Works Contract Under GVAT Act, 2003 CA Prakash B Thakkar PrakashThakkar & Co. Chartered Accountants Baroda July 22, 2014
Sales Tax on Indivisible Contract State of Madras v Gannon Dunkerly & Co., (1958) 9 STC 353 (SC) • Supreme Court while interpreting the expression “sale of goods” held that, the expression "sale of goods” as used in the entries in the Seventh Schedule to the Constitution has the same meaning as in the Sale of Goods Act, 1930. In a building contract, contractor has to construct building in terms of specification of agreement and entitled to receive consideration as provided therein. There was neither contract to sale the material used in the construction nor the property passed therein as the movables. By virtue of this judgement, 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 WC as it has been held that there is no sale of the materials as such and the property in them does not pass as moveables.
Constitutional Amendment I 46th Amendment made to the Constitution from February 2, 1983 In Article 366 a definition of "tax on the sale or purchase of goods by inserting a new clause (29A). The definition specifically include within the scope of that expression tax on--- (i) …. (ii) the transfer of property in goods involved in the execution of a works contract; (iii) ….. • By this amendment the concept of deemed sales was introduced. Under the deemed Sale, an artificial break up of indivisible works contract has to be made to arrive at the ‘material’ value and the ‘labour’ value of the contract. This permitted the States to levy tax on the Sale of goods involved in execution of a work contract.
Meaning – WC – Judicial Pronouncements • It is difficult to establish whether a particular contract is ‘contract for work’ or ‘contract of sale’ and rigid and inflexible fast tests cannot be laid down. It depends on main object of the parties, circumstances and customs of trade. • Generally, a contract of sale is a contract whose main object is the transfer of the property in, and delivery and possession of, a chattel as a chattel to the buyer. 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 labour and work. • The aspects like ownership of material, value of skill and labour compared to value of material can be considered, but these are not conclusive. • State of Gujarat v. Variety Body Builders (1976) 38 STC 176 (SC). – same view in State of Himachal Pradesh v. Associated Hotels - (1972) 29 STC 474 (SC).
Meaning – WC – Judicial Pronouncements • When and how the property in a transaction passes to the customer : is it by transfer at the time of delivery of the finished article as a chattel or by accession during the process of work on fusion to the movable property of the customer? • If a major component of the end product is the material consumed in producing the chattel and skill & labour are employed for converting the main components into the end products, the skill & labour incidental, the delivery of the end product would constitute a sale. On the other hand, if the main object of the contract is to avail the skill & labour of the seller, though some material and components may be incidentally used, the transaction would be a contract for works and labour. • [State of Maharashtra v Sarvodaya Printing Press, Nagpur (1999) 114 STC 242 (SC)]
Meaning – WC – Judicial Pronouncements “Whether the contract involved a dominant intention to transfer the property in goods, in our view, is not at all material. It is not necessary to ascertain what is the dominant intention of the contract. Even if the dominant intention of the contract is not to transfer the property in goods and rather it is the 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 materials used in such contract if it otherwise has elements of works contract…” • [Vide Para 64 - Larsen & Toubro Limited & Anrvs State Of Karnataka & Anr (2013) 65 VST 1 (SC)]
Meaning – WC – Judicial Pronouncements • “In our opinion, the term works contract in Article 366(29- A)(b) 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 contract. The Parliament had such wide meaning of works contract in its view at the time of Forty-sixth Amendment. The object of insertion of clause 29-A in Article 366 was to enlarge the scope of the expression "tax on sale or purchase of goods" and overcome the judgement in the case of State of Madras v Gannon Dunkerly & Co; (1959) 9 STC 353 (SC)” • Vide Para 76 - Larsen & Toubro Limited & Anrvs State Of Karnataka & Anr (2013) 65 VST 1 (SC)]
Meaning – WC – Judicial Pronouncements • “For sustaining the levy of tax on the goods deemed to have been sold in execution of a works contract, in our opinion, three conditions must be fulfilled: (i) there must be a works contract, (ii) the goods should have been involved in the execution of a works contract, and (iii) the property in those goods must be transferred to a third party either as goods or in some other form. In a building contract or any contract to do construction, the above three things are fully met. In a contract to build a flat there will necessarily be a sale of goods element. Works contracts also include building contracts and therefore without any fear of contradiction it can be stated that building contracts are species of the works contract.” • Vide Para 94 - Larsen & Toubro Limited & Anrvs State Of Karnataka & Anr (2013) 65 VST 1 (SC)]
