The question whether contract manufacturing agreements are subject to s. 194C has been decided by the Bombay High Court in Glenmark Pharmaceuticals Ltd. ITA No. 2256 of 2009 and other matters in favour of the assessees.
In an oral judgement pronounced today 12th March 2010, the Court held that while “works contracts” were subject to TDS under section 194C, “sales contracts” were not.
It upheld the arguments of the pharmaceutical companies that the contract manufacturing agreements entered into by them with other manufacturers amounted to a “sales contract” which was not liable to TDS u/s 194C.
Full Text of the case is as follows :-
HIGH COURT OF BOMBAY
CIT Vs Glen mark Pharmaceuticals Limited
324 ITR 199 (Bom)
ITA No. 2256 of 2009
DR. D.Y. CHANDRACHUD, J.: The appeal by the Revenue is u/s. 260A of the IT Act, 1961. This Court has to interpret the ambit of the expression ‘any work’ for the purpose of s. 194C of the Act. The assessee has an agreement with a third party for the manufacture of certain pharmaceutical products. The assessee provides the formulations and specifications. The manufacturer affixes the trademark of the assessee on the articles produced. The raw materials are purchased by the manufacturer. Property in the goods passes to the assessee only on delivery. This agreement is on a principal to principal basis. The assessee contends that the contract is a contract of sale. The Revenue contends that the contract is a contract of ‘work’ and tax was deductible at source u/s. 194C. The appeal by the Revenue raises the following substantial question of law:
“Whether on the facts and in the circumstances of the case, the Tribunal 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 s. 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 s. 194C. The appeal filed by the assessee was allowed.
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 trademark of the assessee. The AO required the assessee to explain why it had not deducted tax at source u/s. 194C and should not be treated as an assessee in default u/s. 201(1). The AO rejected the explanation of the assessee and treated the assessee as in default of Rs. 51,09,347 for not deducting tax at source. The assessee was held liable to pay that amount. The assessee was also called upon to pay interest u/s. 201(1A). The order of the AO pertained to asst. yr. 2006- 07.
4. The CIT(A) confirmed the order of the AO. On an appeal filed by the assessee, the Tribunal by its decision dt. 5th March, 2009 held that in the present case, the assessee had placed orders with manufacturers for manufacturing pharmaceutical products according to the specifications provided by the assessee, and property in the goods passed to the assessee only after delivery. The manufacturers purchased raw materials at their own cost. Though the products were manufactured in accordance with the specifications of the assessee, the manufacturer carried out the process of manufacturing at his own establishment, engaged his own labour force, purchased the raw materials and paid excise duty and sales tax. The property in the goods passed to the assessee only upon the delivery of the product. The Tribunal followed the decision of this Court in BDA Ltd. Vs. ITO (2006) 201 CTR (Bom) 413 : (2006) 281 ITR 99 (Bom) and came to the conclusion that the agreements which were entered into by the assessee with manufacturers were not contracts for work within the meaning of s. 194C. Consequently, the assessee could not be treated as being in default u/s. 201(1) nor could it be subject to the levy of interest u/s. 201(1A) for failure to deduct tax at source.
5. This appeal has been placed for hearing with a batch of matters involving the same question. We have heard arguments on behalf of the assessees and the Revenue by counsel appearing in the present appeal and in the companion appeals.
6. On behalf of the Revenue, the submission of counsel is that from the agreement entered into between the assessee and the third party manufacturer, the following salient features would emerge:
(i) The trade name affixed on the goods is of the assessee;
(ii) The formulation is given by the 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 clement 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 s. 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 CBDT to the effect that a contract of sale would not fall within the purview of s. 194C;
(iii) The circulars of the CBDT reflected the understanding that when any work of fabrication is carried out in accordance with the specifications of the buyer, and the final product is sold to the purchaser that would constitute a contract of sale in a situation where the raw material is not supplied by the purchaser but is purchased on his own account by the manufacturer of the goods. The property in the goods continues to vest in the manufacturer until delivery is effected to the assessee after the manufacture of the product;
(iv) The consistent understanding of the provisions of s. 194C has been embodied in the amendment of the Explanation to the provision by the Finance Act of 2009.
