[The Viewpoint] Classification of goods for tax purposes: Unsettling the settled position

The Supreme Court judgment in the case of Westinghouse is per incuriam as it has neither appreciated the relevant Section Note nor considered or differentiated from its earlier decisions.
Sandeep Sachdeva & Shankar Rochlani
Sandeep Sachdeva & Shankar RochlaniLakshmikumaran & Sridharan, Attorneys

Classification of goods has always been a contentious issue between taxpayers and the tax authorities. While taxpayers strive to classify goods based on legal provisions and technical or functional specification of goods for ensuring consistency irrespective of increase or decrease in tax rates, the Customs Department strives to classify the goods in the category that yields the highest tax collection.

The exercise of classifying goods is complex, as it requires in-depth understanding of the technology, as well as skills of legal interpretation. To facilitate ease of doing business, the government has been taking initiatives over the last three decades to simplify the administration of tax, including classification of goods. To ensure uniformity in classification for cross-border transactions, the World Customs Organisation has designed a code called Harmonized Commodity Description and Coding System (also referred to as HSN Code).

The HSN Code was adopted by India in the year 1986 and has been subjected to varied interpretation since then. Even though the HSN explanatory notes are not legally binding, the courts, time and again, have appreciated them while deciding various classification related disputes.

The Westinghouse decision unsettled the settled position

The automobile industry has constantly been under the scanner for a very long time insofar as classification of goods is concerned. In a series of judgments given by the apex court, to some extent, the position on classification of automobile parts. However, the same was unsettled by the three-judge Bench of the Supreme Court in the case of Westinghouse Saxby Farmer Ltd. In this case, the issue before the apex court was whether 'relays' manufactured by the assessee and used only for railway signalling equipment would fall under Chapter 86, as claimed by the assessee, or under Chapter 85, as claimed by the Department.

Ignoring the trinity test for classifying the parts, the apex court decided the case solely on one test, that is, whether the goods are for ‘sole and principal use’ in the articles and goods described under Chapter 86. The Court did not apply other two tests, that is, whether the part is excluded under Note 2 to Section XVII and whether the part is not goods or article in any other Chapter heading. The Court relied on Note 3 to Section XVII to hold that the ‘relays’ would be classified under Chapter 86 as part of railways and not under Chapter 85 as electronic products. It is pertinent to note that the classification dispute in the said case was under Central Excise Tariff and the period of dispute dates back to 1994, whereas the HSN explanatory notes were made applicable to the Central Excise Tariff with effect from February 28, 2005.

This unsettled the position that was already settled by the apex court itself in the following judgments:

Intel Design Systems (India) Pvt. Ltd. vs. CCE, where it was held that in addition to the ‘sole and principle use test’ as provided in Section Note 3 to Section XVII, the goods must not be excluded from Section XVII by application of Section Note 2 of the said section.

CCE vs. UNI Products India Ltd, where it was held that the specific heading covering the goods would prevail over the general heading and that the explanatory notes would have persuasive value. Further, if goods are specifically excluded from expression “parts and accessories” by the HSN explanatory notes, the same would not be classified under CTH 8708.

In view of the above, it can be said that the Supreme Court judgment in the case of Westinghouse is per incuriam to that extent, as it has neither appreciated the relevant Section Note nor considered or differentiated from its earlier decisions.

Customs Department on overdrive

Though the outcome of the case was against the legal position taken by the Department, it has been using this decision to increase the tax collection from players in the automobile sector and various others. Based on the said decision, the Customs Department started questioning the classification which was earlier accepted by it and adopted by the automobile industry. Customs authorities have initiated investigation and enquiries and have started questioning the past settled cases and succeeded in thrusting wrong classification of parts under Chapter 87. Similar investigation proceedings were also initiated by the Goods and Services Tax (GST) Department with respect to domestic sales. As the rate of duty is higher on the goods classifiable under Chapter 87 as compared to many other chapter headings, it resulted in higher tax outgo for the importers, affecting the already hampered margins and increased litigation.

The CBIC Circular: A relief to the industry

In view of this chaotic situation, the industry had taken up the matter with the government. Taking cognizance of the same, in a welcome initiative, the CBIC, vide Instruction No. 01/2022-Customs dated January 5, 2022, has taken cognizance of the fact that the decision of Supreme Court in the case of Westinghouse is at variance with its other earlier decisions.

Further, the Board has also suggested that the said decision should not be applied to wider issues and should be restricted to the facts presented in cases of “relays” as used in railway signalling equipment. It is further clarified that the classification of goods falling under Section XVII should be based on the relevant facts and considering the decisions on the subject matter as well as the HSN explanatory notes.

Given the fact that this circular was issued in consultation with the Additional Solicitor General of India, it echoes the likely stand of the government in the courts. In fact, the Department has filed a review petition against the Westinghouse judgment. This proves that even the Revenue itself is not in agreement with the position laid down in this judgment.

It is also to be noted that the courts have time and again held that the HSN explanatory notes have persuasive value. The CBIC circular has further re-emphasised the force of the HSN explanatory notes in determining the classification. The question still remains as to whether while addressing the controversy created by Westinghouse, the Board has also indirectly diluted the impact of earlier Supreme Court decisions in the case of GS Auto and Cast Metal. It will certainly be interesting to see how the courts and the tax authorities deal this scenario in days to come.

Therefore, in the present circular, the Board while clarifying the applicability of the Westinghouse judgment, has given much needed room to the assessees to revisit the classification and change the same considering parameters laid down in the HSN explanatory notes. It has come to our notice that to avoid litigation and undue hardship, taxpayers had already started classifying goods under Chapter 87, even though they were more appropriately classifiable under other chapter headings. Therefore, this is the right time for the industry to revisit the classification by applying the relevant Chapter Note, Section Note and also the guidelines provided in HSN explanatory notes.

Having said this, attention is also invited to the fact that the classification at eight-digit level has undergone change for many goods in view of new HSN Code, which has come into effect from January 1, 2022. Therefore, it is imperative that each enterprise should analyse the implication of the said changes before restoring to the original classification.

Sandeep Sachdeva is an Executive Partner and CA Shankar Rochlani is a Principal Associate at Lakshmikumaran & Sridharan, Attorneys.

The views expressed are personal in nature.

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