Supreme Court settles taxability of credit notes for warranty replacements in automobile sales: M/s. Tata Motors Ltd. vs. The Deputy Commissioner of Commercial Taxes (2023) INSC 469 (15 May 2023)

Introduction

Date of the Judgment: 15 May 2023
Citation: (2023) INSC 469
Judges: K.M. Joseph, B.V. Nagarathna, Ahsanuddin Amanullah, JJ.

Are credit notes issued by automobile manufacturers to dealers for replacing defective parts under warranty taxable? This question has been a point of contention in the Indian tax system. The Supreme Court of India recently addressed this issue, clarifying the tax implications of such transactions. The core issue revolves around whether these credit notes represent a ‘sale’ under the respective State’s sales tax laws.

Case Background

The case involves multiple appeals from various High Courts, including Karnataka, Rajasthan, Allahabad, Madhya Pradesh, Bombay, Andhra Pradesh, Kerala, and Gujarat. These appeals arise from disputes between automobile dealers and state tax authorities regarding the taxability of transactions involving warranty replacements.

Specifically, M/s Marudhar Motors, a dealer of Tata vehicles, provides warranty replacements to customers. Under the warranty agreement between the manufacturer (Tata Motors) and the customer, defective parts are replaced free of cost. The dealer replaces the part from their stock and returns the defective part to the manufacturer. In return, the manufacturer issues a credit note to the dealer, crediting their account at the price the part was initially sold to the dealer.

This practice led to tax reassessments by the state authorities, who argued that the credit notes represented a taxable sale. The dealers, on the other hand, contended that the replacement was part of the original sale and not a separate taxable event.

Timeline

Course of Proceedings

The Rajasthan Tax Board set aside the decision of Deputy Commissioner (Appeals), stating that the transaction of replacing defective parts did not constitute a ‘sale’ under Section 2(38) of the Rajasthan Sales Tax Act. The Rajasthan High Court upheld this decision, distinguishing the case from Mohd. Ekram Khan based on three factors: the principal-to-principal relationship between manufacturer and dealer, the independence of the warranty transaction, and the free-of-cost nature of the warranty discharge.

However, other High Courts, such as those in Kerala, Karnataka, Bombay, Andhra Pradesh, Madhya Pradesh, and Gujarat, ruled in favor of the revenue, applying the principles laid down in Mohd. Ekram Khan & Sons vs. CTT, (2004) 6 SCC 183. This divergence in opinions led to the referral to a larger bench of the Supreme Court.

The reference was made due to reservations regarding the observations and legal propositions in Mohd. Ekram Khan, particularly concerning whether credit notes can be treated as a mode of payment and the factual distinctions from Premier Automobiles Ltd. vs. Union of India, (1972) 4 SCC (N) 1.

Legal Framework

The core legal framework for this case includes the Sale of Goods Act, 1930, and the sales tax enactments of various states.

Section 4 of the Sale of Goods Act, 1930 defines a sale as a contract where the seller transfers or agrees to transfer the property in goods to the buyer for a price. It also distinguishes between a sale and an agreement to sell.

Section 12 of the Sale of Goods Act, 1930 defines ‘condition’ and ‘warranty’. A warranty is a stipulation collateral to the main purpose of the contract, the breach of which gives rise to a claim for damages but not to a right to reject the goods.

Section 59 of the Sale of Goods Act, 1930 outlines the remedies for breach of warranty, including setting off the breach against the price or suing for damages.

The various state sales tax acts define “sale” as a transfer of property in goods for cash, deferred payment, or other valuable consideration.

The definition of sale under the Sales Tax legislations are in consonance with Article 366(29-A) as per the Constitution 46th Amendment Act, 1982.

Arguments

Arguments on Behalf of the Assessees:

• The transaction between the manufacturer and the dealer is on a principal-to-principal basis, and the manufacturer has already paid sales tax on the initial sale of the automobiles to the dealers.

• The cost of the warranty is included in the initial transaction of sale and should not be taxed separately.

