Coke wins landmark service tax case

In a judgment that stands to benefit contract manufacturers like fast moving consumer goods, pharmaceutical and cosmetic majors, the Bombay high court on Wednesday ruled that beverage major Coca-Cola could avail of tax credit on the service tax it pays for advertising and promotions.

The judgment also applies to PepsiCo, which had intervened during the hearing in July this year.

Since the credit rule for service tax is applicable retrospectively (since 2004), the cola major stands to make significant gains to its bottom-line. It spends 35 to 40 per cent of its revenue on advertising and promotion.

Soft drink manufacturers can now avail of the service tax rebate as CenVat credit against their excise duty liability on concentrates they supply to their contract manufacturers.

The ruling, passed by a division bench comprising Justice F I Rebello and Justice J H Bhatia of the Bombay high court, stands to benefit companies from other sectors, too, like cosmetics and pharmaceuticals, since they follow the contract manufacturing model and advertise and promote the end-products.

FMCG companies typically spend 10 to 12 per cent of revenues on advertisements and promotions, so the judgment will see the bottom-line of companies improve in direct proportion to the service tax they pay.

"The court judgment will see a company's bottom-line improve by 10.3 per cent (equivalent to the service tax), since this will reduce the input costs of the company and improve its cash flow," explained Prateek Jain, partner, KPMG.

The case dates back to 2006, when Coca-Cola filed an appeal with a tax tribunal for service tax credit against advertising expenditure on soft drinks such as Coca-Cola, Thums Up, Fanta and Sprite. The appeal was, however, rejected on grounds that Coca-Cola's end-product was manufactured by its bottlers.

In 2007, the company filed its appeal in the high court under section 35G of the Central Excise Act.

The basis of the appeal is that the cost of advertising is considered an input cost for manufacturers of packaged and consumer goods, so service tax credit should be allowed.

"Henceforth, all manufacturers will be eligible to avail of credit on the service tax paid on input services that are directly or indirectly related to the business of the manufacturer or the brand owner," said Vikram Nankani, partner, Economic Laws Practice, who appeared in this case for Coca-Cola.