Transitions are messy periods. If a transition is for good, the journey through such transitions is worthwhile. The implementation of Goods and Service Tax has been done by the current government assuring the citizens of the same. A complete overhaul of a tax regime is no mean task but India is, in fact, walking on a new path of change. The idea of one nation, one tax is in force and citizens, although struggling, are still moving on.
One of the most litigated and disputed areas in the previous indirect tax regime was the taxation aspects of a works contract. Years of litigation had, somewhat settled the issues pertaining to the area but not in its entirety. GST brought new hopes in this regard and, prima facie it does seem so. But how far is the prima facie reality real is a question to ponder upon.
The intoxicating journey of the works contracts seems to be far from resolved, predominantly given the fundamental changes that the GST regime has brought in.
Works Contract: The Concept
2. The establishment of a nexus between the sphere of works contracts with the current GST law requires an outline of the developments that shaped the principles associated with the taxability of works contracts. The determination of composite transactions as works contracts has been one of the most litigated topics under the indirect tax regime, proving to be a cumbersome ordeal for businesses over the years. From being not taxed at all, to the levy of tax on sale portion, and finally levy on service portion, works contract disputes have come a long way.
A study about determination of taxation perspective vis-a-vis any transaction limits itself to the following major questions:
(i) What is the tax?
(ii) What is the taxable event?
(iii) Who should pay the tax?
(iv) How the tax is to be calculated?
The response to the above in a definitive manner more or less settles the position relating to levy of a tax. The issues relating to a works contract mainly pertain to the determination of the taxable event. Therefore, the vital question at this stage is why is it so?
Works Contract can be defined as a composite contract which includes in itself an element of sales as well as service. Thus, the taxation perspectives of a works contract have always been related to either sales tax or service tax. Prior to the 46th amendment to the Constitution, such sale element in the execution of works contract1 was not taxable. State legislatures did not have competence to charge sales tax under Entry 54, List II of the Seventh Schedule of the Constitution on an indivisible contract of sale of goods, which had components of labour and service and it was not within the domain of the Assessing Officer to dissect an indivisible contract to distinguish between the two constituent elements. Such works contract was said to be indivisible contract wherein the sale and service could not be separated and taxed by the States. Thereafter, clause 29A was inserted in Article 366 of the Constitution introducing the concept of deemed sales wherein a legal fiction was created to separate the sale element in the execution of a works contract. The mechanism for valuation of such sales was also provided by the Apex Court.2 The service element was also taxable only post the introduction of the definition of works contract under the Finance Act, 1994 (the law governing levy of Service Tax in India)3.
Whether a particular contract was a works contract or a contract for sale of goods depend on the dominant intention, as reflected, inter alia, from the terms and conditions of the contract. There existed no strait-jacket formula to determine the nature of the contract, given its dependence on the facts and circumstances of each case.
Post 46th Amendment, with the insertion of sub-section (29-A) in Article 366 of the Constitution, it became evident4 that the Courts started interpreting works contracts in a Constitutional backdrop. Cases which involved transfer of property along with an element of service in the context of work rendered, stood treated as works contracts.
It is pertinent to note that several principles of significance have been laid down by the Hon'ble Supreme Court in the judgements rendered in Larsen & Toubro Ltd. and Anr. v. State of Karnataka5 and Kone Elevator India Pvt. Ltd. v. State of Tamil Nadu6. The Hon'ble Supreme Court in both these cases has made a departure from the traditional understanding of the term "works contract" as had been laid down in preceding adjudications.
What Is A Works Contract?
2.1 The term "works contract" as envisaged in Article 366(29-A)(b), opined the Supreme Court, 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 contracts. The Parliament had such wide meaning of "works contract" in its view at the time of 46th Amendment. For the purposes of determining the difference between a works contract and contract of sale the Court has further, discussed several cases and finally concluded that a contract may involve both, a contract of work and labour and a contract of sale of goods. The distinction between contract for sale of goods and contract for work (or service) has almost diminished in the matters of composite contract involving both, a contract of work/labour and a contract for the sale for the purposes of Article 366(29-A)(b)7.
Taxable Event For Works Contract
2.2 It was observed by the Hon'ble Court in the Larsen & Toubro Case that following the 46th Amendment, a transfer of property in goods under clause (29-A)(b) of Article 366 came to be deemed to be a sale of the goods involved in the execution of works contract by the person making the transfer and the purchase of those goods by the person to whom such transfer is made. By virtue of the 46th Amendment, States were conferred with the power to tax indivisible contract of works, by enlarging the scope of the expression "tax on the sale or purchase of goods", wherever it occurred in the Constitution. Accordingly, the expression "tax on the sale or purchase of goods" in Entry 54, List II, Schedule VII, when read with the definition clause (29-A) includes the transfer of property in goods whether as goods or in the form other than goods involved in the execution of works contract. The taxable event, thus, is a deemed sale.8
Dominant Intention Test
2.3 The courts, in both the above-stated cases, have also laid down that it is not necessary to ascertain the dominant intention of the contract. Even if it is not to transfer property in goods and rather, is rendering of service or the ultimate transaction is transfer of immovable property, then also it is open to the States to levy sales tax on the material used in such contract if it otherwise has elements of a works contract. Thus, the Supreme Court has completely ruled out that dominant intention of any contract has relevance if the contract has element of works contract9.
