Hindustan Lever Ltd.... v. Asst. Commissioner O...

Rajendra Singh, A.M:— These appeals by the assessee are directed against the orders dated 5-2-2007 and 28-9-2997 of the CIT[A] for the A.Y 2004-2005 and 2005-2006. As disputes raised in both the appeals are common, these are being disposed of by a single consolidated order for the sake of convenience. The common dispute is regarding the decision of the authorities below treating the assessee in default u/s. 201[1] and consequential charge of interest u/s. 201[1A] for non deduction of tax at source.

3. Briefly stated the facts of the case are that the assessee who was engaged in the business of manufacture and marketing of soaps, shampoo, talcum powder, hair oils, tooth pastes and colour cosmetics etc., was also getting the finished products as well as packaging material manufactured through other concerns. A survey conducted u/s. 133A in the case of the assessee on 15-9-2004 showed that the assessee had not deducted tax at source in respect of payments made to the contract manufacturers. During the course of survey, copies of agreements regarding outsourcing of products were found, which contained the following provisions:

i. The seller shall manufacture and/or process the products at its unit by using the formulation provided by the assessee company and as per the specifications and the quality required by the assessee.

ii. As per the company/s instructions the seller shall affix the trade marks of the company to the finished products and also pack the same as per instructions of the company in rappers and cardboard boxes provided by the company which bear the trade mark, copyright and design of the company.

iii. The Seller agrees not sell or otherwise deal in, directly or indirectly in products bearing the company's trade mark, copy rights and design or any other marks, copy right and design similar to that of the company.

iv. The seller shall during the manufacture and/or process and packaging of the products and thereafter follow the quality control procedure prescribed by the company.

v. The completed and tagged product shall be strictly as per the specifications and quality as prescribed by the assessee company.

vi. The seller shall allow the personnel deputed by the company to oversee the obligations of the seller regarding the quality of the products, intellectuals property rights, confidentiality and the observance and performance of the terms and conditions of the contract.

vii. The seller shall not in any manner sell or deal with rejected products with any indication marking or with any logo, trade mark or trade name of the company or with the labels, rappers and packing materials.

viii. The seller, during the terms of contract and following the expiration or termination of the contract shall not disclose in any manner the Proprietary Information such as the specifications, formulations and batch record etc. to any body.

ix. On termination/expiry of the agreement the seller shall return to the company all documents containing technical information relating to the raw materials, packing materials supplied by the company and relating to the finished products and the seller shall not retain any copies or extracts of the documents containing such technical information or use the technical information or part thereof supplied to them by the company.

4. From the terms and conditions mentioned above, AO concluded that it was a case of work contract and the provisions of sec. 194C were attracted regarding deduction of tax at source. AO also noted from Circular No. 715 dated 8/8/1995, that provisions of sec. 194C could be applicable in respect of supply of printed material as per prescribed specifications. AO, therefore, asked the assessee to explain as to why the assessee could not be treated in default u/s. 201[1] and consequential action should be taken. As per the AO, the assessee mainly relied on CBDT's circular No. 681 dated 8/3/1994, in which Board had emphasized that even where the contractor undertakes to supply any article or thing according to the specifications given by the company, but the property in such article or thing passes to the company only after such article or thing is delivered, the contract will be a contract for sale and outside the purview of sec. 194C. The assessee also referred to the judgment of the Hon'ble High Court of Bombay in the case of Bda Ltd. v. Income-Tax Officer (Tds)] in tax appeal No. 44/2003 & 01/2004 in which the High Court had held that sale of packing material based on specifications is not covered by the provisions of sec. 194C. AO, however, rejected the explanation given it was observed by him that Circular No. 681 of CBDT and the judgment of the High Court of Bombay in the case of BDA LTD. [supra], were not applicable as in the present case the main object was to get the material or goods manufactured by the third party manufacturer and not to purchase the manufactured products available in the market. The AO also referred to the judgment of the Hon'ble Supreme Court in the case of State of Tamil Nadu v. Anandam Vishvanatham [73 STC 1], in which it was held that when the finished product supplied to a particular customer is not a commercial commodity in a sense that it cannot be sold in the market to any other person, the transaction is only a work contract. The AO, therefore, held that the contract entered into by the assessee with the third party for the manufacture of goods, was a work contract and the provisions of sec. 194C were applicable and tax was required to be deducted by the assessee in respect of payments made to the third parties. In this case, since the assessee had not deducted tax in respect of payments made, AO treated the assessee in default in respect of tax not deducted u/s. 201[1] and also charged the consequential interest u/s. 201[1A] for both the years i.e A.Y 2004-2005 and 2005-2006.

