The Excise laws, on the other hand, provide for a deeming provision, whereby the value of the goods shall be the normal transaction value at which such goods are sold to the unrelated parties. In case such similar goods are not sold to unrelated parties, the excise laws provide that the valuation for such goods shall be the cost of manufacturing plus 10 per cent mark-up.

The Service Tax (Determination of Value) Rules, 2006 (“Valuation Rules”) is a combination of the aforementioned legislation. In terms of the Valuation Rules, the gross amount charged by a person providing a similar service forms the taxable base provided that the transaction is at arm’s length.

In the alternate, the cost of the provision of the taxable service is deemed to be the consideration which would form the taxable base.

The concept of taxability of transaction between the ‘related parties’ or ‘associated enterprises’ has moved a step ahead after the Finance Act, 2008 carved out an exception with respect to the time of payment of service tax in the case of transaction between the ‘associated enterprises’ to check evasion of service tax by associated enterprises, which render/receive taxable services between themselves and settle dues arising there from, through debit/credit notes and other accounting transaction.

Accordingly, now associated parties are liable to pay service tax as soon as there are entries in the books of accounts irrespective of the nomenclature utilised; irrespective of whether the amount is actually received or not.

State VAT

As indicated, the significance of correct valuation of transaction between the related parties is not limited to Customs and Excise laws. The VAT legislation in India also take cognisance of the fact that price of the goods may be manipulated by related parties in order to reduce or evade the VAT liability.

The VAT legislation in certain States such as Delhi and Arunanchal Pradesh contains a specific provision providing that where a registered dealer who sells or gives goods to a related person and the terms or conditions of the transaction have been influenced by their relationship, the sale price of the goods in such cases shall be deemed to be the ‘fair market value’ of such goods for the purpose of levy of taxes.

However, the applicability of the aforementioned provision is limited only to those cases where the purchasing dealer would not be eligible to claim input credit of the goods purchased from the related parties.

The aforementioned States generally define ‘fair market value’ to mean the value at which goods of like kind and quality are ordinarily sold or would be sold in the same quantities between unrelated parties in the open market at the same time. Further, an interesting point to consider is that no specific rules are provided for cases where goods of the like kind are not sold between unrelated parties.

Most of the other States contain general provision providing that where the VAT authorities are of the view that any goods are sold or purchased by a dealer for a consideration which is less than fair market price of the goods and that consideration for such sale or purchase as agreed to between the parties has not been truly stated in the invoices, the sale price of the goods in such cases shall be deemed to be their fair market value of such goods for the purpose of levy of taxes.

These States define ‘fair market value’ to mean the price that the goods would ordinarily fetch on sale in the open market on the date of sale or dispatch or transfer of such goods. States such as Andhra Pradesh, Kerala, Uttaranchal, etc., also have provision for seizure and acquisition of such goods either on the value declared by the dealer or at 110 per cent of the purchasing value. However again, such States do not provide for specific rules to calculate such ‘fair market value’.

In this regard, it is perhaps useful to take note of the decision of the Supreme Court in Moriroku UT India (P) Ltd vs State of UP and Ors, wherein the court has clearly stated that unlike excise laws, no deeming fictions and notional additions are applicable for sales-tax purposes. Accordingly, notional additions cannot be read into the sales tax laws for calculating the taxable values.

Though the VAT laws in most of the States now contain a provision for assessment of tax on goods on the fair market value, the ratio of the aforementioned case would still apply and in the absence of any rules for determination of the fair market value, the efficacy of such provisions is questionable to say the least.

To conclude, as the transaction between related parties, whether for supply of goods or services, attract greater scrutiny from the revenue authorities and may have serious consequences on the taxability of the transaction, it becomes imperative for the companies to ensure that reasonable care of the legislative provisions is taken while planning business operations.