2005 (11) TMI 202 - AT - Income Tax

Contract For Sale Or Works Contract - whether outsourcing the manufacture of goods is a contract or purchase of goods ? - HELD THAT - In the present case, the transfer of the property by the manufacturer as a finished article is as a chattel and the ownership passes on to the assessee only on taking the delivery of the goods and before the delivery of the goods the ownership remains with the manufacturer only. Therefore, necessarily following the above judgments in the case of State of AP vs. Kone Elevators (India) Ltd. 2005 (2) TMI 519 - SUPREME COURT the contract of the assessee with the manufacturer is that of purchase and sale. As per the said judgment the works contract is one where the ownership passes to the customer by accession during the procession of work i.e., as and when work is in process, the ownership passes on to the customer. Since the theory of manufacturer of goods by specification is almost eliminating, nowadays, therefore, we have to see the intention of the customer and how the goods are supplied whether chattel-qua-chattel and if it is so, then it will be considered a 'sale' instead of 'works contract'. Also there is no definition of contract or sale in the IT Act which can solve the present issue. Therefore, to solve this issue we have to rely upon various other Acts and the interpretations made by Courts of law vis-a-vis the present case. The manufacturers are also independent establishment engaged in business of manufacturing of footwear and other goods and the assessee has issued the purchase order in favour of the manufacturers for supply of footwear and other goods and manufacturers were manufacturing the goods at their premises and they were not captive units of the assessee. The manufacturer as per agreement para 2.4 had the sale responsibility of purchase of raw material regarding quality of the products produced thereunder and the assessee was under no obligation to designate any such supplier. As per para 15.2.1 of the agreement the manufacturer is an independent manufacturer under the agreement and its personnel and other representative shall not act as nor be agents or employees of purchaser and its customer. As an independent the manufacturer will be solely responsible for determining the means and methods for performing the required tasks. As per para 5.4 of the agreement the prices charged and each term and condition applied by manufacturer with regard to each of the products shall be no less favourable than the prices charged for equivalent footwear or terms or conditions applied with regard to any other person for whom manufacturer produces footwear. Hence, the present case falls under the category of contract for purchase and sale and not a works contract u/s 194C of the Act. The views taken by the AO are of no assistance to the ld DR who has relied upon the order of the AO. The facts of the present case are almost identical to the Hindustan Shipyard Ltd. vs. State of AP 2000 (7) TMI 864 - SUPREME COURT , in principle. Therefore, this case of the assessee is a case of contract of sale and not that of works contract u/s 194C of the Act. Thus, we are of considered view that the transaction between the assessee and the manufacturer was of purchase and sale of goods and not of a works contract u/s 194C of the Act and the AO was not justified in treating the same as transaction of works contract u/s 194C of the Act and the assessee cannot be deemed to be an assessee in default in respect of the tax u/s 201(1)/201(1A) of the Act. Therefore, we find no infirmity in the order of learned CIT(A) which is hereby sustained. Thus ground Nos. 1 to 5 of the Revenue are dismissed. In the result, the appeal of the Revenue is dismissed.

Summary

Issues Involved:
1. Whether the transactions between the manufacturers/vendors and the deductor company are transactions of sale and purchase on a principal-to-principal basis or transactions of contract under Section 194C of the IT Act, 1961.
2. Whether the deductor company has full control over the manufacturing activities, raw material supply, patterns, specifications, samples, prices of the products, and sale of the products.
3. The commercial value of products if the purchaser does not accept the production.
4. Applicability of CBDT Circular No. 715 (Question No. 15) dated 8th August 1995.
5. Relevance of the Hon'ble Supreme Court's order in the case of State of Tamil Nadu vs. Anandam Viswanathan (1989) regarding the issue of contract vis-a-vis sale/purchase.

Detailed Analysis:

1. Nature of Transactions:
The primary issue was whether the transactions between the manufacturers/vendors and the deductor company (Reebok) were transactions of sale and purchase on a principal-to-principal basis or transactions of contract under Section 194C of the IT Act, 1961. The Assessing Officer (AO) concluded that the transactions were contracts for work, as the manufacturers were fully controlled by Reebok, which included specifications, quality control, and rejection rights. The AO emphasized that the manufacturers did not have autonomy and were merely executing work under Reebok's supervision, thus falling under Section 194C. However, the CIT(A) and ITAT found that the transactions were sales, as the manufacturers bore the responsibility for raw materials, quality, and had the freedom to sell similar products to other buyers. The agreements indicated an independent contractor relationship, and the property in goods passed to Reebok only upon delivery.

2. Control Over Manufacturing Activities:
The AO argued that Reebok had full control over manufacturing activities, including raw material supply, patterns, specifications, samples, prices, and sales. The CIT(A) and ITAT, however, noted that while Reebok provided specifications and quality checks, the manufacturers retained responsibility for raw materials and production quality. The manufacturers were independent entities and not agents or employees of Reebok. The agreements allowed manufacturers to negotiate prices and supply similar products to other buyers, indicating a sale rather than a work contract.

3. Commercial Value of Products:
The AO contended that the products had no commercial value if Reebok did not accept them, as they bore Reebok's trademarks and could not be sold in the open market. The CIT(A) and ITAT disagreed, stating that the products had commercial value and could be sold after removing Reebok's labels. The manufacturers were free to sell the products to other buyers, and the goods were not rendered worthless if rejected by Reebok.

4. Applicability of CBDT Circular No. 715:
The AO relied on CBDT Circular No. 715, which clarified that Section 194C applies to the supply of printed material as per prescribed specifications. The CIT(A) and ITAT found this circular inapplicable, as it pertained to printing contracts, not manufacturing contracts like those in Reebok's case. Instead, they relied on Circular No. 681, which stated that contracts for the supply of goods fabricated to specifications are contracts for sale if the property in goods passes upon delivery.

5. Relevance of Supreme Court's Order in State of Tamil Nadu vs. Anandam Viswanathan:
The AO cited the Supreme Court's decision in State of Tamil Nadu vs. Anandam Viswanathan, which held that contracts for printing question papers were works contracts. The CIT(A) and ITAT distinguished this case, noting that Reebok's transactions involved commercially marketable products manufactured by independent entities. The products had value and could be sold to other buyers, unlike the confidential and non-marketable printed question papers in the cited case.

Conclusion:
The ITAT upheld the CIT(A)'s decision, concluding that the transactions between Reebok and the manufacturers/vendors were sales and not works contracts under Section 194C. The manufacturers were independent entities responsible for raw materials and production quality, and the goods had commercial value. The relevant CBDT circulars and judicial precedents supported this view, leading to the dismissal of the Revenue's appeal.