Works Contract Vis-À-Vis Nature of Goods Sold In Works Contract

Introduction

Taxation of Works Contract is a debatable issue from beginning. In fact the theory of works contract came into existence because of complicated nature of the transaction. In case of works contract, there is more than one element involved like goods, services, labour and there may be other elements like land etc. Works Contracts are composite transactions involving supply of goods as well as services.

Taxation of Works Contract

After judgment of the Hon. Supreme Court in case of Gannon Dunkerly and Co. (9 STC 353)(SC), the transaction of works contract remained outside the purview of sales tax. In the above case, it was held that only “Sale” as understood under Sale of Goods Act is covered under Sales Tax net and transactions of works contract etc. cannot be covered. It is in 1983, that the 46^th Amendment was effected to the Constitution, whereby clause (29A) was inserted in Article 366 of the Constitution so as to include ‘deemed sale transactions’ in the taxation net of sales tax. There are in all six transactions included in the Constitution. One of them is works contract transaction. Thus, works contract transaction became taxable transaction under sales tax as ‘deemed sale’.

Value of goods under Works Contract

After the above amendment, issue arose about taxable quantum of the works contract under Sales Tax. The landmark judgment in case of Builders Association of India (73 STC 370)(SC) gave the guidelines about taxation of works contract under sales tax. Hon. Supreme Court held that under Works Contract the sales tax can be levied on the value of the goods and not on the total value of contract including labour charges. The relevant portion can be reproduced as under:

“Even after the decision of this Court in the State of Madras vs. Gannon Dunkerley & Co. (Madras) Ltd. [1958] 9 STC 353; [1959] SCR 379, it was quite possible that where a contract entered into in connection with the construction of a building consisted of two parts, namely, one part relating to the sale of materials used in the construction of the building by the contractor to the person who had assigned the contract and another part dealing with the supply of labour and services, sales tax was leviable on the goods which were agreed to be sold under the first part. But sales tax could not be levied when the contract in question was a single and indivisible works contract. After the 46^th Amendment, the works contract which was an indivisible one is by a legal fiction altered into a contract which is divisible into one for sale of goods and the other for supply of labour and services. After the 46^th 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.”

Thus, after 46^th Amendment, the State Government can levy sales tax on the value of the goods involved in the execution of works contract. It is also clear that the levy will be similar to tax levied on normal sale of goods.

Rate of tax

Under Sales Tax Laws, one more important issue is about rate of tax to be applied to value of goods so as to arrive at tax payable. In other words, after finding value of goods, it is also equally important to find out the rate of tax applicable to goods involved in the execution of works contract. This is again a vexed issue. Different types of goods may be involved in a works contract. One view can be that there is passing of property in all goods as one category of goods, attracting one rate. The other view is that different goods are getting transferred and the rate applicable to such goods respectively should be applied. So there can be separate rates applicable to respective values of the goods.

Smt. B. Narasamma vs. Deputy Commissioner Commercial Taxes Karnataka and another (96 VST 357)(SC)

This is the latest judgment wherein the issue about rate of tax in works contract is dealt with by Hon. Supreme Court. The issue arose out of Karnataka Sales Tax Law. The brief facts of the case narrated in the Supreme Court judgment are reproduced below.

“This group of appeals concerns the rate of taxability of declared goods- i.e., goods declared to be of special importance u/s. 14 of the Central Sales Tax Act, 1956. The question that has to be answered in these appeals is whether iron and steel reinforcements of cement concrete that are used in buildings lose their character as iron and steel at the point of taxability, that is, at the point of accretion in a works contract. All these appeals come from the State of Karnataka and can be divided into two groups—one group relatable to the provisions of the Karnataka Sales Tax Act, 1957 and post April 1, 2005, appeals that are relatable to the Karnataka Value Added Tax Act, 2003. The facts in these appeals are more or less similar. Iron and steel products are used in the execution of works contracts for reinforcement of cement, the iron and steel products becoming part of pillars, beams, roofs, etc., which are all parts of the ultimate immovable structure that is the building or other structure to be constructed.”

Thus, the controversy was about rate of tax applicable on iron and steel products used in reinforcement of cement in construction. The argument of State was that the items once used lose their individual existence and they are chargeable at one rate as residuary rate. However, Supreme Court has appreciated the contention of the dealers. The factual position of the use of goods is also narrated by Supreme Court in this judgment as under:

“Different types of steel bars/rods of different diameters are used as reinforcement (like TMT bars, CTD bars, etc.). The reinforcement bars/rods need to be bent at the ends in a particular fashion to with- stand the bending moments and flexural shear. The main reinforcement bars/rods have to be placed parallel along the direction of the longer span. The diameters of such main reinforcement rods/bars and the distance between any two main reinforcement bars/rods is calculated depending on the required loads to be carried by the reinforced cement concrete structure to be built based on various engineering parameters. At right angles to the main reinforcement bars/rods, distribution bars/rods of appropriate lesser diameters are placed and the intersections between the distribution bars/rods and main reinforcement bars/rods are tied together with binding wire. The tying is not for the purposes of fabrication but is to see that the iron bars or rods are not displaced during the course of concreting from the assigned positions as per the drawings. Welding of longitudinal main bars and transverse distribution bars is not done. In fact, welding is contra-indicated because it imparts too much rigidity to the reinforcement which hampers the capacity of the roof structure to oscillate or bend to compensate varying loads on the structure besides welding reduces the cross section of the bars/rods weakening their tensile strength. The reinforcements are placed and tied together in appropriate locations in accordance with the detailed principles and drawings found in standard bar bending schedules which lay down the exact parameters of interspaces between bars/rods, the required diameters of the steel reinforcement bars/rods and contain the required engineering drawings for placement of bars in a particular manner. The placement of reinforcement bars/rods for different structures is done under the supervision of qualified bar tenders and site engineers who are well versed with the engineering aspects related to steel reinforcement for creating reinforced cement concrete of desired load bearing capacities.“

After noting the above, the Hon. Supreme Court held that the steel products were used as it is and they were not different goods at the time of incorporation. Therefore, the rate applicable to the goods purchased would apply. The relevant observations are as under:

“Given the fact-situation in these appeals, it is obvious that paragraph 101 of this judgment squarely covers the case against the State, where, commercial goods without change of their identity as such goods, are merely subject to some processing or finishing, or are merely joined together, and therefore remain commercially the same goods which cannot be taxed again, given the rigor of section 15 of the Central Sales Tax Act. We fail to see how the aforesaid judgment can further carry the case of the Revenue.”

Thus, the Hon. Supreme Court laid down that the rate applicable to the goods transferred was applicable. Further, if the goods transferred are same goods as purchased or processed goods but the process was not amounting to manufacture, then also the rate will be same as applicable to goods purchased. Thus, deciding nature of goods, getting transferred in the contract, is important to decide the rate of tax.         

Conclusion