Warranty Replacement

REPLACEMENT UNDER WARRANTY

CLAUSE – TAXABLE OR NOT

No sooner one thinks of selling the goods, the next eventuality one visualizes is the acceptance of goods on quality parameters with regard to specifications, sizes, the use of right raw-material and workmanship of the manufacturer in respect of goods manufactured and supplied in pursuance of a contract of sale. Followed by this eventuality is acceptance of goods made for the market consumption. While in the first case, the purchaser provides the drawing, design and specifications of materials intended to be used in the manufacture of goods required and ordered by the customer, in the other scenario the manufacturer/producer of goods makes its products for the general consumption of consumers. In such cases the product is manufactured under the self generated design, specifications and quality standards of the manufacturer – be it a Truck, Tractor, Car, Three Wheeler, Two Wheelers, Earth Moving Machinery, Printing & Packaging Machinery, Consumer Durables etc.

 In respect of goods of technical nature, the buyer provides all the technical and material details to the manufacturer-dealer but in other cases the manufacturer/producer retains its own specifications and quality standards and places its products for sale and general consumption to the consumers. This is done through his net work of Distributors, dealers and retailers. Obviously, there is no inter-face between a manufacturer and the consumer-purchaser.

All goods of technical nature including Plant & Machinery, Vehicles, Equipments etc. carry a warranty clause as part of the offering made by the manufacturer in respect of goods offered for sale. Normally, the manufacturer never offers “guarantee” but only a “warranty” in respect of his product and certain conditions are attached to it. The warranty is offered for a limited period or running of the product up to certain kilometers or hours depending on the nature of product.

Such warranty becomes essential because the consumer of the product is stationed at far off distance from that of manufacturer’s place of business and such clauses offer a kind of quality assurance to the customers that in the event of failure of the product and parts, he is insulated from any loss or damage resulting from the purchase and use of the product.

Of late there has been a revolution in the production and sale of Auto Vehicles and two/three wheelers in our country and now the sales are volumenous and field failure of parts cannot be ruled out during running of such Vehicles.

Warranty is a general offering to all the prospective buyers of the manufacturer’s products because at the time of production the buyer is not identified and this offering comes voluntarily and is attached to the sale of the product. Again the product is distributed by the selling agencies, they are the one who carry out this assignment for and on behalf of the manufacturer of the equipment. Besides, there is no inter-face between him (manufacturer) and the ultimate consumer of their product. The consumer can access the selling agency for redressal of his complaint and seek remedy under the warranty offered by the manufacturer.

As part of the marketing policy, the warranty replacements are part of the in-built cost of the product and manufacturers too seek back to back warranty from the suppliers of these parts and equipments to safeguard the financial damages resulting from such replacements. Field failure of parts and equipments also harms their image too and obviously all care is taken at manufacturing stage to offer quality product.

Now the first question arising from warranty offering is whether this offer is to the consumer or a distributor ? This warranty, of course, is made to the consumer, who is not identified at the time of manufacturing but as soon as he buys the product, this clause is activated in his favour as he is one who has paid the price and going to be the ultimate user.

For the sake of convenience and practicability initially it is the distributor/selling agency who has to discharge this duty on behalf of the manufacturer at his cost. So when he is replacing certain defective parts in a product, he is doing so, for and on behalf of his principal manufacturer and here he can only be termed as “ Agent” of his “Principal”. He himself has not undertaken or incurred any liability of warranty offerings and cannot be legally made so.

In light of the above discussions, the first question that arises is as to what is the nature of transaction involving free replacement of parts under a warranty clause. The matter came up before Delhi High Court in the case of Prem Nath Motors -43-STC-52 (Del.).

In Premnath Motor’s case, the dealer had initially contended that the replacement or repairs of defective parts during warranty period was their obligation and such replacement or repairs did not constitute a “sale”. But realizing that this argument of theirs would go against them with regard to the use of Registration Certificates under the Local Act as also under CST Act as they had purchased the goods without payment of tax under the Local Act against Declaration and used “C” form for availing concessional rate of tax and in both the cases, the goods were intended for “resale” only, the dealer sought deduction from the gross turnover but conceded that the replacements were sale.

