Works Contract Vis-À-Vis Nature of Goods Sold In Works Contract

Introduction

Taxation of Works Contract
is a debatable issue from beginning. In fact the theory of works contract came
into existence because of complicated nature of the transaction. In case of
works contract, there is more than one element involved like goods, services,
labour and there may be other elements like land etc. Works Contracts
are composite transactions involving supply of goods as well as services.

Taxation of Works Contract

After judgment of the Hon.
Supreme Court in case of Gannon Dunkerly and Co. (9 STC 353)(SC), the
transaction of works contract remained outside the purview of sales tax. In the
above case, it was held that only “Sale” as understood under Sale of Goods Act
is covered under Sales Tax net and transactions of works contract etc. cannot be
covered. It is in 1983, that the 46^th Amendment was effected to the
Constitution, whereby clause (29A) was inserted in Article 366 of the
Constitution so as to include ‘deemed sale transactions’ in the taxation net of
sales tax. There are in all six transactions included in the Constitution. One
of them is works contract transaction. Thus, works contract transaction became
taxable transaction under sales tax as ‘deemed sale’.

Value of goods under Works
Contract

After the above amendment,
issue arose about taxable quantum of the works contract under Sales Tax. The
landmark judgment in case of Builders Association of India (73 STC 370)(SC)
gave the guidelines about taxation of works contract under sales tax. Hon.
Supreme Court held that under Works Contract the sales tax can be levied on the
value of the goods and not on the total value of contract including labour
charges. The relevant portion can be reproduced as under:

“Even after the decision
of this Court in the State of Madras vs. Gannon Dunkerley & Co. (Madras)
Ltd. [1958] 9 STC 353; [1959] SCR 379, it was quite possible that where a
contract entered into in connection with the construction of a building
consisted of two parts, namely, one part relating to the sale of materials used
in the construction of the building by the contractor to the person who had
assigned the contract and another part dealing with the supply of labour and
services, sales tax was leviable on the goods which were agreed to be sold
under the first part. But sales tax could not be levied when the contract in
question was a single and indivisible works contract. After the 46^th
Amendment, 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. After the 46^th
Amendment, it has become possible for the States to levy sales tax on the value
of goods involved in a works contract in the same way in which the sales tax
was leviable on the price of the goods and materials supplied in a building
contract which had been entered into in two distinct and separate parts as
stated above.”

Thus, after 46^th
Amendment, the State Government can levy sales tax on the value of the goods
involved in the execution of works contract. It is also clear that the levy
will be similar to tax levied on normal sale of goods.

Rate of tax

Under Sales Tax Laws, one
more important issue is about rate of tax to be applied to value of goods so as
to arrive at tax payable. In other words, after finding value of goods, it is
also equally important to find out the rate of tax applicable to goods involved
in the execution of works contract. This is again a vexed issue. Different
types of goods may be involved in a works contract. One view can be that there
is passing of property in all goods as one category of goods, attracting one
rate. The other view is that different goods are getting transferred and the
rate applicable to such goods respectively should be applied. So there can be
separate rates applicable to respective values of the goods.

Smt.
B. Narasamma vs. Deputy Commissioner Commercial Taxes Karnataka and another (96
VST 357)(SC)

This is the latest
judgment wherein the issue about rate of tax in works contract is dealt with by
Hon. Supreme Court. The issue arose out of Karnataka Sales Tax Law. The brief
facts of the case narrated in the Supreme Court judgment are reproduced below.

“This group of appeals
concerns the rate of taxability of declared goods- i.e., goods declared to be
of special importance u/s. 14 of the Central Sales Tax Act, 1956. The question
that has to be answered in these appeals is whether iron and steel reinforcements
of cement concrete that are used in buildings lose their character as iron and
steel at the point of taxability, that is, at the point of accretion in a works
contract. All these appeals come from the State of Karnataka and can be divided
into two groups—one group relatable to the provisions of the Karnataka Sales
Tax Act, 1957 and post April 1, 2005, appeals that are relatable to the
Karnataka Value Added Tax Act, 2003. The facts in these appeals are more or
less similar. Iron and steel products are used in the execution of works
contracts for reinforcement of cement, the iron and steel products becoming
part of pillars, beams, roofs, etc., which are all parts of the ultimate
immovable structure that is the building or other structure to be constructed.”

Thus, the controversy was
about rate of tax applicable on iron and steel products used in reinforcement
of cement in construction. The argument of State was that the items once used
lose their individual existence and they are chargeable at one rate as
residuary rate. However, Supreme Court has appreciated the contention of the
dealers. The factual position of the use of goods is also narrated by Supreme
Court in this judgment as under:

“Different types of
steel bars/rods of different diameters are used as reinforcement (like TMT
bars, CTD bars, etc.). The reinforcement bars/rods need to be bent at
the ends in a particular fashion to with- stand the bending moments and
flexural shear. The main reinforcement bars/rods have to be placed parallel
along the direction of the longer span. The diameters of such main
reinforcement rods/bars and the distance between any two main reinforcement
bars/rods is calculated depending on the required loads to be carried by the
reinforced cement concrete structure to be built based on various engineering
parameters. At right angles to the main reinforcement bars/rods, distribution
bars/rods of appropriate lesser diameters are placed and the intersections
between the distribution bars/rods and main reinforcement bars/rods are tied
together with binding wire. The tying is not for the purposes of fabrication
but is to see that the iron bars or rods are not displaced during the course of
concreting from the assigned positions as per the drawings. Welding of
longitudinal main bars and transverse distribution bars is not done. In fact,
welding is contra-indicated because it imparts too much rigidity to the
reinforcement which hampers the capacity of the roof structure to oscillate or
bend to compensate varying loads on the structure besides welding reduces the
cross section of the bars/rods weakening their tensile strength. The
reinforcements are placed and tied together in appropriate locations in
accordance with the detailed principles and drawings found in standard bar bending
schedules which lay down the exact parameters of interspaces between bars/rods,
the required diameters of the steel reinforcement bars/rods and contain the
required engineering drawings for placement of bars in a particular manner. The
placement of reinforcement bars/rods for different structures is done under the
supervision of qualified bar tenders and site engineers who are well versed
with the engineering aspects related to steel reinforcement for creating
reinforced cement concrete of desired load bearing capacities.“

After noting the above,
the Hon. Supreme Court held that the steel products were used as it is and they
were not different goods at the time of incorporation. Therefore, the rate
applicable to the goods purchased would apply. The relevant observations are as
under:

“Given the fact-situation
in these appeals, it is obvious that paragraph 101 of this judgment squarely
covers the case against the State, where, commercial goods without change of
their identity as such goods, are merely subject to some processing or
finishing, or are merely joined together, and therefore remain commercially the
same goods which cannot be taxed again, given the rigor of section 15 of the
Central Sales Tax Act. We fail to see how the aforesaid judgment can further
carry the case of the Revenue.”

Thus, the Hon. Supreme
Court laid down that the rate applicable to the goods transferred was
applicable. Further, if the goods transferred are same goods as purchased or
processed goods but the process was not amounting to manufacture, then also the
rate will be same as applicable to goods purchased. Thus, deciding nature of
goods, getting transferred in the contract, is important to decide the rate of tax.         

Conclusion