Meaning – WC – Judicial Pronouncements “At this juncture, it is condign to state that four concepts have clearly emerged. They are (i) 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; (ii) the concept of “dominant nature test” or, for that matter, the “degree of intention test” or “overwhelming component test” for treating a contract as a works contract is not applicable; (iii) 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 (iv) 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.” • Vide Para 42 – Kone Elevators India Pvt. Ltd. V State of Tamilnadu and others dtd 6th May 2014
Meaning – WC – Judicial Pronouncements “…. 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 simpliciter. It is not chattel sold as chattel or, for that matter, a chattel being attached to another chattel. …. The conclusion, as has been reached in Kone Elevators (2010) 14 SCC 788), 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. Hence, the fundamental characteristics of works contract are satisfied. ….. • Vide Para 64 – Kone Elevators India Pvt Ltd v State of Tamilnadu & others (SC) judgement dtd 6th May 2014]
Types of contract Supply of Material and Labour : Works Contract(e.g. Construction of a building, roads, bridges, dams, erection of Plant & Machinery, Processing jobs, Job works, Repair jobs, Electrical Fittings, Annual maintenance Contracts (AMCs). Installation of Elevators, Repairs of Vehicles, Re-treading of old tyres, Customized Printing Jobs, Electro Plating, electro-galvanizing, anodizing etc.)
Types of contract 2. Supply of labour and supply of materials is incidental to the contract(e.g. Painting, cleaning, overhauling, lubricating, greasing of an old machinery etc.) These types contracts were not taxable under the Sales Tax Regime (Material Value < 15%, ) but now under VAT regime consideration in relation to material used in such contract is taxable irrespective of whatever small magnitude of material is passed on. The respondent dealer was engaged in printing of lottery tickets on papers supplied by customers. Dealer used ink and other processing materials including chemicals held taxable to the extent of value of ink, chemicals.  41 VST 102 (All) Commissioner, Trade Tax, U.P., Lucknow V. Aristo Printers Pvt. Ltd.
Types of contract Pure Labour Contract–Not a Works contract (e.g. Semi-finished material supplied to Job-worker for further processing, tailor doing stitching work) Itmay involve materials for executing contract but there is no transfer of property in goods, not taxable The respondent company undertook contracts for making aluminum alloys out of aluminum supplied by customers. Silicon and copper were consumed in the process of manufacture of aluminum alloys and lost their identity. no property could be said to pass to the customer. Thus there was no transfer of goods in execution of a works contract of aluminum alloys.  32 VST 56 (Bom) Commissioner of Sales Tax, M.S., Mumbai V. Moonlight Metal Industries Pvt. Ltd.
Works Contract – Statutory Meaning • The GST Act, 1969 did not contain any definition of WC except in indirect way and that to partly. Sec. 55A of the GST Act, permitted payment of composition money at prescribed rates for WCs. These contracts, mentioned in the said notification, by implication, could be construed as WCs. • For the first time vide Finance Act, 2005, definition of WC was brought into The CST Act, 1956 vide Section 2 (ja) as under: • “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”.
Works Contract – Statutory Meaning • The GVAT Act contains the definition of the term “WC”, by way of Explanation (ii), to Sec. 2(23) while defining the term ‘Sale’. Relevant part of the defn. is reproduced as under. • Sec. 2(23) “Sale” means a sale of goods made within the State ….. - • transfer, otherwise than in pursuance of a contract, ……. • transfer of property in goods (whether as goods or in some other form) involved in execution of a WC, • (c) to (j) …., • but does not include a mortgage, ……….. • Explanation – • (i)….. • (ii) for the purpose of sub-clause (b), the expression “Works Contract” means a contract for execution of works and includes such Works Contract as the State Government may, by notification in the Official Gazette, specify: • Vide Noti. (GHN-23) VAT 2006/(S.2)(23)(1)/TH dtd 31/03/06 15 types of “WCs” have been notified.
Taxable Event under WC • Taxable event is transfer of property in goods (whether as goods or in some other form) involved in the execution of WC. The rate of tax will be applicable by the nature of goods that is incorporated. • The contractor becomes liable to pay vat ordinarily when, the goods or materials are used in the contract. It is not necessary to wait till the final bill is prepared for the entire work. • Any stipulation in the agreement that transfer of property in the goods involved in the execution of the contract would take place only on complete execution of contract etc, would have relevance only for determining whether the contractor has fulfilled his obligation under the contract. In WC property would pass on accretion or accession as and when it takes place and not in conglomerate..