In the revision petition, the dealer had also contended that even if for the sake of argument, it was considered as “sale”, there was no sale price of such replacements and accordingly no tax could be levied thereon. It was also argued that the price of the part replaced was already included in the aggregate consideration for the sale of the Car, which has already been subjected to sale tax and hence there was no warrant for imposition of any further tax. In this revision, the Revisional authority held that whenever, the dealer entertained a claim under warranty, it simply replaced the part without charging any consideration and accordingly there being no valuable consideration, it could not be treated as “sale of goods” either under the Sales Tax Act or under the Sale of Goods Act, 1930. It was also held that even if it was held that there was a consideration for the replaced parts, the same was already included in the aggregate consideration of the car sold originally, implying thereby that there was no specific consideration for the replacement of parts.

The matter went to the Financial Commissioner in the subsequent revision petition. The FC held – that the transfer of property in the parts replaced under the warranty constituted a “sale” and as such the replacement of parts as a consequence of the terms and stipulations of the warranty must be deemed to be a continuation of the original sale, the price of which stood included in the consolidated sale price determined and realized at the time of the transfer of goods in the shape of the car with a warranty. The FC also held that the parts supplied in replacement, free of cost, by the dealer, in terms of the warranty, are sold alongwith the car for which a consolidated price was realized at the time of initial transfer and on which sales tax was paid and the replacement of parts would be deemed to be sale not liable to imposition of further sales tax.

The High Court in a reference made to it, discussed the warranty clause attached to the sale of car by the manufacturer and the conditions and stipulations attached thereto. The court also took a reference of section 12 of the Sale of Goods Act, 1930 and also the definition of sale under section 2 (g) of the Sales Tax Act governing Delhi as UT. Warranty was considered distinct from the condition attached to the sale. The court observed that while a breach of a condition gives rise to a right to treat the contract as repudiated, while a breach of a warranty gives rise to a claim for damages but not to a right to reject the goods and treat the contract as repudiated. It also observed that the perusal of the warranty between the dealer and the buyer/consumer did not show that there was any stipulation empowering the buyer/consumer to reject the car and repudiate the contract if any of the parts found to be defective. The stipulation was only that the dealer will replace the defective part or parts free of cost. It is thus clearly a warranty and not a condition.

The High Court further observed that when a part is replaced in accordance the stipulation or warranty, it becomes part of the car and the property in it stands transferred to the buyer/consumer. No separate consideration for the part so transferred is specified. In other words, the transfer of the property in part or parts replaced in pursuance of the stipulation or warranty is a part of the original sale of the car for the price fixed and received from the buyer. The price so fixed and received was a consolidated price for the car and the parts that may have to be supplied by way of replacement in pursuance of the warranty.

The High Court thus concluded that the replacement of parts under warranty were to be regarded as “sale”, the price for which was already paid and on which sales tax was already levied and collected and they were not liable to the imposition of further tax.

The M.P. High Court happened to decide a similar case in the matter of Prem Motors vs. Commissioner of Sales Tax, reported at 61-STC-244 (M.P). In the said case, the dealer was an authorized dealer for the Cars, Tractors & Motor Cycles. The parts were replaced by the said dealer under warranty clause of the manufacturers. The manufacturers either supplied the replaced parts to the dealer or reimbursed the cost, if they were not available in stock. The A.O., however, taxed the turnover relating to replacements. The assessee’s contention was that this turnover does not fall within the sale price which the assessee received from the customers and therefore tax on these items assessed is not in accordance with the law.

In this case as well as  in the case of Prem Nath Motors Pvt Ltd.,(Delhi), a reference was made by the Counsels to the decision of the Supreme Court – Premier Automobiles vs. Union of India, AIR 1972 SC 1690, in which the Apex held that cost of warranty replacement was already included in the sale price of the vehicle on which tax has already been charged and when the manufacturer either replaces the parts or reimburses the cost, there is no sale therein and hence no tax could be charged on such replacements. It was also contended that according to the definition of “sale”, such replacements were not sale and the dealer only acted as intermediary and he replaced the parts on behalf of the manufacturer.

The learned counsel for the Revenue contended that when the spare parts are replaced by the assessee to the customer free of charges being the condition of the warranty, he recovers the price from the manufacturers and in substance it is the sale of the spare parts to the manufacturer and therefore it is liable to tax.

