JULY 02, 2024

By S Rahul Jain, Partner - M2K, Chartered Accountants

IN 2023, the Supreme Court, in the Larger Bench decision of M/s Tata Motors Limited [2023-TIOL-66-SC-CT-LB], reaffirmed the decision of the Supreme Court in Mohd. Ekram Khan.

In Mohd. Ekram Khan [(2004) 6 SCC 183], the Supreme Court concluded that warranty transactions were taxable, as the manufacturer made payments for the parts by issuing credit notes to the dealers.

The Larger bench, while examining the taxability of warranty transactions gave crucial findings on the following aspects

- Nature of Transactions: The Court analyzed whether the relationship between the manufacturer and dealer was principal-to-principal or principal-agent. It was determined that transactions involving the replacement of defective parts under warranty, compensated through credit notes, constituted taxable sales.

- Credit Notes as Consideration: The issuance of credit notes by manufacturers to dealers for replacing defective parts under warranty was deemed a form of monetary consideration, thus falling under the ambit of 'sale' as defined under the Sales Tax Acts.

- Warranty Obligations: The Court noted that warranty replacements were conducted free of charge to customers, and the dealers were reimbursed by manufacturers, establishing the taxable nature of these transactions.

The Court further noted that sales tax cannot be levied where the dealer simply receives spare parts from the manufacturer to replace a defective part under a warranty.

Pursuant to the Court's decision, issued in the context of sales tax, the Central Board of Indirect Taxes & Customs (CBIC) issued detailed clarifications on Goods and Services Tax (GST) implications for warranty replacements and repair services. These clarifications aim to streamline the treatment of such transactions, ensuring uniformity and reducing litigation. This article delves into the key aspects of these circulars and their implications for businesses and distributors involved in warranty-related transactions.

Circular No. 195/07/2023-GST (Dated 17-07-2023)

Background and Purpose

The CBIC issued Circular No. 195/07/2023-GST in response to industry representations seeking clarity on the GST treatment of warranty replacements and repair services. The primary concern was whether GST would be applicable on replacement goods or repair services provided during the warranty period without separate consideration from customers. Additionally, the circular addressed the issue of input tax credit (ITC) reversal in such scenarios.

Key Clarifications

1. GST on Warranty Replacements and Repair Services

The circular clarifies that when manufacturers provide replacement parts or repair services during the warranty period without charging customers separately, no additional GST is payable. This is because the value of the original supply, which includes the warranty, already covers these potential costs. However, if any additional consideration is charged for replacement parts or services, GST will apply to the additional amount.

2. Input Tax Credit (ITC) Reversal

Manufacturers are not required to reverse ITC for replacement parts or repair services provided under warranty without additional consideration. Since the original supply's value already includes these costs, such supplies cannot be considered exempt. Therefore, ITC reversal is not warranted.

3. Distributor's Role

When distributors provide replacement parts or repair services on behalf of manufacturers without charging customers, no GST is payable by the distributor. If the distributor charges the manufacturer for these parts or services, GST applies, and the manufacturer can claim ITC. Various scenarios involving distributors and manufacturers were clarified, ensuring no GST liability or ITC reversal where no additional consideration is involved.

4. Extended Warranty Offers

Extended warranties offered at the time of the original supply are treated as part of the composite supply, with GST payable on the total value. However, extended warranties sold separately after the original supply are considered distinct supplies of services, subject to GST based on the contract's nature.

Circular No. 216/10/2024-GST (Dated 26-06-2024)

Background and Purpose

Following the issuance of Circular No. 195/07/2023-GST, further clarifications were sought by the industry regarding the treatment of warranty replacements, especially when goods as such (not just parts) are replaced. Circular No. 216/10/2024-GST addresses these concerns, providing additional clarity on the GST and ITC implications.

Key Clarifications

1. Replacement of Goods Under Warranty

The circular extends the clarifications from the previous circular to situations where entire goods, not just parts, are replaced under warranty. It affirms that the same principles apply: no additional GST is payable on such replacements, and no ITC reversal is required by the manufacturer.

2. Replenishment by Manufacturers

When distributors replace goods from their own stock and seek replenishment from manufacturers, the transactions are clarified as follows:

- If the manufacturer replenishes the distributor without charging additional consideration, no GST is payable on the replenishment.

- No ITC reversal is required by the distributor or manufacturer in such cases.

3. Extended Warranty as Separate Supply

The circular distinguishes between extended warranties offered by different suppliers (e.g., OEMs or third parties) and those provided at the time of the original sale. Extended warranties offered by different suppliers at the time of the original sale are treated as separate supplies and taxed accordingly. Subsequent sales of extended warranties are always treated as distinct supplies of services, irrespective of the original supply.

Implications for Businesses

These clarifications bring much-needed certainty for businesses involved in manufacturing and distributing goods with warranty provisions.

By clarifying the tax and ITC implications, these guidelines help reduce litigation and provide a uniform framework for businesses. Manufacturers and distributors must align their practices with these clarifications to ensure compliance and optimize their GST management strategies.

[The views expressed are strictly personal.]