Impact of Freight on valuation - Indirect tax

Transportation is a fundamental arrangement without which none of the business entity may survive. It could be playing a significant role in the success of the organization, naturally the cost of such transportation is also forming material portion in the variable cost of a product/service.

The mode of transportation, purpose, time, place and the payer of freights mainly influence the valuation mechanism under various limbs of indirect taxation.

In this article let us have a glance on the impact of transportation charges (here in after referred as freight) on valuation mechanisms in the context of indirect taxation. The approach towards treatment of freight is presented in four categories namely under “Central Excise, Service Tax, K-Vat and CST”.

Freight includes:

A charge paid for carriage or transportation of goods by air, land, or sea. In terms of industrial usage transportation charges may be of freight inward or freight outward.

All freight inwards are nothing but the transportation charges incurred by the manufacturer / trader /service provider for receipt of goods into their premises. Normally freight inwards are incurred by the goods recipient and which will form part in his total cost.

However the transportation charges incurred for dispatch of goods to the customer place (Freight outwards) may be initially borne by the seller and later gets re imbursement from his customer. In some case especially when the price quoted is inclusive of all costs and taxes, seller may bear such costs by himself.

In this article, focus is more on freight outwards because of the complexity and confusions on its treatment exists in the industry.

Freight treatment under Central Excise:

Central Excise is basically a duty on manufacture of excisable goods. The duty is payable on the basis of any of the following subject to Central Excise Valuation (Determination of Price of Excisable Goods) Rules, 2000.

I. Duty based on Tariff Value

II. Duty based on Maximum Retail Price (MRP)

III. Duty based on Transaction value

Duty based Tariff Value and MRP based valuation:

In case of Duty based Tariff Vale, Freight charges are irrelevant since the assessable value is pre-determined by the government without having any nexus with the price. Even in case of MRP based valuation, duty is discharged on Maximum Retail Price which is normally inclusive of all costs to reach the Point Of Sale. Thereby, no separate treatment is necessary in case of valuations methods (I) and (II) specified above.

However, treatment of freight is of very much relevant in case of valuation mechanism based on the Transaction Value as per Section 4 of the Central Excise Act, 1944.

Duty based on Transaction value

The definition of transaction value is comprehensive and covers not only the selling price but also other related aspects in relation to the sales paid or payable either to manufacturer or any person on his behalf. This definition seems to cover various aspects not only covers all costs up to manufacture of a product but beyond its manufacture and sale either paid at the time of sale or any time thereafter. However outward freight incurred for the delivery shall not be part of assessable value since the cost is not in relation to manufacture of a product.

Further, the above view is supported and thereby, the transportation charges including the profit on the same legally are available as deduction in terms of the decision in case of Baroda Electric Meters Ltd Case  [(1997 (94) ELT 13 (SC)]. However in Saraswathi Air products Ltd, case [(2009) (243) ELT 397 (Tri.-Del), deduction freight was disallowed as there were huge difference between the amounts expended and the amounts collected.

Further As per Section 39 of the Sale of Goods Act, 1930 the Goods, handed over to the carrier/transporter is as good as delivery to the buyer. Therefore payment made by the buyer to manufacturer towards reasonable cost is not in connection with the sale as the sale is over at the factory gate itself.  

Hence if the actual freight or equated freight is claimed as a deduction and indicated in the invoice, there may not be an issue.

Freight in connection to C.E Valuation Rules, 2000

Section 4 (1) (b) of C.E act provided rules for valuation, when the same cannot be determined in mechanisms discussed above. Freight incurred during various stages of operating cycles may have some impact in these valuation rules which are discussed below in brief:

Rule 5 deals with the adjustment for the value of excisable goods when the place of delivery is different from the place of removal. The freight payable by the customer if indicated on the invoice, charged on actual basis would not form part of the assessable value. Even the averaged freight is allowed, when it is as per the generally accepted costing principles.

Further, it is clarified vide circular No. 827/4/2006-CX dated 12-04-2006, that the actual cost of transportation from the place of removal up to the place of delivery is only to be excluded.

As per the said circular, if the assessee is recovering an amount from the buyer towards the cost of return fare of the empty vehicle from the place of delivery, this amount would not be available as a deduction. Therefore, unless it is specifically mentioned on the invoice that the transportation charges indicated therein do not include cost of transportation for the return journey of the empty truck/vehicle, the deduction of the said transportation charges would not be admissible.

This circular is questionable since these costs are post removal expenses which cannot form part of assessable value.

