Supreme Court Rules on Service Tax for Imported Engineering Designs: Commissioner of Customs vs. Suzlon Energy Ltd (2023)

Introduction

Date of the Judgment: April 10, 2023

Citation: 2023 INSC 332

Judges: M.R. Shah, J. and Krishna Murari, J.

Can imported engineering designs be classified as “goods” to avoid service tax, or do they fall under “design services”? The Supreme Court of India recently addressed this complex question in a case involving the import of engineering designs for wind turbine generators (WTG). The court had to determine whether these designs, imported on paper, should be taxed as goods or as services under the Finance Act, 1994. This judgment clarifies the distinction between goods and services in the context of intellectual property embedded in physical media. The bench comprised Justices M.R. Shah and Krishna Murari, with the judgment authored by Justice M.R. Shah.

Case Background

M/s Suzlon Energy Ltd. (the respondent) is engaged in manufacturing Wind Turbine Generators (WTG). They entered into a product development and purchase agreement with their sister companies in Germany and the Netherlands. Under this agreement, Suzlon Energy GmbH, Germany, was to provide ‘Engineering Design & Drawings’ for various WTG models. These designs were crucial for manufacturing WTGs in India.

The respondent imported these designs, classifying them as “Paper” under Chapter Sub-heading No. 49119920 of the Customs Tariff, claiming a ‘Nil’ rate of customs duty. They argued that since the designs were received as “goods,” they were not liable to pay service tax. However, the tax authorities noticed that the respondent had not paid service tax on these “Engineering Design & Drawings,” which they classified under “Design Services” for the period from June 2007 to September 2010.

The Commissioner of Customs, Central Excise and Service Tax, Pune, issued show cause notices to the respondent, demanding service tax, interest, and penalties. The Commissioner confirmed these demands, stating that the respondent was a provider of “design services” as defined under Section 65(105)(zzzzd) and Section 65(35b) of the Finance Act, 1994. Aggrieved by this, the respondent appealed to the Customs, Excise and Service Tax Appellate Tribunal (CESTAT).

Timeline

Course of Proceedings

The Commissioner of Customs, Central Excise, and Service Tax, Pune, initially ruled against the respondent, confirming the demands for service tax, interest, and penalties. The Commissioner held that the “Engineering Design & Drawings” fell under the category of “design services” and were taxable under the Finance Act, 1994. The respondent then appealed to the CESTAT.

The CESTAT allowed the respondent’s appeals, relying on its earlier decision in Sojitz Corporation v. Commissioner of Service Tax, New Delhi, [2009 (14) STR 642 (Tri. Delhi)]. The CESTAT held that the designs and drawings were “goods” and not “services,” and therefore, service tax could not be levied. The CESTAT also noted that goods and services are mutually exclusive levies, and the same activity cannot be taxed as both. Consequently, the CESTAT set aside the Commissioner’s order.

Aggrieved by the CESTAT’s decision, the Revenue (Commissioner of Customs, Central Excise & Service Tax) appealed to the Supreme Court.

Legal Framework

The core legal issue revolves around the interpretation of “design services” as defined in the Finance Act, 1994. The relevant sections are:

Section 65(36b) of the Finance Act, 1994:

“design services” includes services provided in relation to designing of furniture, consumer products, industrial products, packages, logos, graphics, websites and corporate identity designing and production of three dimensional models:

This section defines “design services” broadly, encompassing various design-related activities. It specifically includes the design of industrial products, which is pertinent to the case.

Section 65(105)(zzzzd) of the Finance Act, 1994:

“taxable service” means any service provided or to be provided, (zzzzd) to any person, by any other person in relation to design services, but does not include service provided by- (i) an interior decorator referred to in sub- clause (q); and (ii) a fashion designer in relation to fashion designing referred to in sub-clause (zv): and the term “service provider” shall be construed accordingly.”

This section specifies that any service related to “design services” is a taxable service, excluding interior decoration and fashion design. The definition of “design services” is wide and inclusive, specifically excluding only fashion design and interior designing, which were already taxable under separate categories.

