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TMI Blog2010 (3) TMI 289X X X X Extracts X X X X X X X X Extracts X X X X ..... l by the Revenue raises the following substantial question of law: " Whether on the facts and in the circumstances of the case, the ITAT was correct in holding that the transactions between the assessee and the manufacturer is a contract for sale of goods and is not in the nature of works contract and, therefore, the provisions of Section 194C are not attracted? " 2) The Tribunal held that the agreement involved a sale and does not represent a 'contract for work' within the meaning of Section 194C. The appeal filed by the assessee was allowed. The Facts: 3) The assessee engages in the business of the manufacture and marketing of drugs and pharmaceutical products. During the course of a survey, the assessee was found to be engaged in three kinds of activities involving pharmaceutical products. Firstly, certain products were manufactured by the assessee at its factory. Secondly, the assessee was getting products manufactured from third parties. Thirdly, the assessee had entered into an agreement under which pharmaceutical products were being manufactured by third parties to specifications and standards provided by the assessee under the trade-mark of the assessee. The Assessing O ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... assessee; (iii) The entire product manufactured is sold to the assessee; (iv) There is a prohibition on the sale of the same product to third parties; (v) The manufacturer is obligated to surrender the licences after the term of the contract. The submission is that but for the agreement between the assessee and the manufacturer, the product could not be manufactured by the latter, to whom according to the Revenue, the work was entrusted. Counsel submits that there is an element of confidentiality involved in the provision of specifications and formulations by the assessee to its manufacturer. The covenants contained in the agreement will according to the Revenue lead to the conclusion that the contract is a contract for work and is hence within the purview of Section 194C. 7) On the other hand, it has been urged on behalf of the assessees that (i) There is a well settled distinction in law between a contract for 'work' and a contract for 'sale'. (ii) Right from the inception, the understanding of the Revenue was elucidated in circulars issued by the Central Board of Direct Taxes to the effect that a contract of sale would not fall within the purview of Section 194C; (iii) The cir ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d on the execution of a works contract and the expression 'work' must mean a works contract; (ii) The deduction under Section 194C could arise only to the extent to which the sum credited to the contractor comprises an element of income. The submission was not accepted by the Supreme Court. The Supreme Court held that there was no rationale to restrict the ambit of the plain words used in Section 194C to a works contract and the expression 'any work' would mean what the Section says, namely, 'any work' and not a works contract which has a special connotation in tax law. The Supreme Court held thus:- "....there is nothing in the sub-section which could make us hold that the contract to carry out a work or the contract to supply labour to carry out a work should be confined to "works contract" as was argued on behalf of the appellant. We see no reason to curtail or to cut down the meaning of the plain words used in the section. "Any work" means any work and not a "works contract", which has a special connotation in the tax law. Indeed, in the sub-section, the "work" referred to therein expressly includes supply of labour to carry out a work. It is a clear indication of the Le ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n this appeal, what needs to be emphasised are these facets: (i) The understanding of the Revenue was that Section 194C would not cover a contract for the sale of goods; (ii) Contracts for the processing of goods supplied by the Government or by a specified person where the ownership of the goods remains with the Government or such person at all times, would fall within the purview of Section 194C; (iii) Contracts for fabrication where the material was supplied by the Government or by a specified person and the fabrication was done by a contractor would also fall within the purview of Section 194C; (iv) Where a contractor undertakes to supply goods in accordance with specifications furnished to him and the property in the goods passes to the purchaser only after delivery, the contract would be regarded as a contract for sale and would be outside the purview of Section 194C. The illustration which was furnished in the circular was of sea and river crafts. The principles which emerged from the circular, however, are as summarised earlier. 12) The next circular, No.108, dated 20th March, 1973, emphasised that a contract for the sale of goods would lie outside the purview of Section 1 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e subject matter of precedent on the subject. The principles, as decided cases would show, are well defined but the application of those principles to individual cases often poses a difficulty. The consistent line of thinking that emerges from decided cases is that essentially, in determining as to whether a contract constitutes one for work or is a contract of sale, it is the dominant interest and object of the parties in entering into the contract, as evinced by the terms of the contract, the circumstances of the contract and the custom of the trade that provide a guiding indicator. The object of the parties is of necessity to be deduced from the terms of the contract. In order to elucidate the distinction which has been made, it would be necessary to turn to some of the authorities on the subject. While dealing with the authorities, it would be necessary to note that some of the decided cases deal with issues under sales tax legislation and many of those judgments relate to the period prior to the enactment of the Forty Sixth Amendment to the Constitution. The technicalities of sales tax legislation, especially as a consequence of the Forty Sixth amendment do not fall