Classification of Goods and Services

Introduction

In any taxation matter, the classification of any items plays
an important role in determining the quantum of tax payable by the taxable
person. The GST Council has also approved four slabs of rates which are 5%,
12%, 18% and 28%. The different rates have been approved for different products
by the GST Council in their meeting held on 19/05/2017 and 20/05/2017. The
appropriate classification of goods or services will determine the rate of GST
payable.

The Tribunal and Courts have laid down different principles
of classification of goods or services. These principles are very helpful in
classifying the goods and services and accordingly determining the rate of tax.

Principles of Classification

The various principles are summarised below:

(a)
Commercial/Trade Parlance

(b)
Definition given in statute or chapter note/section note etc.

(c)
Description in HSN has persuasive value

(d)
Most specific description to be preferred over general description

(e)
Functional use of the product

(f)
Essential characteristics of goods or service

(g)
Importance of expert opinion and other evidentiary value

(h)
Importance of ISI specification

(i)
Importance of Finance Ministers speech

(j)
Importance of trade notice, circulars etc.

(k)
Chemical examination only provides content and not classification

(l)
Provision of relevant time

(m)
Burden to prove classification on department

(n)
Exemption notification cannot interpret tariff heading or sub heading

(o)
Beneficial classification

(p)
Jurisdiction to decide classification

Each of the above principles are discussed as follows:

a)  Commercial/Trade Parlance

    If meaning of goods/service is not defined
in relevant places in GST Act, then, meaning of the goods/service has to be
judged in the manner understood by the people dealing with it, i.e., the
goods/service should be understood in the commercial sense. This rule has been
consistently applied by various courts to decide the classification of the
product. For example, whether the product should be classified as cosmetic or
medicament shall be judged by the manner in which the people dealing the
product understand.

     The observation of the Supreme Court in
paras 29 & 34 in the case of Dunlop India vs. UOI 1983 (13) ELT 1566
(SC) substantiate this principle. The Supreme Court has observed as follows:

     “29. It is well
established that in interpreting the meaning of words in a taxing statute, the
acceptation of a particular word by the trade and its popular meaning should
commend itself to the authority.”

     “34. We are, however,
unable to accept the submission. It is clear that meanings given to articles in
a fiscal statute must be as people in trade and commerce, conversant with the
subject, generally treat and understand them in the usual course. But once an
article is classified and put under a distinct entry, the basis of the
classification is not open to question. Technical and scientific tests offer
guidance only within limits. Once the articles are in circulation and come to
be described and known in common parlance, we then see no difficulty for statutory
classification under a particular entry.”

     The above Principle of classification has
been followed consistently by the Supreme Court in the following cases:

          
Indian Aluminium Cables Ltd. vs. UOI 1985 (37)

           E.L.T (S.C)

           Collector of Central Excise,
Kanpur vs. Krishna

           Carbon Paper Co.1988 (37) E.L.T
480 (S.C)

     Commissioner vs. Pio Food Pack 1980
(6) ELT 353 (SC)

     Reliance Cellulose Products Ltd.,
Hyderabad vs. Collector of Central Excise, Hyderabad 1997 (93) E.L.T 646
(S.C)

This is the basic principle to determine the classification
of goods or service. Affidavits from persons like customers, distributors,
dealers along with purchase orders from customer, description of product in
invoice raised by supplier, normally substantiate the manner in which the
product is understood in the commercial parlance.

b)  Definition given in statute or chapter
note/section note etc.

     The principle of classification of product
as per trade parlance is not absolute principle. The statute making authority
has the power to define the product in a particular manner. The Hon. Supreme
Court in the case of Akbar Baharuddin vs. Collector of Central Excise, 1990
(47)ELT 161 (SC) has held that tariff entry shall not only be based on trade
parlance and understanding between the person in the trade. The said doctrine
of commercial understanding should be departed where the statute either in the
act or chapter note or in schedule or anywhere else defines the product in a
particular manner. The definition in the statute will take precedence over the
commercial understanding of the product in the trade.