Works Contract –Taxable Event – Case Study K & Co., has launched a scheme for residential flats. On the first day it has received a sum of Rs. 5.00 Crores as booking advance. He has not commenced any construction activity nor has purchased any material. Whether K & Co., is liable to obtain registration under GVAT Act, in view of rule 28(e) which reads as under Rule 28 (e) The amount shall be considered to have been received as under:- (i) from the date on which it becomes due as per the schedule of payment in respect of contracts which provided for a schedule of payment, (ii) the date on which the bill is prepared or the amount is received whichever is earlier in respect of contracts, which do not provide for schedule of payment. (2) In the above case if K & Co. obtains voluntary registration, what shall be the liability on the above advance of Rs. 5.00 Crore.
Works Contract –Taxable Event – Case Study • Opinion :- Taxable event is transfer of property in goods (whether as goods or in some other form) involved in the execution of WC. VAT is payable when the goods or materials are used in the contract. It is not dependent on when the goods purchased or when the payment received or when the Bill issued. • Tax Rate will depend upon nature of goods that is incorporated in WC. • Any stipulation in the agreement that transfer of property in the goods involved in the execution of the contract would take place only on complete execution of contract etc, would have relevance only for determining whether the contractor has fulfilled his obligation under the contract • In view of the above for the issue in hand K & Co., is not required to obtain registration as it has not crossed threshold limits of turnover. However, it will be liable to regn/tax when actually work is carried out. • If K & Co. obtains voluntary registration, then also advance of Rs. 5.00 crore will be taxable when work is carried out to that extent.
Calculation of Sale Price under Gujarat VAT Act Valuation options under Works Contract Actual Labour deduction Standard Labour deduction Composition
Actual labour deduction – Deductions allowed where books of accounts are maintained – Gannon Dunkerly & Co., 88 STC 204 Calculation of Sale Price of Works Contract • Labour charges & Service charges • Sub-contract charges • Planning, designing and architect's fees • Machinery on hire and tools used • Depreciation – L&T 34 VST 53 Karnataka HC • Cost of consumables, the property in which is not transferred ( e.g. Water Electricity, Fuel, Lubricating Oil, Electrodes etc) • Cost of establishment to the extent to it is relatable to the supply of labour and services (e.g. accommodation to labour and other facilities at job site). • Other expenses relatable to the supply of labour and services (in the nature of overheads, rent, salary, telephone charges) • Profit earned by the contractor to the extent it is relatable to the supply of said labour and services (Difference between the value recovered from the contractee and cost incurred by the contractor)
Calculation of Sale Price of Works Contract Indivisible WC – in case separate books of A/c’s are not maintained – Lump sum deductions Rates – Rule 18AA * Amount to be deducted from the contract price (expressed as a percentage of contract
Calculation of Sale Price of Works Contract Indivisible WC – in case separate books of A/c’s are not maintained – Lump sum deductions Rates - Rule 18AA * Amount to be deducted from the contract price (expressed as a percentage of contract pri
Calculation of Sale Price of Works Contract Indivisible WC – in case separate books of A/c’s are not maintained – Lump sum deductions Rates - Rule 18AA To arrive at Taxable turnover above rates are applied after deducting payment made to sub contractor.
Composition Option – Section 14A - For contractors who do not wish to pay tax based on the specific formula or after considering the lump sum deductions Calculation of Sale Price of Works Contract • Section 14A provides option to pay lumpsum tax on total turnover of WC at the rates specified as under. • 0.5% Processing of polyester textile fabrics including bleaching , dyeing and printing thereof • 0.6%- Construction contracts relating to roads, buildings, bridges, pipeline laying, dams, etc. • 2.0% -Other contracts including contracts for erection, installations etc • Dealer can opt for composition of tax either contract wise or on yearly basis. • Restrictions: • ITC not available to contractor (also to contractee) • PT on URD Purchases, in addition to Composition Tax. • Contractor not to issue TAX Invoice • Cannot purchase goods by way of import/interstate/BT
Goods supplied by the contractee-Free of Cost Where the materials are issued free of cost by contractee to the contractor for ensuring project quality what will be the VAT implication? Opinion:- In a works contract where any goods supplied by the contractee to the contractor for execution of Works Contract, Value of such goods cannot be included in the taxable turnover of the contractor [Builders Association of India (88 STC 204 (SC)] Goods supplied free of cost to be used in the works contract, there will be no sale [ONGC v CST UP 1996 102 STC 466 (All)] Mukhya Rail Path Nirishak, Saharanpur v The commissioner of Trade Tax UP, Lucknow  NTN (Vol. 33) -86 and VS Engineering Pvt. Ltd (2014) 68 VST 87 also confirms the same view. In Ts Tech Sun (India) Limited  15 VST 559, Supreme Court held that for sales tax purpose, consideration for transfer of property in goods is to be considered and cost of manufacture is irrelevant.
