The Customs, Excise & Service Tax Appellate Tribunal (CESTAT), Chennai has held that the arrangement under which aircraft were made available to its related concern amounted to taxable “Supply of Tangible Goods” (SOTG) service under the Finance Act, 1994, since possession and effective control of the aircraft were not transferred.

The bench of Ajayan T.V. (Judicial Member) and Vasa Seshagiri Rao (Technical Member) granted substantial relief to the flight school by setting aside the demand relating to “other collections”, holding that the adjudicating authority cannot travel beyond the allegations contained in the show cause notice. 

The bench also rejected invocation of the extended period of limitation, found that confirmation of tax on the same receipts in the hands of both entities would amount to double taxation, and set aside the penalties imposed under Sections 77 and 78 of the Finance Act, 1994.

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The appellant/assessee, the aviation wing of the Hindustan Group of Institutions, Chennai, is engaged in providing flight training to students. The Department initiated verification after receiving intelligence concerning non-scheduled operators permitted by the Directorate General of Civil Aviation (DGCA) and their compliance with service tax provisions relating to supply of tangible goods.

During verification, the Department examined the operations of the flight school’s related concern. The Department noticed that the assessee was engaged in air charting and was using an aircraft, including a King Air C 90A, for providing services to its customers.

The Department examined the arrangement between Orient Flight School and OFPL, along with invoices, balance sheets and trial balances. It took the view that the aircraft had been supplied to OFPL without transfer of possession and effective control. On this basis, the Department treated the arrangement as taxable SOTG service under Section 65(105)(zzzzj) of the Finance Act, 1994.

The Department issued the first show cause notice on October 6, 2010, covering the period 2008-09 and 2009-10 and invoking the extended period of limitation. A subsequent notice dated September 4, 2013 covered 2010-11, 2011-12 and 2012-13 up to December 2012, again invoking the extended period on substantially identical allegations.

The adjudicating authority ultimately confirmed the service tax demand for the period from 2008-09 to December 2012, along with interest. An equivalent penalty was imposed under Section 78 and a further penalty of Rs.10,000 was imposed under Section 77(1)(a). The Commissioner (Appeals) subsequently upheld the adjudication orders in their entirety.

The appellant argued that the aircraft had been given to OFPL under a dry lease, meaning that the aircraft was delivered without crew and possession and effective control had passed to the lessee.

The appellant relied on the lease agreement dated January 27, 2008. Under the agreement, OFPL was required to use the aircraft for a minimum of 50 hours per month and was liable to pay a minimum amount of Rs.2 lakh per month where actual usage fell below that threshold. The agreement also required the lessee to return the aircraft in the same condition and to reimburse losses arising from damage. According to the appellant, these contractual terms demonstrated transfer of possession, risk and effective control.

The appellant further contended that the Department had already issued a separate show cause notice to OFPL covering the very same lease receipts. According to the appellant, confirmation of service tax once again in the hands of the flight school would therefore result in double taxation of the same receipts.

It was also argued that the Department could not invoke the extended period of limitation because the relevant facts were already within its knowledge. The appellant relied upon the Supreme Court’s ruling in Nizam Sugar Factory v. Collector of Central Excise in support of its limitation argument.

The central legal question before the Tribunal was whether the aircraft arrangement constituted a supply of tangible goods for use without transfer of possession and effective control, or whether it amounted to transfer of the right to use the aircraft.

The Tribunal referred to the five-fold test laid down by the Supreme Court in Bharat Sanchar Nigam Ltd. v. Union of India for determining whether there has been a transfer of the right to use goods. Among the requirements are that the goods must be available for delivery, the transferee must have a legal right to use them, that right must operate to the exclusion of the transferor during the relevant period, and the transferor must be precluded from transferring the same right to another during the currency of the arrangement.

After examining the actual terms of the agreement, however, the Tribunal found that the arrangement did not satisfy the requirement of exclusive possession and effective control.

