SUPREME COURT: NO SERVICE TAX ON WORKS CONTRACT PRIOR TO 01/06/2007

THE JUDGMENT OF The HON. SUPREME COURT:
In
various revenue appeals, the substance contended was that the 46th
amendment itself divided works contract by Article 366(29A)(6) and what
remained after removing goods element was labour and service and these
were subjected to service tax by various entries in the Finance Act,
1994. Secondly, the Finance Act, 1994 itself contains both charge of
service tax as well as machinery by which only labour and service
element in indivisible contracts is taxable and the statute need not do
what the constitution amendment has already done viz. splitting of
indivisible works contract into a separate contract of transfer of
property in goods involved in execution of works contract taxable by the
States and labour and service element on the other hand is taxable by
the Central Government. As such, defining works contract in 2007 for the
first time would make no difference as the elements of works contracts
were already taxable under the Finance Act, 1994 even prior to the
introduction of the said definition. Lastly, therefore relying on
section 23 of the Contract Act and McDowell & Company Ltd. 1985 (2)
SCC-230, all indivisible contracts were made with a view to avoid/ evade
tax and this being contrary to public policy, invoking principles laid
down in the said McDowell’s case, the socalled indivisible contracts
should be taxed under the Finance Act, 1994.

As against the
above, it was pleaded for various assessees that works contract is a
separate species known to the world of commerce and law and being so, an
indivisible works contract would have to be split into constituent
parts by necessary legislation to contain a charge to service tax
together with requisite machinery provisions. Secondly, there did not
exist such charge and machinery prior to 2007 and what was taxable was
only the pure service in which no goods element was involved and thirdly
in view of this, the Delhi High Court’s judgment in G. D. Builders’
case 2013 (32) STR 673 (Del) was wholly incorrect.

Analysis:
Considering
the above rival contentions, the Hon. Apex Court examined section 64,
relevant clauses in section 65(105), charging section 66 and section 67
of the Act, Rule 2A of the Service Tax (Determination of Value) Rules,
2006 (Valuation Rules) dealing with valuation in depth and also went
into examining in detail second Gannon Dunkerley judgment (1993) 1 SCC
364, heavily relied by the assessee’s counsel and observed at para 15 of
the judgment, that unless splitting of an indivisible works contract is
done, taking into account the eight deductions elaborated in the said
judgment of Gannon Dunkerley (supra) (i.e. deductions for amount paid to
subcontractor for labour and services, planning, designing and
architect’s fees, hire charges for machineries and equipments,
consumables like water, electricity and fuel etc., other charges for
labour and services, cost of transportation to bring goods to the place
of work and cost of establishment and profit of the contractor relatable
to labour/services) the charge would transgress into forbidden
territory i.e. cost, expense and profit attributable to the transfer of
property in goods in such contract. This being the case, the Court
concurred with the case of the assessees that the charging section
itself must specify that service tax can only be on the works contracts
and the measure of tax can only be on the portion of the works contract
representing service element to be derived only by deducting value of
property in goods transferred in execution of the works contract from
the gross value of the works contract. The Court further noted that as
reflected in Bharat Sanchar Nigam Limited vs. UOI 2006-TIOL-15-
SC-CT-LB, the scheme of taxation under the constitution is such that
powers of the Centre and State are mutually exclusive. Thus, it is
important to segregate the two elements completely and in case of
transgression, the levy would be constitutionally infirm and therefore
exclusivity has to be maintained and thus the Court relying again on
Gannon & Dunkerley (supra), Kone Elevators India P. Ltd. P. Ltd. vs.
State of T. N. 2014-TIOL-57-SC-CT-LB and Larsen & Toubro vs. State
of Karnataka 2013-TIOL- 46-SC-CT-LB endorsed recognition of works
contracts as a separate species of contract and interalia cited Larsen
& Toubro 2013-TIOL-46-SC-CT-LB in approval thereof as follows:

“…..
The term “works contract” in Article 366(29A)(b) is amply wide and
cannot be confined to a particular understanding of the term or to a
particular form. The term encompasses a wide range and many varieties of
contract. The term “works contract” in Article 366(29A)(b) takes within
its fold all genre of works contract and is not restricted to one
specie of contract to provide for labour and service alone”.

The
Court also analysed and accepted the assessee’s next important plea
that there did not exist charge to tax works contract in the Finance
Act, 1994 prior to 01/06/2007 is a correct view. To arrive at the view,
reliance was interalia placed on the following:

Mathuram Agrawal vs. State of M.P. (1999) 8 SCC 667

“The
statute should clearly and unambiguously convey the three components of
the tax law i.e. the subject of the tax, the person who is liable to
pay the tax and the rate at which the tax is to be paid. If there is any
ambiguity regarding any of these ingredients in a taxation statute then
there is no tax in law. Then it is for the legislature to do the
needful in the matter.”

