Whether when assessee outsources manufacturing for which raw materials are supplied by non-resident having interest in assessee company, conversion charges paid to jobworker attract provisions of Sec 194C - YES: HC

BANGALORE, FEB 02, 2012: THE issues before the Bench are - Whether when assessee outsources manufacturing of a pharma product for which raw materials are supplied by a foreign company having interest in the assessee company and trade mark of assessee to be labelled on such products, conversion charges attract provisions of Sec 194C and Whether interest u/s 201(1A) is leviable in case of default. YES is the HC's answer.

Facts of the case

Assessee, an Indian Company, marketed pharmaceutical products. It had outsourced one of its products to M/s.Torrent Pharmaceuticals Limited. The raw materials were supplied for the jobwork by a foreign company NOVA Nordisk, Denmark. It also transpired that the assessee company was a subsidiary of M/s NOVA Nordisk Singapore but had no direct contract or relationship with the Indian manufacturer, but under another agreement between the Indian manufacturing company and the raw material supplying foreign company, the product produced by the use of raw material for manufacture of the product was stipulated to be exclusively supplied to the assessee company and the manufacturing company was under compulsion that the entire product or the output after the consumption of the raw material supplied to the manufacturing company was to be in turn sold only to assessee company in India.

One of the conditions in the agreement between the raw material supply foreign company and the Indian manufacturing company was that even if the agreement expired or the transaction came to an end and if some surplus product was left over with the manufacturing company, the product so left over was not to be sold outside in the market, but necessarily be sold to the assessee company.

In the agreement between the assessee company and its supplier a price fixation formula had been worked out and it was called as conversion charges. The assessee company was to pay the supplier/manufacturing company 19% of the landing cost of the raw material, consumed into the production of the product. This was the interrelation linking the three companies viz, the raw material supplying foreign company, the raw material receiving Indian manufacturing company and the product buying assessee company. The Indian manufacturing company manufactured the products making use of the raw material supplied by the foreign raw material supplier company.

There was another agreement between the assessee company and the manufacturer company also which provided for supply of technical know-how for the manufacture of the product, but at no cost and know-how to be exclusively utilised for converting the raw material received by the Indian manufacturing company from the raw material supplying foreign company. There was yet another agreement between the assessee and the supplier company known as trade mark licence agreement under which the product manufactured by the manufacturing company was to be labelled with the name of the assessee company for marketing and the entire manufactured product was to be restored to the buying company viz. the assessee company, in the even of termination of the contract.

Assessee paid 2% of total amounts paid to the supplying company to the manufacturing company in India. This amount was worked out to be at a sum of Rs.5,10,49,267/- by the assessing officer applying the formula of multiplying payments made by the assessing company to the supplier company using the multiplier 19/119 as being the value of conversion charges which alone was taken to be a payment by the assessing company towards the manufacturing cost or conversion charges paid by the assessee to the manufacturing company though the actual payments included the price of the raw materials, but that amount having been paid by the supplier directly to the foreign raw material supplier company, that was not included in the value of payments by the assessee company for the purpose of computing the amount that was required to be deducted under Section 194C of the Act.

But the price of the raw material having been paid by the supplier company to the raw material supplying foreign company, the income tax officer was of the view that a reading of the agreement between the assessing company and the supplier company and the agreement between the supplier company and the raw material supplying foreign company has linked one another and ultimately the manufacturing company being required to supply the entire product produced by utilising the raw material procured from abroad only to the assessee company, it cannot be held that it was a contract for sale of a product in the sense it was a sale of a product, but it was only a contract for manufacturing and therefore, was of the opinion that there was an obligation on the part of the assessee company to effect deduction of tax at source and there being a failure on the part of the assessee company while noticed that the tax liability had been met by the manufacturing company being an assessee under the Act and having independently filed its return, but at the same time the assessee company being not absolved of the liability of the provisions of Section 201(1A) of the Act proceed to compute the interest in terms of the statutory provisions and worked out to be 7,60,570/- starting from 1.4.1997 till the date of the order under the provisions of Section 201(1A) of the Act which was on 30.7.2001.

The CIT(A) opined that the assessee company not having supplied the raw material, the price paid by the assessee company was to be construed only as a price for the sale of the product and not a contract for manufacturing and therefore, Section 194C was not attracted. Tribunal agreed with the CIT(A).

On appeal, the HC held that,

++ we find that this is not simply a situation of a product manufactured to the specifications of the assessee, being sold to the assessee at the price fixed by the supplier but this is a situation where a product manufactured out of raw materials supplied by a foreign company who had direct interest in the assessee company so manufactured to the specification of the assessee company utilising the technical know-how supplied by it and also labelling the product with the brand name of the assessee and supplying the entire product only to the assessee company and not to anyone else and it is throughout to be held as a specific contract for manufacturing of a particular product notwithstanding the fact that the supplier had paid the price for the raw-material directly to the foreign company which supplied the raw material to the manufacturer, but had interest in the assessee company in India while bearing the trade mark of the foreign supplier, but having a definite communication and in such a situation one has to really look into the real nature of the transaction that emerges on the conjoint reading of the three agreements and the assessing officer in fact having undertaken this exercise and having arrived at the conclusion that the assessee company is one who fits into the definition and situation contemplated u/s.194C of the which on an examination is found is a proper reasoned approach and in consonance with the statutory provision.

++ we are also of the view that the situation contemplated u/s.194C of the Act i.e. the payment for carrying out any work which is to improve the situation of such nature and of course preceded between the contract between the assessee and the manufacturer company;

++ it was a situation where the provisions of Section 194C of the Act applied to the assessee and is clearly attracted to the present situation. The assessing authority has rightly applied the provisions of Section 194 of the Act to the present situation and has very correctly estimated the interest payable in terms of Section 201 (1A) and the Appellate Commissioner and the Tribunal are in error in taking the contrary view