Credit Note Issued By Automobile Manufacturer To Dealer, In Consideration Of Replacement Of Defective Part, Attracts Sales Tax: Supreme Court

The Supreme Court has ruled that a credit note issued by an automobile manufacturer to a dealer of automobiles, in consideration of the replacement of a defective part done by the dealer pursuant to a warranty agreement, is exigible to sales tax.

The court has held that when a dealer replaces a defective part of the automobile by a spare part maintained in its stock 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 transfer of property in the spare part made by the dealer to the customer. The same constitutes a “sale” under both the Central Sales Tax Act as well as the respective sales tax legislations of the States under consideration. Thus, the assessee-dealers are liable to pay sales tax on the said transaction.

The bench comprising Justices K.M. Joseph, B.V. Nagarathna and Ahsanuddin Amanullah was hearing a batch of appeals in pursuance to a larger bench reference made by the Division bench of the Supreme Court in 2019, where the top court had expressed reservations in respect of the observations and legal propositions laid down in Mohd. Ekram Khan & Sons vs CTT, (2004) 6 SCC 183. In Mohd. Ekram Khan (2004), the Apex Court had held that the amount received by the assessee-dealers for supply of spare parts to the customers as a part of the warranty agreement, was liable to sales tax.

While hearing the larger bench reference, the Supreme Court held that merely because the dealer acts as an intermediary on behalf of the manufacturer pursuant to a warranty, and receives a recompense in the form of a credit note, the same cannot escape its liability to pay tax under the Sales Tax Acts.

The bench clarified that the judgment in Mohd. Ekram Khan (2004) 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 under a warranty collateral to the sale of the automobile. Thus, the court said that, in view of the same, the decision in Mohd. Ekram Khan does not call for any interference.

The assessee, M/s Marudhar Motors, is a dealer of TATA Vehicles. Under the dealership agreement, the dealer/assessee is obliged to provide replacement of warranty goods sold to the customer.

In pursuance of the warranty agreement, the dealer is required to replace the defective parts of the automobile free of cost to the customers.

In order to avoid delay, the dealer, on behalf of the manufacturer, Tata Motors, collects a defective component from the customer and replaces it with the parts in the stock purchased from the manufacturer. This defective component is returned back to Tata Motors from whom the dealer had purchased the same in the first place. Tata Motors, thereafter, issues credit notes, crediting the running account of the dealer which is maintained for sale transactions, at the price at which the good was initially sold to the dealer.

Pursuant to the decision of the Supreme Court in Mohd. Ekram Khan (2004), the assessing authority had invoked the power of reassessment under Section 30 of the Rajasthan Sales Tax Act, 1994 to impose a tax on assessee’s turnover, which had escaped assessment. The Deputy Commissioner (Appeals), in appeal, upheld the levy of tax upon the assessee.

In the appeal filed before the Rajasthan Tax Board, the decision of the Deputy Commissioner (Appeals) was set aside. The Board had ruled that the transaction of replacing the defective parts did not fall within the definition of ‘sale’ as defined under Section 2(38) of the Rajasthan Sales Tax Act.

The revision petitions filed by the Revenue Department were dismissed by the Rajasthan High Court.

In the appeal filed before the Supreme Court, Senior Advocate Kavin Gulati, on behalf of Tata Motors, submitted that replacement of spare parts during the warranty period does not constitute a sale; adding that a dealer is contractually bound to service the warranty obligations undertaken by the manufacturer at the time of the sale. He placed reliance on Section 12(3) of the Sale of Goods Act, 1930, which states that a warranty is a stipulation collateral to the main purpose of the contract.

He argued that a case of discharge of a warranty is the exact opposite of a contract of sale, which involves the volitional transfer of goods. He further contended that a credit note is not a sale price or valuable consideration, as the character of the credit is not towards the price of the newly replaced part, but is, in fact, a credit that embodies the diminution of the price already paid for the car.

Therefore, he claimed that Mohd. Ekram Khan (2004) does not correctly appreciate the nature of a warranty transaction and thus, ought to be overruled.

Referring to the decision in Mohd. Ekram Khan, the top court observed that where there is a warranty clause appended to the sale of a motor vehicle for the replacement of a defective part on the part of the manufacturer, if the manufacturer purchases the said part from the open market, it would have paid the tax. In such a case the dealer/ assessee would have supplied the part to the customer but not received the payment of the price from the manufacturer. In such a case, the transaction between the dealer and the manufacturer is not one of sale.

However, it was held in Mohd. Ekram Khan that when a dealer receives a credit note from the manufacturer while discharging his obligation under a warranty clause and uses a spare part from his own stock to replace a defective part, the transaction between the manufacturer and the dealer would constitute sale on which the dealer was liable to pay sales tax.

