IntroductionSeveral controversies have revolved around the issue as to whether a transaction amounts to ‘sale’ or “works contract”. In several judgments, the issue has been dealt with different perspectives. In a very well-known decision in the case of State of Andhra Pradesh vs. Kone Elevators – [2005-(181)-ELT-156-(SC)], a Three Judges Bench of the Supreme Court held that a contract of supply and installation of lift
was one for sale and not a works contract as (a) the obligation of civil construction and preparatory work is that of purchaser of the lift and not of supplier and therefore (b) skill and labour employed for converting main components into end product was only incidental to components in the contract for sale. Consequent to the said judgment, several show cause notices were issued to the appellant proposing re-opening of assessment, as in a large number of cases in various States, the assessments were done considering the contracts as works contracts. In the State of Maharashtra, prior to the above decision in Kone Elevators’ case, the State treated contracts for sale and installation of lifts as works contracts as per the High Court’s decision in Otis Elevator Company (India) Ltd. vs. State of Maharashtra – (1969)-24-STC-525- (Bom). However, following the decision of the Supreme Court in Kone Elevators (Supra) from 01-04-2006, the position was adjusted to the law laid down by the Three Judge Bench of Supreme Court.
In this background, M/s. Kone Elevators India engaged in the manufacture, supply and installation of lifts as well as civil constructions, while undergoing assessment for 1995-1996 in the State of Tamil Nadu, the Sales Tax Tribunal and later the High Court, held that activity of erection and commissioning of lift was works contract and not sale. As against this, in some other States, the assessments closed based on treating the transaction as ‘sale’ were proposed to be re-opened. Driven by the paradox, Kone Elevators India Private Limited filed a writ petition, wherein along with other special leave petitions, it was noted by the Three – Judge Bench that the question raised for consideration is whether the manufacture, supply and installation of lifts is ‘sale’ or “works contract” and that in 2005-(181)-ELT-156-(SC) (supra), the Bench had not noticed the decisions of Supreme Court rendered in State of Rajasthan vs. Man Industrial Corporation Limited – (1969-1-SCC-567, State of Rajasthan & others vs. Nenu Rani – (1970)-26-STC-268-(SC) and Vanguard Rolling Shutters & Steel Works vs. Commissioner of Sales Tax – (1977)-2-SCC-250 and therefore, found it appropriate to refer the controversy to the Larger Bench to resolve the discord and to decide whether contract for manufacture, supply and installation of lifts in a building is a contract for sale of goods, liable for sales tax/VAT under the State legislation or a works contract wherein labour and service components would be excluded from total consideration. Consequently, the Five Judge Bench of the Hon. Supreme Court by majority in Kone Elevator India Pvt. Ltd. vs. State of Tamilnadu 2014 (34) STR 641 (SC) overruled the Three Judge Bench decision of 2005 considering it incorrect and held that individually manufactured goods such as lift, car, motors, ropes, rails etc., are components of lift and they are assembled and installed with skill and labour at site to become permanent fixture of building thus satisfying the fundamental characteristics of works contract. The judgment by the majority as well as the contrary view are briefly summarised below:
Some important decisions relied upon in Kone Elevators vs. State of Tamil Nadu 2014 (34) STR 641 (SC).
Before proceeding with the outline of the judgment, a few of the important decisions relied upon by the Larger Bench are briefly described below:
In Patnaik & Co. vs. State of Orissa 1965 (2) SCR 782 the issue involved related to construction of bodies on the chassis supplied to the contractor as bailee. It was held that such a contract being one for work and not a contract for sale, as the parties under the contract did not sell the bus bodies. The Bombay High Court in Otis Elevator Company (India) Ltd. vs. State of Maharashtra 1969 (24) STC 525 (Bom) held that manufacture, supply and installation of lifts is works contract as per the Bombay Lifts Act, 1939 read with Rules thereunder.
As against the above, in Union of India vs. Central India Machinery Manufacturing Co. Ltd. (1977) 2 SCC 847, the Apex Court held that the contract of manufacture and supply of wagon was nothing but a ‘sale’ and not works contract. However, post 46th Constitutional Amendment and insertion of a sub-Article 29A in Article 366 of the Constitution, in Builders’ Association of India and others vs. UOI & others (1989) 2 SCC 645 it was held that 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 and the property transfers when the goods are supplied in the works and goods involved in the execution of works contract. Therefore, composite contracts for supply and installation, construction of lift or flat are classified as “works contract”.
