This charge started by State of Madras v. Gannon Dunkerley & Co. (Madras) Ltd., 1959 SCR 379 is still in its never ending journey. The Constitution Bench of Apex Court held that in a building contract which was one and entirely indivisible, there was no sale of goods and it was not within the competence of the State Legislature to impose a tax on the supply of materials used in such a contract, treating it as a sale.
The Hon’ble Apex Court held that a works contract is a composite contract which is inseparable and indivisible, and consists of transfer of property in goods but labour and service elements as well. The Court held that what was within the purview of state legislature was to levy tax on sale of goods chattel qua chattel. Hon’ble Court, after considering a large number of judgments, ultimately came to the following conclusion :-
“To sum up, the expression “sale of goods” in Entry 48 is a nomen juris, its essential ingredients being an agreement to sell movables for a price and property passing therein pursuant to that agreement. In a building contract which is, as in the present case, one, entire and indivisible — and that is its norm, there is no sale of goods, and it is not within the competence of the Provincial Legislature under Entry 48 to impose a tax on the supply of the materials used in such a contract treating it as a sale.” (at page 425)
Thereafter a battery of other decisions holding similar decisions were upheld by courts. Accordingly, government came out with a solution viz., by introducing provision of deeming Sale in the Constitution of India
Constitutional Amendment –
The Constitution was amended by 46th Amendment and clause (29-A) was inserted in Article 366, clause (29A) of Article 366 is in the following terms.
“(29-A) tax on the sale or purchase of goods includes-
(b) a tax on the transfer of property in goods (whether as goods or in some other form) involved in the execution of a works contract;
The Constitutional amendment so passed was the subject matter of a challenge in Builders’ Assn. of India v. Union of India, (1989) 2 SCC 645. This challenge was ultimately repelled and Apex Court stated:-
“… After the 46th Amendment, it has become possible for the States to levy sales tax on the value of goods involved in a works contract in the same way in which the sales tax was leviable on the price of the goods and materials supplied in a building contract which had been entered into in two distinct and separate parts as stated above.” (at para 36)
Works contract in VAT Laws
VAT Acts have defined works contract in more or less similar manner. Definition as provided in VAT Acts are as under:
“works contract” includes any agreement for carrying out for cash or for deferred payment or for valuable consideration, the building construction, manufacture, processing, fabrication, erection, installation, fitting out, improvement, repair or commissioning of any moveable or immovable property.
“works contract” includes any agreement for carrying out for cash, deferred payment or other valuable consideration, the assembling, construction, building, altering, manufacturing, processing, fabrication, installation, fitting out, improvement, repair or commissioning of any movable or immovable property
– Tamil Nadu
“works contract” includes any agreement for carrying out for cash, deferred payment or other valuable consideration, building construction, manufacture, processing, fabrication, erection, installation, fitting out, improvement, modification, repair or commissioning, of any movable or immovable property
– Uttar Pradesh
“works contract” includes any agreement for carrying out, for cash, deferred payment or other valuable consideration, the building construction, manufacture, processing, fabrication, erection, installation, fitting out, improvement, modification, repair or commissioning of any movable or immovable property
Thus, it is pertinent to note that specific transaction are included in works contract under State VAT Acts.
Valuations Settled – Gannon Drunkley II
Apex Court again upheld the levy of Sales Tax (now VAT) on works contract pursuant to Constitutional amendment, however, laid down the guidelines for determination of value. Apex Court held that tax on transfer of property in goods (whether as goods or in some other form) involved in the execution of a works contract falling within the ambit of article 366 (29A) (b) is leviable is on the goods involved in the execution of a works contract and the value of the goods which are involved in the execution of works contract would constitute the measure for imposition of the tax.
Hon’ble Court held that the value of the goods involved in the execution of a works contract will, therefore, have to be determined by taking into account the value of the entire works contract and deducting therefrom the charges towards labour and services which would cover:
- a) Labour charges for execution of the works;
- b) amount paid to a sub-contractor for labour and services;
- c) charges for planning, designing and architect’s fees;
- d) charges for obtaining on hire or otherwise machinery and tools used for the execution of the works contract;
- e) cost of consumables such as water, electricity, fuel etc. used in the execution of the works contract the property in which is not transferred in the course of execution of a works contract; and
- f) cost of establishment of the contractor to the extent it is relatable to supply of labour and services;
- g) other similar expenses relatable to supply of labour and services;
- h) profit earned by the contractor to the extent it is relatable to supply of labour and services.
Thus, this was the first time when the Circle for taxability of works contract under Sales tax (VAT) got complete and the state governments got their right to tax such transactions.
Valuation provision is also almost similar in all VAT Acts. VAT law usually provide for three methods of computation of value for the levy of VAT:
- Actual Value
This method requires calculation of actual value of goods whose property is transferred via the executed works contract. The formulae for this as provided in Gannon Drunclety II has been replicated in most of the VAT laws. It is provided that to arrive at the taxable Turnover arising from the execution of a works contract, from the total consideration paid or payable to the dealer under the contract one has to exclude the charges towards labour, services and other like charges (nature provided in case above).
