Source: http://aiftponline.org/journal/2015/january-2015/works-contract-and-overlapping-issue-of-service-taxvat/
Timestamp: 2019-04-25 06:48:35+00:00

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The subject of works contract is one of the most litigated and confusing one. The Constitution (Forty Sixth Amendment) Act, 1982 granted powers to State Governments to enact laws for providing the levy of tax on the transfer of property involved in the execution of works contracts (whether as goods or in some other form). The levy of tax on works contract is currently one of the most debated issues, causing uncertainty, confusion and litigation. An attempt is made in this paper to understand the controversies and come to some conclusions.
The constitutional division of powers in a federal country makes it often more difficult to construct a simple rational system of indirect taxes as compared to a country with unitary constitution. Article 269 of the Indian Constitution provides for levy of tax on sale or purchase of goods other than newspaper, in the course of interstate trade or commerce, to be levied and collected by the Government of India, but assigned to the States in which the tax is leviable. Article 286 of the Indian Constitution places a fetter on the authority of the State to impose or authorise the imposition of tax on sale or purchase of goods in the course of interstate trade or commerce and provides that Parliament by law to formulate principles for determining when a sale or purchase of goods takes place in the course of interstate trade or commerce. These principles have been formulated in Sections 3, 4 and 5 of the CST Act, which have been held to be applicable in respect of transfer in property in goods involved in execution of works contract.
“sale of goods” as used in the seventh schedule to the Constitution has the same meaning as in the Sale of Goods Act.
This position has resulted in scope for avoidance of tax in various ways.
While in the case of a works contract, if the contract specifies the value of material and the cost of the labour separately, the value of material would be taxable as sale per se. But in the case of an indivisible works contract it is not possible to levy sales tax on the transfer of property in the goods involved in the execution of such contract as it has been held that “there is no sale of materials as such and the property in them does not pass as movables”.
In view of the above observation by the Honourable Supreme Court, the Constitution was suitably amended to include in Article 366 by inserting a new clause 29A vide which ‘definition of tax on sale or purchase of goods includes “the transfer of property in goods involved in the execution of a works contract”, and such transfer, delivery or supply of any goods shall be deemed to be a sale of those goods by the person to whom such transfer is made’. On a close reading of this provision tax is not payable on the “works contract” by itself as it is not classified as goods liable to tax, as may be the case, in case of a contract for supply of machinery. The tax as per this clause is payable in the event of transfer of Rs.property in goods’ involved in execution of works contract. The clause also implies that tax on such transfer of property in goods is deemed to be sale of those goods i.e., goods used in the execution of works contract. But for this amendment the property in the goods used in the execution did not pass as a movable property.
Thus, in the terms of the Constitutional Amendment the tax under the sales tax law, can be imposed on “goods involved in the execution of works contract” and not “works contract” by itself.
HAL v. State of Karnataka, (1984) (55 STC 314) held, Rs.A contract of sale is a contract whose main object is the transfer of the property in, and the delivery of the possession of, a chattel as a chattel to the buyer. Where, however, the main object of work undertaken by the payee of the price was not the transfer of chattel qua chattel, the contract is one of work and labour. The test is, whether or not the work and labour bestowed end in anything that can properly become the subject of sale; neither the ownership of the materials, nor the value of the skill and labour as compared with the value of the materials, is conclusive, although such matters may be taken into consideration in determining, in the circumstances of a particular case, whether the contract was in substance one for work and labour or one for the sale of a chattel.
It further held where passing of property was merely ancillary to the contract for the purpose of the works, such a contract does not thereby become a contract of sale. Mere passing of property in an article or commodity during the course of performance of the transaction in question does not render the transaction to be a transaction of sale. Even in a contract purely of work or service, it is possible that articles may have to be used by the person executing the work, and property in such articles or materials may pass to the other party. That would not necessarily make the contract into one of sale of those materials. In every case, the court would have to find out what was the primary object of the transaction and the intention of the parties while into it. It may in some cases be that even while entering into the contract of work or even service, parties might enter into separate agreements, one of work and service and the other of sale and purchase of materials to be used in the course of executing the work or performing the service. But then in such cases the transaction would not be one and indivisible but would fall into two separate agreements, one of work or service, and the other of sale’.
