SC makes works contracts less taxing

Written by Indu Bhan | Updated: May 28 2014, 10:17am hrs
In a judgment that clears the air over the tax liability on installation and commissioning of lifts/elevators, a five-judge constitutional bench of the Supreme Court, in a 4:1 majority decision, has held that the sale and installation of a lift is a works contract, thus no sales or value-added tax (VAT) would be charged on the service element.

This means that the labour and other costs including service element in installing a lift would be excluded from the total consideration received and sales tax/VAT would be charged only on the goods component (the lift only) involved in execution of such a contract.

Legal experts feel the ruling will have far-reaching consequences in indirect taxes and will impact all nature of work contracts across sectors, including real estate, infrastructure and many sectors where work contracts take place.

Overturning its earlier 2005 decision in the Kone Elevators case which ruled otherwise, the top court said installation of lifts is not a contract for sale of goods, a stand taken by various state governments. Under a sale of goods contract, the entire sale consideration would attract sales or value-added tax as per enactments of the state legislatures.

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 simpliciter. It is not chattel sold as chattel or, for that matter, a chattel being attached to another chattel. Therefore, it would not be appropriate to term it as a contract for sale on the bedrock that the components are brought to the site, i.e. building, and prepared for delivery. The conclusion, as has been reached in Kone Elevators (supra), is based on the bedrock of incidental service for delivery. It would not be legally correct to make such a distinction in respect of lift, for the contract itself profoundly speaks of obligation to supply goods and materials as well as installation of the lift which obviously conveys performance of labour and service, the Supreme Court explained.

The judgment has huge tax implications to the elevator industry as the state governments were levying sales tax/VAT on the entire value of the contract without allowing deduction of the service element on which service tax had already been paid to the central government, thus leading to dual taxation.

Taking into consideration the multifarious activities involved in the installation of the lift, the apex court accepted the central governments stand that it is not a mere case of sale and according to the expanded definition of tax on sale, tax can only be levied on the transfer of property in goods, whether in goods or in some other form, involved in the execution of work and no sales tax can be levied on the execution of works contract.

Four concepts have clearly emerged. (1) The works contract is an indivisible contract but, by legal fiction, is divided into two parts, one for sale of goods, and the other for supply of labour and services; (2) the concept of dominant nature test or the degree of intention test or overwhelming component test for treating a contract as a works contract is not applicable; (3) the term works contract as used in Clause (29A) of Article 366 of the Constitution takes in its sweep all genre of works contract and is not to be narrowly construed to cover one species of contract to provide for labour and service alone; and (4) once the characteristics of works contract are met with in a contract entered into between the parties, any additional obligation incorporated in the contract would not change the nature of the contract.

Around 35 elevator manufacturers including Otis Elevators Company (India), a subsidiary of the US engineering giant United Technologies elevator division, had asked the Supreme Court to revisit its 2005 decision.

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