Export tax: Understanding penultimate sales

By Udayan Choksi and Rahul Jain, Economic Laws Practice

What constitutes a penultimate sale, so as to be exempt from sales tax under section 5(3) of the Central Sales Tax Act, 1956 (CST Act)?

Ruling in State of Karnataka v Azad Coach Builders Pvt Ltd & Anr, a constitution bench of the Supreme Court held that the test to be applied is whether an “in-severable link” exists between the local sale and the export and if so, the local sale would be exempt from sales tax.

Basis for this exemption

Article 286 of the constitution exempts goods that are exported from being taxed. Section 5(3) of the CST Act, introduced in furtherance of this principle, reads: “… the last sale or purchase of any goods preceding the sale or purchase occasioning the export of those goods out of the territory of India shall also be deemed to be in the course of such export, if such last sale or purchase took place after, and was for the purpose of complying with, the agreement or order for or in relation to such export.”

Udayan Choksi Partneer Economic Laws Practice
Udayan Choksi
Economic Laws

Background to the case

The assessee, Azad Coach Builders, built bus bodies and mounted them on chassis supplied by its customers. Some of these were exported to foreign buyers who had placed orders for buses with Azad Coach Builders’ customers. The question that arose was whether the sale by Azad Coach Builders to its customers would qualify as a penultimate sale and therefore be tax exempt.

Azad Coach Builders argued that (a) the bus bodies could easily be dismantled by the customer, (b) that the foreign buyers specifically mentioned the types of bus body and chassis to be exported, and (c) most importantly, the identity of the bus body was not lost when mounted on the chassis.

The tax authorities in turn maintained that exemption under section 5(3) was only available if the same commodity that is sold is exported. As such in this case Azad Coach Builders should have manufactured and sold the whole bus in order to be eligible for the exemption.

Azad Coach Builders appealed to Karnataka High Court, which examined the expression “those goods” used in section 5(3). The court also referred to several decisions that had held the exemption could be claimed so long as the identity of the goods was not lost. These included cases of packing material for seafood, bladders going into footballs and volleyballs, and, basic processing such as cleaning and freezing seafood and roasting and grinding coffee beans into coffee powder.

According significance to the fact that after the assesee had built the bus body the exporter had done nothing to change it, the court held that the exemption was applicable. It said that it could not be contemplated that the legislature would have intended to not grant exemption in a case where two articles constituted another article without any manufacture or processing. The court also held that a sale could qualify for exemption even in the absence of an agreement or order for export.

Appealing the decision

Aggrieved by the order of the high court, the state of Karnataka, the recipient of the taxes in dispute, appealed to the Supreme Court. While doing so they relied on the Supreme Court’s decisions in several cases, including Sterling Foods, (in which shrimps, etc., were held to be the same goods after cleaning and freezing) and Vijaylakshmi Cashew Company (in which raw cashew nuts from which kernels were extracted and exported were held not to qualify for the exemption). They also argued that the term “in relation to export” did not extend to goods other than those eventually exported, and, further, that the introduction of section 5(3) was not to entitle goods other than those eventually exported to the exemption from tax.

Rahul Jain Associate Economic Laws Practice
Rahul Jain
Economic Laws Practice

The division bench of the Supreme Court held that the basic point was whether the correct interpretation of section 5(3) would be based on the test of same goods, as suggested by the first clause of section 5(3), or the test of connection with the export, as in the second qualifying clause. Agreeing that due weight had not been given to the words “in relation to exports” in the earlier decisions, the court decided the issue needed to be considered by a constitution bench.

Based on the statement of objects and reasons of the bill that introduced section 5(3), the larger bench held that the test of an “in-severable link” applied. Noting that the foreign buyer had provided specifications for the bus bodies, which were given to Azad Coach Builders by its customer, the court held that there was an inextricable connection between the sale and the export of the goods. The larger bench also held the “same goods” theory would have no application. While this decision ends the controversy about the “same goods” theory, it could open up new questions about how the in-severable link test will apply where the goods in the penultimate sale are different from the exported goods.

Economic Laws Practice is a full-service law firm headquartered in Mumbai and has offices in New Delhi, Pune and Ahmedabad. Udayan Choksi is an associate partner and Rahul Jain is an associate at the firm.


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