5. The assessee disputed the decision of the AO and reiterated before the CIT[A] that the case was covered by Circular No. 681 of CBDT [supra], as per which in case the title in the property manufactured by the third party passes to the assessee only after such property is delivered, it will be a case of contract for sale and thus outside the purview of the sec. 194C. The assessee referred to clause-4 of the agreement, as per which the title in the product passes to the assessee company on the delivery of the completed product to the company or at the destination directed by the company. It was, thus, argued that sec. 194C was not applicable. As regards the judgment of the Hon'ble Supreme Court in the case of State of Tamil Nadu v. Anandam Vishvanatham [supra] relied upon by the AO as per which it is a case of work contract if the goods manufactured cannot be sold in the market to any other person, the assessee submitted that the agreement only provided that the rejected product could not be sold in the market with the labels, wrappers and packing materials with the trade names or trade marks or logo of the assessee company. There was no provision to prohibit the sale of the products without the trade mark or logo of the assessee company and the manufacturer was free to dispose of such products. Moreover, the said judgment was not applicable as the same related to a different kind of transaction i.e printing of question papers of universities. It was, thus, submitted that judgment of the Hon'ble Supreme Court [supra] was not applicable to the facts of the assessee's case. CIT[A], however, was not satisfied. It was observed by him that the seller was manufacturing goods using the formulations, specifications and technical know-how provided by the assessee company and as per the specifications and quality as desired by the assessee company. The manufacture was manufacturing products as well as procuring raw materials and packaging the finished products on behalf of the assessee company. The manufacturer was bound to follow the instructions and advice of the assessee company and, therefore, the agreements were predominantly the contracts of work with confidence and faith and it was not a case of purchase of products which are readily available in the market. CIT[A], therefore, held that the provisions of sec. 194C were attracted and the assessee was, therefore, in default u/s. 201[1]. The assessee had also raised an alternate plea that the assessee could not be held in default in case the taxes had already been paid by the contract manufacturers but the plea was rejected on the ground that no evidence was produced to that effect either before the AO or before the CIT[A]. Aggrieved by the decision of the CIT[A], the assessee is in appeal before the Tribunal in both the years.

6. Before us, the ld. counsel for the assessee at the very out set pointed out that in so far as the issue of deduction of tax in respect of payments made for supply of packaging material was concerned, the issue has already been decided in favour of the assessee in its own case in the earlier year by the Hon'ble High Court of Gujarat [306 ITR 25] in which it was held that the provisions of sec. 194C on the work contract for supply of printing materials were not applicable and, accordingly, the assessee could not be held in default u/s. 201[1]. As regards the applicability of provisions of sec. 194C to the contract manufacturer of finished products was concerned, the ld. counsel submitted that the Hon'ble jurisdiction High Court of Mumbai has already decided an identical issue in case of Glenmark Pharmaceuticals Ltd. in I.T.A No. 2256 of 2009, in which it has been held that provisions of sec. 194C are not applicable in cases where the property in the article manufactured by the contract manufacturer passes to the customers upon delivery and the raw material was not sourced from the customers/purchasers but was independently obtained by the manufacturer from the persons other than the customers. It was, therefore, urged that the order of the CIT[A] be set aside and the demand raised against the assessee be deleted. The ld. DR, on the other hand, placed reliance on the orders of the authorities below.

