1. This is a reference at the instance of the Commissioner and we are concerned with several assessment years, viz., 1956-57 to 1961-62. The assessee in this case, according to the revenue, is an entity described as 'British Drug Houses (India) Private Ltd., and Allen & Hansburys Ltd.' The entity has been sought to be assessed in the status of a registered firm.
2. British Drug Houses (India) Private Ltd., Hereinafter referred to as 'B.D.H.', and Allen and Hansburys Ltd., hereinafter referred to as 'A.& H.', entered into an agreement on December 15, 1954, for manufacturing injectible solutions of insulin in India from solid insulin purchased from U.K. A copy of the said agreement dated December 15, 1954, is to be found annexed to the statement of case as annex. 'A'. The joint manufacturing programme under the said agreement was being carried on, but B.D.H. and A.&H.; thereafter individually sold the stocks lifted by each of them and each of them accounted for the entire profit earned by it individually thereon. The ITO completed the assessments of both these entities separately for the assessment years 1956-57 to 1961-62, i.e., the years under reference, by including the profits earned by them respectively from sales of Indian insulin. Before doing so, the ITO had called for various particulars including a copy of the said agreement dated December 15, 1954.
3. Later on, the ITO initiated assessment proceedings against the assessee in this reference in the status of a firm under s. 147(a) of the I.T. Act, 1961. In his view B.D.H. and A.&H.; had formed themselves into a partnership and the said partnership had carried on the business of manufacturing Indian insulin. According to the ITO, the profit earned by the said firm in the assessment year in question had not been brought to tax. In reply to the notice of the ITO, the assessee first of all protested that there was no entity as suggested by the ITO and filed a return of income showing 'Nil' income. Its contention was that the agreement dated December 15, 1954, between the two companies was a mere business arrangement between the two companies and did not create any partnership. It contended, in the alternative, that even if the two companies were held to have carried on a joint venture, no separate assessment could be made against them jointly as each of then had been separately assessed in respect on its share of profit from such venture. The ITO negatived these contentions and held the agreement to result in a partnership. He found further that in the statement of audited accounts the profit had been described as 'partnership profit'. He accordingly made assessments for the years in question.
4. The assessee preferred appeals from this order and reiterated before the AAC the objections which had been raised before the ITO. It was also contended before the AAC that the ITO had wrongly exercised his jurisdiction under s. 147(a) of the Act. The AAC rejected all the submissions and fully upheld the decision of the ITO.
5. The assessee carried the matter in second appeal to the Income-tax Appellate Tribunal. Before the Tribunal it was contended by counsel appearing on behalf of the assessee that there was no partnership constituted as the essential elements of a partnership, viz., sharing of profits and relationship of principal and agent were conspicuously wanting in the case. In the alternative, it was submitted that even assuming that a partnership had come into existence, no income liable to tax had escaped assessment. Accordingly it was submitted that there was no question of invoking s. 147(a) of the I.T. Act, 1961. It may be mentioned that the assessee had filed an application for registration under protest and that the ITO had completed the assessment in the status of a registered firm.
6. The assessee succeeded in its appeals before the Income-tax Appellate Tribunal. The Tribunal took a broad view of the agreement and observed that the agreement had been entered into with the object of eliminating competition inter se. In the view of the Tribunal, the payments made by the two companies were provisional payments and the transfer value equivalent to 85% of the trade price, which was the initial payment, could not be equated with the regular price but was merely an ad hoc price subject to settlement of account subsequently. The Tribunal found that once each party lifted its quota of insulin, as mutually arranged, it was entirely responsible for its sale and that it was that party and not the other or the supposed joint entity which was concerned with the profit earned or losses made from insulin sold subsequently. In the view of the Tribunal, the activity of manufacturing insulin jointly carried on by the two companies, which was unaccompanied by similar joint activity of sale, could not be said to constitute business and it was neither a business nor an adventure in the nature of business, whatever else it might be. The Tribunal also held in favour of the assessee that the relevant clauses of the agreement failed to disclose the element of mutual agency, which, the opinion of the Tribunal, was an essential ingredient of a partnership. On that count also the Tribunal upheld the objection of the appellants before it, viz., the assessee. The Tribunal concluded that the joint activity under the agreement consisted of and ended with the production of insulin which was jointly owned and that once insulin was produced and was divided and paid for at actual cost, the joint activity ended at that stage. According to the Tribunal, the activity carried on did not result in any profit and the question of sharing the profit did not at all arise. The assessee's objection under s. 147(a) was also upheld by the Tribunal. It is from this decision of the Tribunal that the following three questions have been referred to us in this reference :
'1. Whether, on the facts and in the circumstances of the case, a valid partnership between British Drug Houses (India) Private Ltd., and Allen & Hansburys Ltd., came into existence under the agreement dated December 15, 1954
2. If answer to question No. 1 is in the affirmative, whether the assessee earned any income liable to tax
3. Whether, on the facts and in the circumstances of the case, the assessments were validly initiated under s. 147(a) of the Income-tax Act, 1961 ?'
