Is Schedule Ii To The Central GST Act, 2017 & Other State GST Acts Unconstitutional As Regards Certain Services?

Introduction

The Goods and Services Tax legislations have become a reality
now and are in operation. The start was through a Constitutional (101^st)
Amendment Act, 2016 which came into effect from September 2016 itself. In that
Act, the Constitution was amended to insert, modify and delete several articles
to pave the way for introduction of GST. In doing so, however, Article 366(29a)
was left untouched. This article would analyse the effect of having this clause
remaining in the Constitution.

Goods and Services Tax

The term “goods” is defined in Article 366(12) to include all
materials, commodities and articles. As per Article 366(26A), “services” is
defined to mean anything other than goods. Article 366(12A) defines “goods and
services tax” to mean any tax on supply of goods or services or both except
taxes on the supply of the alcoholic liquor for human consumption.” Therefore,
it stands to reason that the goods and services tax is a tax on supply of goods
or services.

Tax on sale or purchase of goods

However, in Article 366(29a), which was inserted by
Constitution (46^th Amendment) Act, 1982, the definition of tax on
the sale or purchase of goods was introduced. The reason for its introduction
was several transactions which could not be taxed by the States because of
interpretation placed by the Courts was sought to be overcome. Now let us take
a look at the said definition which is set out hereunder (emphasis supplied):

“[(29A) “tax on the sale or purchase of goods” includes –

(a)  a tax on the transfer, otherwise than
in pursuance of a contract, of property in any goods for cash, deferred payment
or other valuable consideration;

(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;

(c)  a tax on the delivery of goods on
hire-purchase or any system of payment by instalments;

(d)  a tax on the transfer of the right to
use any goods for any purpose (whether or not for a specified period) for cash,
deferred payment or other valuable consideration;

(e)  a tax on the supply of goods by any
unincorporated association or body of persons to a member thereof for cash,
deferred payment or other valuable consideration;

(f)   a tax on the supply, by way of or as
part of any service or in any other manner whatsoever, of goods, being food or
any other article for human consumption or any drink (whether or not
intoxicating), where such supply or service, is for cash, deferred payment or
other valuable consideration,

and such transfer, delivery or supply of any goods
shall be deemed to be a sale of those goods by the person making the transfer,
delivery or supply and a purchase of those goods by the person to whom such
transfer, delivery or supply is made;”

In BSNL Ltd vs. UOI 2006 (2) STR 161, the Supreme
Court succinctly brought out reasons for its introduction which is set out
hereunder:

39. Clause (a) covers a situation where the
consensual element is lacking. This normally takes place in an involuntary
sale. Clause (b) covers cases relating to works contracts. This was the
particular fact situation which the Court was faced with in Gannon Dunkerley
and which the Court had held was not a sale. The effect in law of a transfer of
property in goods involved in the execution of the works contract was by this
amendment deemed to be a sale. To that extent the decision in Gannon Dunkerley
was directly overcome. Clause (c) deals with hire purchase where the title to
the goods is not transferred. Yet by fiction of law, it is treated as a sale.
Similarly the title to the goods under Clause (d) remains with the transferor
who only transfers the right to use the goods to the purchaser. In other words,
contrary to A.V. Meiyappan’s decision a lease of a negative print of a picture
would be a sale. Clause (e) covers cases which in law may not have amounted to
sale because the member of an incorporated association would have in a sense
begun both the supplier and the recipient of the supply of goods. Now such
transactions are deemed sales. Clause (f) pertains to contracts which had been
held not to amount to sale in State of Punjab vs. M/s. Associated Hotels of India
Ltd. (supra). That decision has by this clause been effectively legislatively
invalidated.

40. All the clauses of Article 366(29A)
serve to bring transactions where one or more of the essential ingredients of a
sale as defined in the Sale of Goods Act, 1930 are absent, within the ambit of
purchase and sales for the purposes of levy of sales tax. To this extent only
is the principle enunciated in Gannon Dunkerly limited. The amendment
especially allows specific composite contracts viz. works contracts [Clause
(b)], hire purchase contracts [Clause (c)], catering contracts [Clause (e)] by
legal fiction to be divisible contracts where the sale element could be
isolated and be subjected to sales tax.

