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CASE NO.: Appeal (civil)  8426 of 2002

PETITIONER: Commissioner of Customs

RESPONDENT: M/s Ferodo India Pvt. Ltd

DATE OF JUDGMENT: 21/02/2008

BENCH: S. H. Kapadia & B. Sudershan Reddy

JUDGMENT: J U D G M E N T

CIVIL APPEAL NO. 8426 OF 2002 with Civil Appeal Nos. 8417/03, 981/06, 3076/06, 3203/06 and 284/07.

KAPADIA, J.

       This batch of civil appeals is filed by the Department and is directed  against the orders passed by the Customs, Excise & Gold (Control)  Appellate Tribunal ("CEGAT") whereby and whereunder the appeals filed  by the respondents-importers herein stood allowed. They arise from  assessment proceedings and not from show cause. The adjudicating  authority has held that M/s Ferodo India Pvt. Ltd. ("buyer" in short) is a  subsidiary of M/s T & N International Ltd., UK and are thus related, which  finding is not in dispute.

2.      For the sake of convenience we state the facts occurring in Civil  Appeal No. 8426/02 \026Commnr. of Customs  v.  M/s Ferodo India Pvt. Ltd.

3.      The buyer is the manufacturer of brake liners and brake pads in India.  On 8.9.1995, a technical assistance and trade mark agreement ("TAA" for  short) was entered into between the respondent (buyer/licensee) and M/s T  & N International Ltd., UK (foreign collaborator/licensor). Under the said  agreement, the licensor claimed to be in possession of certain secret  processes, formula and information. Under the agreement, the licensor  agreed to permit manufacture of brake liners and brake pads (licensed  products) by the licensee. Under the agreement, the licensor agreed to  disclose the relevant secret processes, formula and information to the  licensee. Under the agreement, the licensee was required to import/buy raw  material and capital goods from the licensor. Under the agreement, the  licensee was obliged to pay a licence fee along with royalty, based on the net  sales value of licensed products sold, consumed or otherwise disposed of.

4.      Vide order dated 22.9.1999 the adjudicating authority held that,  technical know-how fees and royalty were related to the imported goods and  were a condition of sale for the import thereof and consequently, the  adjudicating authority loaded the CIF value of the imported goods with the  proportionate amount of know-how fees and royalty. In this connection,  reliance was placed on the judgment of this Court in CoC  v.  Essar  Gujarat Ltd. reported in 1996 (88) ELT 609 (SC). This order was  confirmed by the Commissioner (A). However, by the impugned order dated  12.2.2002, the Tribunal held that the know-how fees and the royalty  payments stood related to the brake liners and brake pads to be produced in  India and not to the imported goods. Hence, this civil appeal by the  Department.

5.      In this case, we are required to lay down the scope of rule 9(1)(c) and  rule 9(1)(e) of CVR, 1988, which are quoted hereinbelow:

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"9. Cost and services.-  

(1) In determining the transaction value, there shall be  added to the price actually paid or payable for the  imported goods,-

(a)     \005 (b)     \005 (c)     Royalties and licence fees related to the imported  goods that the buyer is required to pay, directly or  indirectly, as a condition of the sale of the goods  being valued, to the extent that such royalties and fees  are not included in the price actually paid or payable. (d)     \005 (e)     All other payments actually made or to be made as a  condition of sale of the imported goods, by the buyer  to the seller, or by the buyer to a third party to satisfy  an obligation of the seller to the extent that such  payments are not included in the price actually paid or  payable."

6.      At the outset, it may be stated that, this is not the case of rejection of  transaction value, though it is held to be a related party transaction. In this  matter we are concerned with adjustment/addition to the price of the  imported goods under rule 9(1)(c) or in the alternative under rule 9(1)(e).

7.      Under Section 14 of the Customs Act, 1962, the assessable value of  imported goods is deemed to be the price at which such or like goods are  ordinarily sold or offered for sale for delivery at the time and place of  importation or exportation, as the case may be, in the course of international  trade, where the seller and the buyer have no interest in the business of each  other and the price is the sole consideration for the sale or offer of sale.

8.      The Customs Valuation (Determination of Price of Imported Goods)  Rules, 1988 ("CVR, 1988" for short) recognises the fundamental principle  of arm’s length price while dealing with transaction value. The Rules  provide for the determination of the correct price of goods that are imported  in the country or exported out of the country uninfluenced by relationship  between the transacting parties.

9.      Transaction Value, Deductive Value, Computed Value and Residual  Value Methods are the methods prescribed in the Rules, to be followed  sequentially in that order in the matter of determination of arm’s length  pricing.