The lease agreement provided that when the aircraft was not being used by OFPL or its nominees, the lessor could use the aircraft for the flight school’s training programme. The agreement also required the aircraft to be returned to the lessor’s custody after every trip. According to the Tribunal, legal possession could not continuously move back and forth between the parties depending on hourly usage.

The Tribunal also attached significance to the economic and operational terms of the arrangement.

Although the agreement described itself as a “dry lease”, the lessor remained responsible for the running costs, maintenance and upkeep of the aircraft. The Tribunal observed that the agreement charged amounts on a per-flying-hour basis and prescribed a monthly minimum commitment.

In the Tribunal’s view, these features were more consistent with commercial hiring or a service-level arrangement for supply of tangible goods than with a conventional lease in which possession and control of the asset are transferred to the lessee.

The Tribunal further noted that the agreement could be terminated by either party on only 30 days’ notice. It considered this another feature indicative of an ongoing service arrangement rather than a conventional asset lease involving a shift of control.

Consequently, the Bench concluded that despite the use of expressions such as “lease” and “lessee”, the operative provisions demonstrated that the lessor retained effective control and legal possession of the aircraft.

The Tribunal, however, disagreed with the Department’s inclusion of amounts described as “other collections” in the taxable value.

According to the appellant, these amounts related to activities such as joy rides, sale of scrap and renewal of commercial pilot or instrument ratings and were unrelated to the aircraft lease receipts.

The Tribunal found that the show cause notices proceeded specifically on the allegation that the aircraft lease constituted SOTG service. The notices did not contain allegations establishing that the “other collections” represented consideration for the same taxable service or had a nexus with the aircraft lease.

Relying on the Supreme Court’s principle in Commissioner of Central Excise, Nagpur v. Ballarpur Industries Ltd., the Tribunal reiterated that the show cause notice constitutes the foundation of adjudication proceedings and that the adjudicating authority cannot travel beyond the allegations contained therein.

Accordingly, the demand attributable to “other collections” was held unsustainable and was set aside.

The Tribunal also accepted the appellant’s contention concerning the earlier proceedings against OFPL.

It noted that the lease receipts in question had already been made the subject matter of SCN No.19/2010 dated May 24, 2010, issued to OFPL. The Department’s position that the same receipts were also taxable in the hands of the flight school therefore raised a clear duplication issue.

The Tribunal held that confirmation of tax on the same receipts in the hands of the appellant would result in double taxation of the same transaction, which the law does not countenance.

Importantly, the Tribunal clarified that its finding was aimed at preventing duplication and would not prevent the Department, where otherwise legally permissible, from proceeding against the person ultimately found liable on the relevant receipts.

The Tribunal found considerable merit in the appellant’s challenge.

The Bench observed that the transaction and receipts forming the basis of the demand against Orient Flight School were already within the Department’s knowledge when the earlier notice was issued to OFPL in May 2010.

Further, the second show cause notice issued in 2013 was based on the same set of facts as the earlier proceedings, without establishment of any fresh act of suppression for the subsequent period.

The Tribunal relied on the Supreme Court’s ruling in Nizam Sugar Factory v. CCE, which held that where the facts constituting alleged suppression were already within the Department’s knowledge when an earlier show cause notice was issued, the extended period cannot subsequently be invoked on the same or similar facts.

Applying that principle, the Tribunal found no surviving basis for alleging wilful suppression or intention to evade tax. It also found no positive act of suppression established in the show cause notices that could satisfy the statutory requirements for invoking the extended limitation period under the proviso to Section 73(1).

The Tribunal therefore held that the extended period was unsustainable and restricted the surviving demand to the normal period of limitation.

Once the Tribunal concluded that fraud, collusion, wilful misstatement or suppression with intent to evade tax had not been established, the penalty imposed under Section 78 could not survive.

The Tribunal consequently set aside the Section 78 penalty. It also extended the benefit of Section 80, as it stood during the relevant period, and set aside the penalty imposed under Section 77(1)(a).

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