• Replacement of spare parts during the warranty period does not constitute a sale because:

  • Spare parts are supplied free of charge.
  • Customers return defective parts.
  • The transaction is a discharge of a warranty obligation.
  • Credit notes are an acknowledgment of the diminution of the original sale price.

• Credit notes are not a sale price or valuable consideration but a credit that embodies the diminution of the price already paid for the car.

• The warranty is a collateral contract to the main contract of sale and not a separate sale.

• The property in the replaced part passed merely as an incident of the performance of the manufacturer’s warranty obligation, which forms a part of the original sale of the automobile.

• There is no inter-state movement of replacement parts as they are fitted at the dealer’s location.

• Even if the transaction is assumed to be a sale between manufacturer and dealer, it should be treated as a purchase return and not be eligible for sales tax.

Arguments on Behalf of the Revenue:

• The presence of a warranty does not alter whether the transaction of replacement of defective goods satisfies the elements of a sale.

• The dealer obtains a discharge of warranty obligation as a valuable consideration for the transfer of fresh parts to the customer.

• The recompense from the manufacturer to the dealer, whether in the form of a credit note or any other form, is a form of payment.

• The credit note is a valuable consideration for the transfer of goods.

• All elements of sale are complete: a seller and a buyer, valuable consideration, and transfer of property.

• The cost of the car does not include the cost of the warranty.

• The sale of the car is separate from the sale of spare parts, and the latter is taxable.

Issues Framed by the Supreme Court

The Supreme Court framed the following issues for consideration:

1. Whether the judgment in Mohd. Ekram Khan calls for reconsideration in terms of the Reference Order dated 05.12.2019? In other words, whether the aforesaid case has been correctly decided or not?
2. What Order?

Treatment of the Issue by the Court

Authorities

The Supreme Court considered the following authorities:

The Court also referred to the following sections of the Sale of Goods Act, 1930:

• Section 4: Definition of sale and agreement to sell.
• Section 12: Condition and warranty.
• Section 59: Remedy for breach of warranty.

The Court also referred to the following sections of the Indian Contract Act, 1872:

• Section 2 (a): Definition of proposal.
• Section 2 (b): Definition of promise.
• Section 2 (c): Definition of promisor and promisee.
• Section 2 (d): Definition of consideration.
• Section 2 (f): Definition of reciprocal promises.

Judgment

How each authority was viewed by the Court?