The underlying purpose of the Explanation is to place beyond doubt the consistent intent that a contract for sale was never regarded as falling within the purview of s. 194C and it is only where the raw material is supplied by a purchaser to the manufacturer that the contract would be regarded as a contract for work within the meaning of s. 194C; (v) The amendment effected by the Finance Act of 2009 is clarificatory. The assessee is not in default for not deducting tax at source.
Sec. 194C: The judgement in Associated Cement
8. Sec. 194C, as it stood at the material time, provided that any person responsible for paying any sum to any resident ‘for carrying out any work’ including the supply of labour for carrying any work in pursuance of a contract between the contractor and a company (or with any of the other entities referred to therein) shall at the time of the credit of such sum to the account of the contractor or at the time of payment thereof in cash or at the time of payment thereafter, deduct an amount stipulated in the provision as income-tax on income comprised therein. The crucial words in s. 194C upon which the balance in the case lies, are “carrying out any work”. The words as they stand have a broad connotation.
9. The Supreme Court had occasion to interpret the expression “any work” in the judgment in Associated Cement Company Ltd. Vs. . CIT (1993) 111 CTR (SC) 165 : (1993) 201 ITR 435 (SC). The contract there involved loading of cement bags into wagons or trucks. The contention of the assessee was that (i) The question of deducting an amount u/s. 194C(1), out of the sum credited or paid to the contractor, would arise when the sum is paid on the execution of a works contract and the expression ‘work’ must mean a works contract; (ii) The deduction u/s. 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 s. 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 legislature that the ‘work’ in the sub-section is not intended to be confined to or restricted to ‘works contract’. ‘Work’ envisaged in the sub-section, therefore, has a wide import and covers ‘any work’ which one or the other of the organisations specified in the sub-section can get carried out through a contractor under a contract and further it includes obtaining by any of such organisations supply of labour under a contract with a contractor for carrying out its work which would have fallen outside the ‘work’, but for its specific inclusion in the sub-section.”
10. The ambit of s. 194C formed the subject-matter of several circulars of the CBDT, both before and after the judgement of the Supreme Court in Associated Cement. The first Circular No. 86, dt. 29th May, 1972 inter alia provided as follows:
“The deduction of income-tax will be made from sums paid for carrying out any work or for supplying labour for carrying out any work. In other words, the new provision will apply only in relation to ‘works contracts’ and ‘labour contracts’ and will not cover contracts for sale of goods.
Since contracts for the construction of buildings or dams or laying of roads and air-fields or railway lines or erection or installation of plant and machinery are in the nature of contracts for work and labour, income-tax will have to be deducted from payments made in respect of such contracts. Similarly, contracts granted for processing of goods supplied by Government or any other specified person, where the ownership of such goods remains at all times with the Government or such person, will also fall within the purview of the new section. The same position will obtain in respect of contracts for fabrication of sea and river crafts where materials are supplied by the Government or any other specified person and the fabrication work is done by a contractor. Where, however, the contractor undertakes to supply any sea or river crafts fabricated according to the specifications given by Government or any other specified person and the property in such sea and river crafts passes to the Government or such person only after such crafts are delivered, the contract will be a contract for sale and, as such, outside the purview of the new provision.”
11. From the circular, insofar as is material to the issue in this appeal, what needs to be emphasised are these facets: (i) The understanding of the Revenue was that s. 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 s. 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 s. 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 s. 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, dt. 20th March, 1973, emphasised that a contract for the sale of goods would lie outside the purview of s. 194C. The circular continued to reiterate the understanding of the Revenue that in a situation where the purchaser supplies material for fabrication and the work of fabrication is carried out in accordance with the specification, such a contract would be treated as a contract for work within the meaning of s. 194C. On the other hand, where a contractor carries out the work of fabrication by purchasing his own materials and the property in the goods passes to the purchaser only upon delivery, such a contract would lie beyond the purview of s. 194C.
