electric conductors. Explanatory Notes to Heading No. 90.01 states that Optical fibres drawn from glass have a very thin coating of plastics, invisible to the naked eye, which renders the fibres less prone to fracture. It further states that OFC of this heading consist of a sheath containing one or more optical fibre bundles, the fibres of which are not individually sheathed.

The classification of OFC made of dual-coated optical fibers has been a controversial issue for many countries. In India, in the case of Optel Telecommunication Ltd, Tribunal held that thin coating of UV cured acrylate on the optical fibre, invisible to eye, does not amount to sheathing. In this case, Revenue was pleading that coating of UV cured acrylate on the optical fibre should be treated as sheathing. As Revenue failed to bring any material on record to show that coating of UV cured acrylate amounts to sheathing of optical fibre cables, it was held that UV cured acrylate coating on fibers is not equivalent to sheathing.

In the case of Alcatel India Ltd, the Authority for Advance Rulings (“AAR”) held that coating was not same as a ‘sheath’, especially as coating was found to be an integral part of manufacturing process of optical fibres. In this case, it was argued on behalf of the party that UV cured acrylate on the optical fibre should be treated as sheathing. However, this AAR ruling does not have any relevance for other parties as AAR rulings are binding only on the party and the Revenue for that party as provided in Section 28J of the Customs Act and 23E of the Central Excise Act.

In United States of America, similar questions were raised by Sumitomo Electric Lightwave Corporation limited and Corning Cable Systems. US Customs vide Ruling HQ No. 963256 and 963016 both dated April 3, 2001 ruled that 62.5 microns of dual acrylate and color coatings do substantially add to the overall protection, security, and reliability of each individual optical fiber, and that the fibers are considered to be individually sheathed and same was subsequently reaffirmed in Ruling HQ No. 965593 dated 16 July 2003.

Explanatory Notes to the Combined Nomenclature of the European Communities of subheading 8544 were amended in 2007 vide 2007/C296/02 to includes optical fibre cables, designed for example for telecommunication use, made up of optical fibres individually coated with a dual layer of acrylate polymer placed in a protective casing. The coating consists of an inner sheath of soft acrylate and an outer sheath of hard acrylate, the latter being coated by a layer of various colours.

However, in India, classification disputes will take a while to settle. There is tendency on the part of Revenue officers to blindly follow the AAR Rulings in spite of specific provision in law that such rulings are not applicable to other parties. One of my client is a manufacturer of OFC, who is also facing similar classification dispute. I submitted voluminous data to the concerned adjudicating authority to support that secondary coating is a protective cover or sheath on the fiber and therefore OFC merits classification under heading 854470. Further, samples were tested by different laboratories and 3 out of 5 laboratories found that OFC was made of individually sheathed fibers. But, without even looking at the evidence and test reports, the adjudicator blindly following AAR held that OFC should be classified under heading 900190. Similar has been the fate of Vodafore Essar in Chennai.

An optical fiber is a glass or plastic fiber that carries light along its length. Light is kept in the "core" of the optical fiber by total internal reflection. Optical fiber are used in telecommunication and networking, sensors to measure strain, temperature, pressure and other parameters, illumination, light guides in medical and imaging.

The optic fibers for telecommunication needs very thin and very long fiber running into several kilometer in length to minimize the needs for frequent joining which may result in leakage of light or hamper total internal reflection, thus causing loss of data. The greatest drawbacks of glass fiber are weak mechanical properties causing proneness to breakage and delicacy, which makes handling difficult. Glass fibers in running length packed in spool require a buffer (primary coating) to improve bending properties of glass optical fibers as very thin glass is brittle in nature.

Undersea OFC cables often face extreme change in the temperature and the difference in response to change in temperature between the glass and the buffer contribute microbending of the fibers resulting in loss of transmission. During cabling of also microbending occurs. Therefore, a sheath or protective layer was required to protect the optical fibers during handling and use of the OFC. Mr Shustack Paul J in his patent (1992) described that the secondary coating must function as a hard protective layer which allows the fiber not to be damaged during its processing and use. Corning Incorporated in patent (2004) described that the secondary coating should have the following characteristics: sufficient stiffness (i.e., modulus) to protect the encapsulated glass fiber yet enough flexibility (i.e., elongation) for handling, low water absorption, low tackiness to enable handling of the optical fiber, chemical resistance, and sufficient adhesion to the primary coating. There is unanimity among the inventors that secondary coating is a protective layer to the primary coating to enable the fibres to withstand stress caused during cabling, environment and contamination.

Departmental officers and investigation agencies have tendency to be revenue biased and therefore, they will frequently ignore any evidence which may favour the case of importer or manufacturer. Considering the key role of trade in information technology products in the development of information industries and dynamic expansion of the world economy which will raise standards of living and human welfare, 70 countries around the world has committed to completely eliminate duties on IT products. India is one of the participant countries of ITA. Expansion of the information and telecommunication infrastructure is also one of the thrust areas of the Government in recent years. Duty burden on the OFC due to classification dispute is hampering spread of the IT infrastructure. USA and EU countries have resolved this dispute. Time is ripe for the CBEC and political bosses to notice and take urgent remedial actions as India is faltering on the global commitment and world is watching India very closely in these extraordinary times of economic distress and turmoil.

(The author works with Khaitan & Co)