WORKS CONTRACT VIS-A-VIS VALUE OF TAXABLE TURNOVER

INTRODUCTION

The taxation of a works
contract under sales tax has been the subject of much debate in the pre-GST
era. The issues arising therefrom are manifold. One such issue is the valuation
of taxable turnover under a works contract.

A ‘Works Contract’ is a
composite contract involving both goods and labour. As per the statutory
provisions only value relating to goods can be taxed under sales tax laws. But
determining the value of goods has remained mired in controversy.

GOODS USED BUT NOT
GETTING TRANSFERRED

This is one of the issues
being hotly discussed. The case of Commissioner of Sales Tax vs.
Matushree Textiles Limited (132 STC 539)(Bom) is, amongst others, one
of the earliest judgements, laying down that even if goods are not getting
transferred physically but their effect gets transferred, it will be considered
a works contract.

In this case, dyes and
chemicals were used for dyeing of cloth. And one of the arguments was that
since the dyes /chemicals are washed away there is no transfer of property in
goods for it to become a part of a works contract.

But the Bombay High Court
turned down this argument, holding that even passing on of colour, in the form
of a colour shade on cloth, is transfer of property in goods, and thus it comes
under a works contract. However, valuation was not discussed in this judgement.

A case where the issue of valuation arose was that of Enviro
Chemicals vs. State of Kerala (39 VST 434)(Ker). The activity
involved here was the treatment of effluent water. The dealer used chemicals to
purify water and such purified water was then allowed to flow into a river. The
argument was that since there is no transfer of property to the employer in any
form, there is no taxable value as the use of materials is only as consumables.

The High Court, by a
majority, rejected the argument and held that the value of goods used, though
not actually transferred to the employer, is taxable.

In the recent case of A.P.
Processors vs. State of Haryana (57 GSTR 491)(P&H), the
facts relevant to the judgement are noted as under by the High Court:

“3. A few facts relevant
for the decision of the controversy involved as narrated in VATAP No. 32 of
2017 may be noticed. The appellant-assessee is a dealer duly registered under
the provisions of the Haryana Value Added Tax Act, 2003 (HVAT Act) and the
Central Sales Tax Act, 1956 (the CST Act). The assessee is a textile processor
and is engaged in the execution of job works. The grey fabric comes to the
processors and after due processing/manufacturing, the finished product is sent
back, raising an invoice on which Basic Excise Duty (BED) and Additional Excise
Duty (AED) is also leviable, although the rate of duty is nil, and as per the
valuation prescribed in the relevant Act considering the cost of grey fabric,
processing charges and other incidental charges, etc.

The assessing authority
concluded the assessment on the basis of observations and findings that all the
dyes and chemicals used in the execution of the job work of bleaching and
dyeing are transferred in physical form or as their inherent properties. Therefore,
the property in goods passed on in the process of execution of the job work
should be taxed; the assessing officer raised a tax demand of Rs. 5,34,516 vide
order dated 20.3.2007 (Annexure A.1). Reliance was placed on the decision of
the Bombay High Court in Commissioner of Sales Tax vs. Matushree Textiles
Limited, (2003) 132 STC 539.

Still not satisfied, the
assessee filed an appeal before the Tribunal, inter alia canvassing that
tax on value of chemicals consumed during the process of dyeing and job work
was not to be included for the purpose of levy of VAT under the HVAT Act/CST
Act. It was also argued that even the dye used in the process would not be
entirely taxable because a substantial portion of the same is not transferred
to the principal eventually. The assessee also submitted a book containing the
reports and technical certificates issued by various competent authorities
justifying the stand of the assessee that chemicals are wasted during the
process of dyeing of textiles and that only a part of the colour is made part
of the final product sent to the principal. Vide impugned order dated 17.3.2017
(Annexure A.5), the Tribunal dismissed the appeal upholding the levy of tax on
the entire value of the chemicals and dyes used in the process irrespective of
the fact whether property in goods had been transferred or not. Hence the
instant appeal by the appellant-assessee.”

The Hon’ble High Court
thereafter examined the process in detail. The processes like washing,
watering, dyeing and softening, etc. are carried out. After examining the scope
of such processes and the technical reports submitted on behalf of the
assessee, the Hon. High Court held as under:

“21. In other words, the
bleaching and dyeing is a multi-level process in which chemicals are used
initially and are mandatorily washed out before the cloth becomes conducive for
the process of dyeing. After undertaking dyeing, the fabric is sent to the
principal. Initially, the fabric indicates washing with the help of caustic
soda, desizer, soda ash, hydrogen peroxide, HCL, potassium permanganate, oxalic
acid, sodium sulphate and acetic acid. The said process would be akin to
washing clothes at home with the help of washing powder. The effect of washing
is to ensure that the portion of elements and dirt attached to the cloth is
removed before any further process is carried out. It was also claimed that in
this process, the weight of the cloth is reduced which shows that no chemical
gets stuck to the cloth. The property of such chemicals, if held to be absorbed
in the fabric and transferred, (is that) the fabric would not remain fit for
wearing. The dyeing work undertaken by the appellant on cotton fabrics
manufactured by them is the final act, but prior to this act of dyeing various
processes are undertaken for making the fabric fit for dyeing. The processes
normally undertaken are as follows: (1) desizing, (2) scouring, (3) bleaching,
(4) mercerizing and (5) dyeing and finishing.

While the textile
undergoes the aforesaid treatment, certain chemicals are used which are
consumables and which do not hold on to the cotton fabrics. After completion of
the aforesaid processes, dyeing is undertaken which holds on to the cotton
fabric giving a lasting impression and ultimately converts the grey fabric into
printed fabric, which is then marketed. In the act of dyeing, as also in
printing, certain amount of chemicals, dyes and colours are washed out and they
do not remain embedded on the textile or fabric. Thus, the benefit of
chemicals, dyes and colours which get washed out to this extent would be
extended to the assessee-appellant. In Gannon Dunkerley & Co. [AIR
1954 Mad 1130] it has been specifically laid down that while permitting
deductions, the consumables are required to be deducted from the total gross
turnover of an assessee for arriving at actual taxable turnover and the dyes
and chemicals in the present case, a certain percentage thereof being
consumables, are required to be excluded.

22. Thus, it would be
pertinent to observe that what is taxable under the HVAT and CST Act is the
value of the goods which get transferred to the customer in the execution of
the works contract either as goods or in any other form and not the value of
goods used or consumed in the execution of the works contract, if such user or
consumption does not result in transfer of property in those goods in any form
to the customer. The tax on the entire value of chemicals consumed during the
process of dyeing and job work are not to be included for the purpose of levy
of VAT as substantial portion of the same is not transferred to the principal
eventually.”

Thus, the Hon’ble High
court has arrived at the scope of consumables in relation to a works contract.
The judgement is laying down a sound principle though there are also some
contrary judgements. The actual extent of transfer of property depends upon the
facts of each case.

CONCLUSION

The judgement will be
useful for guiding the assessee /authorities in deciding the controversial
issue of valuation of goods for the purpose of levy of tax in works contracts.
The judgement will also apply to many such day-to-day transactions like laundry
activities or only cleaning activity, etc. It is expected that the assessee
will give technical / relevant data to determine the value and the authorities will
look at it in a fair and businesslike manner to avoid further disputes in all
such contracts executed up to 30^th June, 2017.