Mumbai: Drug firms outsourcing finished products for domestic as well as export markets are under the income-tax (I-T) scanner.
The I-T department has dragged around half a dozen leading drug makers, including Novartis Healthcare Pvt. Ltd, Elder Pharmaceuticals Ltd, Glenmark Pharmaceuticals Ltd and Aristo Pharmaceuticals Pvt. Ltd, to the Bombay high court for alleged tax law violations in making payments to their contract manufacturers.
The department in Mumbai moved the court in July and August against the firms, claiming unpaid tax that runs into crores of rupees. According to a lawyer representing the department, these firms did not deduct tax at source for payments made to their contract suppliers during 2005-2006.
Mint could not ascertain the exact liability of these firms.
The Rs80,000 crore Indian drug industry outsources 50-60% of manufacturing to third parties to cut cost. Foreign drug makers in India engage contract manufacturers for almost 90% of their products; local drug firms outsource comparatively lower volumes because most of them have their own production lines.
Barring the top 300 pharma firms, most of the 15,000 drug units operating in India are engaged in contract manufacturing.
The court case marks the climax of a legal battle that the I-T department has been fighting with the drug firms for the past three years. At the core of the fight is a critical question—whether contract manufacturing should be treated as a work contract or a sales contract.
Drug makers argue that product outsourcing should be treated as sales deals; the I-T department’s stance is that they are work contracts.
The department slapped notices, claiming I-T payment, in 2007 but the companies challenged the claim at the Income-tax Appellate Tribunal and secured an order in their favour. The I-T department has now moved the Bombay high court against the tribunal’s order.
A few companies, including Glenmark and Elder Pharma, have started deducting tax at source while making payments to contract suppliers in the past two years.
Under I-T norms, TDS, or tax deducted at source, is applied at the rate of 2% on payments for carrying out any contract work.
“As a practice, these companies give their trademark, formula for the product and specification for packaging the product to the manufacturer. But once the product is ready, in their books the drug firms show that they are buying these products and hence they don’t need to pay TDS,” said the lawyer cited earlier. He did not want to be named.
The I-T department’s contention is that the agreement between the pharmaceutical companies and a third party should be treated as a work contract and not a sales contract because the company provides the formula for the products and its trademark to the manufacturer.
“According to a clause of the agreement, if the item is not used by the company once it is manufactured then the manufacturer (third party) cannot sell it in the market. So it’s a work contract given by the pharma companies and they are liable to pay TDS,” said the lawyer.
Elder Pharma’s managing director Alok Saxena said he would not comment on the matter without seeing related documents. Glenmark declined to comment for this story; Novartis and Aristo could not be reached for comment on Saturday.
“We had earlier won an order from the tax appellate tribunal on the ground that most of our contracts with the suppliers were mere sale deals, and every transaction under such contracts was taxed under sales and value-added taxes,” said an executive dealing with finance and legal affairs at one of the drug makers that is involved in the alleged TDS norm violation.
The government modified the definition of contract work in the FY10 Union Budget to cover only those manufacturing outsourcing contracts where the companies supply raw material. Previously, all work contracts—irrespective of whether raw materials were supplied by the firms or not—were treated as contract work and attracted TDS.
“Though we had started deducting tax at source on payments for contract supply, we may even stop this from October as the new amendment in the direct tax law allows it,” said this executive. He doesn’t want himself or his organization to be identified because the matter is still under judicial consideration.