Works Contract Vis-À-Vis Consumables

Introduction

Under VAT era (period prior to 30.6.2017) one of the burning
issues is whether the transaction is a ‘works contract’ or ‘service contract’.
If it is works contract then it can be liable to VAT/CST, otherwise not.

There are boundary line cases where nature of transaction is
known on final decision of higher courts like the High Court.

One such transaction is a contract requiring use of
consumables. There are conflicting judgments on this issue. A brief reference
to such judgments can be tracked as under.

Pest Control India Ltd. (75 STC 188)(Pat)

“There can be no transfer of property in goods unless the
goods themselves exist. In the execution of a contract for eradication of
pests, rodents, termites, although chemicals are used, the chemicals are
sprayed through machines so that when the process ends, the chemicals are
consumed and nothing tangible remains in which property is transferred. Such a
transaction does not involve transfer of any goods as understood in sub-clause
(b) of clause (29-A) of article 366 of the Constitution, or under the
provisions of the Bihar Finance Act, 1981. Such a contract is a pure service
contract, and no sales tax is leviable in relation thereto under the provisions
of the Bihar Finance Act, 1981.”

Enviro Chemicals vs. State of Kerala (39 VST 434)(Ker)

“The petitioner had developed a chemical product by name
“envirofloc” used as a chemical for effluent treatment. The
petitioner carried out pollution control treatment for M, a company engaged in
manufacture of yarn. In the course of effluent treatment entrusted to the
petitioner, the petitioner applied the chemical “envirofloc” and it treated
effluent water probably by neutralising colour, odour, etc.. The
petitioner claimed that no transfer or sale took place in the execution of
works contract. The Department took the view that the material was consumed in
the process of effluent treatment and it got transferred in the course of such
treatment and there was sale of goods involved in the execution of works
contract. The petitioner was therefore assessed to tax under the Kerala General
Sales Tax Act, 1963 on the sale of materials involved in the execution of works
contract of effluent treatment at the premises of M, a manufacturer of yarn:

Held, per majority, that admittedly the chemical in question
was goods and the petitioner was the owner of the goods in question, namely,
the chemical. The intention of the parties was that the petitioner must use the
chemical in the effluent treatment process and the petitioner actually used it.
By using the chemical, the petitioner rendered the effluent compliant with the
standards. The moment the petitioner poured the chemicals into the effluent, it
ceased to be the owner and at that point of time M must be deemed to have taken
delivery thereof. The fact that upon its being poured into the effluent, it
lost its identity and that it was consumed would not detract from the fact that
there was delivery thereof to M. The effluent and the treated effluent both
belonged to M. It was, therefore, into the property of M, namely the effluent,
that the petitioner supplied the chemical. The property in the chemicals passed
to M the moment they were put into the effluent by the petitioner and their
subsequent consumption was consumption after sale and did not detract from the
factum of sale and consequently exigibility to tax. There was a sale of
chemical involved in the execution of the works contract as there was delivery
of it to the awarder by virtue of the chemical being poured into the effluent.”

It can be seen that there is apparent conflict between views
of the authorities.

In case of Enviro Chemicals  vs. State of Kerala (39 VST 434)(Ker),
the Larger Bench of Kerala High Court has taken an extreme view that once goods
are used for customer there is transfer of property, though customer may not be
getting any tangible property.

Recent judgment in case of VPSSR Facilities vs.
Commissioner of Value Added Tax and ans (99 VST 1)(Del).

This judgment is latest in series. The brief facts as stated
by the Hon. Delhi High Court are as under:

“The petitioner is engaged in the business of providing
services of maintenance, cleaning, washing, housekeeping, waste management, etc.

The petitioner was awarded a contract by the Northern
Railways (hereinafter referred to as the contractee) in relation to the
management, cleaning, washing, housekeeping, waste management, etc., at
Diesel Shed Shakurbasti and at Training School Shakurbasti.

It is contended by the
petitioner that the contract was for cleaning of sites of Northern Railways
(contractee) and was a pure service contract and no transfer of property from
the petitioner (contractor) to Northern Railways (contractee) was involved. It
is contended that the activities undertaken by the petitioner did not
constitute a sale within the meaning of Delhi Value Added Tax Act, 2004
(hereinafter referred to as “the DVAT Act”).

It is contended that being a service contract, the petitioner
is paying service tax at 12.36 % on the entire consideration received by it
from the contractee. There is no separate payment made for the use of
consumables. It is contended that as the payment made by the contractee to the
petitioner was not because of transfer of property in goods, no tax was
required to be deducted at source u/s. 36A of the DVAT Act. It is contended
that the contractee (railways) to be on safe side insisted on deduction of tax
at source.

It is contended that for the purposes of providing the
service of cleaning, the petitioner was required to use soap/detergent/chemical
of a very minimal quantity and a very nominal value. The
soap/detergent/chemical was used for removing the muck/grime and the same got
completely “consumed” in the process and were not transferred to the
railways. It is contended that the contract involved pure labour and service
and was a mere works contract.”

There were arguments on both sides. Judgment of the Hon.
Kerala High Court in Enviro Chemicals is also considered.