c)  Description in HSN has persuasive value

     Under the General Agreement for Trade and
Tariff, commonly known as GATT agreement, World Trade Organization (WTO) has
been formed.The Customs Coordination Council (CCCN) working under WTO has
published Harmonized System Nomenclature (HSN) which is normally adopted by all
countries who have signed the GATT Agreement for the purpose of classification of
the products for Customs. In India, classification under Central Excise and in
various state VAT is also basedon HSN. The classification made in GST is also
based on HSN. Harmonized System Nomenclature published by CCCN gives a detailed
description of various products which are covered under a particular heading or
sub-heading. The description in HSN is very helpful in deciding the
classification of the product. The Hon. Supreme Court in the case of Wood
Crafts Products Ltd., 1995 (77) ELT 23 (SC) has held that the description
in HSN Explanatory Note has persuasive value.The Supreme Court has observed in
paras 12 and 18 as follows:

     “12. It is significant, as
expressly stated, in the Statement of Objects and Reasons, that the Central
Excise Tariffs are based on the HSN and the internationally accepted
nomenclature was taken into account to “reduce disputes on account of tariff
classification”. Accordingly, for resolving any dispute relating to tariff
classification, a safe guide is the internationally accepted nomenclature
emerging from the HSN. This being the expressly acknowledged basis of the
structure of Central Excise Tariff in the Act and the tariff classification
made therein, in case of any doubt the HSN is a safe guide for ascertaining the
true meaning of any expression used in the Act. The ISI Glossary of Terms has a
different purpose and, therefore, the specific purpose of tariff classification
for which the internationally accepted nomenclature in HSN has been adopted,
for enacting the Central Excise Tariff Act, 1985, must be preferred, in case of
any difference between the meaning of the expression given in the HSN and the
meaning of that term given in the Glossary of Terms of the ISI.

     18. We are of the view that the
Tribunal as well as the High Court fell into the error of overlooking the fact
that the structure of the Central ExciseTariff is based on the internationally
accepted nomenclature found in the HSN and, therefore, any dispute relating to
tariff classification must, as far as possible, be resolved with reference to
the nomenclature indicated by the HSN unless there be an express different
intention indicated by the Central Excise Tariff Act, 1985 itself. The
definition of a term in the ISI Glossary, which has a different purpose, cannot,
in case of a conflict, override the clear indication of the meaning of an
identical expression in the same context in the HSN. In the HSN, block board is
included within the meaning of the expression “similar laminated wood” in the
same context of classification of block board. Since the Central Excise Tariff
Act, 1985 is enacted on the basis and pattern of the HSN, the same expression
used in the Act must, as far as practicable, be construed to have the meaning
which is expressly given to it in the HSN when there is no indication in the
Indian Tariff of a different intention.

The same principle is repeated in the case of Business
Forms Ltd., 2002-142-ELT-18 (SC). Thus, description given in HSN is
very useful indetermining classification of the product.

d)  Most specific description to be preferred over
general description

     It is a general principle of classification
that most specific description shall be preferred over a more general
description. The judgements laying down the principle that most specific shall
be preferred to general in the matter of classification are discussed below:

     In
the case of Dunlop India Ltd. vs. Union of India 1983 (13) ELT1566 in
para 37, the Supreme Court has observed ‘when an article has by all standard
a reasonable claim to be classified under an enumerated item in the Tariff
Schedule, it will be against the very principle of classification to deny it
the parentage and consign it to the orphanage of the residuary clause.’

      In the case of Moorco (India) Ltd. vs. CCE
(supra), the Supreme Court has observed ‘in either situation, the
classification which is most specific has to be preferred over the one which is
not specific or is general in nature. In other words, between the two competing
entries one nearer to the description should be preferred. Where the class of
goods manufactured by the assessee falls, say, in more than one heading, of
which one may be specific, other more specific, 3^rd most specific
and 4^th general, the rule requires the authorities to classify the
goods in the heading which gives most specific description.’