Goods supplied by the contractee-Price Recovered • Where the materials are issued for a fixed price to be recovered or adjusted in the bill of the contractor what will be VAT implication? • Opinion: - Where contractee supplies goods, cement, steel etc to the contractor for use in the works contract for a fixed price to be recovered or adjusted in the bill of the contractor, such supply is sale of the contractor. [RashtriyaIspat Nigam Ltd V/s State of A.P [1966 102 STC 454 (A.P.)] • Supply of material by contractee to contractor for use in works contract, for consideration is sale [Cooch Bihar Contractor association V/s State of W.B. [1996 103 STC 477 (SC)] also refer  32 VST 355 (Cal) GourangalalChatterjee V. State of West Bengal and others.
Whether Freight forming part of sale price? • Where Ready Mix Concrete (RMC) is supplied to the contractee on site in the vehicle/machine and RMC is filled at the requisite place as per the requirement of Contractee, whether freight charges incurred for the same will form part of the sale price and therefore liable to VAT? • Opinion: -Definition of Sale Price in Sec 2(24) reads as under: • “sale price” means the amount of valuable consideration paid or payable to a dealer or received or receivable by a dealer for any sale of goods made including the amount of duties lived or leviable under the Central Excise Tariff Act, 1985 or the Customs Act, 1962 and any sum charged for anything done by the dealer in respect of the goods at the time of or before delivery thereof and includes,- ……. • From the facts of the case it appears that delivery is completed only on application of RMC at requisite place, therefore Freight will be added in sale price and subject to VAT.
Deduction of payment to sub-contractors in WC Larsen & Toubro Ltd and anothers v State of AP and Ors. 148 STC 616 • The property in goods passes from sub-contractor to employer directly on theory of accretion. • There is only one sale from sub-contractor to employer directly and not two sales (1) from sub-contractor to main contractor and (2) from main contractor to employer. • The sub contractor is an agent of main contractor. • Also note that amount paid to sub-contractor is available as deduction from total turnover of main contractor. • Rule 18AA provides for deduction only if the sub-contractor is RD. • Rule 28(8)(c) provides for deduction of payments to subcontractor in composition option also.
Back to Back Sub Contracting A construction contractor is giving back to back (100% work) sub-contract to another contractor, what will be the tax liability of Main Contractor and Sub-Contractor. Opinion: -A sub-contract, if granted validly and in terms of the provisions of the contract entered into between the principal and the main contractor, is a part of the main contract itself. Therefore, whether the goods are supplied by the sub-contractor or by the contractor himself, title thereto passes to the principal directly in execution of the main contract. Thus, the goods in question would be liable to sale tax only once. If the sub-contractor had already been assessed to sales tax on goods supplied by him in execution of his portion of the contract, no further sales tax would be leviable in relation thereto, on the main Contractor. 75 STC 211 (Pat) Hindustan Dorr-Oliver Ltd. and Another V. Union of India and Others
Entire contract is sub-contracted – VAT Liability Issue:- Mr. X a contractor has been awarded a contract for a total consideration of Rs. 100.00 Crores. He assigns entire contract to Mr. Y sub-contractor for Rs. 90.00 Crores. What will be VAT liability of Mr. X and Mr. Y where:- X and Y both has opted composition. X & Y both has not opted composition. X has opted composition but Y has not opted Composition. Y has opted composition but X has not opted composition. What shall be the consequences if Mr. X is not RD What shall be the consequences if Mr. Y is not RD
Entire contract is sub-contracted – VAT Liability • Opinion: - Tax liability of Mr. X – Main Contractor • Not opted for composition. • The property in goods passes from sub-contractor to employer directly on theory of accretion. The sub contractor is an agent of main contractor. There is only one sale from sub-contractor to employer directly and not two sales (i) from sub-contractor to main contractor and (ii) from main contractor to employer. (17 VST 1–L&T SC) – In view of above there is no tax liability on X as he has not made any sales. Turnover of entire 100.00 Crore is exempt. • Opted for Composition • Rule 28(8)(c): The composition money shall be payable by the dealer on the full amount received by him at any time in respect of those contracts for which permission for composition has been granted after deducting the amount paid by way of price for entire sub-contract, if any, made with sub-contractor. Liability on Rs. 10.00 Cr.