To further consider facts, the High Court referred to para in
agreement, which reads as under:

“For the execution of the above work of maintenance, cleaning
washing of locomotives, etc., the petitioner is required to use
chemicals/solvents.

Clause 38 of the special conditions of contract reads as
under:

“38. Chemical/solvents and machines chemical/solvents
used should be eco-friendly, bio degradable pH value 7-8. Chemical/solvent can
be tested by railway from the independent lab at the contractor’s cost.
Chemical/solvents used should be of reputed brand. Contractor after having gone
through the scope of work will calculate the requirement of chemical/solvent
required per month/year. Chemical will be supplied by the contractor and shall
be kept in the custody of railway. These chemicals will be issued to the
contractor on daily basis as per requirement submitted by the contractor and
empty bottles/cans are required to submit back to issuing authority after
completion of daily work. Railway will not pay any amount separately to
contractor for purchase of chemical or machine. Cost of chemicals and machines
should be inclusive in activities mentioned in the schedule of unit
rates.”

Referring to the above clause 38, the respondent/Revenue has
held that the property in the chemicals/solvents used by the petitioner in the
execution of the work has transferred to the contractee.”

Distinguishing judgments including Enviro Chemicals, the
Delhi High Court observed as under:

“In both Enviro Chemicals [2011] 39 VST 434 (Ker) [FB]
and Xerox Modicorp Ltd. [2005] 142 STC 209 (SC); [2005] 7 SCC 380, the
courts were not dealing with the goods which were integral to the service
contract and which were completely consumed during the execution of the service
contract. The goods were consumed for the purposes of the final output, i.e.,
chemical treatment of effluent water (Enviro Chemicals) and spare parts and
Toners and Developers (Xerox Modicorp Ltd.). The courts were not concerned with
goods (soaps/detergent/chemical/solvent) as in the present case, which are
consumed in the process of cleaning. In the present case the contract, inter
alia, requires the petitioner to perform the task of mechanised scrubbing
of shed floor to keep it free from muck/grime arising due to dropping of
oil/grease/effluents and industrial.

Here italicized waste by using biodegradable floor
chemicals/solvent. Mechanised scrubbing by floor scrubbing/scarifying machine,
removal of industrial waste along with muck, unwanted/useless and dumping the
same at the nominated place within the shed complex. Cleaning of floor of main
shed, SMM store, lab and administrative block to keep it free from dropping of
oil/ grease/grime/effluent including removal of cobwebs from covered area.
Cleaning of DEMU Care Centre, DEMU Block and Diesel Training Centre SSB to keep
it free from dropping of oil/grease/grime/effluent including removal of cobwebs
from covered area. Cleaning of rooms, veranda, etc., of lab,
administrative block and offices of Sr. Subordinate Supervisors with wiping by
wet and dry moppers. Cleaning of rooms, veranda, etc., of DEMU Block and
Diesel Training Centre SSB with wiping by wet and dry moppers. To keep floor,
side walls of inspection pits free from muck/grime/ arises due to dropping of
oil/grease/effluents and industrial waste by using high-pressure cold/hot jet
cleaner. Removal of unwanted industrial waste and dumping the same at the
nominated place within the shed complex. To keep floor, side walls of DEMU Care
Centre pits free from muck/grime/ arises due to dropping of
oil/grease/effluents and industrial waste by using high-pressure cold/hot jet
cleaner. Cleaning of toilets by high-pressure water jet cleaner, removal of silt
and muck from urinals. Loco washing/ cleaning of pit wheel lathe machine
complex to keep it free from dropping of oil/grease/grime/effluent/waste metal
chips including removal of cob-webs from covered area.

The soaps, detergent, chemicals and solvent used purely for
the purposes of cleaning and which are completely consumed, in the process of
the execution of the above referred tasks, cannot by any stretch of imagination
be said to be goods in which property could pass to the contractee. Similarly,
water is also used in the above referred process of cleaning and execution of
the contract. Can it be said, that even property in water, that is used and
consumed in the said process of cleaning and execution of the contract, is also
transferred to the contractee and the value of the water consumed should be
exigible to tax?

The mere fact that soaps, detergent, chemicals and solvents
are deposited in the store of the contractee would not make any difference to
the exigibility, as is sought to be contended by the Revenue/respondents,
because, admittedly, by mere deposit in the store, the property in them is not
stated to pass. It is contended by the Revenue/respondent, that the property
passes when they are actually used. The petitioners and the railways have contended
that the said soaps/detergent/chemical/solvent are deposited with the railways
and issued from their store to ensure that adequate quantity is used by the
petitioner for the execution of the awarded work.

In view of the above, we hold that, the property in the
consumable chemicals used in the process of cleaning does not transfer to the
contractee/railways and accordingly the said goods are not exigible to tax.
Since the said goods are not exigible to tax, the contractee/railways is not
liable to deduct tax at source and the Commissioner, VAT is liable to grant a
certificate for Nil deduction of tax deducted at source.”

Thus the transaction is held as not a works contract on
ground that there is no transfer of property.

Conclusion

The margin in works contract and service transaction is very
thin. It is again the perspective of the authorities which will decide the
nature of transaction.