10.     To determine the assessable value for the levy of customs duty on  imported goods, Section 14 of the 1962 Act has to be read with the  provisions of CVR, 1988 because under Section 14(1) there is reference to a  deemed price of goods imported and under Section 14(1A) such deemed  price is to be determined in accordance with the CVR, 1988.  

11.     Rule 3 of the CVR, 1988 inter alia provides for six methods of  determination of the price of imported goods. The six methods are:

Method 1 \026 Transaction Value (Rule 4)

The primary basis for customs duty is "transaction  value", as defined in rule 4(1) of CVR, 1988, which is the price  actually paid or payable for the goods when sold for export to  India, adjusted in accordance with the provisions of rule 9.  Adjustments to the price actually paid or payable are required in  cases where certain specific elements which form part of the  value for customs purposes are incurred by the buyer but are

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not included in the price actually paid or payable for the  imported goods. Rule 9 embodies the principle of attribution of  certain costs to the price of the imported goods. Rule 9 also  provides for inclusion of certain considerations which passes  from the buyer to the supplier in the form of specified goods or  services, other than in the form of money.

Method 2 \026 TV of Identical Goods (Rule 5)

Rule 5 through rule 7A provides for four alternate  methods of determining the customs value whenever such value  cannot be decided under the provisions of rule 4.

Under Rule 5, the value of imported goods shall be the  transactional value of identical goods sold for export to India if  the goods are:

(i)     the same in all respects (including physical  characteristics, quality and reputation);

(ii)    produced in the same country as the goods being valued;  and

(iii)   produced by the producer of the goods being valued.

Method 3\026 TV of Similar Goods (Rule 6):

       Under this method, the value of imported goods is the  transaction value of similar goods if:

(i)     goods closely resemble the goods being valued in terms  of components, materials and characteristics;

(ii)    goods which are capable of performing the same  functions and are commercially interchangeable with the  goods being valued;

(iii)   goods which are produced in the same country and by the  producer of the goods being valued.

Rule 6A provides for determination of value when  transaction value cannot be determined under rules 4, 5 and 6.  In such cases, the following two methods are envisaged on the  request of the importer and subject to the approval of the proper   officer, i.e., under rules 7 and 7A.

Method 4 \026 Deductive Value (Rule 7)

       Rule 7 provides that when customs value cannot be  determined on the basis of transaction value of the imported  goods or identical or similar goods, the value of the imported  goods shall be based on the unit price at which the imported  goods or identical goods or similar goods are sold to an  unrelated buyer in the country of importation in the greatest  aggregate quantity.

       The starting point in calculating the deductive value is  the same price in the country of importation. Various

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deductions are necessary to reduce that price to the relevant  customs value. These deductions are:

(i)     commissions usually paid or agreed  to be paid, profits  and general expenses added in connection with sales;

(ii)    usual transport cost and corresponding insurance are to  be deducted from the price of the goods when these costs  are usually incurred within the country of importation;

(iii)   the customs duty and other national taxes payable in the  country of importation by reason of importation;

(iv)    value added by further processing, wherever applicable.

Method 5 \026 Computed Value (Rule 7A)

       Computed value determines the customs value on the  basis of the cost of production of the goods being valued plus  an amount for profit and general expenses usually reflected in  sales from the country of exportation to the country of  importation of goods of the same class or kind. It is, therefore,  the total sum of production cost and profit and general  expenses.

Method 6 \026 Fall-Back Method (Rule 8)

       When the customs value cannot be determined under any  of the previous methods, it has to be determined using  reasonable means consistent with the principles and general  provisions of the CVR, 1988 and Section 14(1) of the 1962 Act  and on the basis of data available in India. To the great extent  possible, this method is based on previously determined values  and methods with a reasonable degree of flexibility in their  application.

Basis of CVR, 1988

12.     Article 7 of GATT, 1994 is the foundation of the CVR, 1988. The said  Article brought in the concept of arm’s length price in customs valuation to  test values arrived from sale of identical or similar goods and in cases where  such values were not available, it provided for deductive and computed  value methods, which methods are akin to resale price method and cost plus  method under the transfer pricing in the Income-tax Act, 1961.

Role of Interpretative Notes to CVR, 1988

13.     At the outset, it may be stated that rule 9(1)(c)  has to be read with the  Interpretative Notes and when so read it authorises the Customs to add the  royalties/licence fees to the assessable value only in certain conditions,  namely, when the royalties/licence fees are related to imported goods; that,  when the buyer is required to pay to the seller, directly or indirectly, as the  condition of the sale of the goods being valued, such royalties and licence  fees are not included in the transaction value.