2.4 Conditions For Sustaining Levy Of Tax On Goods Sold In Execution Of Works Contract
Having discussed the scope and ambit of a works contract, the Court went on to broadly frame three conditions for sustaining the levy of tax on the goods sold in the execution of works contract, as under:
(i) there must be a works contract;
(ii) the goods should have been involved in the execution of works contract; and
(iii) the property in those goods must be transferred to a third party either as goods or in some other form.10
Treatment of Works Contract under GST- The twist in the tale
3. The taxable event in the GST regime is the supply of goods or services. Thus, a transaction will come under the purview of the GST law if either it is a supply of goods or a supply of service. A bird's eye view of the provisions of the now applicable GST laws demonstrates that the levy of tax on works contract seems to be settled. As per Section 2(110) of the Central Goods and Services Act, 2017 ('CGST Act), works contract is defined as follows:
"(110) "works contract" means a contract wherein transfer of property in goods is involved in the execution of such contract and includes contract for building, construction, fabrication, completion, erection, installation, fitting out, improvement, modification, repair, maintenance, renovation, alteration or commissioning of any immovable property."
Further, Schedule II of the CGST Act provides for certain supplies to be treated as supplies of goods or services. Entry 5 of the Schedule provides for certain transactions to be treated as supply of services. Consequently, it has been provided as:
(f) works contract including transfer of property in goods (whether as goods or in some other form) involved in the execution of a works contract;
Thus, works contract under GST would be treated as a supply of service and, thus, the rate of tax as provided under the tariff would be applicable on the same. Thus, the dispute as to determination of a contract as a pure sale or a pure service or a works contract has been settled as works contract has to be treated as a supply of service.
However, the point of consideration is as to what constitutes a works contract under the current tax regime? A perusal of the definition of works contract would show that works contract is now defined only in context of an immovable property. Thus, a movable property has been kept outside the purview of a works contract. This slight change of definition has brought the taxpayer to the old but not definitely golden period of tax disputes. On the one hand, GST promises to bring us into a new and simplified era of taxation and on the other hand, it has also brought a taxpayer into a pothole that he had over the years struggled to come out of.
A perusal of the definitions of composite and mixed supply seems to be relevant. Since a movable property is not under the purview of a works contract, the determination of levy of tax on composite transactions relating to movable property would be determined on whether it would constitute a composite supply or a mixed supply. The muddle is created in the composite supply of an immovable property.
As per Section 2(30) of the CGST Act, a composite supply is a supply made by a taxable person comprising of two or more taxable supplies of goods or services or both, which are naturally bundled and supplied in conjunction with each other in the ordinary course of business, one of which is a principal supply, Further, a principal supply under Section 2(90) of the CGST Act means the supply of goods or services which constitutes the predominant element of a composite supply and to which any other supply forming part of the composite supply is ancillary. Thus, the ghosts of the dominant intent test could still be haunting the taxpayer in relation to composite supply of movable property.
Since dominant intent test under the GST law is statutorily recognized there seem to be many hindrances in the reckoning. Practically, the difficulties that may arise in this regard can be understood through following two examples.
If we take an example of an annual maintenance contract (AMC), AMC's do not involve two separate transactions of supply of goods or services. It is essentially a single transaction only. In an AMC transaction, the intention of the recipient is to ensure that the equipment is up and running. However, such contracts may involve supply of goods in certain cases which may be of a substantial value. Thus, determination of such contracts may become cumbersome in certain cases.
Similarly, in cases of book printing wherein the owner provides the content of writing and the publisher prints the books using its own materials, the question of treatment of the contract as supply of goods or supply of services arises. Further, in such cases the questions relating to marketability of goods, special nature of transactions, etc., will also have to be considered.
Thus, it can be observed that tax treatment of a movable property is still very unclear and an interpretational issue which may open a flood of litigations in the near future.
4. A perusal of the above discussion clearly brings to the fore the point that in certain transactions we have been brought into the post Gannon Dunkerley but pre-46th Constitutional Amendment era. An ideal GST in the present circumstances seems to be an Utopian idea. The matter of fact is that taxpayers would have to cope and find a way out of the confusion under the present rules and regulations. One interesting thing that could help in determining the nature of a principal supply in a composite supply could be through reference to the decision of the Apex Court in the case of The Government of Andhra Pradesh v. Guntur Tobaccos Ltd11 wherein the Hon'ble court identified three types of contracts, viz.:
♦ One, it may be for work to be done for remuneration and for supply of materials used in the execution of the works for a price
♦ Two, it may be for work in which the use of materials is accessory or incidental to the execution of the work
♦ Three, it may be a contract for work and use of supply materials, though not accessory to the execution of the contract
As per the view of the court, the first category is a composite supply of work and sale of goods; the second category does not involve any sale of goods, while as the third category is not a sale because the property does not pass for a price. Bringing the same principles into the GST era, the contracts may be classified as:
♦ The first category of contracts would fall in the category of mixed supply. Although service and goods are being supplied together, yet they are not naturally bundled and do not constitute a composite transaction
♦ The second category of contract would clearly be supply of services as the supply of goods is ancillary to the contract. Even if the contract is treated as a composite supply, the principal supply would still constitute a supply of service
♦ The third category of contracts would also be treated as a supply of service as no consideration is being provided for the goods.
A view that with a new levy comes a new dispute is turning into a reality. It is important to understand the consequences of the application of the dominant intention test. Transactions carried out in respect of immovable property will always be treated as a service and the test will be inconsequential. Further, there may arise the age-old dispute of classification between an immovable and movable property. Generally, a taxpayer will choose the two concepts which will be more beneficial to him. On the other hand, the Department, with the intent of raising more revenue, will classify it otherwise. To summarize, a potential litigation is in the offing and the industry needs to be prepared for it.