Mumbai: Pharma companies do not have to deduct tax at source for outsourced manufacturing deals that are in the nature of sales contracts, the Bombay high court said last week in a ruling in favour of drug maker Glenmark Pharmaceuticals Ltd.
In an oral judgement pronounced on 12 March, the court held that while work contracts between two entities—the principal and a contract manufacturer—are subject to tax deduction at source (TDS) under the Income-tax (I-T) Act, a sales contract does not trigger this provision. The court has not released a written version of the judgement.
In its petition, the income-tax department had charged the Mumbai-based drug maker with not deducting tax at source on payments made to contract manufacturers.
Glenmark had earlier won an order from the tax appellate tribunal on the ground that most of its contracts with suppliers were sale deals, and that every transaction under such contracts was taxed under sales and value-added taxes, said a Glenmark executive, who declined to be named.
In its budget for fiscal 2009-10, the Union government had modified the definition of contract work to cover only manufacturing outsourcing, where the outside contractor supplies raw material. Earlier, all work contracts, irrespective of whether raw material was supplied by other firms or contractors, were treated as contract work and attracted TDS.
In July and August, the I-T department took half a dozen leading drug makers, including Novartis Healthcare Pvt. Ltd, Elder Pharmaceuticals Ltd, Glenmark and Aristo Pharmaceuticals Pvt. Ltd, to the Bombay high court for alleged tax violations related to payments to contract manufacturers.
Pharmaceutical firms had contested this, saying contract manufacturing agreements entered into by them with other drug makers amounted to “sales contracts” and were not liable for TDS. A lawyer representing the I-T department said these firms did not deduct tax at source during 2005-06. Mint could not ascertain the exact liability of these firms.
To cut costs, the Rs80,000 crore Indian drug industry outsources 50-60% of manufacturing to third parties. Foreign drug makers in India engage contract manufacturers for almost 90% of their products, while local drug firms outsource lower volumes because many of them have their own production lines.
Barring the top 300 pharma companies, many of the 15,000 drug units operating in India engage in contract manufacturing.
The court case had marked the climax of a legal battle that the I-T department has been fighting with the drug firms for the past three years.