The Taxation of Sales Preceding Export Transactions – Part II

In the first part, I outlined the conflict between the ‘same goods’ and ‘inextricable connection’ test, witness in applying section 5(3) of the Central Sales Tax Act. The resolution of this conflict, mandated a reference to a Constitution Bench in Azad Coach Builders.

On facts, the seller (Azad Coach Builders) has sold bus bodies to the exporter (TELCO), which were mounted on chassis made by the exported, and exported to a foreign company (Lanka Ashok Leyland). The foreign company had specifically asked the exporter to purchase the bus bodies from the seller, which was supposed to manufacture them according to the instructions of the foreign company. This agreement was also evidenced by the Purchase Order and communication between the parties. Thus, there was clearly a link between the export transaction and the preceding sale. However, since the sale was of bus bodies and the export of buses, the goods were not the same, leading to the conflict between the two tests. The Assessing Officer and the Joint Commissioner of Commercial Taxes (Appeals) applied the ‘same goods’ test and disallowed the exemption. The High Court however, allowed the exemption, applying the ‘inextricable connection’ test. It was the appeal by the State of Karnataka against this decision that brought the case to the Supreme Court.

The Constitution Bench of the Supreme Court reaffirmed the Karnataka High Court, and gave primacy to the ‘inextricable connection’ test over the ‘same goods’ test. Relying on the use of the terms ‘occasions’ and ‘in relation to’ in section 5(3), the Court held that if “each link (of the export transaction) is inextricably connected with the one immediately preceding it”, the sale will be exempt. Placing the burden of showing the link on the assessee, the Court observed, “The assessee in this case has succeeded in showing that the sale of bus bodies have occasioned the export of goods. When the transaction between the assessee and the exporter and the transaction between the exporter and foreign buyer are inextricably connected with each other, in our view, the `same goods’ theory has no application”.

However, while the rationale of this dictum is fairly straightforward, and arguably more equitable, it does raise a few questions which merit further attention.

First, this reading of section 5(3) completely nullifies the connection between ‘any goods’ and ‘those goods’, introduced by the initial part of the provision. It may be argued that this is too technical a reading of the provision, but it is nevertheless one which has been accepted by earlier Supreme Court dicta and is not countered by this decision. In fact, a strong case can be made for the proposition that the initial part of the provision narrows the broad language which follows.

Secondly, the Court relies on the Statement of Objects and Reasons; reliance which, it is submitted with due respect, is suspect. While the Statement does mention an ‘inextricable connection’, it merely says that this connection exists when goods are sold to a export canalising agency. It does not say that each case which involves an ‘inextricable connection’ was intended to be exempted. In fact, by mentioning only canalising agencies, which export the goods purchased without any changes whatsoever, the Statement provides more support for the ‘same goods’ test than the ‘inextricable connection’ test.

Finally, the Court hasn’t even gone all the way and given effect to the later part of the provision. We had discussed earlier how the phrase ‘in relation to’ has been given a very wide meaning by the Supreme Court in Doypack Systems Pvt. Ltd. V. Union of India, (1988) 2 SCC 299. In this case, the Court had held that even an indirect connection satisfies the requirement of ‘in relation to’, something which the Constitution Bench in Azad specifically rejects. When choosing a test narrower than Doypack (which was not referred to by the Court) but broader than ‘same goods’, the Court had two options- (a) requiring that the identity of the goods should not have changed between the sale and the export (as argued by Mr. Soli Sorabjee); and (b) requiring that the transaction of sale be inextricably connected to the export (suggested by Mr. Goolam Vahanvati). By choosing the latter, the Court seems to be leaning towards a position that the goods are not relevant for the purposes of determining the scope of the exemption, and all that is needed is some connection between the transactions of sale and export.

In sum, the Court lays down the following propositions for granting an exemption under section 5(3) of the Central Sales Tax Act:

(a) There should be a sale for the purposes of the export;

(b) The purchaser should export;

(c) There should be an inextricable connection (preferably in the form of some degree of privity between the seller and the importer) between the sale and the export, which occasions the export.

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