Company v. State of Orissa (55 STC 327), the Supreme Court held Rs.The primary difference between a contract for work or service and a contract for sale of goods is that in the former there is in the person performing or rendering service no property in the thing produced as a whole notwithstanding that a part or even the whole of material used by him may have been his property. In the case of a contract for sale, the thing produced as a whole has individual existence as the sole property of the party who produced it some time before delivery and property therein passes only under the contract relating thereto to the other party for price’.
Shankar Vittal Motor Co. Ltd. v. State of Karnataka (15 STC 771) stated that Rs.The expression “sale of goods” is not to be construed in its popular sense but it must be interpreted in its legal sense and should be given the same meaning which it has in the sale of goods Act, 1930. One of the tests to find whether a given case is a “Sale of Goods” or “works contract” is to see whether, the work done by a person is work done on his own chattel, or on the chattel of someone-else. If it is on his own chattel and that chattel is later sold, then it is “sale of goods”, but if the work is done on customer’s chattel then it is “work contract”‘.
•	The contract may be for work to be done for remuneration and for supply of materials used in the execution of work for a price. [This is a composite contract consisting essentially of the two contracts, one for the sale of goods and the other for work and labour].
•	It may be a contract for work in which the use of materials is incidental to the execution of work.
•	It may be a contract for supply of goods, where some work is required to be done as incidental to the sale.
[Is contract for sale where the goods are sold as chattels and some work is undoubtedly done, but it is done merely as incidental to the sale].
•	The essence of the contract or the reality of transaction as a whole has to be taken into consideration, in judging whether the contract is for a sale or for work and labour.
•	If the thing to be delivered has any individual existence before the delivery as the sole property of the party who is to deliver it, then it is a sale.
•	If the main object of the contract is the transfer from A to B, for a price, of the property in a thing in which B had no previous property, then the contract is a contract of sale.
•	Where the main object of work undertaken by the payee of the price is not the transfer of a chattel qua chattel, the contract is one for work and labour.
•	If the bulk of material used in the construction belongs to the manufacturer who sells the end product for a price that will be a strong pointer to a conclusion that the contract is in substance one for the sale of goods and not one for work and labour.
•	The nature of the contract has to be determined on the terms of the contract and not from the entries in the invoice. The invoice does not represent any transaction, nor is it evidence of a contract for work or for sale of goods.
iv.	The question whether a particular contract is a contract “for sale” or “for work and labour” is always a difficult question. The difficulty lies not in the formulation of the test for determining when a contract can be said to be a contract for sale or a contract for work and labour, but in the applications of tests to the facts of a particular case in hand. The distinctions and tests enunciated by Courts in various cases are not exhaustive and do not lay down any rigid or inflexible rule applicable alike to all transactions. They merely focus on one or the other aspect of the transaction and afford some guidance in deciding the question, but basically and primarily, the decision depends upon the main object of the parties gathered from the terms of the contract, the circumstances of the transaction and the custom of the trade.
“Works contract” means a contract for carrying out any work which includes assembling, construction, building, altering, manufacturing, processing, fabricating, erection, installation, fitting out, improvement, repair or commissioning of any movable or immovable property.
5.1	Dominant nature test irrelevant to a composite transaction covered by the clauses of Article 366(29-A). Dominant nature test would be confined to a composite transaction not covered by Article 366 (29-A).
5.2	Aspect theory is still a valid law as held in the case of Bharat Sanchar Nigam Ltd. (2006) 3 VST 95 SC –‘Subjects which in one aspect and for one purpose fall within the power of a particular legislature may in another aspect and for another purpose fall within another legislative power – They might be overlapping, but it must be in law – Same transaction may involve two or more taxable events in its different aspects’.
c.	The property in those goods must be transferred to a third party either as goods or in some other form.
5.4	Activity of construction undertaken by the developer would be works contract only from the stage the developer enters into a contract with the flat purchaser. The value addition made to the goods transferred after the agreement is entered into with the flat purchaser can only be made chargeable to tax by the State Government.