Arguments

Arguments by the Revenue (Appellant):

• The Revenue argued that the CESTAT erred in treating the “Engineering Design & Drawings” as goods. They contended that merely because intellectual property is put on a medium, it does not automatically become goods.
• The Revenue submitted that the crucial factor is whether the contracting parties intended a transfer or sale of goods. They argued that the designs were specifically made for the respondent and were not off-the-shelf products.
• The Revenue relied on the Supreme Court’s decision in BSNL v. Union of India [(2006) 3 SCC 1], which distinguishes between the sale of goods and a contract of service. They argued that if the intention is to provide a service, it does not become a sale of goods merely because there is a transfer of some material.
• The Revenue provided illustrations, such as a contract for a boiler’s installation, which involves both the sale of goods and the rendition of services. They argued that the same principle applies to the design services provided to Suzlon.

Arguments by the Respondent (Suzlon Energy Ltd.):

• The respondent argued that the designs were “goods” as they were supplied on paper, and the transaction was a sale of goods, not a provision of services.
• They contended that the supply of goods as per the customer’s specifications is still considered a sale of goods. They relied on Hindustan Shipyard Ltd. v. State of A.P. [(2000) 6 SCC 579] to argue that if the thing to be delivered has an individual existence before the delivery as the sole property of the party who is to deliver it, then it is a sale.
• The respondent heavily relied on Associated Cement Companies Ltd. v. Commissioner of Customs [(2001) 4 SCC 593], where the Supreme Court held that any media containing drawings or designs would be regarded as goods under the Customs Act.
• They also cited Tata Consultancy Services v. State of A.P. [(2005) 1 SCC 308], where the Court held that intellectual property, once put on a medium and marketed, becomes “goods.”
• The respondent argued that service tax should not be levied on the sale of goods and that the aspect theory does not allow the value of goods to be included in services and vice versa.

Issues Framed by the Supreme Court

The Supreme Court framed the following issue for consideration:

✓ Whether the activity of importing “Engineering Design & Drawings” from sister companies by the notice during the period under dispute i.e., June, 2007 to September, 2010 is classifiable under the taxable category “design services” under Section 65(35b) read with Section 65(105)(zzzzd) of the Finance Act, 1994.

Treatment of the Issue by the Court

Authorities

The Supreme Court considered the following authorities:

Cases:

Legal Provisions:

• Section 65(36b) of the Finance Act, 1994: Defines “design services.”
• Section 65(105)(zzzzd) of the Finance Act, 1994: Defines “taxable service” in relation to design services.

Judgment

The Supreme Court overturned the CESTAT’s decision and held that the respondent was liable to pay service tax on the imported “Engineering Design & Drawings”. The Court emphasized that the definition of “design services” under the Finance Act, 1994, is wide enough to cover all “design services,” including those related to industrial products. The Court noted that the designs were tailor-made for the respondent’s specific needs.

How each authority was viewed by the Court:

• BSNL v. Union of India [(2006) 3 SCC 1]:* This case was heavily relied upon by the court to distinguish between the sale of goods and a contract of service. The court reiterated that the intention of the contracting parties is crucial to determine whether the transaction is a sale of goods or a provision of services.
• Sojitz Corporation v. Commissioner of Service Tax, New Delhi [2009 (14) STR 642 (Tri. Delhi)]:* The CESTAT’s reliance on this case was explicitly overruled. The Supreme Court held that the CESTAT erred in treating the designs as goods based on this decision.
• Hindustan Shipyard Ltd. v. State of A.P. [(2000) 6 SCC 579]:* The court distinguished this case, noting that the principle of individual existence before delivery does not apply to the current situation, as the designs were specifically created for the respondent.
• Associated Cement Companies Ltd. v. Commissioner of Customs [(2001) 4 SCC 593]:* The court clarified that while this case held that designs on a medium are goods under the Customs Act, it does not mean the same would apply for service tax.
• Tata Consultancy Services v. State of A.P. [(2005) 1 SCC 308]:* The court distinguished this case as well, stating that the principle of intellectual property on a medium becoming “goods” does not apply to the service tax context.

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily influenced by the following factors:

• Intention of the Contracting Parties: The Court emphasized that the key factor in distinguishing between a sale of goods and a provision of services is the intention of the contracting parties. In this case, the Court found that the intention was to provide “design services,” not to sell goods.
• Definition of “Design Services”: The Court relied on the broad and inclusive definition of “design services” under the Finance Act, 1994, which includes the design of industrial products.
• Aspect Theory: The Court reiterated that the same activity can be taxed as both goods and services if the contract is indivisible and if different aspects of the transaction are being taxed.
• Tailor-Made Designs: The Court noted that the designs were specifically created for the respondent’s use and were not off-the-shelf products, further indicating that the transaction was a provision of service.

