Introduction Works contract is a composite transaction where supply of materials and supply of labour are both involved. As held by Hon’ble Supreme Court in the case of Builders Association of India vs. UOI (73 STC 370), the works contract transaction can be notionally divided into supply of materials and supply of labour. It is further held that the sales tax/VAT can be levied only to the extent of value of goods.
A further question arose as to how value of the goods can be found out from composite value of the contract. The issue has again been dealt with by the Supreme Court in the case of Gannon Dunkerly & Co. vs. State of Rajasthan (88 STC 204). In relation to finding out value of goods, Supreme Court has observed as under;
“The aforesaid discussion leads to the following conclusions:
(1) to (3)……
(4) The 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(29-A)(b) is leviable 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.
(5) In order to determine the value of the goods which are involved in the execution of a works contract for the purpose of levying the tax referred to in article 366(29-A)(b) it is permissible to take the value of the works contract as the basis and the value of the goods involved in the execution of the works contract can be arrived at by deducting expenses incurred by the contractor for providing labour and other services from the value of the works contract.
(6) The charges for labour and services which are required to be deducted from the value of the works contract would cover (i) labour charges for execution of the works, (ii) amount paid to a sub-contractor for labour and services, (iii) charges for obtaining on hire or otherwise machinery and tools used for execution of the works contract, (iv) charges for planning, designing and architect’s fees, and (v) cost of consumables used in the execution of the works contract, (vi) cost of establishment of the contractor to the extent it is relatable to supply of labour and services, (vii) other similar expenses relatable to supply of labour and services, and (viii) profit earned by the contractor to the extent it is relatable to supply of labour and services.
(7) To deal with cases where the contractor does not maintain proper accounts or the account books produced by him are not found worthy of credence by the assessing authority, the Legislature may prescribe a formula for deduction of cost of labour and services on the basis of a percentage of the value of the works contract but while doing so, it has to be ensured that the amount deductible under such formula does not differ appreciably from the expenses for labour and services that would be incurred in normal circumstances in respect of that particular type of works contract. It would be permissible for the Legislature to prescribe varying scales for deduction on account of cost of labour and services for various types of works contract.
(8) While fixing the rate of tax, it is permissible to fix a uniform rate of tax for the various goods involved in the execution of a works contract, which rate may be different from the rates of tax fixed in respect of sales or purchase of those goods as a separate article.”
Determination of sale price in works contract
From the above observations of the Supreme Court, it is clear that value of the goods on which sales tax can be levied is to be arrived at by taking contract value as the base. From the contract value, labour portion can be deducted as narrated above and where determination of labour charges is not possible, it is to be arrived at by taking standard deduction as may be prescribed by the government.
Cost plus gross profit method
In the present controversy about levy of tax on builders and developers, one issue which was hotly discussed was about adopting cost plus gross profit method. One view was that, it is not mandatory to start from contract value and take the deductions for labour charges to arrive at value of goods. As per the said view, the value of the goods can be arrived at by taking cost price of the materials involved and adding gross profit to the same. In other words, the aggregate of cost of the goods involved and gross profit margin on the same will constitute value of goods for levy of tax.
The Commissioner of Sales Tax, Maharashtra State, issued Circular bearing no. 18 T of 2012 dated 26.9.2012. In this circular, Commissioner of Sales Tax, amongst others, clarified that the working as per cost plus gross profit is not the statutory method and will not be admissible. It was clarified that the working should be as per statutory methods, as mentioned in the circular i.e. as per rule 58 read with rule 58(1A) of the MVAT Rules, 2005 or as per the composition schemes. In other words, it was effectively clarified that the cost plus gross profit method will not be admissible.
Writ Petition before Bombay High Court
A Writ Petition was filed before Hon’ble Bombay High Court by the Builders Association of India (Writ Petition (LODG) No. 2440 of 2012). Amongst others, it was challenged that the circular disallowing cost plus gross profit method is unconstitutional, as well as ultra virus. The plea was that the same method should be allowed to work out the value of goods. Hon’ble Bombay High Court has decided the said Writ Petition vide judgment dated 30th October, 2012. In respect of the above plea about the method of working out value of goods for levy of tax, Hon’ble Bombay High Court has observed as under;
“17. Essentially, what rule 58(1A) does is to provide a particular modality for determining the value of goods involved in the execution of construction contracts where an interest in land or land is also to be conveyed under the contract. The provisions of rule 58(1A) are not under challenge. Where the Legislature has an option of adopting one of several methods of determining assessable value, it is trite law that the legislature or its delegate can choose one among several accepted modalities of computation. The legislature while enacting law or its delegate while framing subordinate legislation are legitimately entitled to provide, in the interest of uniformity, that a particular method of computation shall be adopted. So long as the method which has been adopted is not arbitrary and bears a reasonable nexus with the object of the legislation, the Court would not interfere in a statutory choice made by the legislature or by its delegate. In the present case, rule 58(1A) mandates on how the value of goods, involved in the execution of a construction contract at the time of the transfer of property in the goods is to be determined in those cases where contract also involves a transfer of land or interest in land. The Circular dated 26.9.2012 does no more than specify the mandate of the statute. The Circular has not introduced a condition by way of a restriction which is not found in the statute. Plainly, rule 58(1A) does not permit the developer to take recourse to a method of computation other than what is specified in the provision. Hence, the Circular dated 6th September 2012 was only clarificatory.”
Observing as above, at the end of the judgment, Hon’ble High Court has held that the circular is not ultra virus.
In view of above, it can be said that effectively Hon’ble High Court has put a seal of approval on the proposition made in the circular. The contractor has to find out the value of goods as per the statutory provisions and cannot adopt other methods like cost plus gross profit etc.
Conclusion
The above judgment is in relation to builders and developers. However, the legal position discussed is about validity of the method for finding out the value of goods for levy of VAT. From the judgment, it is clear that no method other than statutory method can be adopted for working out the value of goods. Therefore, though the judgment is in relation to builders and developers, it will govern the position in relation to other contracts also. In other words, even in relation to other contracts, it may be difficult to adopt cost plus gross profit method and the working may have to be done as per the statutory methods.