However vide circular No. 923/13/2010-CX dated 19.05.2010, it was clarified that if the manufacturer/transporter  charges transportation charges for outward journey up to the point of delivery and return  there from, cost of transportation of return journey of empty truck/vehicle would also be allowed as a deduction.

As per Rule 6, one of the additional consideration to be considered for valuation is the proportionate cost of moulds/dies/machinery/designs and drawings having commercial value which is supplied at free of cost by the customer. While apportioning the cost of such tools, it is advisable to capture the freight incurred for transportation of such tools up to the job worker’s premises as well.  

In Rule 10 A, where the excisable goods are produced by a job worker on behalf of principal manufacturer, then the cost of transportation, if any, from the premises wherefrom  the goods are sold, to the place of delivery shall not be included in the value of excisable goods.

In Short:

Excise being the duty on manufacture, post manufacture freight which does not depress the basic price, normally would not form part of assessable value. There by cost of transportation can be excluded for the purpose of determining the assessable value of the excisable goods. In cases where vehicles are owned by the manufacturers, then the cost of transportation can be calculated through the accepted principles of costing. The cost of transportation should, however, be separately shown on the face of the invoice.

Freight treatment under Service Tax:

Service tax is a levy on provision/performance of a service. Valuation of service provides the methodology of arriving at the amount on which the applicable service tax is to be charged.

Up to 2006 April, only the amounts charged and the amount received in cash was considered as value for service tax and whereas now, even the re imbursement have been sought to be included in the value.

Impact on freight incurred by the provider of taxable service:

Section 67 provides the basis for valuation where in, gross amount charged by the service provider or money equivalent of the consideration shall be construed as taxable value depending on the consideration whether received in money / not fully in money.

Further Rule 5 (1) of Service Tax (Determination of Value) Rules, 2006, specifically provides the clause for inclusion of cost or expenditure in value of taxable services. This deeming fiction created to consider all the expenditure or costs incurred by the service provider in the course of providing taxable services, there by including freights incurred to render the services as well.

However Rule 5 (2) provides exclusion for those expenditure or costs incurred by the service provider as a pure agent of the recipient of the service subject to fulfilling various conditions specified there in. Hence if the service provider gets actual re imbursement of freight charges incurred in the course of output service, then subject to the conditions specified in the rule, such expenses can be excluded while arriving the taxable value.

The Delhi High Court in case of Intercontinental Consultants and Technocrats P Ltd has down the provisions related to reimbursement as ultra-virus. This may be finally decided in the Supreme Court. However in the meantime as long as freight incurred are more or less in line with Rule 5 (2) and are the liability of the receiver to pay borne by the provider for convenience, the same may be possible to be excluded.

Impact on freight incurred by the receiver of taxable service:

There will be no question of considering the freight which is incurred directly by the receiver of service since such expenses will not form part of the service. Further Section 67 read with 5 (1) of Service Tax (Determination of Value) Rules, 2006, only those expenses to be considered which are incurred by the service provider in the course of providing taxable services. Hence all such expenditure incurred by the service receiver and which does not form part of a service provided may be excluded from the tax purview.

Impact on freight received by the provider of transportation service:

Freights collected by way of services of transportation of passengers as well as goods are covered under negative list, thereby not attracting the service tax liability, however specific exclusions specified there in, certainly attracts the tax liability. For example, services of transportation of passengers by railways in first class or an air-conditioned coach, transportation of goods by a Goods Transport Agency or a courier agency.

Impact under Reverse charge Mechanism:

As per S. No. 2 of the S. T Notification No 30/2012, read with S. No. 7 of Notification No. 26/2012- S. T, The person liable to pay the freight is liable to pay the service tax liability on the value of services provided by the Goods Transport Agency (Subject to exemption provided under entry 21 of the mega exemption notification (25/2012-ST)) after availing the 75% abatement if the condition that Cenvat credit on inputs, capital goods and input services, used for providing the taxable service is not availed up to 01/07/2012.

In short:

Freight incurred up to the provision of services as per the principles laid down in the Place of provision of Service Rules, 2012 would be included in the assessable value for the purpose of levying service tax.

Freight treatment under Central Sales Tax Act, 1956

Under Central Sales Tax Act, 1956, every dealer shall be liable to pay the tax on all sale of the goods effected during the course of inter-state trade or Commerce.

As per Section 2 (j) of the Act ‘turnover’ means, “Aggregate of the ‘sale price’ received or receivable by the dealer. Section 8A (1) of the Act provides deduction for CST payable. Therefore dealer is liable to pay CST on value of ‘Sale price’”.