13. On 8th Oct., 1993 following the decision of the Supreme Court in Associated Cement, a fresh Circular No. 666 [(1993) 114 CTR (SO 62], was issued which provided that the term “any work” in s. 194C has to be understood in its natural connotation and would mean any work and not only a works contract. The circular stated that the provisions of s. 194C would be applicable to all types of contracts for carrying out any work, such as transport contracts, service contracts, labour contracts, material contracts as well as works contracts. By a circular issued on 8th March, 1994 [Circular No. 681-Ed.] the CBDT withdrew Circular No. 86 of 29th May, 1972 and para 11 of Circular No. 108, dt. 29th March, 1973 and provided that s. 194C would apply to all types of contracts for carrying out any work including transport contracts, service contracts, advertisement contracts, broadcasting contracts, telecasting contracts, labour contracts, material contracts and works contracts. Despite that, the circular however continues to assert that “the provisions of this section will not cover contracts for sale of goods”. The circular continued to reiterate that a contract for fabrication of articles or things where materials were supplied by the Government or by a specified person and the fabrication work is done by a contractor would fall within the purview of s. 194C. On the other hand, where a contractor undertook to supply an article or thing fabricated according to the specifications given by Government or by any other specified person and the property in such article or thing would pass only upon delivery, the contract would be a contract for sale and would lie outside the purview of the section.
Contract of work or a contract of sale
14. The question as to whether a contract is a contract of work or a contract of sale is the 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 determination in this proceeding. The decided cases are being referred to only with a view to emphasise the distinction between a contract for work and a contract for sale.
15. In Government of Andhra Pradesh Vs. Guntur Tobaccos Ltd. AIR 1965 SC 1396, the Supreme Court held that in the execution of a contract of work some materials may be used and property in the goods so used passes to the other party. However, the contractor who undertakes to do the work will not necessarily be deemed on that account to sell the materials. The Supreme Court noted that a contract for work in the execution of which goods are used may take one or three forms. Those three forms were elaborated as follows:
“The contract may be for work to be done for remuneration and for supply of materials used in the execution of the works for a price; it may be a contract for work in which the use of materials is accessory or incidental to the execution of the work; or it may be a contract for work and use or supply of materials though not accessory to the execution of the contract is voluntary or gratuitous. In the last class there is no sale because though property passes it does not pass for a price. Whether a contract is of the first or the second class must depend upon the circumstances: if it is of the first; it is a composite contract for work and sale of goods: where it is of the second category, it is a contract for execution of work not involving sale of goods.”
