SHAMS MEHMOOD MIRZA, J: This Sales Tax Reference is filed under section 47 of the Sales Tax Act, 1990 (the "Act") to seek the opinion of this Court on the following questions of law which are said to have arisen from the judgment rendered by the Appellate Tribunal, Inland Revenue (the "Tribunal") on 06.02.2010:
(i) Whether the learned tribunal erred in law by holding that "the replacement parts constituted a distinguishable 'supply' on which tax was required to be charged and deposited, under the law, at the time of supply/replacement";
(ii) Whether the learned tribunal fell in palpable error in finding out the true nature of the transaction in hand and has upheld the order of the forums below which would result into imposition of tax twice for one taxable supply;
(iii) Whether the learned tribunal omitted to take into consideration the definition of "supply" provided in section 2(33) as it was at the relevant time especially with reference to the words "for consideration" used therein;
(iv) Whether the learned tribunal failed to take into consideration various provisions of the Act including section 2(46)(b) in order to find out intention of legislature in respect of the transactions like the one under discussion.
2. Another reference application bearing STR No.85 of 2011 filed by the present applicant raises identical questions and shall be decided through this composite judgment. This judgment shall refer to the facts of the present case as both the reference applications deal with similar facts which are not in dispute.
3. The applicant, which is a car manufacturer, received a show cause notice on 28.06.2006 from the Additional Collector (Legal), Large Taxpayers Unit, Lahore/respondent No.1 alleging evasion of sales tax under different heads as set out in the audit report of the Deputy Collector (Audit-II), Large Taxpayers Unit, Lahore for the tax period July 2004 to December 2005. The present case and the connected reference application only deal with that part of the show cause notice which relates to non-payment of sales tax on alleged "supply" of auto parts against warranty claims. The applicant duly replied to the show cause notice. The adjudication officer, however, passed the order-in- original No.39/06 dated 29.12.2006 holding the applicant liable to pay sales tax together with penalty. The applicant filed the first appeal before the Collector Customs, Sales Tax & Federal Excise (Appeals), Lahore who dismissed the same on 12.11.2007. This applicant then filed the second appeal before the Tribunal, inter alia, for calling into question the findings on imposition of sale tax on supply of auto parts under warranty claims. The Tribunal also dismissed the appeal of the applicant through its judgment issued on 06.02.2010.
4. Learned counsel for the applicant submits that the cars manufactured by the applicant are sold with the warranty for replacing the defective parts within a specified time and that such parts are supplied free of charge and no separate amount is charged or recovered from the customer. In order to further explain this aspect of the transaction, it is stated that the costs of such parts that are replaced under the warranty are included in the cost of the vehicle. In other words, the warranty is included in and attached to the sale price of the vehicle. As consideration is missing in such transaction, it does not come within the purview of "taxable supply". A reference was also made to section 3 of the Act as it existed at the relevant time. It was also pointed out the definition of "supply" in the Act at the relevant time did not contain the element of "consideration" which was subsequently included in the definition through the Finance Act, 2008.
5. The learned counsel for the respondents supported the judgment of the Tribunal.
6. Before dilating upon the questions of law involved in this reference application, it would be expedient to refer to the allegation made in the show cause notice and its reply by the auditor of the applicant.
7. The show cause notice made the following allegation in regard to the supply of auto parts under warranty claims: It was observed during audit that the registered person has supplied auto parts against warranty claims amounting to Rs.11,628,873/- without charging sales tax amounting to Rs.1,744,331/- on the premise that they have not charged any amount from the consumers against the above said supplies. The above said supply is taxable (being not exempt under section 13 of the Sales Tax Act, 1990, hence it can be safely concluded that the registered person has made taxable supplies amounting to Rs.11,628,873/- without charging of sales tax amounting to Rs.1,744,331/- in contravention of section 2(39), 2(41), 2(46), 3, 6, 7, 23 and 26 of the Sales Tax Act, 1990. Therefore, an amount of Rs.1,744,331/- is recoverable under section 11(2) and 36(1) of the Sales Tax Act, 1990 along with additional tax/default surcharge (to be calculated at the time of deposit) under section 34 and penalty Sr. No.5 of the Table of section 33 ibid.