Govind Saran Ganga Saran vs. CST, 1985 Supp SCC 205 = 2002-TIOL-589-SC-CT

“The
components which enter into the concept of a tax are well known. The
first is the character of the imposition known by its nature which
prescribes the taxable event attracting the levy, the second is a clear
indication of the person on whom the levy is imposed and who is obliged
to pay the tax, the third is the rate at which the tax is imposed, and
the fourth is the measure or value to which the rate will be applied for
computing the tax liability. If those components are not clearly and
definitely ascertainable, it is difficult to say that the levy exists in
point of law.”

CIT vs. B. C. Srinivasa Setty (1981) 2 SCC 460

“Thus
the charging section and the computation provisions together constitute
an integrated code. When there is a case to which the computation
provisions cannot apply at all, it is evident that such a case was not
intended to fall within the charging section.”

The Court held that the five taxable services referred to the charging section 65(105) would refer only to service contracts simpliciter and not the composite works contracts which was clear from the very language defining taxable service as “any service provided”. To fortify and advance the above contention further, the Court observed that in contrast to the above, section 67 post amendment in 2006 for the first time prescribed that when the provision of service is for a consideration which is not ascertainable to be the amount as may be determined in the prescribed manner. It is also evident that Rule 2(A) of the Valuation Rules framed pursuant to the power has followed the second Gannon Dunkerley’s case (supra) while segregating the ‘service’ component from the component of ‘goods’. In consonance thereof, the Court also noted that not only the statute was amended and rules framed but a Works Contract (Composition Scheme for payment of Service Tax) Rules, 2007 was also notified for payment of service tax at presumptive rate.

Lastly, the Court examined the Delhi High Court’s judgment in G. D. Builders (supra) holding that levy of service tax in section 65(105) sub-clauses (g), (zzd), (zzh), (zzq) and (zzzh) is good enough to tax indivisible works contract and commented as follows:

•     Reference was made to various judgments which had no direct bearing on the point at issue and further the second Gannon Dunkerley (supra) was referred to in passing without noticing any of the key paras set out in this judgment.

Mahim Patram Private Ltd. vs. Union of India, 2007

(3)    SCC 668 was completely misread to arrive at the proposition that even when rules are not framed for computation of tax, tax would be leviable. This judgment concerned itself with works contract being taxed under the Central Sales Tax Act. In accordance with sections 9(2) and 13(3) of Central Sales Tax Act, powers are conferred on officers of various States to utilise the machinery provisions of the States sales tax statutes for levy and assessment of Central sales tax under the Central Act, so long as the said rules were not inconsistent with the provisions of the Central Act. Thus, the extracted passage from Mahim Patram’s case (supra) in G. D. Builders’ case (supra) referred to rules not being framed under the Central Act and not to the rules not being framed at all. The conclusion drawn based on such misreading was found wholly incorrect by the Court. The finding in G. D. Builders (supra) was thus contrary to the line of decisions discussed above among various others. In support thereof one such passage from para 17 of Jagannath Baksh Singh vs. State of U.P. [AIR 1962 SC 1563] was extracted from Heinz India (P) Ltd. vs. State of U.P. (2012) 5 SCC 443 which read as:

“An imposition of tax which in the absence of a prescribed machinery and the prescribed procedure would partake of the character of a purely administrative affair can, in a proper sense, be challenged as contravening Article 19(1)(f).” (emphasis supplied).

•     In addition to the above, the Court also took note of the fact that either machinery provisions were struck down or held inadequate and therefore assessment thereunder was rendered ineffective vide the Patna High Court’s decision (affirmed by Apex Court in State of Jharkhand vs. Voltas Ltd. 2007-TIOL-86-SC-ST, Madras High Court in Larsen & Toubro Ltd. vs. State of Tamil Nadu & Ors. (1993) 88 STC 289 and Orissa High Court in Larsen & Toubro vs. State of Orissa, (2008) 012 VST 0031).

The Court concluded by holding that the Finance Act (prior to 01/06/2007) laid down no charge or machinery to levy and assess service tax on indivisible works contracts. Therefore, the revenue’s apprehension that several exemption notifications have been granted qua service tax levied by the Finance Act, 1994 was also answered emphatically that whichever judgment would be appealed against before the Supreme Apex Court, such notifications would have to be disregarded.

Conclusion:

While it is heartening to note that the controversy which began with the decision in Daelim’s case 2003(155) ELT 457 (T) at the end of over ten years has reached finality for better; nevertheless a large number of assessees who met with an adverse decision in this battle and who did not litigate for want of resources or any other reason would have certainly succumbed to the suffering of financial loss in one or the other way in different proportions for no fault of theirs but only on account of vague and unprecise legislation. The question therefore arises thus, is whether an honest assessee has any recourse under the constitution to question accountability of the law administering machinery which also encompasses drafting of laws? Many open issues of similar nature like dual taxation to the transactions of providing license to software or transfer of intellectual property etc. on a similar uncertainty have made tax payers and stakeholders suffer without having any recourse to even consider questionability. Is it the fruit that we are ‘enjoying’ in a democratic setup?