7. It becomes necessary in these circumstances to go through the various clauses of the said agreement and understand their implications. The recitals of this agreement indicate that hitherto the two companies, viz., B.D.H. and A.&H.;, were marketing in India insulin bearing the registered trade mark 'A.B.' and were then desirous of entering into a manufacturing and packaging arrangement in India. With that object B.D.H. was given the task of preparing injectible solutions of insulin from solid insulin purchased from the U.K., and the various clauses of the agreement were intended to govern this manufacturing and packaging activity. Clause 2 of the agreement provided that during the tenure of the agreement, which was to commence from January 1, 1954, both the companies would remain jointly interested in all matters relating to manufacture of Indian insulin from solid insulin and that neither was to make, prepare for sale, or sell, or be interested in the manufacture, preparation for sale or sale in India of Indian insulin otherwise than in accordance with the terms of the agreement. Under clause 3, B.D.H. were to use their buildings, plant and machinery installed for the purpose of manufacturing Indian insulin from solid insulin, and it was provided that the raw materials, i.e., solid insulin, shall be obtained from British Drug Houses Ltd., of 16/34, Graham Street, London, U.K. Solid insulin procured from the said English concern was, under clause 4, to be jointly owned by the two parties, and similarly Indian insulin was to be jointly owned until transferred in agreed proportions to the respective parties. Clause 6 provided for accounts to be kept by individual parties relating to manufacture and advertisement of Indian insulin and to any research thereon. We then have cls. 7 and 8 which may be fully extracted :
'7. All expenditure and receipts arising from the manufacture of Indian insulin and its transfer from jointly owned stock to the individual parties hereto in accordance with this agreement shall be borne by and belong to the parties in equal shares.
8. A & H shall pay B.D.H. (India) monthly at the transfer price as defined in clause 11 hereof for all stocks taken from jointly owned stock during the immediately preceding calendar month.
Provided that every such payment shall be subject to adjustment and settlement on the taking and settling of next half yearly account as hereinafter provided.'
8. These two clauses are followed by clause 9 which indicates what amounts are to be debited to the joint account. There are certain rights and obligations thereafter provided for in clause 10, which are not very material. Clause 11, however, is very material, of which sub-clause (i) may be fully extracted, since counsel for the revenue strongly relied upon the provisions contained therein. His argument will be noted hereafter.
'11(i). All Indian insulin manufactured in accordance with this agreement shall be issued to the parties respectively in proportions or amounts to be mutually agreed and each such issued shall be regarded as taking place at the time of transfer to either party's separate selling organisation. The value of each such issue to a party, hereinafter called 'the transfer value', shall be credited as hereinafter provided to that party's account with the joint account and shall be calculated as 85% of the trade price. PROVIDED THAT...'
9. It may be mentioned that provisions (a) and (b) [under clause 11(i)] which have not been extracted, pertain to change of price as may be made by either party and to special transfer value in case of exceptional orders for large quantities. Thereafter follow certain minor clauses pertaining to the usual exigencies of business, and we then have clause 16 which pertains to how accounts are to be made up between the parties. The final clause dealing with the accounts to be taken on termination is clause 19; and we may, therefore, extract fully clause 16 and clause 19, which latter clause also provides for distribution of the existing stocks of solid insulin and Indian insulin between the two parties on the termination of the agreement. The said two clauses read as under :
'16. Accounts between the parties shall be prepared half-yearly at the thirtieth day of June and thirty-first day of December, the first account to be made up to the thirtieth day of June one thousand nine hundred and fifty-four, and the total amounts debited and credited to the joint accounts by the parties as provided by this agreement shall be ascertained and thereupon the one party shall pay to the other such sum as shall be necessary to equalise the net joint expenditure or receipts, as the case may be, due allowance being made for the sums paid and received on account under clause 7 hereof since the last account was taken.'