e)  Functional use of the product

     Functional use of the product can certainly
be one of the factors in determining the classification, but cannot be the sole
criteria for determining the classification. Normally use of the product is not
relevant as the product is required to be classified in the condition in which
it is supplied. However, sometimes, tariff heading itself provides the use of
the product. In such a case, the ultimate use of the product is very important
for classifying the product. For example, entry No. 2309 in Central Excise
Tariff Act is “preparation of a kind used in animal feeding”. It is evident
from the description itself that preparation shall be used in animal feeding.
Where the description itself specifies the use of the product, classification
will be based on the ultimate use of the product. The Hon. Supreme Court in the
case of Atul Glass Industries vs. Collector of Central Excise, 1986 (25)
ELT 473 has held that in such a case, the goods are to be classified on the
basis of their primary function.

f)   Essential characteristics

     The product is purchased and sold due to
its essential characteristics. The principles for determining the essential
characteristics are –

     (a) Cost of components of the
product.

     (b) Functionality of the product.

     These are discussed below:

     (i) 
Cost of components of the product—

     The Hon’ble Supreme Court in the case of Xerox
India Ltd. vs. Cenvat Credit 2010 (260) ELT 161 has determined the
classification of multifunctional printing machines on this basis. The assessee
claimed classification under Chapter heading 8479.89 whereas the revenue
claimed classification under Chapter heading 8471.60. The machine performs
various functions of printer, fax, copier and scanner. The court observed that
printing function emerges as principal function and gives the machine its
essential character. In arriving at the principal function, the court held
that, in case of product Xerox Regal 5799, 85% of its total parts and
components and manufacturing cost is allocated to printing. Similarly, in case
of product Xerox XD 155df model, 74% of the parts and components along with
cost are allocated to printing. Similar principle of determining the essential
characteristic based on cost has been laid down in various other judgments.
Therefore, this is one of the criteria which can be applied for the purpose of
determining the essential characteristic.

     (ii) 
Functionality of the product—

     In the case of CCE, Hyderabad vs.
Bakelite Hylam Ltd. 1997 (91) ELT13 (SC) the issue was regarding
classification of decorative laminate sheet where paper constituted 60% to 70%
of the total weight and other input was plastic which constituted 30% to 40% of
the total weight. The Hon’ble Supreme Court in para 25, reproduced below, held
that the essential characteristic is given by plastic. The quality of plastic
like rigidity, strength, resistance to heat provide essential characteristic to
the product. Therefore, the product merits classification as plastic.

     “25. Rule 1 does not help to
classify the goods in the present case because Note 1(f) in Chapter 48 is not
applicable to these goods. The other relevant rule of interpretation is Rule
3(b) which provides that mixtures or composite goods consisting of different
materials which cannot be classified with reference to Rule 3(a) as in the
present case, are to be classified as if they consisted of the material or
component which gives them their essential character. In the present case, the
essential character of a decorative laminated sheet is its rigidity or strength
and its resistance to heat and moisture. These are essentially characteristics
which are imparted by resins. Paper does not possess any of these
characteristics.Therefore, applying Rule 3(b) and going by the essential
characteristicsof such laminated sheets, these goods are more appropriately
classifiable under Chapter 39.”

     Thus, in determining the essential
characteristics,   the above two factors
can be considered as guidelines. 

g)  Importance of expert opinion and other
evidentiary value

     Very often, when there is dispute regarding
nature of goods, it will be advisable for the authorities as well as the
taxable person to obtain opinion from technical experts or person dealing in
the goods to know the true character of the goods. It has been consistently
held that expert opinion is to be taken to understand the nature of product but
cannot decide the classification of the goods. It has no binding effect, but
only guiding effect on the authorities because ultimately, decision of proper
classification of the product is to be decided by the jurisdictional authority.
The Delhi Tribunal in case of Guest Keen William 1987 (29)ELT 68 has
observed in para 23 as follows:

     23. ……………………We have also
examined Shri Gujral’s argument that the opinion of the expert should be considered.
He cited the case of ‘K. Mohan & Co., Bombay vs. Collector of Customs,
Madras’ reported in ‘1984(15) E.L.T. 430’, and also cited ‘1984 E.C.R. 1086’
and ‘1986 (6) E.C.R. 334’. While we agree that expert opinion should be
considered, we observe that it is the language of the notification and the
facts of the matter whichshould be examined. An expert’s opinion has to be
given due respect but it cannot be the deciding, or binding factor.