‘In the development agreement between the owner of the land and the developer, direct monetary consideration may not be involved but such agreement cannot be seen in isolation to the terms contained therein and following development agreement, the agreement in the nature of the tripartite agreement between the owner of the land, the developer and the flat purchaser whereunder the developer has undertaken to construct for the flat purchaser for monetary consideration. Seen thus, there is nothing wrong if the transaction is treated as a composite contract comprising of both a works contract and a transfer of immovable property and levy sales tax on the value of the material involved in execution of the works contract. The observation in the referral order that if the ratio in Raheja Development (2005) 5 SCC 162 is to be accepted then there would be no difference between works contract and a contract for sale of chattel as chattel overlooks the legal position which we have summarised above’ emphasis supplied.
In terms of the above paragraph a question will arise whether flats given in exchange of land to the land owner (barter) in case of Joint Development Agreement (JDA) would be liable to VAT. Whether the judgement of the Karnataka High Court in the case of Ozone Properties Pvt. Limited  52 VST 370 (Kar.) will hold good wherein it is held that ‘Exchange agreement between property developer and owners of land for exchange of portion of built-up area of project in lieu of percentage or undivided interest of owner in land — appellate authority holding not sale as no consideration passing — revision with remand to assessing authority to consider all aspects of matter’. This will be a matter of litigation if the revenue department relies on para 111 of Larsen & Tubro 65 VST 1.
1.	The value addition made to the goods transferred after the agreement is entered into with the flat purchaser is chargeable to VAT. Value addition made up to the date of agreement with the customer would not be liable to VAT.
2.	Value of undivided share in land not liable to VAT.
The method adopted for the purpose of computation of “Land Cost” has always been a vexed issue as far as the construction industry is concerned. Given this fact, it became imperative to adopt a proper method to arrive at the “true value of land”. The industry adopts various methods for arriving at the value of land cost, and we have in the following paragraphs alluded upon the possible methods.
•	Normally, the first and safest method was to apportion the purchase price of land, to the undivided interest in land (UDI) of the prospective buyer. This method does not reflect the true land value, since the acquisition of land would be much before the agreements are entered into with the prospective buyer.
•	The second method was to adopt the “guidance value”. The guidance value is a value fixed by the appropriate government, much before the date of the agreement entered into with the prospective buyer. Thus, the true value of the land will not stand reflected.
•	The third method would be to adopt the market value of land, based on valuation reports of a government approved valuer. Normally, valuation reports are obtained by business entities, from 2 or 3 approved valuers and an average value based on such valuation reports can be adopted. This method would reflect the fair value of land. It will not be out of place to mention, that this method is not litigation free.
•	The fourth method would be to assign an element of gross profit to the construction cost and treat the balance as land value. This method, would certainly lead to litigation as the department can argue, that this is an arbitrary method with an intent to transfer a substantive part of the profits to the land cost thereby reduce the impact of tax.
b.	Labour and other like charges on actual or on presumptive basis as provided in the VAT laws.
4.	Input tax credit on eligible purchase is deductible from output tax.
(ii) The amount charged for the unit is less than rupees one crore.
(b) In case the condition mentioned in (a) above is not fulfilled, the taxable value shall be at 30% of the total contract value including land.
No CENVAT credit on inputs used for providing the said services can be availed as credit in terms of the CENVAT Credit Rules, 2004.
2.	There is another school of thought that the developer is entitled to classify the same under ‘works contract service’.
(viii) Profit earned by the service provider relatable to supply of labour and service.
Option 2: As per the Service Tax (Determination of Value) Rules – Alternatively, it is provided that if the value of works contract is not determined as above, in case of original works, service tax shall be payable on 40% of the total amount charged for the works contract.
Fair market value of goods and services so supplied would have to be determined in accordance with the generally accepted accounting principles.
(iii) erection, commissioning or installation of plant, machinery or equipment or structures, whether pre-fabricated or otherwise.
1.	The judgement in Larsen & Tubro 65 VST 1 to the extent ‘The value addition made to the goods transferred after the agreement is entered into with the flat purchaser is chargeable to VAT’ would not be applicable to the sub-contractor since the sub-contractor does not enter into agreement with the flat purchaser and also transfer of goods in execution of works contract generally starts only after the agreement and before commencement of any work.
2.	Deduction of labour and other like charges on actual or on presumptive basis as provided in the VAT laws can be claimed.
