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Outward Transit Insurance - Whether Part of Taxable Sale Price

Written by: Sanjeev Malhotra - F.C.A, F.C.S, A.I.C.W.A
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The Contract of sale can either be Ex works contract or F.O.R contracts. Further F.O.R contracts of sale can either be F.O.R destination i.e customer godown or F.O.R transport. In F.O.R contracts the seller undertakes an obligation to arrange for carrying the goods to the destination at his own expense of freight and insurance etc. Though all these expenses incurred by seller are recovered from the buyer as part of the sale price. In Ex works contracts, the seller's obligation ends at giving the delivery of sold goods at his factory gate and it is buyer's obligation and expenditure to pick up the material from sellers gate. However, seller's in Ex works contracts help the buyers in sending them the goods at the cost and risk of buyer. The actual cost incurred by seller's in these contracts is reimbursed to them by buyers. Can a seller in an ex works contract of sale arrange to send the goods to buyer at his own risk but at the cost of buyer? Is this valid under the Insurance laws? Will cost of such transit insurance and outward freight be part of assessable value for the purpose of taxing under Central Excise and Sales Tax Act?

The Hon'ble Supreme Court also ruled on this issue in the case of Escorts JCB Limited V Commissioner of Central Excise, Delhi II. A detailed study on this aspect in the following article reveals that cost of insurance and outward freight in all such arrangements will form part of sale price and be taxable under the Sale Tax Act. Many big companies having all India operations follow the practice of incurring the expenditure of freight and insurance and then charging equalized freight and insurance to their dealers spread all over India in order to maintain the price of their products in total country irrespective the location of such dealers.

In this respect let us examine the question Can a seller take a marine insurance cover in his own name on the goods sold Ex works by him.

Insurance Law in respect of Marine Policies

All of us know that for an insurance contract to be valid it is necessary that the insured should have an Insurable Interest in the property insured otherwise it would amount to a wager and will be void. In the case of Anctil V Manufacturers life, (1989) A.C. 604, it was held that if this interest is absent, the insurance is illegal and void and no agreement between the parties dispensing with this requirement can be effective. The word 'Interest' has been defined to mean " if the event takes place, the party would gain advantage and if it is frustrated, the party would suffer a loss. Further, the assured must be interested in the subject matter insured at the time of loss, though he need not be interested when the insurance is effected, and where the assured has no interest at the time of loss, he cannot acquire interest by any act or election after he gets aware of the loss.

Insurable interest is not limited to absolute ownership of property but may arise in other ways also. It may be based on ownership whether absolute, partial or limited, legal or equitable. Example : Joint owners, mortgager and mortgagee, trustee or beneficiary. A person without any interest at all can insure as trustee for the person having interest, provided interest in such insurance is not required by statute held in Prudential and Staff union V Hall (1947) K.B. 685. He will then have to hold the claim amounts received as trustee for the interested person. This is under the principle that a party to contract can constitute himself a trustee for a third party of rights under a contract and thus confer rights on the third party. Vondepitte V Preferred Accident, (1932) - 527.

In the case of Escorts JCB Limited V Commissioner of Central Excise, Delhi II, 2002 (146) ELT 31 (SC), the company Escorts had the transit policy in its name for the goods sold by it on ex works basis. The Excise department raised the demand on the company treating the cost of transit insurance and outward freight as being part of the assessable value on the ground that since transit insurance was arranged by the assessee, thus the ownership of the goods was retained by the assessee until it was delivered to the buyer on the reasoning that otherwise there would be no occasion for the seller namely, the assessee to take risk of any kind of damage to the goods during transportation.

The Hon'ble Supreme Court in this case overruled the observations of CGAT ruled that:
"The two aspects have been mixed up - one relating to the transaction of sale of the goods and the other arranging for the transit insurance for the buyer and charging the amount expended for the purpose from him separately. In connection with the proposition that insurance can be taken by a third person on behalf of another, reliance has been placed by the assessee on "Chitty on Contracts" Twenty-Eight Edition Vol. 2 Special Contracts P. 978 Chap. 41 Note 007 under the heading "Insurance of Another's interest". It is indicated that in varied facts and circumstances and subject to the statutory provisions of contract, it is possible to ensure the interest of another."