The High court held that when a dealer sells automobile vehicle, he sells it with all parts in a salable condition. The warranty is the warranty from the manufacturers and therefore, if during the warranty period any part is found to be defective and is to be replaced, the responsibility of replacement is that of the manufacturer. For the convenience of the customer, there is an arrangement between the manufacturer and the dealer so that the customer may get replacement done from the dealer which in due course is again made good by the manufacturer.

It further held that under these circumstances, when the dealer assessee replaces parts to the customers and either gets those parts from the manufacturer or gets it reimbursed, it is neither sale of these parts by the dealer to the customer or to the manufacturer. What he does only is to pass on the parts from the manufacturer to the customer but in order avoid delay and inconvenience of the customer, he replaces the parts first and gets them from the manufacturer later and thus it does not fall within the ambit of the definition of “sale” as has been provided in s. 2 (n) of the MP General Sales Tax Act.

The Kerala High Court in the matter of Geo Motors vs. State of Kerala, reported at 122-STC-285 (Ker.), happen to decide a similar case of taxation of warranty replacements. In the said case, the petitioner dealer had purchased the spare parts by issue of “C” form. The revenue contended that the petitioner has purchased the spare parts from outside the State by issue of C forms for resale only and not for replacement of parts under warranty free of cost and the value of goods replaced are reimbursed by the manufacturer by issue of credit notes and accordingly no exemption could be allowed.

The appellant Tribunal was of the view that the petitioner has transferred the property in the spare parts replaced to the customer. The transfer was effected in the course of trade or business. The petitioner also received the consideration for the transfer of property in goods by way of reimbursement from the manufacturer and hence all the elements of sales are present in the transaction.

The High Court, however, relied upon the reasoning given in the decision of the Delhi High Court in the matter of Commissioner of Sales Tax vs. Prem Nath Motors (P) Ltd. (supra) and held that the warranty replacements were not taxable and allowed exemption to the turnover of the spare parts which were given for replacement.

However, the Apex Court in the case of Mohd. Ekram Khan & Sons vs. Commissioner of Trade Tax, UP, Lucknow, reported at STI -2004 - Supreme Court 141, overruled the decisions of the Madhya Pradesh High Court & Kerala High Court and distinquished the decision of the Delhi High Court and restricted itself in interpreting the nature of transaction between a dealer replacing the parts under warranty stipulation and the manufacturer who reimburses the cost of replaced parts by issue of the credit notes.

 Apparently, the Apex Court did not discuss the issue where the dealer got the replacements from the manufacturer. What was discussed is as to what was the nature of transaction between the dealer and manufacturer who reimbursed the cost of replaced parts by way of issuing credit notes towards the cost of such parts instead of replacing them. The court ruled that the elements of term “sale” were present in the nature of transaction which took place between the dealer and the manufacturer because the counsel for the revenue submitted that the transaction between the assessee and the manufacturer was a separate transaction. The manufacturer was obligated to make the replacement. If it did not possess the parts to meet the contractual obligation, it would have purchased the parts from any seller of the parts and would have paid the sales. In this case, the assessee dealer had supplied the goods for which it received the consideration by way of credit notes and/or other mode of payment.

On the nature of transaction involved in the present case (whether such sales amounted to inter-state sale or intra state),  the Court said that the assessee had not advanced any such plea before the forums below but the Assessing Officer had recorded the finding that the sales were intra-state.

Personal view

Undoubtedly when a dealer supplies any parts to any person and someone else is paying the consideration thereof, the conditions of the terms are complete and it becomes a completed sale. But the issue remains as it is. The basic question is that if the parts fitted in the Car are found to be defective and are liable to be replaced, then these parts are liable to be rejected and these should either be replaced or the cost should be reimbursed to the customer – may be directly or through the dealer appointed by the manufacturer. Without commenting on the decisions and judgements referred to hereinabove, I would only like to say that the entire matter needs a re-look and a fresh decision is required treating the replaced parts as rejected parts for which the consideration was already received by the manufacturer and the dealer. The replacement of rejections can not and should not be termed as sales. There is no time limit prescribed for such rejections and replacement thereof.

By: Adv. B.R. Bhalla

advocatebhalla@gmail.com