1 cIN THE HIGH COURT OF JUDICATURE AT BOMBAY ORDINARY ORIGINAL CIVIL JURISDICTION INCOME TAX APPEAL NO.2256 OF 2009 The Commissioner of Income Tax-TDS, ) 9th Floor, Smt. K.G. Mittal Ayurvedic ) Hospital Bldg., Charni Road (West), ) Mumbai - 400 002. )..Appellant. V/s. M/s. Glenmark Pharmaceuticals Ltd., ) Glenmark House, HDO Corporate Building, ) Wing "A", B.D. Sawant Marg,, Chakala, ) Off Western Express Highway, Andheri(E), ) Mumbai - 99. )..Respondent. Mr. Suresh Kumar for appellant. Mr.Atul K. Jasani with P.C. Tripathi for respondent. CORAM : DR. D.Y.CHANDRACHUD AND J.P.DEVADHAR, JJ. DATED : 12TH MARCH, 2010 2 ORAL JUDGMENT (PER DR. D.Y.CHANDRACHUD, J.) 1) The appeal by the Revenue is under Section 260A of the Income Tax Act, 1961. This Court has to interpret the ambit of the expression 'any work' for the purpose of Section 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 under Section 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 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 3 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 Officer required the assessee to explain why it had not deducted tax at source under Section 194C and should not be treated as an assessee in default under Section 201(1). The Assessing Officer 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 under Section 201(1) A. The order of the Assessing Officer pertained to assessment year 4 2006-07. 4) The Commissioner of Income Tax (Appeals) confirmed the order of the Assessing Officer. On an appeal filed by the assessee, the Income Tax Appellate Tribunal by its decision dated 5 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 India Ltd. V/s. ITO1 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 Section 194C. Consequently, the assessee could not be treated 1 [2006] 281 ITR 99 (Bom) 5 as being in default under Section 201(1) nor could it be subject to the levy of interest under Section 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. Submissions : 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 6 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 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 7 after the manufacture of the product; (iv) The consistent understanding of the provisions of Section 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 Section 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 Section 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. Section 194C : the judgment in Associated Cement 8) Section 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 8 stipulated in the provision as income tax on income comprised therein. The crucial words in Section 194C upon which the balance in the case lies, are "carrying out any work". The words as they stands have a broad connotation. 9) The Supreme Court had occasion to interpret the expression "any work" in the judgment in Associated Cement Co. Ltd. V/s. Commissioner of Income-Tax2. 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 under Section 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 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 :- 2 [1993] 201 I.T.R. 435 9 "....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. " CBDT Circulars : 10) The ambit of Section 194C formed the subject matter of several circulars of the Central Board of Director Taxes (CBDT), both before and after the judgment of the Supreme in Associated Cement. The first circular, No.86, dated 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. 10 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. " (emphasis supplied) 11) From the circular, in so far 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 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 11 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 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 Section 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 Section 194C. 12 13) On 8 October, 1993 following the decision of the Supreme Court in Associated Cement, a fresh circular, No.666, was issued which provided that the term "any work" in Section 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 Section 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 8 March, 1994 the Central Board of Direct Taxes withdrew circular No.86 of 29 May, 1972 and paragraph 11 of Circular No.108 dated 29 March, 1973 and provided that Section 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 continue 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 Section 194. On the other hand, where a contractor 13 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 14 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 Govt. of Andhra Pradesh V/s. Guntur Tobaccos Ltd.3, 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 taken 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 3 A.I.R. 1965 Supreme Court 1396 15 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 and others V/s. M/s. Associated Hotels of India Ltd.4, 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. Pvt. Ltd. V/s. The Commissioner of Sales Tax5, this principle was reiterated by the Supreme Court. In 4 A.I.R. 1972 Supreme Court 1131 5 A.I.R. 1978 Supreme Court 1747 16 State of Tamil Nadu V/s. Anandam Viswanath6, 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.7, 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:- 6 A.I.R. 1989 Supreme Court 962 7 (2005) 3 Supreme Court Cases 389 17 " ...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. V/s. State of Andhra Pradesh8, 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 judgment 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 8 [2000]119 STC 533 (S.C.) 18 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