MAY 31, 2021

By Mr Jignesh Ghelani, Partner and Mr Ashwin Ramesh, Principal Associate, ELP, Mumbai 

Background

ISSUE of classification of parts and accessories has always been a bone of contention which has plagued a plethora of tax payers as well as the Department at large. The said issue was recently examined by the Honourable Supreme Court ('SC') in the case of WestingHouse Saxby Farmer Ltd ¹ ('Westing House') where the question which came up for consideration before the Larger Bench of SC was whether 'relays' manufactured by the assessee, used only as railway signalling equipment would fall under Chapter 86, Tariff Item 8608 as claimed by the assessee or under Chapter 85 Tariff Item 8536.90 as claimed by the Department.

Department issued several show cause notices primarily on the premise that in view of Note 2(f) of Section XVII of Central Excise Tariff Act, 1985 ('CETA'), the expressions 'parts' and 'parts and accessories' appearing in Chapter 8608 i.e. parts of railways signalling equipment, do not apply to electrical machinery or equipment covered by Chapter 85.

Department also relied upon Rule 3(a) of the 'General Rules for Interpretation of the First Schedule' ('GIR') to CETA and held that the heading which provides the most specific description shall be preferred to the heading providing a more general description. In view of this, it was contended that 'relays' will not qualify under Chapter 8608, but will be classified only under sub-heading 8536.90, as 'Other Apparatus'.

SC Ruling

- SC held that 'relays' manufactured by the appellant, which were used solely or principally as part of the railway signalling equipment, should be classified under 8608 as opposed to 8536 of CETA. The key observations of the SC are as follows:

- GIR are applicable only when classification cannot be determined, basis the terms of heading and relevant section/chapter notes.

- Rule 3 of GIR is applicable only when a product can be classified under 2 or more headings.

- Note 3 of Section XVII of CETA recognizes 'user test'. Accordingly, parts suitable for use solely or principally with an article in Chapter 86, cannot be classified under a different Chapter, as the same will negate the objective of group classification.

- Invocation of Note 2(f) in Section XVII, overlooking the 'sole or principal user test' indicated in Note 3, is not justified.

Implications of SC Ruling

While this judgement offers relief to parts/accessories for use in railway equipments, it appears that the judgement will open the pandora box of classification disputes, for various other sectors, for example, automobile sector.

For instance, parts of motor vehicles, if classifiable under Chapter 87 attracts Basic Customs Duty ('BCD') of 15% and Goods and Services Tax ('GST') rate of 28%, whereas parts which are not classifiable under Chapter 87, generally attracts BCD in the range of 7.5% to 10% and GST @ 18% or less. In light of the SC judgement, it appears that Note 2 of Schedule XVII will become redundant and all parts/accessories of motor vehicles would get classifiable under 8708 attracting higher rate of BCD and GST.

Resultantly, in the case of rate arbitrage, whether beneficial to the assessee (e.g. 'relays') or adverse (e.g. automobile industry), all the importers of parts and accessories will be required to have a complete re-look at the classification adopted and the resultant tax implications/liability exposures, for the past concluded imports as well as future imports.

Apex Court decision - Unsettling the settled practice of classification and inviting more questions

The SC decision raises more questions than providing an answer, such as:

- Whether Note 3 of Section XVII to CETA is to be given credence over Note 2?

- Whether there is a need that Note 2 and Note 3 should be read cohesively, to arrive at the appropriate tariff classification, in the absence of which it is likely that Note 2 will become redundant?

On perusal of the Explanatory Notes to HSN as issued by the World Customs Organization ('WCO'), it is observed that for the purpose of classification of parts or accessories, it is essential to comply with the following 3 conditions:

- They must not be excluded from Section Note 2 of Section XVII; and

- They must be suitable for use solely or principally with the articles of Chapter 86 to 88 and;

- They must not be specifically covered elsewhere in the nomenclature.

SC in Uni Products India Ltd ² has upheld the compliance of all 3 conditions mentioned in the Explanatory Notes of WCO, for determining classification. However, it appears that the present SC decision has overlooked the settled practice of classification.

Road Ahead

It appears that the SC decision will have wide ramifications across industries, propelling investigation by departmental authorities, who may question the classification adopted by the Companies for the past period. At the same time, the Companies will be compelled to re-look at the classification adopted at a granular level for inward and outward supplies in the entire supply chain and adopt a consistent position on classification.

The SC decision will also impact the classification and rate adopted under the GST regime for domestic supplies of parts and accessories throughout the supply chain. The same is for the reason that GST adopts the principles of classification as per the Customs Tariff Act, 1975.

While the SC decision is binding unless reviewed or negated by legislative amendment, it is to be seen as to how the industry at large, is able to weather the storm which may arise from the tidal wave of notices that may ensue.

To confront this issue, the assessees will have to adopt pragmatic strategy measures such as policy advocacy and/or timely judicial actions in the form writ petitions, advance rulings. In any case, to bring some respite into this conundrum, there is a need for immediate clarification from the Government.

[The views expressed are strictly personal.]

¹ 2021-TIOL-121-SC-CX-LB

² 2020-TIOL-91-SC-CX