Tax implications in a product loan transaction

In this age of the China price and rising crude oil prices, companies look for innovative ways to reduce production costs. Such a thought process gave birth to the concept of Product Loan . A product loan or product support transaction is one where the goods are delivered by one company's storage unit to another company according to the latter's request, such goods are treated as a loan and this loan is repaid by goods of interchangeable quality. This concept can be illustrated with the example of Companies X oil company and Y oil company. If company X has a stock yard in Maharashtra and its commercial outlet is in Bihar and company Y, having its commercial outlet in Maharashtra and its stock yard in West Bengal, both the companies deal in similar goods, then these companies, so as to save on transportation costs can enter into an agreement called the product support contract where the companies agree to supply each others outlet with goods from their respective stock yards.

Stock Transfer and Sale:
Many times such a transaction can be confused to be a sale transaction, especially by the sales tax authorities, as both these transactions have certain common aspects. Those aspects that are common are, that both the transactions have goods that have been exchanged and these goods have a fixed monetary value.

Legislation in relation to Sale:
A sale transaction has been defined in the sale of goods act of 1930, as a contract whereby a seller transfers or agrees to transfer the property in goods to the buyer for a price. 'Price' here is a money consideration for the sale of goods. In a case it has been held that sale has four essential elements - (1) parties competent to contract; (2) mutual assent; (3) a thing, the absolute or general property which is transferred from the seller to the buyer; and (4) a price in money paid as promised.

Difference between a sale and product loan transaction:
The important points of difference between these transactions are the way they are treated in the books of accounts and the consideration that is paid. A sale transaction is registered in either the cash, sales or purchases books with their corresponding value and in the case of a stock transfer, two accounting documents are created in addition to the material document: An accounting document for the removal from storage at the issuing company code. An accounting document for the placement into storage at the receiving company code. The stock posting is offset against a company code clearing account. As seen in the definition of sale in the Sale of Goods Act, it is mandatory that the consideration be monetary. In a Product Loan transaction the goods are repaid with goods and hence there is no money consideration.

Product loan within the company:
Many times such a product loan transfer is carried out within the same company between its different stock plants. This transfer is recorded in books differently Stock transfer from plant to plant ,this affects both accounting and Materials Planning and Accounting is also affected if both plants are assigned to different valuation areas. This means that a stock transfer leads not only to a quantity update but also to a value update (stock value, G/L accounts). Thus, parallel to the material document for stock transfer, an accounting document is created.

Product loan transaction and the Sales Tax Authorities:
It is regular practice for a sale transaction to be taxed by the sales tax authorities on the monetary consideration in the transaction. The same cannot be done in a product loan transaction as there is no monetary consideration involved and there is no profit being made by either of these companies on this transaction.

There have been many instances in our country where the sales tax commission has wrongly taxed a product loan transaction as a sale solely on the consideration that it involves the movement of goods between two different organisations and the value of these goods can be calculated*.However, this transaction will come within the purview of a sales tax authority if the goods that are in transit are anything other than the raw material of that companies or a finished product that are of interchangeable quality to the other's retail outlet. Thus, if a transaction consists of all the essential aspects of a product loan transaction mentioned above then such transaction will not be liable for sales tax.

The  author can be reached at: c.aishwarya@legalserviceindia.com