'19. On the termination of this agreement -
(a) A final account shall be taken and settled between the parties hereto and the amount of receipts or outgoings as the case may be shown by such account shall be divided between the parties hereto in equal shares.
(b) All stocks of Indian insulin and solid insulin and materials purchased for and/or used in the making or packing thereof in the hands of the parties hereto shall be pooled and equally divided between them.'
10. Under clause 18 the term of agreement is for a period of five years from January 1, 1954, and it is thereafter to continue from year to year unless and until either party shall give twelve month's notice in writing for determination thereof.
11. According to Mr. Joshi, under this agreement B.D.H. were to manufacture from solid insulin to be procured from the named English concern injectible Indian insulin and both the raw materials and the manufactured product were to be jointly owned by the two parties until it was transferred to the individual accounts of the two parties in mutually agreed proportions at the transfer value provided for under clause 11 read with clause 8. In his submission this transfer value was the price at which the insulin manufactured by B.D.H. on the joint account was sold to the individual parties and the difference between this price and the cost of production would be the profit of the partnership. On the other hand, Mr. Palkhivala urged that the transfer value provided for was not a price in the normal business sense but an ad hoc price initially charged from the party lifting the quantities which was subject to six monthly settlement of account. In his submission this was a business arrangement whereunder B.D.H. undertook to manufacture injectible insulin from solid insulin for it self and A & H, and the product was ultimately to be transferred to the two entities in mutual agreed proportions at cost. In his submission, further, the transfer value provided for clause 11 of the agreement was not commercial price at all and there was no question of any profit being realised by this entity from the manufacturing programme under the agreement. In his submission, therefore, whatever be the nature of the new entity, whether a partnership or the two companies entering into a joint venture or the two companies entering into a business arrangement under which one undertook a manufacturing programme for both of them, the agreement could not yield profit to this entity and hence all the other questions were academic and need not be gone into. He further submitted that the Tribunal was entirely right in the view that it took that there was no business carried on by this entity in the commercial sense and further that the entity did not constitute a partnership. He also supported a decision of the Tribunal on the question of invoking s. 147(a). In his submission all the necessary particulars had been given to the respective ITOs by the two companies and there was no question, therefore, of anything having been kept back from the revenue.
12. It would appear to us that the analysis by the Tribunal of the essential provisions of the agreement above indicated is entirely correct and we are in full agreement with the Tribunal's view that the transfer value provided for under clause 11 is an ad hoc payment in the nature of contribution initially charged from the party lifting the quantities of produced injectible insulin. Under the elaborate accounting procedure prescribed, this initial contribution is subsequently to be adjusted between the two parties with one party making necessary payment for equalising expenditure or receipts. The so-called profit of the partnership appears to us only to be a surplus arising from the fact that the initial contribution collected under the transfer value (as provided by clause 11) might have been in excess of the cost of production as required to be calculated under the arrangement. That surplus is not and can in no way be considered to be the profit of the so-called partnership. It is a business arrangements between the two entities, under which one of them is to carry out the manufacturing programme for both of them and the full cost of that programme is to be covered in the manner as indicated by the various clauses of the agreement earlier set out. Such an activity, in our opinion, does not and cannot result in any profit. Profit would certainly accrue from the sales activity, but the sales activity is to be carried out individually by the two companies and the joint manufacturing programme comes to an end, as rightly observed by the Tribunal, at the stage when the injectible insulin is transferred to the individual accounts of the two parties. Once the essential nature of this arrangement is realised, all other questions become academic and one need not concern oneself with whether the arrangement is a pure business arrangement in the nature of the manufacturing programme undertaken by one party on behalf of itself and another or a joint venture or perhaps even a partnership as the same is known to law. Whatever be the nature of the entity, the arrangement is such that it results in manufacture of insulin which is distributed to the two companies at cost; such a venture does not result in any profit. If that is so, no question of any tax liability or assessment can at all arise. Once that aspect is realised and the view of the Tribunal there on is confirmed, it appears to us unnecessary to go into the other two questions which are referred to us in this reference.
13. In the result, question No. 2 referred to us is answered in the negative and in favour of the assessee. In the view that we have taken of the agreement, there was no income earned by the assessee liable to tax.
14. In our view, in the view we have taken of the answer to question No. 2, it is unnecessary to answer questions Nos. 1 & 3. Accordingly, this two questions are not answered.
15. The Commissioner will pay the costs of this reference to the assessee.