for determ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rs & Engineering Co. Pvt. Ltd. V/s. The Commissioner of Sales Tax {A.I.R. 1978 Supreme Court 1747}, this principle was reiterated by the Supreme Court. In State of Tamil Nadu V/s. Anandam Viswanath {A.I.R. 1989 Supreme Court 962}, the contract in question involved supply and printing of question papers to Universities. The assessee entered into those contracts for printing and the question involved was whether the taxable turnover for the purpose of the Tamil Nadu General Sales Tax, 1959 would include the printing and block making charges. The Supreme Court held that the contract in question was a contract of work, having regard to the nature of the job to be done and the confidence reposed in the contractor for work to be rendered. The supply of paper was merely incidental. More recently, in State of A.P. V/s. Kone Elevators (India) Ltd. {(2005) 3 Supreme Court Cases 389}, the assessee was under the terms of the contract required to supply and install lifts to its customers, while it was the customers' obligation to undertake work connected in keeping the site ready for installation. The Supreme Court noted that under its contractual obligations, the assessee had undertaken ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... transaction and the custom of the trade. It is the substance of the contract document/s and not merely the form, which has to be looked into. The court may form an opinion that the contract is one whose main object is transfer of property in a chattel as a chattel to the buyer, though some work may be required to be done under the contract as ancillary or incidental to the sale, then it is a sale. If the primary object of the contract is the carrying out of work by bestowal of labour and services and materials are incidentally used in execution of such work then the contract is one for work and labour. (3) If the thing to be delivered has any individual existence before the delivery as the sole property of the party who is to deliver it, then it is a sale. If A may transfer property for a price in a thing in which B had no previous property then the contact is a contract for sale. On the other hand where the main object of work undertaken by the payee of the price is not the transfer of a chattel qua chattel, the contract is one for work and labour. (4) The bulk of material used in construction belongs to the manufacturer who sells the end-product for a price, then it is a stron ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , commencing from 29 May, 1972 that contracts for the sale of goods would lie outside the purview of Section 194C, that reflected a correct understanding of the position as it stood in Indian Law in regard to the distinction between a contract of work and a contract for the sale of goods. Section 194C applied to a contract for carrying out any work. A contract for sale is not and has not in law been regarded as a contract for work. The judgment of the Supreme Court in Associated Cement, undoubtedly emphasised that the expression "any work" in Section 194C has a broad connotation and would cover work of every description. The case before the Supreme Court involved a contract for the loading of goods into trucks or wagons. The argument of the assessee that Section 194C would cover only a works contract was repelled. 20) Following the decision of the Supreme Court in Associated Cement, the Central Board of Direct Taxes issued a circular on 8 March, 1994 stipulating that Section 194C would apply to all types of contract for carrying out any work, including transport contracts. The circular was challenged before the Rajasthan High Court which held it to be valid. The decision of the Su ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on 21) Broadly speaking, three situations are involved in the manufacture of pharmaceutical products. In the first situation, the pharmaceutical company itself manufactures pharmaceutical preparations which are sold under its brand name. The second situation involves loan licensing where the raw materials are supplied by the pharmaceutical company to the licensee manufacturer who in turn manufactures a pharmaceutical product on behalf of the Company. The third situation is one where by an agreement between a pharmaceutical company and a manufacturer, it is the manufacturer who procures the raw materials and manufactures the product under the specifications of the company and sells the end product to the Company. In the third situation, the manufacturer may also affix the trade mark or brand name of the Company, which in turn markets the product. The present case relates to the third category where admittedly, the entire process of manufacturing is carried out by a third party with whom the assessee has a contract. The work of manufacture is carried out at the establishment of the third party manufacturer. The raw materials are purchased by the third party manufacturer. The contra ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rer is required by the terms of the agreement to affix the trade-mark of the assessee on the products manufactured, subject to the obligation not to use the mark upon the termination of the agreement. On the termination of the agreement or cessation the licences have to be surrendered. 23) Counsel appearing on behalf of the Revenue submitted that the conditions of the agreement under which the manufacturer affixes the mark of the assessee; uses a formulation provided by the assessee; and is obligated not to sell the product to others, detracts from the contract being a contract of a sale. According to counsel, the restrictions which have been imposed on the manufacturer in the present case are: (i) To utilise the formula provided by the assessee; (ii) To affix the trade-mark of the assessee; and (iii) To deal exclusively with the assessee. These according to counsel must result in an inference that the contract is not a contract of sale. 24) The submission that the contract is not a contract of sale because, specifications are provided to the manufacturer by the purchaser cannot be accepted. That has not been the understanding of the law at any point of time. The fact that the pu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... have