14.     One more significance of the Interpretative Notes is that it has placed  the burden on the importer/buyer to prove the correctness of the price of the  imported goods in terms of the means prescribed in rule 4(3)(a) and rule  4(3)(b). In other words, the CVR mandates the hierarchy of valuation  methods to be applied in the event of the transfer price being rejected.

Analysis of Rule 9(1)(c)

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15.     Rule 9(1)(c) extends the quantum of levy under rule 4. Rule 9(4)  mandates that there can be addition to the transaction value except as  provided in rule 9(1) and (2). Hence, addition for cost can only be made in  situations coming under rule 9(1) and (2). Rule 9(1) and (2) is based on the  principle of attribution. Under Customs law, valuation is done on pricing  whereas in the case of transfer pricing under Income-tax Act, 1961,  valuation is profit based. The principle of attribution of certain costs  (including royalty and licence fee payments) to the price of the imported  goods is provided for in rule 9 under situations mentioned in rule 9(1) and  (2). In transfer pricing, the arm’s length price is inferred from various  methods to avoid profit-shift from one jurisdiction to another and it is here  that principle of allocation of profits comes in (i.e. in the case of transfer  pricing).

16.     Under rule 9(1)(c), the cost of technical know-how and payment of  royalty is includible in the price of the imported goods if the said payment  constitutes a condition pre-requisite for the supply of the imported goods  by the foreign supplier. If such a condition exists then the payment made  towards technical know-how and royalties has to be included in the price of  the imported goods. On the other hand, if such payment has no nexus with  the working of the imported goods then such payment was not includible in  the price of the imported goods. 17.     In the case of Essar Gujarat Ltd. (supra) the condition pre-requisite,  referred to above, had direct nexus with the functioning of the imported  plant and, therefore, it had to be loaded to the price thereof.

18.     Royalties and licence fees related to the imported goods is the cost  which is incurred by the buyer in addition to the price which the buyer has to  pay as consideration for the purchase of the imported goods. In other words,  in addition to the price for the imported goods the buyer incurs costs on  account of royalty and licence fee which the buyer pays to the foreign  supplier for using information, patent, trade mark and know-how in the  manufacture of the licensed product in India. Therefore, there are two  concepts which operate simultaneously, namely, price for the imported  goods and the royalties/licence fees which are also paid to the foreign  supplier. Rule 9(1)(c) stipulates that payments made towards technical  know-how must be a condition pre-requisite for the supply of imported  goods by the foreign supplier and if such condition exists then such royalties  and fees have to be included in the price of the imported goods. Under rule  9(1)(c) the cost of technical know-how is included if the same is to be paid,  directly or indirectly, as a condition of the sale of imported goods. At this  stage, we would like to emphasis  the word indirectly  in rule 9(1)(c). As  stated above, the buyer/importer makes payment of the price of the imported  goods. He also incurs the cost of technical know-how. Therefore, the  Department in every case is not only required to look at  TAA, it is also  required to look at the pricing arrangement/agreement between the buyer  and his foreign collaborator. For example if on examination of the pricing  arrangement in juxtaposition with the TAA, the Department finds that the  importer/buyer has misled the Department by adjusting the price of the  imported item in guise of increased royalty/licence fees then the adjudicating  authority would be right in including the cost of royalty/licence fees  payment in the price of the imported goods. In such cases the principle of  attribution of royalty/licence fees to the price of imported goods would  apply. This is because every importer/buyer is obliged to pay not only the  price for the imported goods but he also incurs the cost of technical know- how which is paid to the foreign supplier. Therefore, such adjustments  would certainly attract rule 9(1))(c).

Application of Rule 9(1)(c) to the facts of the present case 19.     Applying the above tests to the facts of the present case, we find that  the adjudicating authority had not examined the pricing arrangement  between the foreign collaborator and the buyer. It has only examined the  royalty/TAA. 20.     Be that as it may, in the present case, on reading TAA we find  that

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the payments of royalty/licence fees was entirely relatable to the  manufacture of brake liners and brake pads (licensed products). The said  payments were in no way related to the imported items. In the present case,  no effort was made by the Department to examine the pricing arrangement.  No effort was made by the Department to ascertain whether there exists a  price adjustment between cost incurred by the buyer on account of  royalty/licence fees payments and the price paid for imported items. No  effort was made by the Department to ascertain enhancement of  royalty/licence fees by reducing the price of the imported items. In the  circumstances, we find no infirmity in the impugned judgment of the  Tribunal. In this case, the Department has gone by TAA alone. On reading  TAA in entirety, we are of the view that there was no nexus between  royalty/licence fees payable for the know-how and the goods imported for  the manufacture of licensed products. The Department itself has invoked  rule 9(1)(c).  