The bench further noted that Mohd. Ekram Khan had construed the said two situations as similar. “Thus, a situation where the assessee supplies the part from his own stock and receives a credit note by way of recompense for the said replacement from the manufacturer is construed to be identical to a situation where a manufacturer buys a spare part from the open market and replaces the defective part through the dealer (assessee) and the dealer returns the defective part to the manufacturer,” the court observed.

The court reckoned that the dealer, while acting on behalf of the manufacturer in replacing the defective part free of cost under the warranty, is using the spare part from its own stock which it would have bought earlier by paying the requisite tax on the same.

It further noted, “If the said part, instead of being replaced pursuant to the warranty free of cost had been sold, the dealer would have earned a return on his investment and possibly with a reasonable profit also and would have also collected the sales tax. But when the dealer replaces a defective part with a spare part from his stock pursuant to a warranty, he does not receive anything in return from the customer for the spare part used from his own stock.”

The court added: “It is in such a situation that the manufacturer issues a credit note to recompense the dealer for his investment on the spare part in his stock which was used to replace a defective part pursuant to a warranty in the sale of automobile as nothing would have been received in return from the customer.”

The bench observed that a credit note is issued with a particular intention in mind, and that is to recompense the dealer. The court reckoned that while acting under the warranty on behalf of the manufacturer, the dealer does not receive any price from the customer. Thus, he is recompensated by the manufacturer in the form of a credit note.

While noting that a credit note is a convenient and legal method by which the value of the goods or services in the original tax invoice can be amended or revised, which will easily allow the supplier to decrease his tax liability, the court said, “Therefore, the entire controversy must be viewed in the perspective of a composite transaction and not in isolation as the dealer (assessee) would be acting under a warranty with there being a manufacturer on one end and the purchaser or customer of an automobile at the other end and the dealer acting on behalf of the manufacturer or an intermediary between the said customer and manufacturer.”

The Supreme Court further concluded that a credit note issued by a manufacturer in favour of a dealer is a valuable consideration within the meaning of the definition of “sale”, under both the Central Sales Tax Act as well as the respective State enactments.

The court thus said, “Where there is transfer of property by the dealer to the customer while acting under a warranty and the dealer being paid by the manufacturer, when viewed in the aforesaid prism, the credit note shown in the account of the dealer is a valuable consideration pursuant to the sale that has taken place of a spare part from his stock.”

The bench, however, added that all credit notes received by the dealer are not indicative of the value of the spare part supplied by the dealer- either from his own stock or when he buys it from the open market- to the customer under a warranty. “It could be for rendering a service under a dealership agreement which can cover a situation when the manufacturer sends the spare part to the dealer to replace a defective part and receives a consideration for the said service. In such a case, there is no recompense for spare part. It is only when a credit note is issued for a spare part used by a dealer from his own stock or when he has purchased it from the open market or from another manufacturer of a spare part that it becomes a sale within the meaning of the sales tax enactments under consideration,” said the court.

The court said that the consideration received by a dealer under the terms of an ‘Agency Agreement’ for the service rendered by the dealer pursuant to a warranty, cannot be construed as a transaction of sale. “It is a service contract and possibly a service tax is leviable depending on the terms and conditions of the Agency,” the court held.

The bench further held that the dealership agreements established a Principal-to-Principal relationship between the manufacturer and the dealer, and not a Principal-to-Agent.

The bench thus concluded that there is a transfer of property in the spare part from the stock of the dealer to the customer, for which the manufacturer pays by way of a credit note- which is a valuable consideration and is exigible to tax. It added that the person who pays the valuable consideration in a sale transaction is irrelevant so long as it is paid.

“In this context, it would be relevant to refer to the provisions of the Indian Contract Act, 1872. Section 2 (d) of the said Act states that when, at the desire of the promisor, the promisee or any other person has done or abstained from doing, or does or abstains from doing, or promises to do or to abstain from doing, something, such act or abstinence or promise is called a consideration for the promise,” the court held. Thus, the manufacturer is the promisor who makes the proposal to recompensate the dealer and the dealer is the promisee, the court said.

The bench thus allowed the appeals filed by the Revenue Department and dismissed the appeals of the assessee-dealers.

Case Title: M/S. Tata Motors Ltd. vs The Deputy Commissioner Of Commercial Taxes (SPL) & Anr.