8. The auditor of the applicant in reply to the show cause notice stated as follows:
11. Any particular vehicle sold by our client is covered by a warranty period which is usually 'one year or 20,000 Kilometers, whichever occurs earlier'. If any particular item or component or part of the motor vehicle turns out to be defective, within the stipulated 'warranty period', such component/part is to be returned to the company. In such a manner that the original component/part is to be returned to the company. In the context of the warranty claims, this business process reveals that the matter revolves around two different components on which sales tax liability is discharged as below:
(I) The component that forms part of the vehicle is subject to sales tax at the time of sale of the composite vehicle as obviously the price of such component is already included in the aggregate sale price of the motor vehicle;
(II) On receipt of a warranty claim, the original component is replaced and the substituted component forms the part of the composite vehicle whereas the original part is taken back into the records and later on sold as an item of scrap;
12. The above business process and mechanism reveals that both the items are properly chargeable to tax under the provisions of the Act. It is not a disputed position that the items substituted by our client are taken back into the records and sold as scrap on which sales tax is paid under the relevant provisions of law. If for arguments sake the contention of the auditors is accepted than this would give rise to a situation where one particular item would be taken to have been sold twice which is not a possibility.
9. The assessing officer and the Collector in their orders concluded that the replacement of auto parts under warranty claims constituted taxable supplies and that the applicant was liable to pay sales tax thereon together with additional tax/default surcharge and penalty.
10. The Tribunal in its judgment dealt with the issue by holding as under: The replacement parts constituted a distinguishable 'supply' on which tax was required to be charged and deposited, under the law, at the time of supply/replacement. No relationship can legally be made with the defective part. The position being admitted that no tax was charged and paid on the replacement part by the appellant, we dismiss the appeal on this point and conclude that the authorities below were justified in treating the appellant under default. The consequential additional tax and penalty, however, are annulled in view of applicability of amnesty on the basis of which the first appellate authority, in the impugned order, decided the issue listed at Serial No.(ii) supra, in the favour of the appellant.
11. It is evident that the revenue did not dispute the stance of the applicant that the warranty replacements were free of cost and that such replacements were part of the in-built cost of the motor vehicle. This stance of the applicant was also not contradicted either by the Tribunal or the forums below in their orders. The Tribunal simply declared warranty replacements to be distinguishable supplies on which sales tax was payable. None of the forums directly touched upon the issue set up by the applicant that the warranty replacements were an integral part of the sale price of the motor vehicle and thus sales tax had already been paid and that warranty replacements did not come within the purview of "supply".
12. It is indisputable that the transaction of sale of vehicles manufactured by the applicant is covered by the Sale of Goods Act, 1930. Section 12 thereof acknowledges that warranty forms an integral part of the sale contract.
13. The definition of "supply" in the Act at the relevant time was as follows.
"Supply" includes sale, lease or other disposition of goods carried out for consideration and also includes........
This definition was replaced by the Finance Act, 2008 in the following manner.
"Supply" means a sale or other transfer of the right to dispose of goods as owner, including such sale or transfer under a hire purchase agreement, and also includes ............
It is evident that the expression "sale carried for consideration" was omitted in the subsequent definition of "supply". Learned counsel for the respondents, in order to counter this argument, placed reliance on the definition of "taxable supply" in section 2 (41) of the Act which states that a taxable supply means a supply of taxable goods made by an importer, manufacturer, wholesaler (including dealer), distributor or retailer other than a supply of goods which is exempt under section 13 and includes a supply of goods chargeable to tax at the rate of zero per cent under section 4. This definition, however, is predicated on supply of taxable goods. The pertinent question is whether warranty replacements were taxable goods or not.
14. A somewhat similar issue arose in Indian jurisdiction when conflicting decisions were rendered by various High Courts. In all the cases, the dealers and not the manufacturers were assessed by the revenue. The issue related to replacement of parts during the subsistence of warranty and the question that required answer was whether such replacement would constitute "sale" which is liable to tax under the relevant sales tax laws and whether the sale price of the car already subject to the sales tax would include the cost or value of spare parts replaced under the warranty.
15. In the case of Commissioner of Sales Tax vs. Prem Nath Motors, (1979) 43 STC 52 (Delhi), the learned Division bench of Delhi High Court after taking note of section 12 of the Sales of Goods Act, 1930 held as under.