     The above judgement has been maintained by
the Supreme Court in case of Guest Keen Williams Ltd. vs. Collector – 1997
(95) E.L.T. A144(S.C)

     It is also held that expert opinion
expressed by specialised institution has to be preferred over the opinion of
individual experts obtained at the instance of the assessee. These expert
opinions are not ignorable particularly if they are given by public
authorities. Opinion of any other persons who have knowledge in the field
regarding the product shall be given due importance for deciding the
classification of the product. The opinion of authorities like Textile
Commissioner, Law Ministry, etc. are to be given due importance for
classification of the product.

h)  Importance of ISI specification

     In many cases, the product is manufactured
as per ISI specification. Sometimes, the taxable person also affixes ISI mark
on the product.The ISI specification certifies the quality of the product and
not the name or character. View of the ISI shall be looked at some amount of
credibility for deciding the classification. It can be used as specialised
material in expert opinion, but other tangible consideration should also weigh
while determining the classification. Therefore, description of product in ISI
has limited value in determining the classification of goods.

i)   Finance Minister’s speech

     In some case, Finance Minister in the
Finance Bill may make certain reference while introducing the changes. Speech
of the Finance Minister represents the manner in which the authorities have
understood the change. Therefore, the speech of the Finance Minister can be
helpful in deciding the classification as held by the Hon. Gujarat High Court
in the case of ECHJAY Industries vs. UOI 1988 (34) ELT 42 (Guj)

j)   Importance of Trade Notice/Circulars, etc.

     Section
168 of GST Act empowers the Board or the Competent Authority of the State
wherever it considers necessary for the purpose of uniformity in implementation
of the Act to issue such orders, instructions or directions to GST Officers as
may deem fit. Similar provisions are contained in section 37B of Central Excise
Act. It has been consistently held that trade notices, tariff advices,
circulars, press notes etc. issued by the authorities are hardly
relevant for the purpose of classification of the product under Central Excise
Act as it cannot override the true meaning or interpretation underlined
statutory provisions. The classification has to be decided by the authorities
based on the description of relevant tariff entry and not on the basis of
tariff advice or instructions or circulars etc.

k)  Report by Chemical Examiner

     Very often, the authorities insist upon
testing of the product in order to determine the true composition of product
and nature of the product. Section 154 of GST Act also provides taking of
samples. It has been consistently held that the role of Chemical Examiner is
only to provide the content of the product or the nature of the product, but
not to decide classification of the product. Mention of classification in the
test report shall be ignored.The Hon. Gujarat High Court in the case of Stadfast
Paper Mills vs. Dr.Kohli, Former Collector of Central Excise, Baroda and
others 1983 (12)ELT 744 (Guj) has held that Chemical Examiner is required to
provide the constituent of different material contained in the article to
substantiate the nature of product. If the report mentions the classification
of product, the same shall be ignored. The relevant Extract of the above
judgment is as follows:

     12………………… Here it should
be recalled that the evidentiary value of the report of the Chemist lies only
in so far as it supplies the data obtained by him through the Chemical
analysis. It is none of the functions of the Chemists to give an opinion as to
whether the goods in question would be covered by a particular item of the
Tariff Schedule.

l)   Provision at the relevant time

     Sometime, the tariff description of the
entry may be amended over a period of time. While classifying the product, the
tariff description of relevant period should only be used for classification.
For example, say, goods are supplied in the month of August 2017. Further
assume there is amendment in the tariff entry in April 2018. The classification
of the product based on tariff description in August 2017 should only be
considered while classification for supplies made in August 2017. Subsequent
amendment will not be relevant for the purpose of deciding the classification.

m) Burden to prove classification is on department

     It has been held under Central Excise Act
that burden to prove is primarily on the excise authorities to establish
whether particular products falls under one tariff heading or another when the
manufacturer has classified the product in a particular tariff heading and the
department intends to classify it in a different heading. The department  must produce enough evidence to substantiate
that the product must classify differently. In other words, the burden of proof
of particular classification is on the department. This burden can be shifted
to the assessee when the classification adopted by him is not totally correct.