Citation : 2023 LiveLaw (SC) 443

Counsel for the Appellants: Mr. Kavin Gulati, Sr. Adv. Mr. Avi Tandon, Adv. Mr. Rohit Amit Sthalekar, Adv., Mr. Vishal Gehrana, Adv. Mr. Japppanpreet Hura, Adv. Mr. M. P. Devanath, AOR Ms. Pragati Neekhra, AOR Mr. Sonal Jain, AOR Mr. R. K. Raizada, Sr. Adv. Mr. Bhakti Vardhan Singh, AOR Mr. Ankit, Adv. Mr. Rahul Kaushik, AOR Mrs. Manik Karanjawala, AOR Mr. Irshad Ahmad, AOR Mr. Yashraj Singh Deora, AOR Mr. Priyesh Mohan Srivastava, Adv. Mr. Abhishek Singh, Adv. Mr. Punit Dutt Tyagi, AOR Mr. P. K. Manohar, AOR Mr. K. K. Mani, AOR Ms. T.archana, Adv. Mr. Rajeev Gupta, Adv. Mr. Vinay Rajput, Adv. M/S. Karanjawala & Co., AOR Mr. V Sridharan, Sr. Adv. Ms. Apeksha Mehta, Adv. Mr. Sahil Parghi, Adv. Ms. Neha Choudhary, Adv. Mr. Gopal Machiraju, Adv. Ms. Falguni Gupta, Adv. Ms. Umang Motiyani, Adv. Ms. Charanya Lakshmikumaran, AOR Dr. Manish Singhvi, Sr. Adv. Ms. Shubhangi Agarwal, Adv. Mr. Milind Kumar, AOR

Counsel for the Respondent: Mr. Nikhil Goel, A.A.G. Mr. V. N. Raghupathy, AOR Mr. Manendra Pal Gupta, Adv., Mr. Adithya Roy, Adv. Mrs. Ansha Varma, Adv. Mr. Sanjay Jain, AOR Mr. Kamlendra Mishra, AOR Mr. G. N. Reddy, AOR Mr. Pallav Shishodia, Sr. Adv. Mr. C. K. Sasi, AOR Mr. Abdulla Naseeh V T, Adv. Ms. Meena K Poulose, Adv. Mr. Rahul Kaushik, AOR Ms. Deepanwita Priyanka, AOR Mr. Bhakti Vardhan Singh, AOR Mr. Aniruddha Joshi, Adv. Mr. Siddharth Dharmadhikari, Adv. Mr. Aaditya Aniruddha Pande, AOR Mr. Bharat Bagla, Adv. Mr. Sourav Singh, Adv. Ms. Ruby Singh Ahuja, Adv. Mr. Vishal Gehrana, Adv. Ms. Hanry Maisi, Adv. Mr. Jappanpreet Hora, Adv. Ms. Meghna Mishra, Adv. For M/S. Karanjawala & Co., AOR Mr. Saurabh Mishra, A.A.G. Mr. Pashupathi Nath Razdan, AOR Mr. Tarun Gulia, Adv. Ms. Maitreyee Jagat Joshi, Adv. Mr. Astik Gupta, Adv. Ms. Ayushi Mittal, Adv. Mr. Vipul Abhishek, Adv. Mr. Kuldeep Kumar Shukla, Adv. Mr. Nishe Rajen Shonker, AOR Ms. Rashmi Singhania, AOR Mr. Sarad Kumar Singhania, Adv. Mr. S. K. Upadhayay, Sr. Adv. Mr. Hitesh Kumar Sharma, Adv. Mr. Akhileshwar Jha, Adv. Mr. Amit Kumar Chawla, Adv. Mr. Ravish Kumar Goyal, Adv., Mr. Nitin Sharma, Adv. Mr. Chaman Sharma, Adv. Mr. Naresh Kumar, AOR Mr. Alok Sangwan, Adv. Mr. Sumit Kumar Sharma, Adv. Ms. Ankita Choudhary, AAG Mr. Abhinav Shrivastava, Adv. Mr. Sunny Choudhary, AOR Ms. Radhika S. Adv. Mr. Shivang Rawat, Adv.

Sale of Goods Act, 1930; Central Sales Tax Act; Rajasthan Sales Tax Act, 1994- The Supreme Court has ruled that a credit note issued by an automobile manufacturer to a dealer of automobiles, in consideration of the replacement of a defective part done by the dealer pursuant to a warranty agreement, is exigible to sales tax.

The court has held that when a dealer replaces a defective part of the automobile by a spare part maintained in its stock 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 transfer of property in the spare part made by the dealer to the customer. The same constitutes a “sale” under both the Central Sales Tax Act as well as the respective sales tax legislations of the respective States. Thus, the assessee-dealers are liable to pay sales tax on the said transaction.

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