(18) Now, the warranty was to replace the defective part or parts free of cost. When a part is replaced in accordance with the stipulation or warranty, it becomes a part of the car and the property in it stands transferred to buyer/consumer. No separate consideration for the part so transferred is specified. No dealer can reasonably be expected to enter into such a stipulation or warranty which might result in the transfer of the property in the part or parts replaced without consideration for the transfer. In the circumstances, the only reasonable inference is that the consideration or the part or parts that might be replaced under the warranty was not separately specified, because it was included in the price fixed and paid for the car at the time of its sale. In other words, the transfer of the property in the part or parts replaced in pursuance of the stipulation or warranty is a part of the original sale of the car for the price fixed and received from the buyer consumer. The price so fixed and received was a consolidated price for the car and the parts that may have to be supplied by way of replacement in pursuance of the warranty.
16. The next case of Prem Motors, Gwalior vs. Commissioner of Sales Tax, Gwalior, 1986 (61) STC 244 MP dealt with a similar issue
7. The contention advanced by the learned counsel for the revenue, it appears, suffers from a basic fallacy. When a dealer sells automobile vehicle, he sells it with all parts in a saleable condition. The warranty is the warranty from the manufacturer and therefore if during the warranty period any part is found to be defective and is to be replaced, the responsibility of replacement is that of the manufacturer. For the convenience of the customer there is an arrangement between the manufacturer and the dealer so that the customer may get replacement done from the dealer which in due course is again made good by the manufacturer. Under these circumstances, when the dealer-assessee replaces parts to the customers and either gets those parts from the manufacturer or gets it reimbursed, it is neither sale of these parts by the dealer to the customer or to the manufacturer. What he does only is to pass on the parts from the manufacturer to the customer but in order to avoid delay and inconvenience of the customer he replaces the parts first and gets them from the manufacturer later and thus in our opinion it does not fall within the ambit of the definition of "sale" as has been provided in Section 2(n) of the M.P. General Sales Tax Act:
17. In the case of Geo Motors vs. State of Kerala, (2001) 122 STC 285, the warranty replacement was made by the dealer from the spare parts purchased in bulk from the manufacturer. After such replacement, the dealer would be issued the credit note by the manufacturer for the value together with excise duty and sales tax by cancelling the original sale made to the dealer in respect of the item so replaced. The learned Division Bench of the Kerala High Court by relying on Prem Nath's case held that the transaction in question cannot be said to be a sale as the issuance of the C-form was used purely for replacement and not for sale and that the credit notes were issued by the manufacturer by reducing the sale value.
18. The Indian Supreme Court in the case of Mohd. Ekram Khan & Sons v. Commissioner of Trade Tax UP, (2004) 6 SCC 183 overruled both the judgments rendered in Prem Motors and Geo Motors.
On account of conflicting judgments rendered by High Courts of Karnataka, Rajasthan, Allahabad, Madhya Pradesh, Bombay, Andhra Pradesh, Kerala and Gujarat, the matter was once again considered by the Indian Supreme Court in the case of M/s Tata Motors v. The Deputy Commissioner of Commercial Taxes (SPL) and another (Civil Appeal No.1822 of 2007) which case was decided on 15.05.2023. After considering the lengthy submissions of the learned counsels for the parties, the Indian Supreme Court formulated the following circumstances emerging from the facts of the cases for rendering decision thereon.