supplied the labels to any other establishment in the market. The finding that there was no marketability was also held to be vitiated since it was based on a fallacious premise that the seller was printing an unlimited number of labels. The judgment of the Division Bench of this Court, therefore, clearly reflected the position of law that providing a specification to the manufacturer who produces the article or thing would not detract from the nature of the transaction as a sale so long as the purchaser had not supplied raw material to the seller; and there was nothing to indicate that the seller was a captive unit of the purchaser. Such a contract would be a contract of sale. A similar view was taken in other judgments of the High Court, to which it would be necessary to refer to. The Delhi High Court reiterated the principle in its decisions in Commissioner of Income Tax V/s. Dabur India Ltd. {(2006) 283 I.T.R. 197 (Delhi)}and CIT Vs. Scagram Manufacturing Private Limited {(2009) 221 ITR (DCI) 509} Another decision of the Delhi High Court in Commissioner of Income Tax V/s. Reebok India Co. {(2008) 306 I.T.R. 124 (Delhi)} involved a case where the assessee had entered into ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ) as follows: "manufacturing or supplying a product according to the requirement or specification of a customer by using material, purchased from such customer, but does not include manufacturing or supplying a product according to the requirement or specification of a customer by using material purchased from a person, other than such customer". 27) The reason why clause (e) has been incorporated in the explanation has been explained in the Memorandum explaining the provisions of the Finance Bill of 2009. The Memorandum contains the following statement:-c. Clarification regarding "work" under section 194C. There is ongoing litigation as to whether TDS is deductible under section 194C on outsourcing contracts and whether outsourcing constitutes work or not. To bring clarity on this issue, it is proposed to provide that "work" shall not include manufacturing or supplying a product according to the requirement or specification of a customer by using raw material purchased from a person other than such a customer as such a contract is a contract for "sale". This will however not apply to a contract which does not entail manufacture or supply of an article or thing (e.g., a construct ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... product or thing is manufactured to the specifications of a customer, the agreement would constitute a contract for sale, if (i) The property in the article or thing passes to the customer upon delivery; and (ii) The material that was required was not sourced from the customer / purchaser, but was independently obtained by the manufacturer from a person other than the customer. The rationale for this was that where a customer provides the material, what the manufacturer does is to convert the material into a product desired by the customer and ownership of the material being of the customer, the contract essentially involves work of labour and not a sale. Parliament recognized the distinction which held the field both administratively in the form of circulars of the CBDT and judicially in the judgments of several High Courts to which a reference has been made earlier. Consequently, the principles underlying the applicability of Section 194C as construed administratively and judicially in decided cases, find statutory recognition in the Explanation. The Explanation, therefore, as the Memorandum explaining the clauses of the Finance Bill of 2009 states, was in the nature of a clarifi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... erwise legal owners are deemed to be owners for certain purposes. The Finance Bill of 1987 contained in its Memorandum a statement that as measure of rationalisation the bill sought to enlarge the meaning of the expression "owner of house property" in clause (iii) of Section 27 by providing that a person who comes to have control over the property by virtue of such transactions as referred to in Section 269UA(f) will also be deemed to be the owner of the property. The Supreme Court held that from the Memorandum explaining the Finance Bill of 1987 it was crystal clear that the amendment was intended to supply an obvious omission or to clear up doubts as to the meaning of the word 'owner' in Section 22 and it was, therefore, declaratory or clarificatory. The same principle was applied in Allied Motors (P) Ltd. V/s. Commissioner of Income Tax {(1997) 224 I.T.R. 677 (S.C.). In that case, the Supreme Court held that "a proviso which is resorted to remedy unintended consequences and to make the provision workable" or one "which supplies an obvious omission in the Section and is required to be read into the section to give the Section a reasonable interpretation", requires to be treated a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... diced by the consumption of a product not meeting prescribed standards. The owner of a mark, therefore, introduces specifications to ensure that the product meets the standards justifiably associated with the reputation in the mark. The specification ensures the observance of standards. Similarly, a clause relating to exclusivity is not inconsistent with a transaction of sale. Here again, much depends upon the nature of the product. Restrictive covenants of this kind are intended to protect the intellectual and other property rights of a party which markets its goods by requiring a manufacturer to observe norms of specification and exclusivity. The law is, therefore, consistent with the transaction being regarded as a transaction of sale, provided that the requirements of a contract of sale are met. They are in this case. The contract entered into by the assessee is not a contract for carrying on any work within the meaning of Section 194C. Conclusions: 33) For the reasons aforesaid, we are of the view that the Revenue was not justified in treating the assessee, as an assessee in default. The Tribunal was justified in coming to the conclusion which it did, though for the reasons ..... X X X X Extracts X X X X X X X X Extracts X X X X
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