The Supreme Court in the said case also took note of the following:
Para 5-012 at Page 184 of Benjamin's Sale of Goods Fourth Edition has been made which is to the following effect:
"Insurance. The passing of property is rarely of relevance to insurance. A person can insure goods to their full value against any loss on behalf of anyone who may be entitled to an interest in the goods at the time the loss occurs, provided that it appears from the terms of the policy that it was intended to cover their interest. Also a buyer will have an insurable interest in goods if they are at his risk, whether or not the property has passed to him".

On the similar facts of sale of goods from depot, the same view taken in the Escorts JCB case was upheld by Supreme Court in the case of Prabhat Zarda Factory Limited V Commissioner of Central Excise (2003) 130 STC 96 (SC)

Sale under the Sales Tax Laws

Section 2(g) of Central Sales Tax Act, 1956 defines 'Sale' as 
" Sale with its grammatical variations and cognate expressions, means any transfer of property in goods by one person to another for cash or deferred payment or for any other value consideration and includes :- 
(i) ....................................
(ii) ....................................
(iii) ....................................
(iv) ....................................
(v) ....................................
(vi) ....................................
but does not include a mortgage or hypothecation of or a charge or pledge on goods;
When is a sale considered as completed

A completed sale requires the presence of following elements:
(1) There must be involvement of two persons competent to contract.
(2) Mutual consent of both the parties to contract.
(3) A thing in which property is transferred from seller to buyer ; and
(4) Valuable consideration.

In the case of Dy. Commissioner (CT) Vs Jilite Engg. Works (2002) 126 STC 269 (TNTST), it was held that a transaction of sale completes on absolute transfer of property for a valuable consideration. Finalisation of sale price or raising of invoice does not have any bearing on such completion. Where the seller had agreed to sell the goods and purchaser had agreed to buy the goods and the goods were also transferred unconditionally from the seller to buyer, it would be a case of sale.

Thus, a transaction cannot be considered as a sale unless the property in the goods concerned passes from seller to buyer.

Sale Price
The word sale price has been defined in Section 2(h) of Central Sales Tax Act, 1956 as follows:
"Sale price means the amount payable to a dealer as consideration for the sale of any goods, less any sum allowed as cash discount according to the practice normally prevailing in the trade, but inclusive of any sum charged for anything done by the dealer in respect of the goods at the time of or before the delivery thereof other than the cost of freight or delivery or the cost of installation in cases where such cost is separately charged :"

The definition of sale price in respect of inclusion of freight in sale price was analysed by Hon'ble Supreme Court in the case of Hindustan Sugar Mills Ltd. V State of Rajasthan (1979) 43 STC 13 (SC). The Hon'ble Supreme Court in this case observed as:
"The second part enacts an inclusive clause. It says that "sale price" includes "any sum charged for anything done by the dealer in respect of the goods at the time of or before the delivery thereof other than the cost of freight or delivery or the cost of installation in case where such cost is separately charged". Therefore, "any sum charged for anything done by the dealer in respect of the goods at the time of or before the delivery thereof" is to be regarded as part of "sale price", even if it does not fall within the first part of the definition. But there is an exception carved out of this inclusive. Not all sums charged for something done by the dealer in respect of the goods at the time of or before the delivery thereof are covered by the inclusive clause. The cost of freight or delivery or the cost of installation certainly represents an amount charged for transportation or installation of the goods at the time of or before the delivery thereof and would, therefore, fall within the inclusive clause on its plain terms but it is taken out by the exclusion clause, "other than the cost of freight or delivery or the cost of installation in case where such cost is separately charged".

This exclusion clause does not operate as an exception to the first part of the definition. It merely enacts an exclusion out of the inclusive clause and takes out something which would otherwise be within the inclusive clause. Obviously, therefore, this exclusion clause can be availed of by the assessee only if the State seeks to rely on the inclusive clause for the purpose of bringing a particular amount within the definition of "sale price". But if the State is able to show that the particular amount falls within the first part of the definition and is, therefore, part of the "sale price", the exclusion clause cannot avail the assessee to take the amount in question out of the definition of "sale price". Here, on the view taken by us, the amount of freight forms part of the "sale price" within the meaning of the first part of the definition and it is not necessary for the State to invoke the inclusive clause and in fact the State has not done so. The exclusion clause is, therefore, irrelevant and cannot be called in aid by the assessee.

We may point out that even if the exclusion clause were read as an exception to the first part of the definition which, as we have pointed out, cannot be done, it cannot avail the assessee. It is only where the cost of freight is separately charged that it would fall within the exclusion clause and in the context of the definition as a whole, it is obvious that the expression "... cost of freight ... is separately charged" is used in contradistinction to a case where the cost of freight is not separately charged but is included in the price. It is not intended to apply to a case where the cost of freight is part of the price but the dealer chooses to split up the price and claim the amount of freight as a separate item in the invoice. Where the cost of freight is part of the price, it would fall within the first part of the definition and to such a case, the exclusion clause in the second part has no application."