16. In a subsequent decision in the State of Himachal Pradesh & Ors. Vs. Associated Hotels of India Ltd. AIR 1972 SC 1131, the Supreme Court held that a contract for sale is one whose main object is the transfer of property in, and the delivery of the possession of, a chattel as a chattel to the buyer. Where the principal object of the work undertaken by the payee of the price is not the transfer of a chattel, the contract is one of work and labour. The test is whether or not the work and labour bestowed end in anything that can properly become the subject of sale; neither the ownership of material, nor the value of the skill and labour as compared with the value of the material, is conclusive, though these circumstances may be taken into consideration in deciding whether a subsisting contract is a contract of work and labour or contract for a sale of a chattel. In Sentinel Rolling Shutters & Engineering Co. (P) Ltd. Vs. . CST AIR 1978 SC 1747, this principle was reiterated by the Supreme Court. In State of Tamil Nadu Vs. . Anandam Viswanath AIR 1989 SC 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 Act, 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 Andhra Pradesh Vs Kone Elevators (India) Ltd. (2005) 3 SCC 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 the installation of lifts manufactured and brought to site in a knocked-down state and the contract in question was a contract of sale and not a works contract. The distinction between a contract of sale and a works contract found elaboration in the following observations:
“If the intention is to transfer for a price a chattel in which the transferee had no previous property, then the contract is a contract for sale. Ultimately, the true effect of an accretion made pursuant to a contract has to be judged not by artificial rules but from the intention of the parties to the contract. In a ‘contract of sale’, the main object is the transfer of property and delivery of possession of the property, whereas the main object in a ‘contract for work’ is not the transfer of the property but it is one for work and labour. Another test often to be applied is: when and how the property of the leader in such a transaction passes to the customer: is it by transfer at the time of delivery of the finished article as a chattel or by accession during the procession of work on fusion to the movable property of the customer? If it is the former, it is a ‘sale’; if it is the latter, it is a ‘works contract’. Therefore, in judging whether the contract is for ‘sale’ or for ‘work and labour’, the essence of the contract or the reality of the transaction as a whole has to be taken into consideration. The predominant object of the contract, the circumstances of the case and the custom of the trade provide a guide in deciding whether transaction is a ‘sale’ or a ‘works contract’. Essentially, the question is of interpretation of the ‘contract’. It is settled law that the substance and not the form of the contract is material in determining the nature of transaction.”
17. In Hindustan Shipyard Ltd. Vs. State of Andhra Pradesh (2000) 119 STC 533 (SC), the Supreme Court enunciated certain principles which were deduced from the decided cases on the distinction between the two concepts. The second, third and fourth principles laid down in the judgement of the Supreme Court, read thus:
“(2) Transfer of property of goods for a price is the linchpin of the definition of ‘sale’. Whether a particular contract is one of sale of goods or for work and labour depends upon the main object of the parties found out from an overview of the terms of the contract, the circumstances of the 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 contract 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 strong pointer to a conclusion that the contract is in substance one for the sale of goods and not for work and labour. However, the test is not decisive…………”
18. A contract for sale has hence to be distinguished from a contract of work. Whether a particular agreement falls within one or the other category depends upon the object and intent of the parties, as evidenced by the terms of the contract, the circumstances in which it was entered into and the custom of the trade. The substance of the matter and not the form is what is of importance. If a contract involves the sale of movable property as movable property, it would constitute a contract for sale. On the other hand, if the contract primarily involves carrying on of work involving labour and service and the use of materials is incidental to the execution of the work, the contract would constitute a contract of work and labour. One of the circumstances which is of relevance is whether the article which has to be delivered has an identifiable existence prior to its delivery to the purchaser upon the payment of a price. If the article has an identifiable existence prior to its delivery to the purchaser, and when the title to the property vests with the purchaser only upon delivery, that is an important indicator to suggest that the contract is a contract for sale and not a contract for work. In India, the distinction between the two categories is elucidated by the Sale of Goods Act, 1930. Sub-s. (1) of s. 4 provides that a contract of the sale of goods is a contract, whereby a seller transfers or agrees to transfer the property in goods to the buyer for a price. Where under a contract of sale, the property in goods is transferred from the seller to the buyer, the contract is that of sale, but where transfer of property in the goods is to take place at a future time, or subject to some condition thereafter to be fulfilled, the contract is not a sale but is an agreement to sell. A contract of sale is made by an offer to buy or sell goods for a price and the acceptance of the offer. Under s. 5(1) the contract may provide for immediate delivery of the goods or immediate payment of the price or postponement of delivery or payment of the price by instalments.
Birla Cement-Contracts for carriage of goods
19. In this background, when the circulars issued by the CBDT clarified, commencing from 29th May, 1972 that contracts for the sale of goods would lie outside the purview of s. 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. Sec. 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 judgement of the Supreme Court in Associated Cement, undoubtedly emphasised that the expression ‘any work’ in s. 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 s. 194C would cover only a works contract was repelled.
