IntroductionThe issue about nature of transaction as to whether it is sale, service or works contract, is always debatable. This is because there are no pre-set guidelines about deciding the nature of transaction, as to whether sale, service or works contract. There are a number of judgments from various forums but still the issue has remained unresolved.
Constitutional amendment
By the 46th amendment, works contract transactions were made taxable under sales tax by insertion of Clause (29A) in Article 366 of the Constitution of India. Thereafter, the issue of deciding the nature of transaction has become much more complicated. Prior to above amendment, there were normally two types of transactions, i.e., normal sale or works contract. Since works contract was not taxable, no further demarcation used to be made. After the amendment, works contract transactions are taxable. However, all the transactions involving goods cannot become taxable works contract transactions under sales tax laws. In other words, if it can be substantiated that if in a transaction, goods are used, but such use of goods is only incidental to providing service and that the said use is not as sale of material itself, then the transaction can be classified as a transaction for rending service, not liable to tax under the sales tax laws. Therefore, after the amendment, in addition to classifying the transaction as works contract, the further classification can be made as taxable works contract under sales tax laws and non taxable transaction (involving use of goods), but which can be termed as service transaction.
Case study
Reference can be made to the judgment in case of Dr. Hemendra Surana vs. State of Rajasthan (90 STC 251)(Raj). In this case the appellant, a doctor by profession, took an X-ray of the patient and gave his report with an X-ray film. The transaction was treated as works contract by sales tax authorities, whereas the Hon. High Court held that it is not a works contract. It was held as ‘service transaction’ implying that transfer of X-ray film is incidental to professional services.
In the case of Bharat Sanchar Nigam Ltd. (145 STC 91), the Hon’ble Supreme Court discussed about deciding nature of sale vis-à-vis works contract, service transaction. The relevant observations are in para 46 which are reproduced below.
“46.. The reason why these services do not involve a sale for the purposes of Entry 54 of List II is, as we see it, for reasons ultimately attributable to the principles enunciated in Gannon Dunkerley’s case [1958] 9 STC 353 (SC), namely, if there is an instrument of contract which may be composite in form in any case other than the exceptions in Article 366(29A), unless the transaction in truth represents two distinct and separate contracts and is discernible as such, then the State would not have the power to separate the agreement to sell from the agreement to render service, and impose tax on the sale. The test therefore for composite contracts other than those mentioned in Article 366(29A) continues to be—did the parties have in mind or intend separate rights arising out of the sale of goods. If there was no such intention there is no sale even if the contract could be disintegrated. The test for deciding whether a contract falls into one category or the other is as to what is “the substance of the contract”. We will, for the want of a better phrase, call this the dominant nature test.”
In light of above, one can look into the intention of parties, the scope of work and decide the nature of transaction. The ‘dominant nature test’ was evolved by the Hon’ble Supreme Court in the BSNL judgement.
Judgment of Larger Bench in case of M/s Kone Elevators (71 VST 1)
In this case, the Hon’ble Larger Bench (5 judges) of the Supreme Court has discussed about nature of transaction of installation of lift. The judgment is by majority of four judges to one judge. The minority judgment has confirmed the original judgment that supply and installation of the lift is ‘sale’.
However, the majority judgment of four judges has held that the lift installation transaction is a ‘works contract.’ Therefore, the binding judgment will be of the majority and transaction of installation of lift will be considered as ‘works contract.’
The Hon’ble Supreme Court, in this judgment, has discussed the entire historical background of works contract transaction. And after making observations about the legal position, the Hon’ble Supreme Court turned to facts of the case.
As per the larger bench, in case of lift, the lift comes into existence on installation. Therefore, the Larger Bench has considered service part as also equally important and hence lift installation transaction is held to be a composite transaction of sale and service, i.e., works contract. This position is clear from the paragraph reproduced below.