IN this case, Supreme Court held that the cost of freight in a FOR destination contract will be part of Sale price and exclusion clause of the definition will not be applicable in this case.

There were similar observations of the Supreme court in the case of Cement Marketing company of India Limited V CCT (1980) 46 STC 215 (SC)

In the case of Orient Paper Mills Ltd. V State of Orissa (1975) 35 STC 84 (Orissa), the Hon'ble court observed as follows:
" When the goods are sold, delivery is normally given by the seller at his own place of business or godown. In order to accommodate the customer's convenience, the seller may also agree to send the goods to the former's place, but on the condition that the former would pay to the latter such cost as the latter may incur in so sending the goods.

When the seller's bill or invoice for sale shows any " cost of freight" charged separately from the price of goods, the presumption is that there have been two contracts, one for the sale of goods and the other for their transportation and it is only the first which earns the "sale price" excluding the latter therefrom"
In the case of Escorts JCB Limited (Supra), the Supreme Court also ruled that even if the insurance policy has been taken by the seller in its own name on products sold by seller ex works, it should be treated as taken on behalf of the buyer and its cost should not be treated as part of assessable value.

Sale Price in case of outward insurance cover taken by seller

The outward transit insurance cover being in the name of seller will not constitute any basis of whether the contract of sale of such goods is ex works or F.O.R customer destination. Courts have ruled that these are two different aspects. A seller in an Ex works contract of sale may agree to the request of the buyer to insurance the goods for him and also may arrange to transport the goods to the buyer at the cost and risk of buyer. In this case, the seller for these two services will be considered to be acting as agent of the buyer.

Can an agent or trustee take up the losses of principal

All of us are aware of the common law on agency and trust that the agent or the trustee works for and on behalf of the principal. The agent or trustee do not take up any losses suffered while working for principal. Also agent and trustee do not make any profits while working as such for principal. In reference to facts of our case, in case the seller in a ex works contract is charging an amount to the buyer on account of freight charges, which is substantially more or less than the actual freight paid by the seller in his case, he can not be considered to be acting as agent of the buyer for transporting the goods to such buyer. Similarly, in case the seller takes a transit insurance cover in his own name in an ex works contract of sale and also eventually take up the loss on transit loss on him, he can not be considered to be acting as agent of buyer. Example : A seller in a contract of ex works of sale arranged transportation of goods to the buyer and also took a transit insurance cover in his own name thereby paying Rs. 25,000/- as freight and Rs. 5,000/- as insurance premium. The seller charged the buyer Rs. 35,000/- as freight and Rs. 5,000/- as insurance charges.

There is an accident during the transit of goods to the buyer. The seller had to spend Rs. 1,00,000/- towards making the goods in its original condition. Insurance company passed the seller's claim for Rs. 95,000/-. Seller charged the balance Rs. 5,000/- as an expense in his own books. In this case the seller cannot be treated as agent or trustee of buyer other wise the seller should have passed on this loss of Rs. 5,000/- to the buyer. In respect of freight also, the seller cannot be considered as agent or trustee of buyer as he is charging more than what he has actually spent on this account.

Final test of inclusion of freight and insurance premium

Thus the final test of inclusion of outward freight and outward transit insurance in the sale price will rest on the fact of who carried the risk of goods when these goods were in transit. In case the seller carried the risk and made the claims on insurance company of any loss to goods during transit of such goods to buyers and also charged the losses on account of such claims in his own books, it will be conclusive evidence to show that the sale was not complete during the time goods were in transit and sale got completed only when goods reached the buyers godown. The every expenditure incurred by seller like freight, insurance premium and loading and unloading expenses even if charged separately by seller will be considered part of sale price and subject to tax.

Second relevant factor in this case would be the amount of freight and insurance premium charged to the buyer. In case the amount charged to the buyer is almost the same amount as has been incurred by the seller then that can be considered as amount reimbursed by the buyer on account of duty done by the seller as agent of buyer. But in case amount of freight and insurance charged to buyer exceeds or falls short of actual amount incurred by the seller on this account, then it cannot be argued that this was done by the seller for and on behalf of the buyer.

The author can be reached at: User Tel : 0124-5037889, 5038890 / Print This Article

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