- Deemed Value
If a dealer does not want to or cannot make calculation on actual basis, a choice has been given to him in terms of prescribed percentages of value towards labour, services and other like charges. For eg.
||Type of contract
||Labour, service and other like charges are percentage of total value of the contract
||Fabrication and installation of plant and machinery.
||Twenty five percent
||Fabrication and erection of structural works of iron and steel including fabrication, supply and erection of iron trusses, purloins and the like.
||Fabrication and installation of cranes and hoists.
- Composition Scheme
In a Composition scheme, government provides for payment of VAT a predefined rate on the entire consideration of the contract say 5%. Such composition schemes are usually restrictive in terms of inter state purchase and sale and input credits.
Dominant intention would determine nature – initial understanding
The Hon’ble Supreme Court in Rainbow Colour Lab Vs. State of Madhya Pradesh (2000) 118 STC 9 (SC) held that unless there is a sale and purchase of goods, either in fact or deemed, and such sale is primarily intended and not incidental to the contract, the State cannot impose sale tax on a work contract simply on the basis of the expanded definition found in article 366 (29-A)(b) of the Constitution.
In Hindustan Aeronautics Limited v. State of Orissa – (1984) 2 SCC 16, the Court, while emphasizing that there is no rigid or inflexible rule applicable alike to all transactions which can indicate distinction between a contract for sale and a contract for work and labour, opined that basically and primarily, whether a particular contract was one of sale or for work and labour depended upon the main object of the parties in the circumstances of the transaction.
Associated Cement Co. Limited – the Game Changer
A three – Judge Bench of the Supreme Court in Associated Cement Co. Ltd. Vs. Commission of Custom. (2001)124 STC 59(SC) overturned the Dominant nature theory and held as under:
“The 46th Amendment was made precisely with a view to empower the State to bifurcate the contract and to levy sales tax on the value of the material involved in the execution of the works contract, notwithstanding that the value may represent a small percentage of the amount paid for the execution of the works contract. Even if the dominant intention of the works contract is the rendering of services which amounts to a works contract, after the 46th Amendment the state would now be empowered to levy sales tax on the material used in such contract. The conclusion arrived at in Rainbow Colour Lab case (2000) 118 STC 9 (SC), (2000) 2 SFC 385, in our opinion, runs counter to the express provision contained in article 366 (29A) as also of the Constitution Bench decision of Apex Court in Builders’ Association of India V. Union of India (1989) 73 STC 370: (1989) 2 SCC 645.”
In Bharat Sanchar Nigam Ltd., a three-Judge Bench agreed with the position adopted in above case.
Kone Elevator – the Settler
In Kone Elevator India Pvt. Ltd. [2014 (34) S.T.R. 641 (S.C.)], five member bench, by majority, of Supreme Court held that supply and installation of lifts is a works contract overruling its ealier decision in the same case. The Court observed that no single formula could have been stated to be made applicable for the determination of the nature of the contract, for it depended on the facts and circumstances of each case. Upholding the contract as works contract, it was held as under:
“The installation requires considerable skill and experience. The labour and service element is obvious. What has been taken note of in Kone Elevators (supra) is that the company had brochures for various types of lifts and one is required to place order, regard being had to the building, and also make certain preparatory work. But it is not in dispute that the preparatory work has to be done taking into consideration as to how the lift is going to be attached to the building. The nature of the contracts clearly exposit that they are contracts for supply and installation of the lift where labour and service element is involved. Individually manufactured goods such as lift car, motors, ropes, rails, etc. are the components of the lift which are eventually installed at the site for the lift to operate in the building. In constitutional terms, it is transfer either in goods or some other form. In fact, after the goods are assembled and installed with skill and labour at the site, it becomes a permanent fixture of the building. Involvement of the skill has been elaborately dealt with by the High Court of Bombay in Otis Elevator (supra) and the factual position is undisputable and irrespective of whether installation is regulated by statutory law or not, the result would be the same. We may hasten to add that this position is stated in respect of a composite contract which requires the contractor to install a lift in a building. It is necessary to state here that if there are two contracts, namely, purchase of the components of the lift from a dealer, it would be a contract for sale and similarly, if separate contract is entered into for installation, that would be a contract for labour and service. But, a pregnant one, once there is a composite contract for supply and installation, it has to be treated as a works contract, for it is not a sale of goods/chattel simpliciter. It is not chattel sold as chattel or, for that matter, a chattel being attached to another chattel. Therefore, it would not be appropriate to term it as a contract for sale on the bedrock that the components are brought to the site, i.e., building, and prepared for delivery. The conclusion, as has been reached in Kone Elevators (supra), is based on the bedrock of incidental service for delivery. It would not be legally correct to make such a distinction in respect of lift, for the contract itself profoundly speaks of obligation to supply goods and materials as well as installation of the lift which obviously conveys performance of labour and service. Hence, the fundamental characteristics of works contract are satisfied. Thus analysed, we conclude and hold that the decision rendered in Kone Elevators (supra) does not correctly lay down the law and it is, accordingly, overruled.”
Thus, the nature of works contract was now settled and its valuation shall be what has been settled by Gannon Drunkley II and adopted as part of their Rules by most of the state VAT Laws.