7. We have perused the records and considered the rival contentions carefully. The dispute is regarding applicability of provisions of sec. 194C in respect of payments made by the assessee to third parties for contract manufacture of finished products as well as packing material. There is no dispute that as per the agreement the contract manufacturer was required to manufacture the finished products/packing material as per the formulations and specifications given by the assessee but procurement of raw material was responsibility of the contract manufacturer who was required to manufacture the products at its own establishment and the property in the product manufactured passed on to the assessee only upon delivery of the products. The issue is whether it would be a case of work contract for which provisions of sec. 194C are applicable or it is case of contract for sale for which TDS provisions are not applicable. We find that identical issue has already been considered by the Hon'ble High Court of Mumbai in the case of Glenmark Pharmaceuticals Ltd. in I.T.A No. 2256 of 2009. In that case also the assessee who was manufacturing pharmaceutical products, was in agreement with a third party for manufacture of certain pharmaceutical products. The products were manufactured as per formulations and specifications of the assessee and the manufacturer was to attach the trade mark of the assessee on the goods produced. However raw materials were required to be purchased by the manufacturer and the property in goods passed to the assessee only upon in delivery. The Hon'ble High Court noted that the CBDT right since the issue of Circular dated 29-5-72 had consistently taken the position that furnishing of specification to the manufacturer by the purchaser would not detract from a contract being regarded as a contract for sale so long as the property in the goods was passed upon delivery. Various courts had also taken the same view. The court referred to the earlier judgment in case of BDA Ltd. v. ITO [281 ITR 99] in which the court had taken the view that providing specification to the manufacturer who produces an article or thing would not detract from the nature of transaction as a of sale so long as the purchasers had not supplied raw material to the seller and there was nothing to indicate that the seller was a captive unit of the purchaser. The High Court also referred to the amendment to the provisions of sec. 194C by the Finance Act, 2009 in which the expression “work” has been defined in clause [iv] of the substituted Explanation as under:

“manufacturing or supplying a product according to the requirement or specification of a customer by using material, purchased from such customer, 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.”

8. The High Court after referring to the Memorandum explaining the clauses of the Finance Bill 2009, held that amendment only clarified the position which was reflected in the circulars issued by the CBDT since 29-5-1972. It was observed that the revenue always understood sec. 194C to mean that though a product or thing is manufactured to the specification of the customer, the agreement would constitute 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 a manufacturer from the person other than the customer. The High Court, accordingly, held that the amendment was only clarificatory in nature and was reflective of the law as it always stood in the past. The amendment had, therefore, retrospective application. The High Court held that the provisions of sec. 194C were not applicable in the case of the assessee. The facts in the present case are identical and, therefore, respectfully following the judgment of the jurisdictional High Court [supra], we hold that provisions of sec. 194C are not applicable in case of the assessee and, therefore, the assessee cannot be treated in default u/s. 201[1] for not deducting tax at source. We may also mention here that in so far as applicability of provisions of sec. 194C to the contract manufacture of packing material is concerned, the issue has already been decided in favour of the assessee in the earlier year in the assessee's own case by the Hon'ble High Court of Gujarat as reported in 306 ITR 25. We, therefore, set aside the order of the CIT[A] upholding the decision of the AO to treat the assessee in default u/s. 201[1] and to charge interest u/s. 201[1A]. As we have held that the provisions of sec. 194C are not applicable, it is not necessary for us to deal with the alternate plea raised by the assessee that the assessee cannot be treated in default in case taxes had been paid by the contract manufacture or the issue of jurisdiction in A.Y 2005-2006 is in relation to payments made at Bangalore Office, which have become infructuous.

9. In the result, both the appeals of the assessee are allowed.