n)  Exemption notification cannot interpret the
tariff entry

     Sometimes, the department provides
exemption to a particular product and specifies the tariff entry for that
product. In such cases, the department has been taking plea that the product
should be classified under the heading mentioned in the exemption notification.
It has been consistently held that exemption notification cannot interpret the
tariff entry nor it can provide norms for the purpose of classification. The
classification of product must be decided based on description of tariff entry.
The Hon. Bombay High court in case of Mechanical Packing Industries vs.UOI
1987 (32) ELT 35 (Bom) has observed in para 11 as follows:

11.Secondly,
this is exactly what the Government cannot do by virtue of an exemption
notification. If there has to be any exemption, or classification that
necessarily must be done by the legislature and not by virtue of any power to
issue exemption notification under Rule 8(1) or (2) of the Central Excise
Rules.

o)  Beneficial classification

     It is a well established principle that when
the goods are classified under two different items or said items or ambiguous
sentences leave reasonable doubt about its meaning, then benefit of doubt is
given to the manufacturer and the classification should be adopted which is
beneficial to the manufacturer. This is based on the principle that when the
legislature has not clearly laid down the provisions of law benefit of doubt is
given to the manufacturer. The Hon. Bombay High Court in the case of Garware
Nylons Ltd. vs. UOI 1980 (6) ELT 249 (Guj) has held that the classification
beneficial to the assessee should be adopted.

p)  Jurisdiction to decide classification

     The jurisdiction to decide the
classification is on the jurisdictional officers of the supplier of
goods/service. The classification cannot be decided by the jurisdictional
officer of recipient of goods/service. They have no authority to change the
classification adopted by supplier of goods/service. The Hon. Supreme Court in
the case of Sarvesh Refractories, 2007 (218) ELT 488 (SC) has held that
classification cannot be changed by jurisdictional officer of recipient. The
relevant extract of the above mentioned judgment is as follows:

     6. The finding recorded by the
Tribunal is unexceptionable. We agree with the view taken by the Tribunal that
the appellant could not get the classification of ‘Loadall’ changed to Heading
84.27 from 84.29, as declared by the manufacturer. Insofar as the penalty
imposed by the authority-in-original is concerned, we are of the view that a
case for imposition of penalty is not made out and accordingly the same is set
aside and deleted. Rest of the order of the Tribunal restoring the order of the
authority-in-original is confirmed.

     The taxable person shall apply the above
principles for the purpose of classifying the goods or services.

    Classification of composite supply

     In trade parlance when both the goods or
services are supplied, it is considered as a ‘works contract’.  However, under GST the ‘works contract’ has
been defined in Section 2(119) as follows:

     “119.            “works contract” means a contract for building,
construction, fabrication, completion, erection, installation, fitting out,
improvement, modification, repair, maintenance, renovation, alteration or
commissioning of any immovable property wherein transfer of property in goods
(whether as goods or in some other form) is involved in the execution of such
contract.”

     The definition of ‘works contract’ can be
divided into following two parts:

a)  It should be contract for building,
construction, fabrication, completion, erection, installation, fitting out,
improvement, modification, repair, maintenance, renovation, alteration or
commission;

b)  It should result in an immovable property
wherein transfer of goods is also involved.

     Thus, as a result of provision of supply,
the contract shall result in immovable property. If it does not result in
immovable property, the supply cannot be considered as a supply of ‘works
contract’.

     If the contract of supply involves both
supply of goods or services and does not result in immovable property, the
supply can be considered either as a mixed supply or composite supply. The
‘mixed supply’ and ‘composite supply’ has been defined in section 2(30) and
2(74) of the GST Act which reads as follows:

     30.   “composite
supply” means a supply made by a taxable person to a recipient  consisting of two or more taxable supplies of
goods or services or both, or any combination thereof, which are naturally
bundled and supplied in conjunction with each other in the ordinary course of
business, one of which is a principal supply.”

     Illustration: Where goods are packed, and
transported with insurance, the supply of goods, packing materials, transport
and insurance is a composite supply and supply of goods is a principal supply.”