21.     In the alternate, it has invoked rule 9(1)(e). This rule 9(e) cannot stand  alone. It is a corollary to rule 4. There is no finding in the present case that  what was termed as royalty/licence fee was in fact not such royalty/licence  fee but some other payment made or to be made as a condition pre-requisite  to the sale of the imported goods. It is important to bear in mind that rule 9  refers to cost and services. Under rule 9(1), the price for the imported goods  had to be enhanced/loaded by adding certain costs, royalties and licence fees  and values mentioned in sub-rules 9(1)(a) to 9(1)(d). It refers to "all other  payments actually made or to be made as a condition of sale of the imported  goods." In the present case, the Department invoked rule 9(1)(c) on the  ground that royalty was related to the imported goods, having failed it  cannot fall back upon rule 9(1)(e) because essentially we are concerned with  the addition of royalty etc. to the price of the imported goods. Further, in the  present case, the Department has accepted the transaction value of the  imported goods.

22.     In the case of Essar Gujarat Ltd. (supra), the buyer had entered into  a contract with TIL for purchase of Direct Reduction Iron Plant ("the  plant"). The entire agreement was for import of the plant. The agreement  was subject to two conditions- (a) approval of G.O.I. and (b) obtaining  transfer of licence from M/s Midrex, USA. Without the licence from  Midrex, the imported plant was of no use to the buyer. Therefore, it was  essential to have the licence from Midrex to operate the plant. Therefore, it  was held by this Court that procurement of licence from Midrex was a pre- condition of sale which was specifically recorded in the agreement itself. In  view of specific terms and conditions to that effect in the agreement, this  Court held that payments made to Midrex by way of licence fees had to be  added to the price paid to TIL for purchase of the plant. There is no such  stipulations in the TAA in the present case. Therefore, in our view, the  adjudicating authority erred in placing reliance on the judgment of this Court  in Essar Gujarat Ltd. (supra). 23.     In the case of Matsushita Television & Audio India Ltd.  v.  CoC  reported in 2007 (211) ELT 200 (SC) the question which arose for  determination was whether royalty amount was attributable to the price of  the imported goods. In that case, the appellant was a joint venture company  of MEI, Japan and SIL for obtaining technical assistance and know-how.  Under the agreement, the appellants were to pay MEI a royalty @ 3% on net  ex-factory sale price of the colour TV receivers manufactured by the  appellants for the technical assistance rendered by MEI. The appellants were  to pay a lump-sum amount of U.S. $ 2 lakhs to MEI for transfer of technical  know-how. It was the case of the appellant that payment of royalty was not  related to imported goods as the said payment was made for supply of  technical assistance and not as a condition pre-requisite for the sale of the  components. 24.     One of the questions which arises for determination in this civil  appeal is whether reliance could be placed by the Department only on the  Consideration Clause in the TAA for arriving at the conclusion that payment  for royalty was includible in the price of the important components.

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25.     Rule 4(3)(b) of the CVR, 1988 provides for an opportunity for the  importer to demonstrate that the transaction value closely approximates to a  "test" value. A number of factors, therefore, have to be taken into  consideration in determining whether one value "closely approximates" to  another value. These factors include the nature of the imported goods, the  nature of the industry itself, the difference in values etc.. As stated above,  rule 4(3)(a) and rule 4(3)(b) of the CVR, 1988 provides for different means  of establishing the acceptability of a transaction value. In the case of  Matsushita Television (supra) the pricing arrangement was not produced  before the Department. In our view, the Consideration Clause in such  circumstances is of relevance. As stated above, pricing arrangement and  TAA are both to be seen by the Department. As stated above, in a given  case, if the Consideration Clause indicates that the importer/buyer had  adjusted the price of the imported goods  in guise of enhanced royalty or if  the Department finds that the buyer had misled the Department by such  pricing adjustments then the adjudicating authority would be justified in  adding the royalty/licence fees payment to the price of the imported goods.  Therefore, it cannot be said that the consideration clause in TAA is not  relevant. Ultimately, the test of close approximation of values require all  circumstances to be taken into account. It is keeping in mind the  Consideration Clause along with other surrounding circumstances that the  Tribunal in the case of Matsushita Television (supra) had taken the view  that royalty payment had to be added to the price of the imported goods.

26.     For the aforestated reasons, we find no infirmity in the impugned  orders of the Tribunals. Accordingly, the civil appeals filed by the  Department are hereby dismissed with no order as to costs.