20. Following the decision of the Supreme Court in Associated Cement, the CBDT issued a circular on 8th March, 1994 stipulating that s. 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 Supreme Court in appeal was rendered in Birla Cement Works Vs. . CBDT & Ors. (2001) 166 CTR (SC) 291 : (2001) 248 ITR 216 (5C). The agreement that came up for consideration before the Supreme Court involved transportation of goods between different destinations by transport operators. Parliament had in the meantime inserted Expln. III into s. 194C w.e.f. 1st July, 1995. As a result, contracts of carriage were brought within the fold of the provision, among other contracts. The other contracts were contracts for advertising, broadcasting and telecasting and catering. The Supreme Court noted that right from 1st April, 1972 until the circular dt. 8th March, 1994 was issued the understanding of the Revenue was that s. 194C would not apply at all to transportation contracts. The Supreme Court in its earlier judgement in Associated Cement held that ‘any work’ within the meaning of s. 194C can be work of any other description. In Birla Cement Works, the Supreme Court held that the specific question as to whether work involving carriage of goods would fall within the ambit of s. 194C was not decided in Associated Cement. The Supreme Court noted that the decisions of the High Courts of Bombay, Calcutta, Karnataka, Gujarat, Madras, Orissa and Delhi were to the effect that the expression ‘carrying any work’ would not include carriage of goods. The Supreme Court accepted the submission that the word ‘work’ must be understood in the limited sense as a product or result. Two interpretations of s. 194C were, according to the Supreme Court, reasonably possible, on the question as to whether a contract for carriage of goods would fall within the purview of the provision. Since the view taken by several High Courts had held the field for a long period, the Supreme Court held that this view should not be disturbed. Consequently, the Supreme Court held that Expln. III which was inserted in s. 194C w.e.f. 1st July, 1995 would not be applicable to transport contracts which involved contracts for carriage of goods prior to the date of its insertion. The Supreme Court declined to disturb the understanding which had held the field for over two decades, particularly in view of the fact that it reflected an interpretation which had been placed on the provision by several High Courts.
Pharmaceutical industry: The agreement in question
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 trademark 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 contract envisages that the trademark of the assessee is to be affixed to the goods manufactured by the third party.
The contract in issue in the appeal
22. The salient aspects of the contracts that form the subject-matter of the present appeal have to be considered. The attention of the Court is drawn to an agreement dt. 18th May, 2005 entered into between the assessee, Glenmark Pharmaceuticals and Maxim Pharmaceuticals (P) Ltd. The agreement envisages that the assessee has developed certain pharmaceutical formulations which it intends to market under specified brand names. The assessee agreed to disclose to the manufacturer technical information and data relating to the manufacture of the products in accordance with the specifications and standards laid down by the assessee. The process of manufacturing is to be carried out by the manufacturer at its own establishment. The assessee has to purchase the entire quantity of the product manufactured at a price to be mutually agreed upon between the parties. The manufacturer is obligated under the terms of the agreement to obtain a licence to manufacture and to obtain the endorsement of the Food & Drug Administration on the licence. The agreement envisages that the transaction between the parties is on a principal to principal basis. The assessee is required from time to time to place orders for the supply of the product in such quantities and at the agreed price, which the manufacturer has to supply. The agreement specifically stipulates that the manufacturer will be solely and exclusively responsible for the purchase, procurement and storage of raw materials required for the manufacture of the product. All approvals, licences, permits, permissions and sanctions are to be obtained by the manufacturer and to be kept valid during the term of the contract. The agreement envisages that the manufacturer is an independent contractor and is solely responsible for payment of taxes, duties and other impositions, under the agreement. The property in the product is to vest in the assessee on