In case of Hindustan Shipyard Ltd. vs. State of A.P. (2000) 6 SCC 579 (relied on in the case of Kone Elevators 3 Bench Judgment – supra also), the Court held that if the thing to be delivered has individual existence before delivery as the sole property of the party delivering it, then it is a sale. If the bulk of the material used in construction belongs to the manufacturer selling the end product for a price, then it is a stronger pointer that contract in substance is of sale of goods and not one for labour. However, the test is not decisive. The Court finally ruled observed that it is not bulk of the material alone but the relative importance of material qua the work, skill and labour of the payee is also to be seen. If the major component of the end product is material consumed in producing the chattel to be delivered and skill & labour is incidentally used, the end product delivered by the seller to the buyer would constitute sale whereas if the main object of the contract is to avail skill and labour of the seller though same material may be used incidentally by investing skill and labour of the supplier, the transaction would be a contract of work and labour.
In Vanguard Rolling Shutter’s case (1977) 2 SCC 250, the Supreme Court while reversing the decision of the High Court had observed that material as supplied was not supplied by the owner so far as to pass as chattel simplicitor but affixing to one immovable property and after which it became permanent fixture and accretion to the immovable property. Further, the operation to be done at site was not incidental but a fundamental part of the contract and therefore it was a works contract. Similarly, in Man Industrial Corporation Ltd. (supra) also, the Court treated the contract for providing and fixing different windows of certain sizes as per specification, design, drawings etc., as contract for work and labour and a contract for sale for fixing the windows to the building was not incidental/subsidiary to the sale but was essential term of the contract.
In addition to the above, interalia the decisions such as State of Madras vs. Gannon Dunkerley & Co. AIR 1958 SC 560, Associated Hotel’s case (1972) 1 SCC 472, State of Gujarat vs. M/s. Variety Body Builders (1996) 3 SCC 500 etc. were discussed to appreciate the controversy and genesis of law in respect of works contract before dwelling upon the principles in relation to works contract to apply to manufacture, supply and installation of lifts. Nevertheless, it was also observed and noted that there is no standard formula by which a contract of sale could be distinguished from a contract of work as it depended on facts and circumstances of each case. Further, citing landmark judgment of Bharat Sanchar Nigam Ltd. vs. UOI
Others 2006 (2) STR 111 (SC), which dealt with the issue of whether mobile phone connection was a transaction of sale or service or both, the Court observed that after 46th Amendment, the sale elements when covered under Article 366 (29A), the “dominant nature test” was not applicable and this was also reiterated in recent decision of the Apex Court in Larsen & Toubro Ltd.’s case 2014 (34) STR 481 (SC) relied upon heavily while deciding the instant case of Kone Elevators.
Core issue in brief:
The petitioners contended that supply and installation of lift cannot be treated as contract of sale. Each major component of crane has its own identity prior to installation and they are assembled/installed at site to bring ‘lift’ into existence and installation requires great skill and expertise and without installation, adjustment, testing etc. no lift could become operational in a building. Besides discussing various rulings on the subject matter, the petitioner’s counsel referred to Bombay Lifts Act, 1939 and Rules made thereunder to drive home the point that manufacture, supply and installation were controlled by statutory provisions under an enactment of the legislature which reflected that immense skill is required for such installation, as a result of which only lift becomes operational and lift is not sold like goods.
Various States like Maharashtra, Gujarat, Karnataka, Orissa, Tamilnadu and Andhra Pradesh, Rajasthan, Haryana etc., have put forward their submissions. Those of which argued against the transaction being treated as a works contract, in substance, contended that even if a high degree of skill went into the installation was an inseggregable facet of the manufacturing process and would not be more than an article for sale on the basis of a special order and erection meant only a functional part of the system to bring the goods to use and hence it was the culmination of the fact of sale. The contract involved goods in any form intended for transfer but the completion of transfer involved certain activities, under any name but the term “deliverable state” as provided in section 21 of the Sale of Goods Act, 1930 was attracted and therefore the contract was purely of sale of goods. As against this, the States contending the contract as one of works contract, backed the theory that considering multifarious activities involved in the installation, it should be construed as works contract.
Majority view:
Thoroughly considering Article 366(29A), the Larger Bench interalia importantly referred to three categories of contracts as explained in Hindustan Shipyard (supra) as follows:
“(i) the contract may be for work to be done for remunera-tion and for supply of materials used in the execution of the work for a price;
it may be a contract for work in which the use of the materials is accessory or incidental to the execution of the work; and
it may be a contract for supply of goods where some work is required to be done as incidental to the sale.”