3.	Input tax credit on eligible purchase is deductible from output tax.
The sub-contractor work is classifiable under ‘works contract service’. The taxability would be similar as discussed in para 5.6.1 (B) (2) supra.
a.	In addition to the gross amount agreed for works contract, value of free issue of goods will have to be included for the purpose of valuation of service as per Explanation 1(b) of Rule 2A of Service Tax (Determination of Value) Rules, 2006.
b.	On the value determined as in (a) service tax will have to be paid by the contractee to the contractor.
Construction of building other than residential flats would tantamount to works contract under VAT and service tax. The VAT and service tax implication are similar as discussed in para 5.6.2 supra.
Maintenance or repair works / contracts would tantamount to works contract under VAT and service tax. The VAT and service tax implication are similar as discussed in para 5.6.2 supra. If the contractor opts for presumptive tax, then service tax will be payable on 70% of the total amount charged for the works contract.
There is one difficulty which the industry is facing in case annual maintenance contracts (AMC) where the consideration is received in advance on a monthly, quarterly, half yearly or yearly basis. In case of VAT in some States and under service tax, tax is required to be paid on receipt of advances. In such cases the dealer will not be able to determine how much value of goods and labour and other like charges would be involved when advance is received and invariably the entity is forced to adopt deemed deduction of labour and other like charges (generally it is between 25% to 30%) under VAT laws and 30% under service tax. The dealer will end up paying VAT on 75% or 70% of advance and service tax on 70% of advance.
Owing to a perceived contradiction between judgments in : (a) Kone Elevators (supra) and (b) State of Rajasthan v. Man Industrial Corpn. Ltd.  1 SCC 567, State of Rajasthan v. Nenu Ram  26 STC 288 (SC) and Vanuguard Rolling Shutters Steel Works v. Commissioner of Sales Tax  39 STC 372 (SC) matter was referred to Constitution Bench of Hon’ble Five judges.
•	“Dominant nature test” or “predominant intention test” is not applicable in view of judgment in the case of Larsen & Toubro Ltd. v. State of Karnataka 65 VST 1 (SC).
•	In Kone Elevators (supra), the Court took note of the customers’ obligation to do the civil construction and the time schedule for delivery and thereafter proceeded to state about the major component facet and how the skill and labour employed for converting the main components into the end-product was only incidental and arrived at the conclusion that it was a contract for sale. The principal logic applied, i.e., the incidental facet of labour and service was not correct. It may be noted here that in all the cases, there is a composite contract for the purchase and installation of the lift. The price quoted is a composite one for both.
•	Various technical aspects go into the installation of the lift. There has to be a safety device. In certain States, it is controlled by the legislative enactment and the rules. In certain States, it is not, but the fact remains that a lift is installed on certain norms and parameters keeping in view numerous factors. The installation requires considerable skill and experience. The labour and service element is obvious. The preparatory work has to be done taking into consideration as to how the lift is going to be attached to the building. The nature of the contracts clearly exposit that they are contracts for supply and installation of the lift where labour and service element is involved. Individually manufactured goods such as lift car, motors, ropes, rails, etc. are the components of the lift which are eventually installed at the site for the lift to operate in the building. In constitutional terms, it is transfer either in goods or some other form. In fact, after the goods are assembled and installed with skill and labour at the site, it becomes a permanent fixture of the building. Involvement of the skill is undisputable and irrespective of whether installation is regulated by statutory law or not, the result would be the same. This position is stated in respect of a composite contract which requires the contractor to install a lift in a building.
•	It is necessary to state here that if there are two contracts, namely, purchase of the components of the lift from a dealer, it would be a contract for sale and similarly, if separate contract is entered into for installation, that would be a contract for labour and service.
•	But, a pregnant one, once there is a composite contract for supply and installation, it has to be treated as a works contract, for it is not a sale of goods / chattel simplicitor. It is not chattel sold as chattel or, for that matter, a chattel being attached to another chattel.
a.	Canned / packaged / branded software – software developed to meet the needs of variety of users, and which is intended for sale or capable of being sold, off the shelf viz., Oracle, Lotus, Master Key, N-Export, Unigraphics.
b.	Uncanned / unbranded / customised software – developed for a specific user or client other than packaged software or canned software.
Tata Consultancy Services 2004 (57) KLJ 345 (SC). However, the Honourable Supreme Court has not rendered any opinion on the taxability of unbranded software.