Entire contract is sub-contracted – VAT Liability • Opinion: - Tax liability of Mr. X – Main Contractor • Y is Registered/Un Registered Dealer. • Rule 18AA(1) : The value of the goods at the time of the transfer of property in the goods (whether as goods or in some other form) involved in the execution of a works contract shall be determined by deducting the amounts paid by way of price for sub-contract made with a registered dealer, if any, pertaining to the said works contract. In view of the above Sub contractor should be RD , but no such condition should be enforced by making rule, which is inconsistent with the principle of accretion theory. The department has got right to tax URD sub-contractor, but cannot deny deduction to Main Contractor which is otherwise available. • VAT liability of Mr. Y–Sub Contractor Composition opted/not opted • Sub Contractor is liable for VAT on Rs. 90.00 Crores if he has opted composition, If he had not opted composition he will be entitled to get deductions of labour charges and tax will be charged only on the value of transfer of property involved in the execution of WC. • What if X is RD/URD – No difference in tax liability of Sub Contractor.
VAT Liability in Building Construction
Tax liability of Builders as Works Contractor • K Raheja Development Corporation v State of Karnataka 141 STC 298 • The Hon’ble SC while interpreting the definition of term works contract as contained in Karnataka Sales Tax Act, held that, ‘works contract’ has an inclusive definition which includes any agreement for carrying out building for construction activity hence appellants are owner to the extent that they have entered into agreement to carry out construction activity on behalf of somebody else they would be carrying out a ‘works contract’ and would become liable to pay turnover tax on the transfer of property in the goods involved in such works contract. • "2(1)(v-i) 'works contract' includes any agreement for carrying out for cash, deferred payment or other valuable consideration, the building, construction, manufacture, processing, fabrication, erection, installation, fitting out, improvement, modification, repair or commissioning of any moveable or immoveable property.
Larson & Toubro Ltd V/s. State of Karnataka • In Larson & Toubro Ltd. V/s. State of Karnataka ( 2008 17 VST 460 S.C.) the question was whether the appellant which was engaged in property development involving construction and building of flats and subsequent sale of completed flats would be liable to pay tax under the KST Act, 1957. • The appellant had agreed to develop the plot. There were two agreements 1) Developments agreement between the owner of plot and the developer and 2) Tripartite agreement between the owner of the plot, the developer and the prospective buyer of the flat. Dept. relied on the decision of K. Raheja took the view that appellant had constructed the flat on behalf of prospective buyers. According to them it was not the development agreement but the tripartite agreement that was the works contract. • Expressing the doubts on the ratio laid down by Raheja’s case the Lordship referred the matter for reconsideration by larger bench as the view if accepted than there would be no difference between works contract and Sale.
Larson & Toubro Ltd (SC) 65 VST 1 “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 where under 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 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 summarized above.”
Scope of Tax Planning in Works Contract 115. “It may, however, be clarified that 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.” 117. “ …. If at the time of construction and until the construction was completed, there was no contract for construction of the building with the flat purchaser, the goods used in the construction cannot be deemed to have been sold by the builder since at that time there is no purchaser. That the building is intended for sale ultimately after construction does not make any difference.”
Historical Background of TDS Larson & Toubro Ltd v Commissioner Of Sales Tax Gujarat –124 STC 162 (Guj HC) • TDS provisions - object to check evasion of tax in case of WC. • Gujarat High Court while examining the constitutional validity of TDS provisions under GST Act, declared the provisions of TDS as ultravires the constitution of India. • To overcome the said judgement, the TDS liability on labour/import/OGS purchases/sales were eliminated. TDS was made applicable only on the material part transferred from contractor to contractee
TDS Provisions under GVAT Personresponsible for payment of Specified Sale Price >Rs. 1 crore for works contract is responsible for deduction of tax.