Thereafter, it opined that the first contract is a composite contract consisting of two contracts, one of which is for the sale of goods and the other is for work and labour; the second is clearly a contract for work and labour not involving sale of goods; and the third is a contract for sale where the goods are sold as chattels and the work done is merely incidental to the sale.”
Also in detail was considered Larsen and Toubro (su-pra) wherein it was found to have been elucidated that after 46th Amendment, transfer of property in goods whether as goods or in some other form would include goods ceased to be chattels or movables or mer-chandise and become attached or embedded to earth. Thus goods which are incorporated into immovable property are deemed as good/s and therefore the narrow meaning given to the term “works contract” in Gannon Dunkerley-I (supra) no longer survives. Once the characteristics of works contract are satisfied in a contract, irrespective of existence of additional obligation, the contract does not cease to be a works contract because nothing in Article 366(29A)(b) limits the term “works contract”. In view thereof, the Larger Bench among other things reiterated what was stated in Larsen and Toubro (supra) “even if dominant intention of the contract is not to transfer the property in goods and rather it is the rendering of service or the ultimate transaction is transfer of immovable property, then also it is open to the States to levy sales tax on the materials used in such contract if it otherwise has elements of works contract”. The Bench noted that from their detailed analysis, the following 4 concepts emerge:
“(i) the works contract is an indivisible contract but, by le-gal fiction, is divided into two parts, one for sale of goods and the other for supply of labour and services;
The concept of “dominant nature test” or, for that matter, the “degree of intention test” or “overwhelming component test” for treating a contract as works con-tract is not applicable;
The term “works contract” as used in clause (29A) of Article 366 of the Constitution takes in its sweep all genre of works contract and is not to be narrowly construed to cover one species of contract to provide for labour and service alone; and once the characteristics of works contract are met within a contract entered into between the parties, any additional obligation incorporated in the contract would not change the nature of the contract.”
The Court went through the terms of the agreement in detail and referring to Richardson & Crudass Ltd. (1968) 21 STC 245 (SC), noted that they were also indicative of the fact that the whole contractual obligation was not divisible in parts and was intimately connected with labour and services undertaken by the applicants in erecting and installing the apparatus. Further, for functioning of lift in a huge building to carry persons to several floors calls for considerable technical skill, expertise, experience and precision in execution of work and therefore found it difficult to sever the agreement in two parts, one for sale of goods and another for services as the two are intimately connected. Severance is not possible and in fact it was an indivisible contract. For installation of the elevator, regard must be had to its technical facet, safety devise and actual operation and apart from it, it is an important fact that upon installation, it becomes a permanent fixture in the premises. Therefore, installation of a lift in a building cannot be regarded as transfer of a chattel as goods but a composite contract.
The Bench per majority view thus held that:
The dominant nature test or overwhelming component fees is not applicable.
A composite contract is works contract in terms of Article 366(29A)(B) of the Constitution, the incidental part of labour and services pales into total insignificance for determination of nature of contract.
The conclusions reached in Kone Elevator (supra) were based on bedrock of incidental service for de-livery since the contract itself speaks about obligation to supply lift as well as its installation which conveys performance of labour and service. Hence fundamental characteristic of works contract are satisfied. The decision rendered in Kone Elevators (supra) does not lay down the law correctly and it is accordingly overruled.
Contrary view:
According to the view expressed at great length by the Hon. Justice F. M. Ibrahim Kalifulla, by calling an activity as “works contract” by itself will not make the activity a works contract unless as explained in the document confirms to that effect. The contract according to the Bench, related only to supply a branded lift in the premises of the purchaser. Major part of the work is carried out by the purchaser in order to enable the petitioner to erect its elevator in the premises. In view of the nature of the prod-uct supplied, it has to necessarily assemble different parts in purchaser’s premises and thereby fulfill the contract of supply of lift in a working condition.
It was also noted emphatically that reference made by petitioner’s counsel to Bombay Lifts Act,1639 did not provide any scope to reach the conclusion that a contract between petitioner and the purchaser was one of works contact and therefore the submissions made in such re-gard were not acceptable. Next aspect dealt with this in contrary view is elaborate analysis of terms and condi-tions of the specimen contract of the petitioner with purchaser of the elevator. The first part of the contract related to preparatory work for the erection of the lift, the whole of which was observed to have been done by the purchaser whereas provision of ladder in the pit or steel fascia at every sill level were found to be only material and part of the lift and hence did not involve any work therein according to the Bench.
