Per Justice K. Sreedharan :

For a proper understanding of the facts and circumstances of this case we feel that some background history has to be stated. M/s. BHEL is a Government of India Undertaking. They are engaged in the manufacture of heavy and sophisticated electrical and electronic equipment and machinery. Virtually in all the contracts entered into between BHEL and the Customers a Clause is included indicating the liability to make good by replacement or repair the goods that suffer loss or damage. This Clause is called Warranty Clause in the contract. This Clause is operational for a period of 12 months from the date of commissioning of the equipment or 18 months from the date of despatch whichever is earlier. In terms of the pricing policy a sum equal to 2.5% of the estimated factory cost are reserved for Warranty obligations. BHEL was paying duty on the contractual value of the machinery at the time of clearance. In other words duty was also paid on 2.5% set apart for warranty replacements, even though warranty replacements were not cleared at the time of the clearance of the equipment. When replacement items were cleared for complying with the terms of the contract