The Karnataka government has found German retail giant Metro Cash & Carry India guilty of violating licence conditions that prohibit it from "selling goods to consumers and carrying on retail trade".

A report prepared by the additional chief secretary and principal secretary to the government of Karnataka has also said Metro's activities have resulted in revenue losses for the state. The report was sent to the Foreign Investment Promotion Board on February 3.

Metro has been in the eye of a storm since it started operations in Bangalore last year. Retailers in the state have accused the company of selling to individual customers.

Metro has, however, argued that it is allowed to sell to the business-to-business segment, which includes hotels and offices.

While this may look like retail sales, it is not so, it has pointed out. The matter is pending with the FIPB and is also in court.

Metro managing director Harsh Bahadur said he had been in discussions with the FIPB for several months but was unaware of the Karnataka report.

The FIPB had sent a notice to Metro in December, alleging that the company was violating its original licence conditions.

"FIPB officials were here on February 17 in connection with the case, and they told the court that they were still investigating the matter," Bahadur said.

The current report is based on a detailed inquiry by the commercial tax department of the state government. According to the report, Metro's original licence says the company is allowed to sell only to retailers with a sales tax registration and not to consumers.

"In a subsequent letter on December 12, 2002, it was clarified that the company could supply to distributors, wholesalers and retailers with valid licences or sales tax registrations. Business-to-business sales are permissible under the extant policy, which cannot be termed as retail trade," the report adds.

Metro has signed an agreement with its customers, which includes hotels and security agencies, that goods sold to them are not to be used for personal consumption and they will be held responsible for any violation.

Despite this, the report cites several instances of violation. Executives at Bhima Jewellers bought footwear, confectionery and other food products from Metro for personal use, the report points out, adding that in several other cases dealers had purchased Metro's products for their own use.

"Thus is it clear that the company has violated the original conditions laid down in the government's approval letter. It has also violated the modified conditions laid down in the subsequent letter dated December 10, 2002. This is because the company has not taken care to sell goods to those who are trading in similar goods, either in wholesale or retail, as declared in their sales tax registration," the report says.

According to the Karnataka government, Metro should have sold shoes only to shoe retailers and not to retailers of, say, detergent or toothpaste.

"Metro cannot shift the responsibility of ensuring that goods bought are not used for personal consumption to its dealers," the report says.