The Unending Saga of ‘Classification’ – The Need for Consistency in Policy
Classification of goods for the purpose of taxation under the Central Excise and Customs laws has always been an area of dispute. The tussle on the subject between the taxpayers and Revenue authorities has continued under the GST regime as well. This is primarily due to the fact that the Indian scheme of classification is based on the Harmonized System of Nomenclature (HSN), an internationally developed mechanism for the classification of goods, which defies localization. The HSN is divided into 21 Sections and 98 Chapters, each of which contains Notes on how to classify the items of that Section.
The issue of classification on several occasions has been disputed and settled by the Hon’ble Supreme Court (SC) in the past, but the current judgment of the Apex Court, delivered on 8 March 2021, in the case of Westinghouse Saxby Farmer Limited vs. Commr. of Central Excise, Calcutta1 has caused (unintended) ripple effects on various industries and sectors.
In the said case, the Hon’ble SC dealt with the question of whether ‘relays’ would be classifiable as parts of ‘railway signaling equipment’ under Heading 8608 of Central Excise Tariff (as put forth by the assessee) or independently as ‘electrical equipment’ under Heading 8536 (as contested by the Revenue). The dispute revolved around the interpretation of Note 2 and Note 3 of Section XVII2 of the Central Excise Tariff, which are briefly explained hereunder:
Note 2: The expressions “parts” and “parts and accessories” do not apply to listed articles, whether or not they are identifiable as for the goods of Section XVII. The list inter alia includes electrical machinery or equipment (Chapter 85), articles of Chapter 90, etc.
Note 3: References in Chapters 86 to 88 to “parts” or “accessories” do not apply to parts or accessories which are not suitable for use solely or principally with the articles of those Chapters. A part or an accessory that answers to a description in two or more of the headings of those Chapters is to be classified under that heading that corresponds to the principal use of that part of the accessory.
To provide a historic background to this judgment's context, it may be pertinent to note that from March 1986 to February 1993, the effective excise duty rate under both headings was 15%. However, with effect from 28 February 1993, the effective excise duty for the goods under sub-heading 8536.90 became much higher than that for goods under Heading 8608.
Giving precedence to the ‘predominant use’ or ‘sole / principal use’ test of Note 3 of Section XVII over the exclusion/ embargo contained in Note 2, the Hon’ble Court ruled in favor of the appellant-assessee.
To summarize, the Hon’ble SC held that if an article/item is solely or principally designed for use with a specific finished good and the Section/Chapter Notes prescribe classification of parts basis ‘principal use,’ the article/item would be classifiable under “parts” as opposed to the specific heading of the particular item, notwithstanding any specific exclusions/embargo for such goods from the scope of “parts” under such Section/Chapter Notes.
Ironically, the success of the assessee in the aforesaid case has adversely impacted other taxpayers, especially the automobile sector. Demand notices are being issued to taxpayers dealing in automobile parts. Even investigations by intelligence authorities are being initiated against them, seeking to assess such parts at a higher GST bracket of 28% as applicable to motor vehicles falling under Chapter 87, along with interest.
Resultantly, parts like auto engine valves, switch panels, automotive chains, electric motors, transmission belts, fasteners, LCD displays, etc., which hitherto attracted a lower GST of 18%, are being proposed to be taxed at 28%.
Taking cognizance of the divergent practices arising in the assessment of ‘automobile parts’ and other impacted industries under Customs pursuant to the Apex Court’s ruling in Westinghouse Saxby, the CBIC recently issued an advisory3 for the field officers clarifying the implications of the said judgment.
In the Instruction, the Central Board of Indirect Taxes and Customs (CBIC) has highlighted inter alia that the judgment decided the classification of the commodity ‘relays’ used in railway signaling equipment of Chapter 86 and not parts of goods falling under Chapter 87. In fact, the Hon’ble Supreme Court itself has acknowledged the complexity of the issue and has pointed to the undesirability of generalizing the decisions of one case to others.
Furthermore, reference has been made to other Apex Court judgments4 wherein the exclusionary clause under Note 2 has been given precedence over the sole or principal use of the items after considering the HSN Explanatory Notes issued by the World Customs Organization (WCO). As per the Board, these judgments did not come up for consideration in the Westinghouse Saxby case and therefore, there appears to be a variance with the stand taken in classifying other parts of goods falling under Section XVII.
Accordingly, the Board has advised that, “…in general, the practice of assessment of such ‘parts’ or any change in it may holistically keep in view and in a speaking manner, all relevant aspects including HS Explanatory Notes, the relevant Section and Chapter notes and the various decisions of the Hon’ble Supreme Court…”
It has also been highlighted that the Department has filed a review petition against the Westinghouse Saxby judgment after taking cognizance of other Supreme Court decisions in case of parts and accessories and on the grounds of interpretation of Section Notes and the HSN Explanatory Notes.
Here, reference may be drawn to the clarification regarding GST rates applicable to ‘External Batteries’ sold along with ‘UPS Systems / Inverters’. It was clarified that UPS/Inverter and external batteries are two separately identifiable items, and thus, it constitutes the supply of two distinctly identifiable items even if both the items are sold on the same invoice.
Thus, UPS/Inverter would attract a GST rate of 18% under heading 8504, while external batteries would attract the GST rate as applicable to them under heading 8507.
It, accordingly, appears that CBIC has adopted the rule of classifying two separately identifiable items as distinct, based on the recommendations provided in the 45th GST Council meeting held on 17 September 2021, read with the Circular5.
The above instructions/advisory should mitigate the impact of the above judgment to an extent and provide an interim respite to the industry players, who have been exploring the most optimized approach against these Dept. actions. Such approach includes either - (i) engaging in prolonged litigation with the authorities; or (ii) aligning to the position prescribed by them and commercially negotiating with the customers who would eventually bear the higher tax incidence, which can be claimed as ITC; or (iii) building a case for policy action through advocacy.
One would have to await the outcome of the review petition and the ensuing suitable amendment if any, for the issue to be addressed finally.
It would be worthwhile if these longstanding classification disputes were concluded through a one-time retrospective legislative amendment, thereby entailing consistency in the position being adopted on the Revenue side. Harping on one principle for the classification of goods that is advantageous for a particular industry may not be counter-productive for another industry. Hence, a cohesive policy by the government is the need of the hour to alleviate wider ramifications from classification disputes under Customs and GST laws.
1. [Civil Appeal No. 37 of 2009]
2. Section XVII governs Chapters 86 and 87, that include railway locomotives and motor vehicles
3. Instruction No. 01/2022-Customs dated January 5, 2022
4. Intel Design Systems (India) Pvt Ltd. vs. Commissioner of Customs and C. Ex. [2008-TIOL-18-SC-CX], CCE Delhi vs. Uni Products Ltd [2020 (372) ELT 465 (SC)
5. Circular No. 163/19/2021-GST dated October 6, 2021