delivery of the product. The manufacturer has undertaken not to sell or supply the products which are to be manufactured for the assessee to any third party or to undertake the manufacture or sale of similar products to any third party. The assessee is entitled to inspect the facility and to approve the goods manufactured. The manufacturer is required by the terms of the agreement to affix the trademark 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 trademark 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 purchaser provides specifications to the manufacturer has never been construed even by the Revenue to be a circumstance which should lead to the inference that the contract is not a contract of sale. Firstly, the circulars issued by the CBDT right since 29th May, 1972 consistently took the position that furnishing of specifications to the manufacturer of goods by the purchaser would not detract from a contract being regarded as a contract for sale so long as the property in the goods passes upon delivery. The consideration which was regarded by the Revenue as having relevance was whether the material was supplied to the contractor by the Government, or, as the case may be, by a specified person. Where the material is provided by the purchaser and the work of fabrication or manufacture is carried out by the contractor, the agreement would, it was clarified, constitute a contract for work. On the other hand, where a manufacturer produces goods to the specifications of the purchaser and the property passes to the purchaser only upon delivery, the contract would be regarded as a contract of sale if the raw material is sourced by manufacturer and is not supplied to him by the purchaser. Secondly, the consistent view which held the field in several High Courts was that contracts where
(i) property passes to the purchaser upon the delivery of the goods; and
(ii) the raw material was sourced by the manufacturer and was not supplied by the purchaser do not fall within the scope and ambit of s. 194C.
In this Court, a Division Bench in BDA Ltd. dealt with a case where a manufacturer of Indian made foreign liquor entered into an agreement for printing labels which were to be affixed on liquor bottles. The question was whether the agreement for printing and packing material involved a contract of sale or a contract of work. The Division Bench noted that the assessee had supplied specifications to the seller for printing labels but the raw materials were not supplied by the assessee. The printing work was not carried out at the premises of the assessee and the seller was not a captive unit of the assessee. The Division Bench held that the seller could obviously not print beyond the quantity specified in the purchase order. Hence, the Tribunal had erred in relying upon the circumstance that the seller who was producing the labels could not 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 judgement 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 judgements of the High Court, to which it would be necessary to refer to. The Delhi High Court reiterated the principle in its decisions in CIT Vs. . Dabur India Ltd. (2005) 198 CTR (Del) 375 : (2006) 283 ITR 197 (Del) and CIT Vs. . Seagram Manufacturing (P) Ltd. (2009) 221 CTR (Del) 509 : (2009) 17 DTR (Del) 276. Another decision of the Delhi High Court in CIT Vs. . Reebok India Co. (2009) 221 CTR (Del) 508 : (2009) 17 DTR (Del) 274 : (2008) 306 ITR 124 (Del) involved a case where the assessee had entered into an agreement with a manufacturer who manufactured footwear, apparel accessories and sports goods for the assessee. The Delhi High Court affirmed the judgement of the Tribunal that the provisions of s. 194C were not attracted. The Gujarat High Court had occasion to deal with a contract relating to supply of printing and packing materials in its decision in CIT Vs. . Girnar Food & Beverage (P) Ltd. (2008) 306 ITR 23 (Guj). The Punjab & Haryana High Court dealt with a contract for the supply of packing material in its decision in CIT Vs. . Dy. Chief Accounts Officer, Mark fed (2008) 217 CTR (P&H) 555 : (2008) 5 DTR (P&H) 326 : (2008) 304 ITR 17 (P&H). Sec. 194C was held not to be attracted. Speaking for a Division Bench of this Court, one of us (Shri Justice J.P. Devadhar) held in The East India Hotels Ltd. Vs. . CBDT (2009) 223 CTR (Bom) 183 : (2009) 21 DTR (Bom) 244 that the words “carrying out any work” in s. 194C are limited to any work which is carried out to culminate into a product or result. The Court held that the service rendered by a hotel to its customers by giving certain facilities and/or amenities did not involve carrying out work within the purview of s. 194C.
