Deduction for “Depreciation” in Works Contract A Dilemma

The State VAT Acts normally provide statutory method for arriving at taxable value of goods in light of the above judgment. This can be referred to as statutory method. Under MVAT, Rule 58(1) of MVAT Rules, 2005 prescribes the method for arriving at value of goods. The relevant portion is reproduced for ready reference.

“58. (1) The value of the goods at the time of the transfer of property in the goods (whether as goods or in some other form) involved in the execution of a works contract may be determined by effecting the following deductions from the value of the entire contract, in so far as the amounts relating to the deduction pertain to the said works contract:–

(a) labour and service charges for the execution of the works;

(b) amounts paid by way of price for sub contract, if any, to sub-contractors;

(c) charges for planning, designing and architect’s fees;

(d) charges for obtaining on hire or otherwise, machinery and tools for the execution of the works contract;

(e) cost of consumables such as water, electricity, fuel used in the execution of works contract, the property in which is not transferred in the course of execution of the works contract;

(f) cost of establishment of the contractor to the extent to which it is relatable to supply of the said labour and services;

(g) other similar expenses relatable to the said supply of labour and services, where the labour and services are subsequent to the said transfer of property;

(h) profit earned by the contractor to the extent it is relatable to the supply of said labour and services: …” (emphasis given)

Deduction for Depreciation

One of the deductions is for charges for obtaining on hire, the machinery and tools used in the execution of works contract (item (d) above in Rule 58(1)).

If machinery is obtained on hire, there is no doubt that deduction will be available for hire charges paid. However, it is also possible that contractor will have its own machinery and will be using it for execution of contract. An issue can arise, as to whether or not depreciation relating to such machinery is eligible for deduction under above category? The issue can be examined vis-a-vis into from the following judgments.

Larsen & Toubro Ltd. v. State of Karnataka (34 VST 53)(Kar)

In this case Hon. High Court, in relation to the allowability of depreciation has observed as under:

“It is in the background of these further developments, we are examining the merits of the submissions made by Sri T. Suryanarayana, learned counsel for the appellant-assessee. On such an examination, while we find and as submitted by the learned Additional Government Advocate the word “depreciation” is conspicuously absent either in rule 6 particularly, Explanation 1 to sub-rule (4) of rule 6 or even in the judgment of the Supreme Court in Gannon Dunkerley’s case [1993] 88 STC 204 as it occurs on this aspect at pages 233 and 235, we are nevertheless inclined to examine the submissions made by Shri Suryanarayana, learned counsel for the appellant-assessee, for the reason that the entire exercise for the purpose of levy of tax under section 5B of the Act is only to ascertain the precise value of the goods in respect of which title passes from the contractor to the client on the execution of the work. The charge cannot be on anything over and above the value of the goods, not even by a pie ! Even assuming that rule 6 when read in its entirety does not contain the word “depreciation”, but nevertheless should necessarily take the hue from the permitted deductions as indicated by the Supreme Court in clause (d) occurring at page 235 of the judgment which reads as “charges for obtaining on hire or otherwise, machinery and tools used for the execution of the works of the Rules construed in this background and answer the question. We say so, for the reason that it is the goods of the assessee for the purpose of execution of the works contract, which the assessee otherwise, could have hired the machinery and tools, instead of utilizing its own machinery and tools and in the process of execution of the work, the machinery and tools are worn down and depreciate in value and as the end price, i.e., the value of the contract is fixed or determined by the contractor factoring this wear and tear to the machinery and tools as a consequence of using them for the execution of the works contract, the value of the proportionate wear and tear of the machinery which is otherwise identified as depreciation has to be necessarily permitted as a deduction on the premise that it is equivalent to the hire charges as is otherwise provided in clause (d) and for such purpose one has to understand the same even in terms of the language of Explanation I as quoted above and particularly, to be one within the scope of “other similar expenses relatable to supply of labour and services”.

We find the submission of Shri Suryanarayana, learned counsel for the appellant attractive enough for acceptance, for the reason that section 5B of the Act is only as a sequel to sub-clause (b) of clause (29A) of article 366 which reads as “a tax on the transfer of the property in goods (whether as goods or in some other form) involved in the execution of a works contract:”.

The Hon. Karnataka High Court held that depreciation amount is deductible expenditure before arriving at value of goods.

State of Kerala v. Thampi & Company (41 VST 107)(Ker)

In this case Kerala High Court was also dealing with similar controversy. Hon. Kerala High Court held that the claim is non-admissible, observing as under:

“Depreciation has a definite meaning and content and its rates are varying both for the purpose of income-tax and for preparing profit and loss account and balance sheet under the Companies Act. Therefore, if the Legislature ever intended to provide for deduction of depreciation in the computation of taxable turnover on works contract, we are sure that it would have been specifically provided in section 5C along with other deductions specifically provided. If the Tribunal’s reasoning that depreciation is also covered by sub-clause (2) of section 5C(1) under the head “charges otherwise incurred on machinery and tools for the execution of works contract”, then the provision becomes vague inasmuch as what is the rate of depreciation to be granted and whether it should be straight line method or written down value method, should have been mentioned in the section itself. In the absence of any specific provision in section 5C, we feel depreciation on machinery or tools is not eligible for any deduction in the computation of taxable turnover on works contract. Besides this, in our view, “charges for obtaining on hire or otherwise” in sub-clause (c)(ii) can only mean charges paid for obtaining machinery or tools under any other arrangement other than hire. In other words, if the charges are paid on any other terms, i.e., other than on hire arrangement for availing of the facility of machinery and tools, then only such charges are eligible for deduction, which certainly does not include depreciation because notional expenditure in the form of amortisation of cost of machinery and tools owned by the contractor is not visualised in section 5C(1)(c)(ii) of the Act.”

Thus, the situation has become debatable. In this judgment of Kerala High Court, the earlier judgment of Karnataka High court in Larsen & Toubro Ltd. (cited  supra) was not cited, and not considered. Had it been the case, it may have made a difference.

Conclusion
When Hon. Supreme Court intended to allow hire charges towards machinery, on same parity, depreciation needs to be allowed. Depreciation is nothing but writing off of sum spent earlier, in part, over a certain number of years. Therefore, with due respect, it can be said that the judgment of Kerala High Court requires reconsideration.  It is expected that the issue will be resolved at the earliest.