     74.   “mixed supply” means two or more individual supplies of goods
or services, or any combination thereof, made in conjunction with each other by
a taxable person for a single price where such supply does not constitute a
composite supply.

     Thus, the composite supply will be
classified as a supply of goods or service based on principal supply. Hence in
any composite supply, the principal supply is required to be determined. For
example, a person books a ticket from Mumbai to Delhi in Rajdhani Express. The
railways provide the service of transportation of passengers which is a
principal supply. However, in a train the food is also served and bed rolls are
also provided. These two supplies of food and bed rolls are to make the supply
of transportation of passengers more convenient and comfortable. Therefore, as
per section 2(30) of the GST Act, all the three supplies will be classified as
‘transportation of passengers’ and the tax rate applicable to transportation of
passengers will be payable by the railways.

     However, in many cases, it becomes very
difficult to determine the principal supply in composite supply. The Honourable
Supreme Court has laid down certain principles for determining the essential
character of the product. These principles can be helpful in determining the
principal supply of a product. These principles are:

     a. Cost of components of
the product—

     The Hon’ble Supreme Court in the case of Xerox
India Ltd. vs. CC 2010 (260) ELT 161 has determined the classification of
multi-functional printing machines. The assessee claimed classification under
Chapter heading 8479.89, whereas the revenue claimed classification under
Chapter heading 847160. The machine performs various functions of printer, fax,
copier and scanner. The court observed that printing function emerges as
principal function and gives the machine its essential character.In arriving at
the principal function, the court held that, in case of product XeroxRegal
5799, 85% of its total parts and components and manufacturing cost is allocated
to printing. Similarly, in case of product Xerox XD 155df model, 74% of the
parts and components along with cost are allocated to printing. Similar
principle of determining the essential characteristic based on cost has been
laid down in various other judgements. Therefore, this is one of the criteria
which can be applied for the purpose of determining the essential
characteristic.

     b. Functionality of the product
–

     In the case of CCE, Hyderabad vs.
Bakelite Hylam Ltd. 1997 (91) ELT 13 (SC) the issue was regarding
classification of decorative laminate sheet where paper constituted 60% to 70%
of the total weight and other input was plastic which constituted 30% to 40% of
the total weight. The Hon’ble Supreme Court in para 25, reproduced below, held
that the essential characteristic is given by plastic. The quality of plastic
like rigidity, strength, resistance to heat provide essential characteristic to
product. Therefore, the product merits classification as plastic.

     “25. Rule 1 does not help
to classify the goods in the present case because Note 1(f) in Chapter 48 is
not applicable to these goods. The other relevant rule of interpretation is
Rule 3(b) which provides that mixtures or composite goods consisting of
different materials which cannot be classified with reference to Rule 3(a) as
in the present case, are to be classified as if they consisted of the material
or component which gives them their essential character. In the present case,
the essential character of a decorative laminated sheet is itsrigidity or
strength and its resistance to heat and moisture. These are essentially
characteristics which are imparted by resins. Paper does not possess any of
these characteristics.Therefore, applying Rule 3(b) and going by the essential
characteristics of such laminated sheets, these goods are more appropriately
classifiable under Chapter 39.”

    Thus, in determining the essential
characteristic, the above two factors can be considered as guidelines.

    Thus, the functionality test or the test of
cost of product can be applied for the purpose of determining the principle of
supply.

     This principle can be applied to
comprehensive AMC. In case of comprehensive AMC, the intention of the recipient
is to ensure that the equipments run in a smooth condition, so that the maximum
benefit of the equipment can be derived by the recipient. Therefore, the
supplier of service regularly visits and inspects the equipments. He carries
out the function of cleaning, washing and greasing wherever required for the
equipments. However, wherever requbired, the service provider will also carry
out the replacement of the part which is covered in the contract. There may or
may not be any replacement of any part. Therefore, in this case, applying the
principle of functionality test, the service appears to be predominant and
accordingly the entire contract shall be classified as a service contract
levied to tax rate of 18%. It is quite possible that the part if any which is
replaced in the performance of the contract may attract 28% tax. However, since
it is a composite supply, where service is a principal supply, therefore, the
rate of tax would be 18%.

Conclusion