The Explanation to s. 194C
25. The Explanation to s. 194C inter alia defines the expression “work”. The expression work has been defined to include contracts for advertising, broadcasting and telecasting; carriage of goods and passengers by any mode of transport, other than by railways and catering. Initially, Expln. III was included in s. 194C by the Finance Act of 1995 w.e.f. 1st July, 1995. As inserted, the Explanation reads as follows:
“Explanation III-For the purposes of this section, the expression, ‘work’ shall also include-
(b) broadcasting and telecasting including production of programmes for such broadcasting or telecasting;
(c) carriage of goods and passengers by any mode of transport other than by railways;
The Amendment of 2009
26. By the Finance Act of 2009, which substituted the provisions of s. 194C, the expression “work” has now been defined in cl. (iv) of the substituted Explanation. Clauses (a) to (d) are the same as cls. (a) to (d) of the erstwhile Expln. III. However, Expln. (e) has now been inserted. As a result, the expression “work” has been defined in cl. (e) 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 cl. (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’ u/s. 194C.
There is ongoing litigation as to whether TDS is deductible u/s. 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 construction contract). It is also proposed to include manufacturing or supplying a product according to the requirement or specification of a customer by using material purchased from such customer, within the definition of ‘work’.”
28. Hence, what has weighed in the introduction of cl. (e) to the Explanation was ongoing litigation on the question as to whether TDS was deductible on outsourcing contracts. Clause (e) was introduced “to bring clarity on this issue” or, in other words, to remove the ambiguity on the question. Clause (e) as introduced contains a positive affirmation that the expression ‘work’ will cover manufacturing or supplying a product, according to the requirement or specification of a customer, by using material purchased from such a customer. Clause (e) has placed the position beyond doubt by incorporating language to the effect that the expression ‘work’ shall not include manufacture or supply of a product according to the requirement or specification of a customer by using material which is purchased from a person other than such customer. In other words, the circumstance that the requirements or specifications are provided by the purchaser is not regarded by the statute as being dispositive of the question as to whether a contract constitutes a contract of work or sale. What is of significance is whether material has been purchased from the customer, who orders the product. When the material is purchased from the customer who orders the product, it constitutes a contract of work while on the other hand, where the manufacturer has sourced the material from a person other than the customer, it would constitute a sale. What is significant is that in using the words which cl. (e) uses in the Explanation, Parliament has taken note of the position that was reflected in the circulars issued by the CBDT since 29th May, 1972. The judgement of the Supreme Court in Associated Cement gave an expansive definition to the expression work and rejected the attempt of the assessee in that case to restrict the expression work to works contracts. Both before and after the judgement of the Supreme Court the expansive definition of the expression ‘work’ co-existed with the Revenue’s understanding that a contract for sale would not be within the purview of s. 194C. The Revenue always understood s. 194C to mean that though a 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 recognised the distinction which held the field both administratively in the form of circulars of the CBDT and judicially in the judgements of several High Courts to which a reference has been made earlier. Consequently, the principles underlying the applicability of s. 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 t1w nature of a clarification. Where an explanatory provision is brought to remove an ambiguity or to clear a doubt, it is reflective of the law as it has always stood in the past. Where, as in the present case, an Explanation is introduced statutorily to adopt an understanding of the law both in the form of the circulars of the CBDT and in judicial decisions, Parliament must be regarded as having intended to affirm that intent. In the present case, the intent has held the field for over three decades.