Another set of conditions related to prize variation clause captioned as “works contract.” The Bench making a threadbare analysis of conditions laid therein observed that the caption had nothing to do with the contents there-in. Under this very head, it was stipulated by way of pay-ments that claim for manufactured material had to be paid with material invoice and claim for installation relating to labour costs was required to be paid along with their final invoice. This was found to be indicative of contract be-ing divisible in nature and calling it an indivisible one is contrary to its own terms. The most glaring condition that 90% was payable on signing of the contract and 10% on commissioning of lift or in case of delay beyond control of appellant, then within 90 days of the material getting ready for dispatch itself was suggestive of the fact that the contract was separable, one for supply of material and minuscule portion for work involved. It was further found that receiving 90% upfront without having obligation to fulfill or suffer damages read along with other stipulations disclose that it was attributable towards manufacturing cost whereas the balance towards installation service. Therefore, it would have to be the contract of manufac-ture, supply and installation would be one of ‘sale’ alone and therefore could not be called works contract. Once conclusion reached accordingly, then application of Ar-ticle 366(29A)(b) could not be made.
The next in line, was the observation that as a general proposition, it is not appropriate to hold that whenever any element of works is involved, irrespective of its magnitude, all contracts should be held to be works contracts, though the contract may be for supply of goods. Such sweeping interpretations is inappropriate; what is omitted to be considered is whether in the first instance, by the essential ingredients of the contract, the essential ingredi-ents of ‘sale’ as defined in the Sale of Goods Act are present or absent for the purpose of levy of sales tax. If they are present, then going by the ratio of Bharat Sanchar Nigam’s case (supra), application of Article 366(29A) is not available. In the instant case, the essential ingredient of the contract was for sale of the lift and for this purpose, the petitioner also agreed to carry out installation. In Larsen & Toubro’s case (supra), the contract related to development of property which did not pertain to labour and services alone but also to bring into existence some element of works. Such a ratio considering the nature of contract dealt with could not have universal application to every contract. In the case on hand, when the contract itself was for supply of lift, simply because some work element was involved for installation of the lift, it cannot be held that the whole contract is a works contrathe Larsen
Toubro (supra) at para 76 would apply in the peculiar facts of that case relating to the construction of building between developer and owner on one side and purchaser on the other.
In the instant case, since sale as defined under the Sale of Goods Act occurred when a lift was supplied and there-fore the question of deemed ‘sale’ did not arise. Also going by the dictum in Patnaik and Company (supra), the contract as a whole has to be examined to understand the real intention of the parties. Applying the said principle to the instant contract to ascertain a contract of ‘sale’ and “works contract”, it can be held that what was transferred by petitioner to the purchaser after its installation was lift as a chattel and this contract is nothing but a sale. To conclude, simply because some element of works is involved in a contract, the whole contract would not be-come works contract. Even after the 46th Amendment, if Article 366(29A)(6) is to be invoked, as a necessary con-comitant, it must be shown that terms of contract lead to conclusion that it is works contract. Unless a contract is proved to be a works contract, Article 36B(29A)(b) is not invokable. Alternatively, if the terms of contract lead to a conclusion of sale, it will attract the provisions of relevant sale tax contract. The Bench thus concluded that the instant case was sale of lift and therefore the decision in Kone Elev.ators (India) Pvt. Ltd. (supra) was correct.
Conclusion:
Considering that each of the views above, whether majority or otherwise has its own merits and due consideration of facts involved in the issue, it is hard to infer that sanity is necessarily statistical. Nevertheless, the majority view of the Apex Court is respected as law and a binding precent for all. Yet, it is difficult to conclude that controversy surrounding various composite contracts involving sale and works or services of different proportions would cease to exist, considering the fact that each transaction is unique on its own facts and each emerging issue may be different from the available precedents on the larger issue. However, on having a closer look, it is not an up-hill task to deduce that the chief cause of controversy is nothing but absence of a common legislation to tax sale and service. Non-taxability of one component or difference in rate of taxation under separate legislations and Centr-State tug of war are the main contributories to the litigation relating to composite contracts involving sale and works. When a common tax tool is available to tax both goods and services, irrespective of their proportion in a composite contract, the courts will not be required to hair-split and make microscopic observations to analyses their divisibility or otherwise or the elements of sale or service or interpret whether intangible element is goods or service. Every tax compliant corporate citizen is awaiting a day when one complies with the law under a legislation, the hanging sword of wrath under the other legislation no longer exists.
