[Parv Jain is a 4th-year B.A., LL.B. (Hons.) student at the Institute of Law, Nirma University, Ahmedabad]
Late last year, Skoda Auto Volkswagen India Private Limited (‘Skoda’) received the largest tax demand ever issued to an automaker in India, amounting to $1.4 billion. The demand challenges the classification of imported parts at its Aurangabad factory. According to the customs department, Skoda has been misclassifying its vehicle parts as individual components rather than as completely knocked down (‘CKD’) kits while importing into India. This case is critical for Skoda, as losing could potentially force the company to cease operations in India. Moreover, the dispute carries wider implications for the entire automobile industry, potentially affecting the billions in foreign direct investment (‘FDI’)generated by this sector. Most importantly, this case is expected to set legal and tax precedent regarding how courts interpret different methods of car imports into India. Skoda has challenged the notice in the Bombay High Court, deeming it unjustified, and the case is currently pending.
This post does not aim to predict the judicial outcome of the Skoda dispute. Instead, it seeks to highlight the urgent need for clear differentiation of car kits during imports to ensure the correct levy of customs duty. To establish this distinction, the author begins by highlighting how common terminologies used to describe car kits are insufficient for distinguishing between them. Further, the post explores the Harmonised System of Nomenclature (‘HSN’) and its impact on import duties of vehicles. It then traces the history of jurisprudence behind the car kits in the automobile industry and examines the general interpretational rules that influence these classifications. Finally, the author provides a clearer distinction between the different types of kits while emphasising the need for more comprehensive classification guidelines, especially as the automobile sector continues to grow rapidly.
Background
Foreign automakers primarily import cars into India through three methods. First, they do so as a completely built unit (‘CBU’), which refers to a fully assembled car imported as a whole. It does not require any additional assembly, testing, or finishing. Second, semi knocked down (‘SKD’) kits involve partially disassembled vehicles that require limited reassembly in the destination country. Third, in CKD kits, cars are imported as completely disassembled parts and require full assembly in the importing country. Additionally, automakers also import individual parts for repair and stock purposes. The choice of import method depends on the manufacturer’s assembly option in India.
Import tariffs are levied in an ascending order based on an increase in pre-assembly at the time of import. The underlying rationale is to promote local manufacturing by imposing higher tariffs on vehicles that require less domestic production. As a result, CBUs attract the highest import tariffs since they require no local manufacturing, whereas CKD kits are subject to the lowest tariffs as they involve complete assembly in India.
Nearly all customs disputes revolve around the HSN and classification of products under different HSN codes. The World Customs Organization (‘WCO’) developed this standardised international coding system to ensure uniform tax rates and prevent misclassification to evade duties. The HSN code is used by over 200 countries for taxation, trade, and customs duty purposes through a six-digit universal code (can be expanded based on country specification). For instance, India follows the HSN code but expands the code to eight digits for more precise classifications. Under the HSN, CBUs are classified under the other head 8703.31 to 8703.33, while CKD and SKD kits fall under code 8708.99. However, while the HSN code assigns different import tariffs to each of these kits, the lack of detailed guidance makes the system unreliable for precise classification. For instance, if a company imports a CBU but excludes the car’s steering from the shipment, should it still be classified as a CBU, or would it fall under SKD? While judicial precedents have addressed some of these ambiguities, many classification gaps remain unsolved.
Mapping the History
Before 2002, CKD, SKD and CBU kits were loosely defined, leading to inconsistent customs tariff applications. In 1997, India introduced Public Notice 60 (‘PN 60’), which restricted automotive imports. Under PN 60, automakers seeking import licences were required to enter into a contract with the government through a Memorandum of Understanding (‘MOU’). Even after obtaining licences, the MoU imposed strict indigenisation requirements, mandating local production of at least 50% of components by the third year (or earlier) and 70% by the fifth year. This policy was strongly challenged by European communities and the United States under the Understanding on Rules and Procedures Governing the Settlement of Disputes, which is World Trade Organization’s legal framework for resolving trade disputes among member countries. As a result of the proceedings, India abolished its licensing scheme entirely on 1 April 2001. Since then, all quantitative restrictions on vehicle imports have been lifted, increasing the need for clear classification rules. On 1 March 2002, the Central Board of Indirect Taxes & Customs (‘CBIC’) issued Notification No. 21/2002-Customs, defining CBUs as completely assembled vehicles, whether or not fitted with tyres or batteries. The notification further clarified that a vehicle would be deemed a CBU as long as the engine and the gearbox are installed in the body assembly.