29. Courts are often called upon to decide whether a legislative amendment is clarificatory in nature or declaratory of the law. If it is, the amendment has a retrospective effect. The legislature which intends to bring clarity to a legislative provision or to remove an ambiguity is inferred to do so at the inception. For, it would be contrary to the grain of human experience to infer that the legislature would while removing an ambiguity allow it to remain in the past, leaving a state of uncertainty to persist. In the Interpretation of Statutes by Justice G.P. Singh (Tenth Edn., 2006), the position of law has been stated as follows:
“(i) Declaratory statutes
If a new Act is ‘to explain’ an earlier Act, it would be without object unless construed retrospective. An explanatory Act is generally passed to supply an obvious omission or to clear up doubts as to the meaning of the previous Act. It is well settled that if a statute is curative or merely declaratory of the previous law retrospective operation is generally intended. The language ‘shall be deemed always to have meant’ is declaratory, and is in plain terms retrospective. In the absence of clear words indicating that the amending Act is declaratory, it would not be so construed when the pre-amended provision was clear and unambiguous. An amending Act may be purely clarificatory to clear a meaning of a provision of the principal Act which was already implicit. A clarificatory amendment of this nature will have retrospective effect”
This extract has been cited with approval by the Supreme Court and the principle which is formulated as aforesaid has been consistently applied.
30. In CIT Vs. Podar Cement (P) Ltd. (1997) 141 CTR (SC) 67 : (1997) 226 ITR 625 (SC), the Supreme Court considered the provisions of s. 27 of the IT Act under which certain persons who were not otherwise 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 cl. (iii) of s. 27 by providing that a person who comes to have control over the property by virtue of such transactions as referred to in s. 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 s. 22 and it was, therefore, declaratory or clarificatory. The same principle was applied in Allied Motors (P) Ltd. Vs. . CIT (1997) 139 CTR (SC) 364 : (1997) 224 ITR 677 (SC). 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 as retrospective in operation, so that a reasonable interpretation can be given to the section as a whole. Recently, the same principle has been laid down in CIT Vs. . Atom Extrusions Ltd. (2009) 227 CTR (SC) 417 : (2009) 32 DTR (SC) 49 : (2009) 319 ITR 306 (SC), where the Supreme Court considered the second proviso to s. 43B and held that it was curative in nature having regard to the fact that it was intended to bring about a degree of uniformity and to obviate problems in implementation. For the purpose of this case, it is not necessary to multiply authority, save and except to note that those principles have been applied in the judgements of the Supreme Court in Brij Mohan Das Laxman Das Vs. . CIT (1997) 138 CTR (SC) 214 : AIR 1997 SC 1651 and K. Govindan & Sons Vs. . CIT (2000) 164 CTR (SC) 490 : (2001) 247 ITR 192 (SC).
Trademarks and specifications:
31. The circumstances which have been pointed out on behalf of the Revenue will not detract from the character of the transaction as being a sale as distinct from a contract of work. The fact that the specifications are provided by the assessee to the manufacturer/ supplier would make no difference to the legal position. The agreement in the present case is on a principal to principal basis. The manufacturer has his own establishment where the product is manufactured. The material required in the manufacture of the article or thing is obtained by the manufacturer from a person other than the assessee. The property in the articles passes upon the delivery of the product manufactured. Until delivery, the assessee has no title to the goods. The goods have an identifiable existence prior to delivery.
32. The reason that a specification or requirement is enunciated by the assessee constitutes a matter of business expediency. A purchaser who desires to get the product, which he intends to sell under his brand name, or trademark, manufactured from a third party would be interested ill ensuring the quality of the product. The trademark has associated with it an assurance of the quality of the goods which are marketed traceable to the origin of the goods. Associated with the trademark is the goodwill and reputation which is associated with the mark. This is particularly so in the case of a pharmaceutical product where the ultimate consumer is legitimately entitled to ensure that her health is not prejudiced 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 s. 194C.
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 that we have indicated in this judgement. The Tribunal has during the course of its judgement observed and relied upon the circumstance that the manufacturer of the pharmaceutical products paid excise duty and sales-tax. This circumstance has not been regarded in this judgement as conclusive for the purpose of the present case. The decision in the present ease is structured, consistent with the law laid down by the Supreme Court, by the provisions of s. 194C, by the dominant nature of the transaction as evidenced by the terms of the contract, and the circumstances of the case.
34. For the reasons stated earlier, the question of law, as formulated shall stand answered in favour of the assessee and against the Revenue. The appeal is dismissed. There shall be no order as to costs.