Definition of sale price as per sec 2 (h) is in two parts. The first part says that the sale price means the amount payable to a dealer as consideration for the sale of goods. The second part is inclusive clause, which says that sales price includes any sum charged for anything done by the dealer in respect of goods at the time of or before delivery thereof other than the cost of freight or delivery, or the cost of installation where such cost is separately charged in the invoice.

Thus, Freight is includible only if

a. Freight is not shown separately in invoice.

b. Contract is for sale FOR destination and property in goods is transferred only at the destination.

In case of Hindustan Sugar Mills Ltd [43 STC 13 (SC) honorable Supreme Court has envisaged three situations:

1. When the price is at factory gate : Tax is not payable on freight

2. In case of contract for sale is FOR destination, where dealer is under the obligation to put the goods on road/rail and pays freight up to destination, freight will have to be included for CST purposes.

3. When the price is for FOR destination but contract does not have all the ingredients for FOR destination railway contracts, and then if the risk of the purchaser starts as soon as goods are loaded in rail, then railway becomes agent of the purchaser. In such case freight will be allowed as deduction for the purposes of CST.

Deduction only when freight is incidental to sale:

Freight and delivery charges allowable as deduction are only those which are incidental to sale. Thus, in case of sale of goods from depot, transport charges from factory to depot will not be allowed as deduction   as these are incurred prior to sale {Dyer Meakin Breweries Ltd., (1970) 3 SCC 253, 26 STC 248 (SC).

Treatment of freight incurred from Factory to depot:

In case of stock transfer, freight from factory to depot is responsibility if its dealers or its principles and not of buyers. Thus freight charges from factory to depot are includible in turnover for sales tax even if shown separately in invoice {Avon Elastomers (2008) 16 VST 510 (All HC) and Agarwal Mandi Janta Ent Nirmata (2008) 16 VST 527 (All HC).

Further, It is essential that, dealer has to show the freight separately in the tax invoice. Failure to do so will attract CST on the freight as well. In case of “CIT Vs Indian Aluminium (1999) 115 STC (444)”, it was held that, If the dealer is unable to show the freight separately, even the department cannot give the deduction on notional basis.

In contract for sale FOR destination, dealer is under an obligation to deliver the goods at buyer’s destination and property in goods passes only at the buyers destination in such scenario dealer is required to discharge the CST on value of the freight as well.             

In short:

In cases where freight and transportation charges incurred are at the time of or before delivery, deduction is not permitted for such expenses even though the freight is separately shown in the invoice. Further wherever it is the responsibility of the dealer to incur freight (such as transportation from the factory to depot /stock transfer) freight will form part of assessable value.

Freight treatment under Karnataka Value Added Tax Act, 2003

Every Dealer who is required to be (or is) registered under the provisions of K-VAT Act, 2003 shall be liable to pay tax, on his taxable turnover.

As per Sec 2 (34) taxable turnover is the total turnover (after allowed deductions) on which a dealer shall be liable to pay. Further if we see the definition of turnover, it is nothing but the aggregate amount for which goods are sold for a valuable consideration and it also covers any sums charged for anything done by the dealer in respect of the goods sold at the time of or before the delivery there of.

The term sale also defined in Act (Sec 29) where in, it considers every transfer of property in goods by one person to another in the course of trade or business for any valuable consideration with certain exclusions and specific inclusions.

Since there is no specific entry for treatment of freight in the valuation provisions under K-VAT law, the decisions of the judicial authorities are crucial in this matter.

In case of The Karnataka State Forest Industries Corporation Ltd vs Deputy Commissioner of Commercial Tax, honorable Karnataka High Court held that “When the transfer of Property in goods is to be at the place of buyer to which seller is under an obligation to transport goods, the expenditure incurred by the seller on the freight in order to carry the goods from his place of manufacture to the place at which he is required under the contract to deliver, would become the part of the amount for which the goods are sold by the seller to the buyer  and would fall within the scope of ‘turnover’. Similar view is expressed by the honorable Supreme Court in case of “India Meters Limited vs State of Tamil Nadu (2010 34 VST 273 (SC)” as well.

In other way whenever the transfer of property in goods are transferred to buyer at the place of seller itself the expenses incurred after such transfer like freight and transit insurance may not form part of the turnover, thereby it stands out of the purview of sales tax.

Conclusion:

The levy is the basis for charge in any taxation laws in that matter. The charging section read with valuation rules issued under the respective acts will decide whether a particular item is to be included or to be excluded from the tax purview. With that basis, in case of Excise, service tax and sales tax, the activity of manufacturing, service and the sale plays fundamental role in determining the impact of respective tax on transportation expenses incurred by the assessee.

By Nagendra Hegde