Creative accounting can turn source documents into works of abstract art

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BILLS, cash memos and invoices come in all sizes. More than the final amount, what is of interest is the level of abstraction in the bill.

For instance, Andy Brough, a fund manager at Schroders, wonders "if the invoice submitted by the broker comes with a breakdown stating the number of hours worked, by whom and at what rate, with items such as bacon sandwiches and postage separately identified," in an article dated December 15 on

. "Or does it just come as one big line saying `money raised £150 million x 4 per cent = £6 million plus VAT'?" And many a cellphone user pores over the detailed monthly bills, even while losing count of the hidden charges that pop up with fancy names such as `value added services'.

At times, break-up (as breakdown or itemisation is often referred to) can cause trouble. Which is what happened in

Associated Cement Companies Ltd vs Government of Andhra Pradesh

, decided by the Supreme Court on January 4. The case is of relevance to accountants because behind every innovative invoice there is you-know-who!

Packed cement taxed

The story begins with ACC selling cement, sales tax being 16 per cent. In 1984, Section 6-C was introduced in the Andhra Pradesh General Sales Tax Act, to levy tax on packing material. It said that the materials in which the goods are packed should be deemed to have been sold or purchased along with the goods; accordingly, value of packing material was also charged to sales tax.

Predictably, the levy was judicially challenged, as in the

Raj Steel

case, decided by the apex court in 1989. "Section 6-C can at best be regarded as a provision by way of clarification of existing legal situation," the court had said then. Whether the packing material has been sold or merely transferred without consideration depends on the contract between the parties, the court had observed.

"The fact that the packing is of insignificant value in relation to the value of the contents may imply that there was no intention to sell the packing, but where any packing material is of significant value it may imply an intention to sell the packing material. In a case where the packing material is an independent commodity and the packing material as well as the contents are sold independently, the packing material is liable to tax on its own footing," reads a snatch from the earlier judgment cited in the



This interpretation created a new problem: the taxman had to make `elaborate enquiries on the question whether there was an agreement express or implied for the sale of packing material and whether any artificial or colourable devices were adopted by the assessee to split up the transaction so as to take the plea that there was a separate contract for the sale of packing material'.

Therefore, Section 6-C underwent change in 1995: that the rate of tax on packing material sold with the goods shall be the same as that of the goods packed or filled, whether or not there is separate sale or agreement for sale for the packing material and the goods packed or filled. Two rates were, however, stipulated for cement: One was at 16 paise in the rupee, "where the sale price of cement includes the value of packing material"; and the other, at 20 paise, "where material and cement are sold separately and/or the sale price of cement does not include the value of packing material". Yet another amendment took place in 1997 "to invigorate the charging provision read with Section 6-C to the desired extent".

Accordingly, `packing material that is to say bottles of all types whether of glass, plastic or any fibre or any other material' were to be taxed at 4 paise in the rupee `when sold without contents'; and `at the rate at which the content is liable to tax' where the material is `sold containing contents'. Relief was, however, provided for tax levied and collected on packing materials in respect of sale or purchase of such materials inside the State.

As a result, tax on cement was at 16 per cent "where the sale price of cement includes the value of packing material"; and at 20 per cent "if the cement is sold along with separate sale of packing material for a separate price." ACC argued that the same commodity, that is, the cement, couldn't be treated and made liable to pay differential duty of tax depending upon how the sale of cement was done.

Split in the bills

The company's bills showed separately the value of cement and that of packing material, so as to claim exemption for the packing material (as sales tax is not levied on second sales of packing material). For consumers who bought in bulk, ACC sold cement in unpacked condition, by loading the same in `special type of wagons'.

The Andhra Pradesh High Court's view was that ACC's was "not a case in which a species of the genus is picked up for higher taxation without apparent justification". If the packing material cost is shown as an integral part of the price at which the cement was sold, it would attract lesser rate of tax, explained the High Court.

"If the packing material cost is excluded from the value of the cement, the turnover will be less and in such an event, the Legislature thought it fit to prescribe a higher rate of tax. It is left to the dealer to choose one of the courses." The High Court pointed out that the amendment was thus aimed at checking the `rampant' tax avoidance.

Justices Ashok Bhan and S. H. Kapadia of the apex court heard the case and studied many precedents, such as

Ayurveda Pharmacy vs State of Tamil Nadu


Vasavadatta Cement vs State of Karnataka


Premier Breweries vs State of Kerala


Khandige Sham Bhat vs Agricultural Income Tax Officer

, and

Ganga Sugar Corporation vs State of UP


The apex court cited

Twyford Tea Co vs State of Kerala

, for the observation of Justice Hidayatullah, that the state enjoys a wide discretion in the matters of taxation and enjoys more freedom for classifying the objects to be taxed and the rates of taxation. "The burden for proving discrimination is always heavy on the person who alleges discrimination and heavier still when a taxing statute is under attack."

Another decision, a recent one, was

State of WB vs Kesoram Industries Ltd

, where the court had said that devising the measure of taxation is a far more complex exercise than defining the subject of tax, and therefore the legislature has to be given much more flexibility for devising the measure of taxation. There is this interesting vintage decision too,

Hyderabad Deccan Cigarette Factory vs State of AP (1966)

, which spoke about scent or whisky sold in costly containers, and cigarettes `sold in silver or gold caskets'.

Bifurcation that didn't pay off

Resuming the ACC discussion, it was not lost on the court that contrary to normal business practices and modalities for the sale of cement, ACC was bifurcating the price of cement and packing material to make it appear that there was separate sale of each of them, so that the company need not have to pay the higher tax on the component of packing material.

"It is common knowledge that cement, barring some bulk supplies, is ordinarily sold in packed condition, i.e., either gunny bags or HDPE bags. Going by ordinary business practice and common sense, one does not think of purchasing the cement and bag separately," said the court.

"The agreement and the bargain would be for sale and purchase of cement in packed condition, that is to say, together with the container." It would be difficult to infer a separate agreement for the sale of bags used for packing the cement, said the apex court.

"High Court was right in observing that the manufacturers, in order to claim the tax benefit, had resorted to the

modus operandi

of the sale of containers (bags) by bifurcating the price," ruled the court. "When evidence is created

prima facie

supporting the plea of separate sale of packing material, it would be difficult for the taxing authorities to establish otherwise even though the design and purpose of creating such evidence by the process of billing etc., is quite evident," noted the court empathising with the taxman's plight and dismissing ACC's plea.

Like the nuke-proof cockroach, creative accounting too is perhaps quite resilient. Just when you think you have banished it from the financial statements, it may be finding solace in turning source documents such as invoices into works of abstract art.

D. Murali

(This article was published in the Business Line print edition dated January 12, 2006)
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