Decoding CKD Classification: Tax Evasion Charges over Automobile Imports by Kia & Volkswagen

[Neha is a student at NALSAR University of Law.]

On 7 February 2025, car companies Kia and Volkswagen received notices from the customs with a tax demand of USD 150 million and USD 1.4 billion respectively for allegedly misclassifying their imported components to evade taxes. The Bombay High Court is set to hear the matter as a result of a plea by Volkswagen challenging the customs notice while Kia opted to contest the allegations privately.

The primary objective of India’s customs laws is to regulate the import of goods in order to safeguard the competitiveness of domestic industries. Nevertheless, concessional import duty rates are extended in specific circumstances to ensure the availability of essential products. An example of such a concessional regime relates to the import of Completely Knocked Down (CKD) units within the automotive sector.

According to Chapter 87 of the Indian Customs Tariff Act 1975, motor vehicles imported as Completely Built Units attract a significantly high customs duty of 125% of the import value. However, in order to encourage domestic assembly and manufacturing, a concessional duty rate of 35% is applicable on vehicles imported in CKD form, provided they are subsequently assembled in India. Further, an even lower duty rate of 15% is applicable on imported goods which do not qualify as CKDs and are instead classified as individual parts and components.

Overview of the Dispute

A key point of contention in this regulatory framework concerns the classification of imported vehicles as either CKDs or mere parts and components. In the recent controversy concerning Kia Motors, it has been alleged that the imports were reportedly declared in a manner suggesting that they did not meet the CKD criteria and was thus subjected to a lower customs duty rate of 15%, however their website indicated that the Carnival model was imported in CKD form, retailing 9,887 units in India between 2020 and 2022.

Similarly, Volkswagen’s defense in the ongoing customs dispute relies on its import methodology. The company asserts that it did not import vehicle components as a single pre-packaged “kit” but rather procured parts individually, supplementing them with locally sourced materials. However, according to the Indian authorities, Volkswagen’s specialized software system which facilitated large-scale procurement of complete vehicle components from suppliers overseas, subsequently fragmented these bulk orders into smaller shipments, each containing between 700 and 1,500 parts per vehicle. This strategy allegedly enabled Volkswagen to categorize these shipments under different classifications, thereby circumventing higher import duties.

Judicial Precedents on CKD Classification

A CKD kit as per the Notification dated 17 March 2012 of the Ministry of Finance, refers to a unit containing all the necessary components, parts, or sub-assemblies for assembling a complete vehicle, but does not include:

1. A kit containing a pre-assembled engine, gearbox, or transmission mechanism.

2. A chassis or body assembly of a vehicle on which any of the components or sub-assemblies (engine, gearbox, or transmission mechanism) is installed.

The Supreme Court in the case of Commissioner of Customs v. Sony India Limited (2008) relied on Rule 2(a) of the General Interpretative Rules for the Interpretation of the Harmonized System, in its ruling on the classification of CKD units and held that Rule 2(a) was not applicable unless all the necessary components were imported together. 

According to Rule 2(a), if all components are imported in a CKD condition and collectively possess the essential character of a complete vehicle, they must be classified as a complete article for customs purposes. However, components imported separately cannot be aggregated post-import to qualify as a CKD kit, as they were not presented as a unified shipment at the time of import. 

Applying this Rule, the Supreme Court in the Sony case, addressed the issue of unfinished or incomplete parts imported simultaneously, wherein the court ruled that goods imported in separate consignments cannot be collectively considered a finished product for the purpose of classification. Furthermore, the court held that such parts and components lacking the essential characteristics of the complete product must be classified under their respective tariff headings or sub-headings, rather than being assessed as a complete article or kit.

Subsequently in a similar case concerning the automobile industry, the Madras High Court in Commissioner of Customs (Port-Import), Chennai v. Authority of Advance Rulings & BMW India Private Limited (2024), relying on the precedent set by the Sony judgement, ruled in favour of BMW and held that Rule 2(a) was not applicable since firstly, the essential components such as the engine, transmission, and axle were not imported as part of the same shipment but were instead procured locally and secondly, the imported parts arrived at different times from multiple suppliers, failing to meet the requirement for classification as a CKD kit under customs law.

The classification of motor vehicle parts has been a contentious issue, with revenue authorities frequently asserting that imported components should be classified under the same heading as CKD kits, as this attracts higher tax rates than individual parts. Authorities have remained cautious, as separate classification leads to lower revenue collection and potential tax evasion by importers. In cases where essential components were sourced locally from third parties, who themselves had imported these parts, Revenue authorities have alleged that such third-party arrangements were structured to evade higher taxes. The apex court has upheld such allegations in some instances. However, in the BMW case, the High Court rejected this claim, emphasizing that BMW did not control the import timing of third parties, nor were all essential parts imported simultaneously, disqualifying them from CKD classification under Rule 2(a).

Loopholes in the Classification of Motor Vehicle Parts

Fragmentation of bulk orders to avoid CKD classification

The Sony India case established that goods imported in separate consignments cannot be clubbed together to classify them as a complete article under Rule 2(a) of the General Interpretative Rules, thereby meaning that CKD classification would not be applicable to such imports and they would thus be subjected to lowers customs rates. This principle however allows companies to intentionally break down their imports into multiple shipments, thereby avoiding CKD classification and qualifying for a lower tax rate applicable to parts and components (15% instead of 35%) and such tactics creates a façade of disassembly aimed at circumventing import tax regulations or other conditions imposed on importers.

Import timing manipulation

The BMW India case (2024) reinforced that essential components sourced locally do not contribute to CKD classification, and shipments from different suppliers at different times do not automatically constitute a CKD kit. Companies may time their imports strategically, bringing in different parts at different intervals and arguing that they are individual parts rather than a CKD unit.

Preventing Tax Evasion in the Automobile Sector

The lacunae within the present legal framework is particularly problematic as it enables companies to artificially separate essential vehicle components without fundamentally altering their import methodology. In order to prevent tax avoidance by misclassification of imports, the customs authorities must, instead of relying purely on shipment structure and timing, assess whether an import, when considered as a whole, has the essential character of a CKD kit. If multiple shipments arriving within a short time contain interdependent components that together form a CKD structure, customs should have the authority to reclassify them as a CKD unit, even if they arrive separately. This could be effectuated by amending the customs regime towards preventing intentional misclassification of CKD kits by fragmentation of shipments via a staggered timeline.

For instance, if a company imports all essential and interdependent components required for vehicle assembly within a certain time frame (example, 6 months) and from the same source overseas, these should automatically be classified under the CKD duty rate even if each individual shipment does not contain all the essential components required for classification as a CKD, as long the import within the time frame taken as a whole meets this criterion. To implement this, customs could require importers to disclose long-term procurement contracts or establish a digital tracking system for linked shipments. Thus, this would ensure that functionally interdependent components procured from the same source in bulk cannot be artificially classified under different headings by fragmenting the components procured in bulk into smaller parts while importing them into India, if their combined purpose is to form a complete vehicle and if those components were procured from the same overseas source as was the alleged situation in the Volkswagen case.

Conclusion

The recent tax evasion allegations against Kia and Volkswagen highlight gaps in the current CKD classification system. To prevent such misclassification, customs authorities must assess imports holistically, considering shipment timing and interdependence rather than isolated consignments. Judicial precedents reveal how fragmenting bulk orders and manipulating import timing enable companies to evade higher duties. A policy reform requiring all essential components imported within a set timeframe and from the same source to be classified as CKD can help close these loopholes and ensure fair tax enforcement.