An earlier article in this series had addressed the service tax implications of brand licensing vis-à-vis contract manufacturing. With particular reference to service tax on production of alcoholic products on a job work basis, in terms of the aforesaid brand licensing vs. contract manufacturing situations, certain recent developments have introduced an element of uncertainty into what was understood to be a well settled position.
In order to properly appreciate the matter, it is important to understand the background. The genesis of the issue was the extension of the service tax to packaging activities. A definition for packaging activity was hence introduced. Several typical activities of packaging were incorporated therein but more importantly there was a significant exclusion for packaging activity that amounted to manufacture within the meaning of the Central Excise Act, 1994 (CE Act) which contained a definition thereof, as per Section 2 (f). Thus, the service tax provisions contained a specific exclusion for manufacturing activity.
This definition was the subject matter of writ petitions filed in the Madhya Pradesh High Court in the case of Som Distilleries with regard to alcoholic products. It was argued that the activities that were performed by the petitioners would be covered within the meaning of manufacture, as per Section 2 (f) of CE Act, even though that Act, in terms, did not extend to such products. The Court came to the conclusion that in order to qualify for the exclusion from the service tax both with regard to packaging activities and ‘business auxiliary services’, which contained a similar exclusion for manufacture, it was not necessary that the products in question should be covered within the ambit of the CE Act.
In order to qualify for the exclusion from the service tax, it was only that the underlying processes actually carried out should amount to manufacture. Accordingly, it held that since the underlying activity of bottling and packaging of alcoholic products undoubtedly amounted to manufacture, the exemption from the service tax would apply.
However, the Tribunal in a stay application case in Midas Care Ltd. Vs. CCE [2008-TIOL-1295-CESTAT-MUM] held that if products which were manufactured were not covered under the CE Act, such as formulations containing alcohol, the exclusion from the service tax under the heading of ‘business auxiliary services’ was not applicable. This decision was thus directly contrary to the rationale followed by the Madhya Pradesh High Court in the aforesaid case. Indeed, this order of Midas Care was followed by the Tribunal in a similar decision in another stay matter of Rubicon Formulations.
Given the aforesaid fluid situation, the Ministry of Finance issued a detailed Circular on 27.10.2008, particularly with reference to alcoholic products. This Circular referred to the earlier draft Circular of November 2006 on the subject and stated that the draft Circular stood finalised in terms of this Circular. The Circular took note of the fact that in situations where alcohol products were produced by distilleries who also owned the brand names affixed thereon, it was a simple case of manufacture and sale of goods and there was no case of affixation of brand names owned by others on the products so as to attract service tax.
In other cases, where the brand owners and the manufacturers of the products were different entities, the applicability of the service tax would need be considered. The Circular was based on the fundamental conclusion that the fact that alcohol products were not covered under the CE Act was not relevant for deciding whether or not the service tax was applicable. What was relevant was whether the process followed for manufacture of alcohol products under certain typical arrangements relevant for the industry qualified to be considered as ‘manufacture’, under Section 2 (f) of the CE Act. The Circular held that should the answer be in the affirmative, then the service tax would not apply.
Based on this conclusion, the Circular then considered brand licensing arrangements whereby the brand owners authorised the license holders to manufacture alcoholic products bearing their brand name. In such cases, the brand owners would only receive an agreed sum for granting the permission to use the brand name and possibly also to supply technical know how. The Circular held that the payments so received from the licencees / manufacturers would be for rendering intellectual property services and would hence be chargeable to service tax.
It is important to note here that the amounts retained by the licencees / manufacturers were not for carrying out manufacturing activities, since it was understood that property, risk and reward in goods was that of the licencees / manufacturers and not of the brand owners and hence what was chargeable to service tax was only the amounts paid over to the brand owners. As against this, the Circular envisaged contract manufacturing arrangements where the contract manufacturers manufactured goods for and on behalf of the brand owners who, in effect, bore the effective risks and hence the rewards in the products so manufactured.
The Circular held that such contract manufacturing activity would undoubtedly qualify as manufacture under Section 2(f) of the CE Act and the exclusion from the service tax would apply.
It can thus be seen that the beneficial Circular was based on an understanding of how the arrangements for manufacture and sale of alcohol products were typically carried out. Accordingly, the Circular held that contract manufacturing arrangements did not attract service tax on the ground that the exclusion vis-à-vis manufacture would apply. Consequently, the Circular was understood to clarify the non applicability of service tax on contract manufacturing arrangements.
However, in a recent decision in the case of Rubicon Formulations, the same company with regard to which the earlier order on the stay application had been passed, the Tribunal once again considered another stay application on the same matter. The Tribunal considered the underlying contract and the fact that the applicants manufactured the products in question, formulations containing alcohol, on behalf of their clients in the manner described under the contract. Strangely, the Tribunal concluded that despite the above fact, the activity was not covered within the ambit of contract manufacturing as per para 3 of the Circular referred to above. Hence, notwithstanding that the applicants manufactured products as per contract where they were paid job charges, the activities were yet not excluded from the purview of service tax. The Tribunal came to this conclusion even though the case of the Department was on the other point, which had already been fully settled by the Circular, that since the products in question were not covered under the CE Act, the exclusion from the service tax to manufacture of such products would not apply.
Accordingly, the Tribunal held that the activities would be chargeable to service tax as ‘business auxiliary services’.
Although this decision of the Tribunal of June 2009 is on a stay application, it nevertheless sets the stage for a final decision which would potentially not grant the benefits as envisaged to contract manufacturing arrangements of alcohol products and other similar products on the ground that the underlying arrangements were somehow different from the arrangements envisaged in para 3 of the said beneficial Circular. It appears that this particular interpretation of the beneficial Circular is a narrow one and is against the principles of interpretation of such Circulars. It is hoped that the Tribunal would reconsider the matter as and when the case is finally decided since it has significant ramifications for contract manufacturing arrangements for alcoholic products and other products not covered under Central Excise Law.