Fact:Law Ratio

The court’s reasoning was primarily based on legal interpretations and the application of the law to the facts of the case, as evidenced by the higher percentage attributed to legal considerations.

The Supreme Court considered the arguments of both the parties, the relevant legal provisions, and the intention behind the transaction. The Court rejected the argument that the designs were “goods” simply because they were delivered on paper. The Court emphasized that the intention of the contracting parties and the nature of the transaction are crucial in determining whether it is a sale of goods or a provision of service.

The Court also clarified that the same activity can be taxed under different heads if the contract is indivisible and if different aspects of the transaction are being taxed. This is known as the aspect theory, which allows for the taxation of different aspects of the same transaction.

The Court also noted that the designs were specifically created for the respondent, indicating that the transaction was a provision of service. The Court relied on its previous decision in BSNL v. Union of India, which distinguished between the sale of goods and a contract of service.

The Court also rejected the respondent’s reliance on Associated Cement Companies Ltd. v. Commissioner of Customs and Tata Consultancy Services v. State of A.P., stating that the principles in those cases do not apply to the service tax context.

The Court held that the CESTAT erred in treating the designs as goods and that the respondent was liable to pay service tax on the “design services” received from abroad under reverse charge. The Court also noted that the respondent’s sister company, M/s SEG, was a related unit, and the amount received for service was liable to service tax under reverse charge in terms of the concept of ‘associated enterprise’.

“Even otherwise, as observed by this Court in the case of BSNL (supra) , there is a distinction between the sale of goods and a contract of service. What is relevant is the intention of the contracting parties and whether the contracting parties intend transfer of both goods and services, either separately or in an indivisible manner or in a composite manner.”

“As per the settled position of law now, the same activity can be taxed as ‘goods’ and ‘services’ provided the contract is indivisible and on the aspect of services there may be levy of service tax.”

“Merely because “Engineering Design & Drawings” prepared and supplied by sister company were shown as ‘goods’ under the Customs Act and in the bill of entry, by that itself cannot be a ground to take such services out of the definition of “design services” under the Finance Act, 1994.”

Key Takeaways

• Service Tax on Imported Designs: The Supreme Court clarified that imported “Engineering Design & Drawings” for industrial products are subject to service tax under the category of “design services,” even if they are delivered on a physical medium like paper.
• Intention Matters: The intention of the contracting parties is crucial in determining whether a transaction is a sale of goods or a provision of services. If the intention is to provide a service, it will be taxed as such, even if goods are transferred in the process.
• Aspect Theory: The same activity can be taxed as both goods and services if the contract is indivisible and if different aspects of the transaction are being taxed.
• Overruling of CESTAT Decision: The Supreme Court overruled the CESTAT’s decision that treated the designs as goods, reinforcing that the designs are taxable as services under the Finance Act, 1994.

Directions

The Supreme Court remitted the matter back to the CESTAT to consider the following grounds raised by the respondent:

• Whether the services (if any) rendered by a foreign entity will fall within the purview of “design services.”
• Whether the department was justified in invoking the extended period of limitation.

The Court clarified that the matter was remitted only for consideration of these two grounds and that the issue of levy of service tax on the “Engineering Design & Drawings” was decided in favor of the revenue and against the assessee.

Development of Law

The ratio decidendi of this case is that the intention of the contracting parties determines whether a transaction is a sale of goods or a provision of services. If the intention is to provide a service, it will be taxed as such, even if goods are transferred in the process. This judgment clarifies the distinction between goods and services in the context of intellectual property embedded in physical media. It also reinforces the application of the aspect theory in taxation, allowing for the taxation of different aspects of the same transaction.

There is a change in the previous position of law as the Supreme Court has overruled the CESTAT’s decision that treated the designs as goods. The Court has clarified that the designs are taxable as services under the Finance Act, 1994.

Conclusion

The Supreme Court’s ruling in Commissioner of Customs, Central Excise & Service Tax vs. M/s Suzlon Energy Ltd. clarifies that imported engineering designs for industrial products are subject to service tax under the category of “design services.” The Court emphasized that the intention of the contracting parties and the nature of the transaction are crucial factors in determining tax liability. This judgment reinforces the distinction between goods and services and the application of the aspect theory in taxation. The matter was remitted back to the CESTAT to consider other grounds raised by the respondent, but the core issue of taxability on “design services” was decided in favor of the revenue.