1.	Licence to use software is liable to VAT at the rate prescribed in the respective State laws.
2.	Permanent transfer of software is liable to VAT at the rate prescribed in the respective State laws.
3.	No deduction towards labour and other like charges, as the licenced software or permanent transfer of software does not tantamount to works contract.
1.	Prepackaged software put in media is goods and not liable to service tax – para 6.4.1 of Taxation of Service: An Education Guide dated 20-6-2012, TRU, CBEC.
2.	Licence to use software which does not involve transfer of ‘right to use’ would neither be a transfer of title in goods nor a deemed sale of goods. Such an activity would fall within the ambit of definition of ‘service’ and also declared service category specified in clause (f) of section 66E ‘transfer of goods by way of hiring, leasing, licensing or in any such manner without transfer of right to use such goods’ – para 6.4.4 of Taxation of Service: An Education Guide dated 20-6-2012 , TRU, CBEC.
three specific situations, a works contract, a hire purchase contract and a catering contract to bring within the fiction of a deemed sale. Of these three, the first and third involve a kind of service and sale at the same time. Apart from these two cases where splitting of the service and supply has been Constitutionally permitted in Clauses (b) and (f) of Clause 29A of Article 366, there is no other service which has been permitted to be so split’.
Based on this in our view it is incorrect to levy service tax on Licence to use software which does not involve transfer of ‘right to use’ since it does not fall under clause (b) or (f) of Article 366 (29A) and further there cannot be a case of licence to use software without transfer of right to use. The said transaction in our view would only be liable to VAT. However, the service tax department in respect of all licence to use software will argue that it is a declared service and tax the same. The issue is debatable.
366(29-A) of Constitution to attract levy of sales tax under KVAT Act – Sasken Communication Technologies Limited, Karnataka HC-55 VST 89.
for service simplicitor and hence not liable to VAT. In other words if the agreement is for development of software at the premise of the client and the consideration for the same is payable in terms of time spent it is not works contract and hence not liable to VAT – Sasken Communication Technologies Limited, Karnataka HC–55 VST 89.
2. If the software developed does not vest with the customer at the time of development, then the same is tantamount to ‘works contract’.
a. Deduction towards labour and other like charges can be on actual or on presumptive basis as provided in the VAT laws.
b. Input tax credit on eligible purchase is deductible from output tax.
If the software developed does not vest with the customer at the time of development, then the same is liable to service tax as declared service ‘development, design, programming, customisation, adaptation, upgradation, enhancement, implementation of information technology software’. No deduction / abatement allowed under service tax. Full value is liable to service tax.
•	There will be overlapping of taxes since VAT is payable after deduction of labour and other like charges and service tax is payable on full value.
•	Under service tax provision ‘development, design, programming, customisation, adaptation, upgradation, enhancement, implementation of information technology software’ and ‘works contract service’ have separate entry under ‘declared service’. Therefore, service tax provision, by carving out a separate entry of software, is levying full tax; therefore in our view service tax is getting levied on goods portion also. This in our view can be challenged. If the ‘development, design, programming, customisation, adaptation, upgradation, enhancement, implementation of information technology software’ was considered as part of works contract definition under service tax, then the conflict could have been avoided.
The petitioner dealer was engaged in sterilisation of goods with Ethylene Oxide i.e., goods were made free of germs. This was done with the use of ethylene oxide, a toxic, highly inflammable gas. The goods to be sterilised were exposed in packed form to ethylene oxide in a compact airtight room for around six hours and then the gas was released after neutralising it with carbon-dioxide. The Assessing Officer brought to tax the value of ethylene oxide used up in the course of sterilisation work done by the petitioner dealer for various parties and service charges received as turnover for works contract. The assessment was affirmed in appeal and, on further appeal, by the Tribunal.
Held, allowing the petition, that sales tax is payable only on the value of goods that get transferred from the contractor in the execution of the works contract. Consumables are items which are lost in the course of execution of works contract. In other words they are used up in the process of executing the work. Admittedly after sterilisation the goods do not retain any trace of ethylene oxide works.
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.
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.
The information contained in this write up are the views of the paper writer and is not intended to address the facts and circumstances of any particular individual or entity. There can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future.
Every effort has been made to avoid errors or omissions in this write-up. In spite of this, errors may have crept in. Any mistake, error or discrepancy noted may be brought to the notice of the paper writers.

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