It is clear from the above definition and analysis, that the
following goals get achieved through the amendment:

i.   The definition talks of a tax on sale or
purchase of goods to include several things listed therein;

ii.  There are three clauses dealing with tax on
transfer (clauses a, b and d), one clause dealing with tax on delivery (clause
d) and two clauses dealing with tax on supply;

iii.  All the clauses deal with goods only;

iv. Further, the clause states that such transfer,
delivery and supply shall be deemed to be a sale or purchase of goods.

GST scenario

In the GST scenario, there are two principal legislations
dealing with tax on supply of goods or services – the Central GST Act, 2017 and
the State GST Act, 2017. It would be noted that the IGST Act, 2017 deals with
interstate supplies and imports. We take the CGST 2017 for analysis for the
sake of convenience and as this has been replicated by all states, it will hold
equally valid. Supply is defined in section 7 to include all forms of supply
of goods or services or both such as sale, transfer, barter, exchange, licence,
rental, lease or disposal made for a consideration in the course or furtherance
of business. Thus, the terminology supply includes sale of goods.

If we look further into section 7(1)(d), supply includes
activities to be treated as supply of goods or supply of services as referred
to in Schedule II. Schedule II attempts to classify what would be termed as
supply of goods and what is termed supply of services.

A close look at Schedule II would reveal the general theme
that transfer of title in goods will be classified as supply of goods and
transfer of other rights in goods would be classified as supply of services.
Further, transactions covered by clauses (b), (c), (d), and (f) of Article
366(29a) are classified as services while transactions covered by clause (e) is
covered as supply of goods. In effect therefore, works contract, hire
purchase transactions and transfer of right to use goods apart from goods
supplied in restaurant/hotels are classified now as supply of services and not
supply of goods.

Does this conflict with Article 366(29a)?

There are no two opinions about this that tax on works
contract, hire purchase and transfer of right to use goods apart from food
supplied in restaurants were and are treated as sale and purchase of goods by
virtue of the deeming fiction appearing in Article 366(29a) of the
Constitution. Therefore, to this extent the transactions being covered by
Schedule II are termed as services are seemingly in direct conflict with the
above constitutional provisions. Therefore, one has to find whether we can
harmonise Article 366(26A) which deals with tax on goods and services vis-a-vis
Article 366(29a) which deals with tax on sale or purchase of goods and deeming
certain transactions to be sale or purchase of goods.

Whether harmonising possible?

If we look at the constitutional provisions, there is no
definition of what is supply. But when we look at the statute, the term supply
is defined to have a wider meaning than the term sale as the latter is included
in the former. Therefore, sale is only a sub-sect of supply which includes
several other things. Can a statute be used to interpret the meaning of the
terms in the Constitution? Is such recourse possible? One argument is that the
term “sale” appearing in the Constitution was so interpreted by the Supreme
Court to be what was being used under a legislation. The summary of this
discussion is found in BSNL case supra which is reproduced hereunder:

To answer the questions formulated by us, it is necessary
to delve briefly into the legal history of Art. 366(29A). Prior to the 46th
Amendment, composite contracts such as works contracts, hire-purchase contacts
and catering contracts were not assessable as contracts for sale of goods. The
locus classicus holding the field was State of Madras vs. Gannon Dunkerley
& Co. – IX STC 353 (SC). There this Court held that the words “sale of
goods” in Entry 48 of List II, Schedule VII to the Government of India Act,
1935 did not cover the sale sought to be taxed by the State Government under
the Madras General Sales Tax Act, 1939. The classical concept of sale was held
to apply to the entry in the legislative list in that there had to be three
essential components to constitute a transaction of sale – namely, (i) an
agreement to transfer title, (ii) supported by consideration, and (iii) an
actual transfer of title in the goods. In the absence of any one of these
elements it was held that there was no sale. Therefore, a contract under which
a contractor agreed to set up a building would not be a contract for sale. It
was one contract, entire and indivisible and there was no separate agreement
for sale of goods justifying the levy of sales tax by the provincial
legislatures. “Under the law, therefore, there cannot be an agreement relating
to one kind of property and a sale as regards another”. Parties could have
provided for two independent agreements, one relating to the labour and work
involved in the execution of the work and erection of the building and the
second relating to the sale of the material used in the building in which case
the latter would be an agreement to sell and the supply of materials
thereunder, a sale. Where there was no such separation, the contract was a
composite one. It was not classifiable as a sale. The Court accepted the
submission of the assessee that the expression “sale of goods” was, at the time
when the Government of India Act, 1935 was enacted, a term of well recognized
legal import in the general law relating to sale of goods and must be
interpreted in Entry 48 in List II of Schedule VII of the 1935 Act as having
the same meaning as in the Sale of Goods Act, 1930. According to this decision
if the words “sale of goods” have to be interpreted in their legal sense, that
sense can only be what it has in the law relating to sale of goods. To use the
language of the Court :

“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”.