31...... When a dealer-assessee sells an automobile to a customer containing a warranty for the replacement of a defective part of the automobile in terms of the warranty and when the customer during the period of warranty approaches the dealer for the replacement of a defective part, the dealer could resort to the following:-
(a) request the manufacturer to supply the defective part of the automobile for replacement. In such a situation, the manufacturer of the automobile could do any of the following:
(i) send the spare part from his factory either as a manufacturer of the same to the dealer for replacement and seek return of the defective part, or by paying the requisite taxes and send it to the dealer and seek return of the defective part, or
(iii) purchase the spare part from the open market after paying the requisite taxes and send it to the dealer for replacement of the defective part in the automobile and seek return of the defective part. or
(b) may purchase the spare part from the open market by paying the requisite taxes and replace the defective part and return the same to the manufacturer, or
(c) may replace the defective part from his stock maintained in his showroom and return the defective part to the manufacturer In the case falling in paragraph 31(a) (i), which is precisely the issue in the present case, it was held by the Indian Supreme Court that "In situation (a), since the manufacturer himself has dispatched the spare part to the dealer for the purpose of replacement, there is no investment made by the dealer on the said part. The dealer merely acts on behalf of the manufacturer, pursuant to the warranty." It was furthermore observed that "We, however, clarify that the judgment of this Court in Mohd. Ekram Khan must be read in the context of a case where a dealer is utilising a spare part from his stock to replace a defective part under a warranty and receiving a recompense in the form of a credit note from the manufacturer. When given such an understanding of the judgment in Mohd. Ekram Khan to the aforesaid conspectus of facts, we do not think that the said judgment has been erroneously rendered." In conclusion, it was held by the Indian Supreme Court as follows.
70. In the circumstances, the reference is answered in the following terms: i) The judgment of this Court in Mohd. Ekram Khan is applicable to a situation where a manufacturer issues a credit note to a dealer acting under a warranty given by the manufacturer pursuant to a sale of an automobile in the following situations. The dealer replaces a defective part of the automobile by a spare part maintained in the stock of the dealer or when the same is purchased by the dealer from the open market. In such situations, the credit note issued in the name of the dealer is a valuable consideration for a transfer of property in the spare part made by the dealer to the customer and hence a sale within the meaning of the sales tax legislations of the respective States under consideration. The value in the credit note is thus exigible to sales tax under the respective sales tax enactments under consideration. ii) The judgment in Mohd. Ekram Khan does not apply to a case where the dealer has simply received a spare part from the manufacturer of the automobile so as to replace a defective part therein under a warranty collateral to the sale of the automobile. In such a situation also, the dealer may receive a consideration for the purpose of the service rendered by him as a dealer under a dealership agreement or any other agreement akin to an agent of the manufacturer which is not a sale transaction.
19. Since the factual aspect of the present reference applications is covered by the situation visualized in paragraph 31(a) (i) of the judgment in Tata's case, the judgments in Prem Motors and Geo Motors and the reasoning contained therein would squarely be applicable to the questions to be answered by this Court. It may relevantly be pointed out that in the present reference applications the auto parts were replaced directly by the applicant which is the manufacturer of the motor vehicle.
20. As is apparent from the reply to the show cause notice, the warranty assured the customers of replacement of the defective parts within the agreed period or the mileage free of charge, which fact was not rejected in the orders of all the forums. The contract of sale in the present case related to composite supply of vehicle and the service for replacement of defective parts. Both were bundled in one contract. The auto parts were supplied free of charge to the customers by the applicant under the warranty and at the time of such replacement no separate consideration was charged for the reason that consideration of such parts formed an integral part of the price of the contract which was received at the time of sale. It is thus axiomatic that sales tax charged and paid on the contractual consideration at the time of supply of motor vehicle included such tax on auto parts to be replaced under the warranty. In other words, the cost of warranty replacements was incorporated in the price of the motor vehicle on which sales tax had already been paid.
Absent the consideration in such transaction, it does not fall under the definition of 'supply' as contained in the Act at the relevant time. Given the fact that the replacement of auto parts under the warranty did not form part of supply of taxable goods, the reliance by the learned counsel for the respondents on the definition of "taxable supply" is not apt.
21. The Tribunal and the forums below did not dwell upon the question of replacement of auto parts by the applicant in the correct legal perspective and erroneously held that the supply of auto parts under the replacement warranty was a distinguishable transaction without making any effort to say what that means. The provisions contained in section 2(33) of the Act were also not taken into account by the Tribunal and the forums below while passing the orders assessing the supply of auto parts under the warranty to be taxable.
22. In view of what has been stated above, we answer all the questions in affirmative and set aside the orders/judgments of the Tribunal and the forums below by holding that replacement of auto parts covered by a manufacturer's warranty were not taxable at the relevant time. Consequently, instant Reference is allowed.
23. The Office is directed to send a copy of this judgment under the seal of the Court to the Appellate Tribunal in terms of section 47(5) of the Act.