SC holds warranty replacement by dealer against credit note issued by manufacturer is exigible to sales tax

 This tax alert summarizes the recent ruling of the larger bench of Supreme Court (SC) on whether replacement of defective parts of cars under warranty by the dealer, against credit note issued by the manufacturer, is exigible to sales tax.

Earlier, SC in the case of Mohd. Ekram Khan had concluded that such transactions were taxable as the manufacturer had made payment for the parts by issuing credit notes to the dealers. Pursuant to the same, Revenue passed orders demanding sales tax on such transaction undertaken by various dealers.

Divergent rulings were passed by various High Courts (HC) on the above issue and hence, cross appeals were filed before the SC to decide the correctness of the judgement in case of Mohd. Ekram Khan (supra).

The key observations of the SC are:

• A perusal of the definition of “credit note” from various dictionaries would clearly indicate that the same, issued by the manufacturer in favor of a dealer, is a valuable consideration within the definition of “sale” as per Section 2(g) of the Central Sales Tax Act, 1956.
• In case of warranty replacement as in the present scenario, there was transfer of property between the dealer and the customer on one hand and receipt of a valuable consideration from the manufacturer on the other, in the form of a credit note. Therefore, the same amounts to sale.
• However, sales tax cannot be levied where the dealer simply receives spare parts from the manufacturer to replace a defective part under a warranty.
  
  Accordingly, SC upheld its judgement in the case of Mohd. Ekram Khan (supra) and held that the credit note issued by manufacturer to a dealer for replacement of defective parts pursuant to a warranty agreement is exigible to sales tax under the respective sales tax enactments.

Comments

• This ruling is likely to impact all the businesses where warranty on goods is provided by the manufacturer, but the same is fulfilled by the dealer.
• In the factual scenario of the given case, issuance of credit note by the manufacturer or invoice by the dealer for replacement of defective part could be a revenue neutral situation under GST. However, department may invoke tax demand against dealers where the manufacturers have issued the credit notes.
• SC has clarified that there may be no tax where the manufacturers supply parts free of charge to the dealers to fulfill warranty obligations. Businesses may accordingly plan their warranty stock requirement and maintain separate identification of such stock procured free of cost from the manufacturer to substantiate no tax position.