34. Following the ratio in Gannon Dunkerley,
that “sale” in Entry 48 must be construed as having the same meaning which it
has in the Sale of Goods Act, 1930, this Court as well as the High Courts held
that several composite transactions in which there was an element of sale were
not liable to sales tax.

One could also view that actually the Gannon Dunkerly
decision to treat sale in the context of how the Government of India Act, 1935
had viewed it and as our Lists in VII Schedule were more or less reproductions,
it was to be interpreted keeping in mind what was the meaning in the earlier
legislation which was parallel to our constitutional provisions and therefore,
the Supreme Court has actually not subordinated the Constitution to the
statute. However, the BSNL’s case (supra) does not follow this argument
as also other Courts and have consistently interpreted the Gannon Dunkerly
judgement that the terms used in the constitution have been interpreted keeping
in mind the legislation present at that time.

If this argument be accepted, then clearly, the CGST Act 2017
can be used to refer to the meaning of the term supply which is conspicuous by
its absence in the Constitution. So read, sale is a sub-sect of supply as
supply will include other forms like transfer, barter, lease, rental, etc.
apart from sale. Therefore, Article 366(29a) is now a sub-sect of Article
366(26A) which seems to be plausible but flawed in one clear sense – the
sub-sect was introduced before the sect itself. But we assume here that the
makers wanted to so do as they were introducing a tax on a wider system of
supply than the narrow system of sale. If we do not treat the same as a sub
sect, then the two clauses are independent and the GST legislations will
clearly suffer from the vice of unconstitutionality in that respect.

Harmonising will still not save

Assuming for a moment that the clause is a sub-sect of
supply, still the challenge to the provisions contained in schedule II will
hold good because to the extent those clauses treat the transactions as supply
of services, they are still in conflict with the express provisions of Article 366(29a).

One other argument which can be thought of is that Article
366(29a) was retained in the Constitution for a specific reason that those
transactions which were entered into prior to 1.7.2017 when the GST
legislations were brought into force would still be protected for realisations
made after 1.7.2017. To put it simply, suppose you entered into a lease
transaction before 1.7.2017 which amounted to a transfer of right to use goods
and was treated as supply of goods earlier, the instalments that are realised
after 1.7.2017 could still be collected as the Constitutional mechanism is
still intact. However, this would lead us to a very paradoxical position. If
those transactions are covered still as tax on sale or purchase of goods, the
new levy of GST cannot be applied at all. In fact, that is clearly the
situation. For example, if I entered into a car lease on 1.4.2017, the
transaction would have been taxed as a sale of goods under the respective VAT
legislations and VAT has to be discharged every time the lease rentals are
invoiced. Similar would be cases of transfer of rights to use other goods like
machinery. Come 1.7.2017, the car lease rentals are described as services and
taxed at a rate of 43% or other transfers of right to use are now taxed under
GST as services. Can the recovery of instalments be taxed under GST where the
delivery or transfer of right to use is already complete prior to 1.7.2017 when
GST was introduced? The answer is a clear no and therefore, to charge GST on
such transactions may be beyond the statute itself, leave alone the
constitution. This is because, there is no supply under GST and the transfer of
right to use or delivery of goods has already occurred before the GST
legislation came into force. Even section 142(10) of the CGST Act, 2017 will
apply where in a continuing contract the supply is made after 1.7.2017.

That would mean that those collections have to be done under
the old VAT laws which now stand repealed. By virtue of section 174 of the CGST
Act, 2017 or section 173/174 of the Karnataka GST Act 2017 read with section 6
of the General Clauses Act, 1897 can it be said that the previous liability
will still continue under such Acts, in which case, till those transactions
conclude, the respective liability continues. However, it can be equally argued
that liability to pay tax occurs every month on lease rentals and unless the
legislation is in force, there is no liability to pay at all and my previous
liabilities are completely discharged.

Conclusion