Despite this clarification, disputes continued. In 2005, BMW sought clarity from the Authority for Advance Ruling (‘AAR’), New Delhi [2006 (193) E.L.T. 138 (A.A.R.)], where the AAR observed that no specific guideline defined CKD or SKD kit. To address this gap, on 1 March 2011, the CBIC issued Notification No. 21/2011-Customs, which defined a CKD kit as a unit containing all necessary components of a complete vehicle, except for a pre-assembled engine, gearbox or transmission mechanism. Subsequently, on 11 March 2011, CBIC provided a clarification to the above definition via F. No. 354/38/2011-TRU, differentiating CKD kits from individual parts. It emphasised that importing vehicle components on a standalone basis does not qualify as importing a CKD kit. To this day, this definition remains central to resolving automobile classification disputes. Nonetheless, rule 2(a) of the General Rules for the Interpretation (‘GRI’) continues to play a crucial role in adjudicating CKD, SKD, and CBU classification disputes.
Rule 2(a) of GRI
Rule 2(a) of GRI states that an incomplete or unfinished article should be treated as a complete or finished article if it possesses the essential characteristics of the finished product. In the automobile sector, this means that if a company imports individual parts essential for the functioning of a vehicle, those parts could be classified as a CKD kit or even a CBU, attracting significantly higher import duties. Judicial interpretations have extensively debated as to what constitutes an “essential characteristic” of an item. In the BMW case mentioned earlier, the AAR ruled that even if an automaker imports a CKD kit without seats, these kits still retain the essential characteristics of a completely built vehicle. As a result, despite the cars being unassembled and lacking seats, they were classified as CBU kits. Similarly, in Commissioner Of Customs, New Delhi v Phoenix International Ltd., the Supreme Court upheld that the import of individual items through different invoices and at different ports can be clubbed together, as they collectively carried the essential characteristics of a finished product.
In the present case, whether Skoda is importing standalone parts or CKD kits would depend on two key factors. Firstly, it would be essential to analyse whether Skoda’s imports possess the characteristics of a CKD kit or merely consist of standalone components. Secondly, according to rule 2(a) of GRI, incomplete or unfurnished articles are classified based on how they are presented at the time of importation. Therefore, the court’s decision in Skoda’s case will likely depend on the condition of the goods at the time of import rather than their transformation after processing or assembly.
The Way Forward
It is now clear that despite the thoroughness of the customs laws, they often lack a clear distinction between key terms. A comprehensive review of legislative history and judicial interpretations of automobile imports reveals that a fully built car is imported as a CBU. However, if non-essential car components such as mats, steering wheels or seats are not preassembled with the CBU, they would still incur the same import duty without being classified as a SKD or CKD kit. For SKD kits, the process involves reassembling pre-manufactured and inspected parts, typically using nuts and bolts. In contrast, CKD kits require complete reassembly of disassembled parts, including installation of interior parts, as well as welding and painting. Importantly, a CKD kit cannot include a preassembled engine, gearbox or transmission mechanism; otherwise it could incur a higher import tariff applicable to an SKD kit. Further, the classification of standalone parts presents a significant issue, as they can be considered a CKD kit if intended for manufacturing a specific vehicle unless they are imported solely for repairing or inventory purposes.
Despite existing regulations, customs disputes persist primarily because tariffs are primarily influenced by the technicalities of the product rather than legal principles. This rigidity leads to ongoing disputes due to the broad scope of interpretation. However, there is a growing need for much clearer and more comprehensive guidelines on classifications, especially as the automobile sector experiences rapid growth. In a limited capacity, the government has begun to address these classification challenges. For instance, last year, the Government introduced a new EV policy to reduce import duty on electric car CKD kits from 70% to a mere 15%, provided that the companies invest in India. Such policies not only promote local production but also provide clarity and confidence for foreign companies in India. The ongoing Skoda dispute is likely to be argued based on the intended purpose of importing individual parts rather than the company’s long-standing practices. Nevertheless, the resolution of this case will provide much needed clarity and establish a judicial precedent that could benefit other automakers in the future.
– Parv Jain