• The Court distinguished Premier Automobiles Ltd. vs. Union of India, (1972) 4 SCC (N) 1, stating that it dealt with a different factual situation regarding ex-works cost.
• The Court distinguished Commissioner of Sales Tax vs. Prem Nath Motors, (1979) 43 STC 52, stating that it dealt with transfer of parts under warranty as part of the original sale.
• The Court overruled Prem Motors, Gwalior vs. Commissioner of Sales Tax, Gwalior, 1986 (61) STC 244 MP, stating that it incorrectly held that reimbursement was not a sale.
• The Court overruled Geo Motors vs. State of Kerala, (2001) 122 STC 285, stating that it incorrectly held that the replacement was not a sale.
• The Court affirmed Mohd. Ekram Khan & Sons vs. CTT, (2004) 6 SCC 183, holding that credit notes are consideration for a sale.
• The Court referred to State of Madras vs. Gannon Dunkerley & Co, (1959) SCR 379, while discussing the essential elements of a sale.
• The Court referred to Government of India vs. Madras Rubber Factory Limited, (1995) 4 SCC 349, stating that warranty is not a trade discount.
• The Court referred to Devi Dass Gopal Krishnan vs. State of Punjab, (1967) 3 SCR 557, stating that the expression ‘other valuable consideration’ has a wider connotation than cash and deferred payment.
• The Court referred to Builders’ Association of India vs. Union of India, (1989) 2 SCC 645, while discussing the constitutional position of states’ legislative competence to tax the sale of goods.
• The Court referred to Kone Elevators Pvt. Ltd. vs. State of Tamil Nadu, (2014) 7 SCC 1, while discussing the nature of a sale.
• The Court referred to Commissioner of Customs vs. Dilip Kumar & Co., (2018) 9 SCC 1 and CIT vs. Motor & General Stores Pvt. Ltd., AIR 1968 SC 200, stating that taxing statutes ought to be specific and must be interpreted strictly.
• The Court referred to Nabha Power Ltd. vs. Punjab State Power Corporation Ltd., (2018) 11 SCC 508, which laid down a five-fold test for construing a contract.
• The Court referred to M/s Vishnu Agencies (Pvt.) Ltd. vs. Commercial Tax Officers, (1978) 1 SCC 520, stating that even when there was a transfer of controlled commodities in pursuance of a direction under the Control Order where an element of mutual assent was absent, there was, nevertheless, sale as defined under the Act.
• The Court referred to Sunrise Associates vs. Govt. of NCT of Delhi, (2006) 5 SCC 603, stating that when there is a sale of a lottery ticket, there is no sale of goods within the meaning of Sales Tax Acts of the different States but at the highest a transfer of an actionable claim.
• The Court referred to Rotork Controls India Pvt. Ltd. vs. Commissioner of Income Tax, Chennai, (2009) 13 SCC 283, stating that a provision is a liability which can be measured only by using a substantial degree of estimation.
• The Court referred to Medley Pharmaceuticals Ltd. vs. Commissioner of Central Excise and Customs, Daman, (2011) 2 SCC 601, stating that a tax levied on the first sale must, in the nature of things, be a tax on the sale by the manufacturer or producer; but it is levied upon him qua seller and not qua manufacturer or producer.
• The Court referred to Bharat Heavy Electricals Ltd. vs. Commissioner of Customs and Central Excise, Indore, (2003) 9 SCC 185, stating that when a manufacturer offers a warranty to replace a defective part within a particular period and defective part is replaced by another part, the latter is exigible to excise duty.
• The Court referred to Govind Saran Ganga Saran vs. Commissioner of Sales Tax, AIR 1985 SC 1041, while discussing the components which entered into tax.
• The Court referred to Dhampur Sugar Mills Ltd. vs. Commissioner of Trade Tax, U.P., (2) 2006) 5 SCC 624, stating that the expression cash, deferred payment or other valuable consideration had to be given its true meaning and the latter two expressions enlarge the ambit of consideration beyond cash only.
• The Court referred to Commissioner of Central Excise, Mumbai vs. Fiat India Private Limited, (2012) 9 SCC 332, stating that consideration means something which is of value in the eye of the law.
• The Court referred to Assistant Collector of Central Excise vs. Madras Rubber Factory Ltd., 1986 Supp SCC 751, stating that a warranty is not a discount on the tyre already sold, but relates to the goods which are being subsequently sold to the same customers.
• The Court referred to State of T.N. vs. Sri Srinivasa Sales Circulation, (1996) 10 SCC 648, stating that the consideration was not only money paid or promised to be paid, but it was something more.

The Court also considered the definitions of sale, condition, and warranty under the Sale of Goods Act, 1930, and the definitions of proposal, promise, promisor, promisee, consideration, and reciprocal promises under the Indian Contract Act, 1872.

Conclusion

The Supreme Court’s decision clarifies that credit notes issued by automobile manufacturers to dealers for warranty replacements are indeed taxable under sales tax laws. This ruling affirms the principle that a transfer of goods for a valuable consideration, even if it’s in the form of a credit note, constitutes a sale.

The Court’s reasoning is based on the understanding that the warranty is a separate contract collateral to the main contract of sale. The replacement of parts under warranty is a new transaction, and the credit note provided by the manufacturer to the dealer is the consideration for this new sale. The Court emphasized that the definition of ‘sale’ under the sales tax laws is wide enough to include such transactions.

This judgment has significant implications for the automobile industry and tax law. It ensures that transactions involving warranty replacements are not treated differently from regular sales and are subject to appropriate taxation. This decision also provides clarity for tax authorities and businesses, reducing the potential for future disputes.

Flowchart of Warranty Replacement