“63. Considered on the touchstone of the aforesaid two Constitution Bench decisions, we are of the convinced opinion that the principles stated in Larsen and Toubro (supra) as reproduced by us hereinabove, do correctly enunciate the legal position. Therefore, “the dominant nature test” or “overwhelming component test” or “the degree of labour and service test”are really not applicable. If the contract is a composite one which falls under the definition of works contracts as engrafted under clause (29A)(b) of Article 366 of the Constitution, the incidental part as regards labour and service pales into total insignificance for the purpose of determining the nature of the contract.
64. Coming back to Kone Elevators (supra), it is perceivable that the three-Judge Bench has referred to the statutory provisions of the 1957 Act and thereafter referred to the decision in Hindustan Shipyard Ltd. (supra), and has further taken note of the customers’ obligation to do the civil construction and the time schedule for delivery and thereafter proceeded to state about the major component facet and how the skill and labour employed for converting the main components into the end product was only incidental and arrived at the conclusion that it was a contract for sale. The principal logic applied, i.e., the incidental facet of labour and service, according to us, is not correct. It may be noted here that in all the cases that have been brought before us, there is a composite contract for the purchase and installation of the lift. The price quoted is a composite one for both. As has been held by the High Court of Bombay in Otis Elevator (supra), various technical aspects go into the installation of the lift. There has to be a safety device. In certain States, it is controlled by the legislative enactment and the rules. In certain States, it is not, but the fact remains that a lift is installed on certain norms and parameters keeping in view numerous factors. 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.”
It can be seen that, ultimately the Hon’ble Supreme Court has decided the issue on the factual position.
OUTCOME
As per above judgment, the dominant nature test etc.,
are irrelevant. It appears that the basic nature of the transaction is required to be seen and if it is works contract then the dominant nature test or overwhelming component test etc., are not relevant. Thus, one is again in a dilemma about deciding nature of taxable works contract transaction vis-à-vis service transaction, where some materials may be involved.
By virtue of BSNL decision, dominant nature test could have been applied. In fact, in this case the Hon’ble Supreme Court has observed that doctors, lawyers cannot be liable to tax as the basic nature of transaction is rendering service, though some goods may be involved and transferred. In the judgment of Kone Elevators, the Hon’ble Supreme Court has observed that the dominant nature test is not relevant. Thus, someone may take a view that the doctors and lawyers can also be liable, as the service nature of transaction is not relevant.
This will be an extreme view, which cannot be justified. Though, the dominant nature test is not relevant, still the issue will arise whether services of doctors and lawyers can be considered to be works contract. We have to look into the basic nature of transaction to decide whether it is a works contract? But as discussed, the position has become more fluid and the issue of above nature may crop up. In fact, this is the guidance expected from the judicial pronouncements from the Hon’ble Supreme Court. In any case, in light of direct observations of the Supreme Court in case of BSNL, it can be said that, the services of doctors and lawyers are still out of purview of sales tax laws.
In fact in recent judgment in case of International Hospital Pvt. Ltd. (71 VST 139)(All), the Hon. Allahabad High Court has held that use of stents and valves in heart procedure of patient at hospital is not works contract. However, there can be contrary judgment and the situation will remain uncertain. In above judgment of the Hon. Allahabad High Court itself, there is reporting of contrary judgment of the Kerala High Court in case of Aswini Hospital Pvt. Ltd. (51 NTN 29)(Ker), wherein the hospital is held as liable to works contract tax.
CONCLUSION
In case of International Hospital Pvt. Ltd., the judgment of the Supreme Court in Kone Elevators, i.e., (71 VST 1) was not available. Therefore, one may be tempted to say that the above judgment may require reconsideration in light of above judgment in case of Kone Elevators. However, it appears that the judgment in case of International Hospital Pvt. Ltd., will still hold good as the same is based on basic nature of transaction and will be saved even by judgment of Kone Elevators. In the future, reconfirmation of above judgment of the Allahabad High Court will certainly helpful in deciding correct nature of transaction, more particularly the service transaction where some material is involved in the rending of service.
