gstanalyst
Exemption under section 6(2) of the CST Act in respect of Turnkey or EPC Contracts : Claim Inadmissible
It has now become a common practice for the contractor dealers executing works contract involving civil work and installation of plant and machinery etc to claim that the contracts are divisible where supply of goods and supply of service have been specifically separately mentioned. In respect of the contract for the supply of goods there is also claim for exemption for subsequent sale under section 6(2) of the Central Sales Tax Act, 1956 for goods purchased from outside the State. The goods purportedly sold under section 6(2) are again handed over by the contractee to the contractor dealer or his agent for incorporation in the works contract. A significant part is also seen to be claimed as exempted as works done through sub-contractors. This write-up covers the legal and factual aspects relating to such claims.
Let us consider the relevant definitions under the CST Act, 1956:
(1) ''sale'' with its grammatical variations and cognate expressions, means any transfer of property in goods by one person to another for cash or for deferred payment or for any other valuable consideration, and includes ,-
…………………………………………………..
(ii) a transfer of property in goods (whether as goods or in some other form) involved in the execution of a works contract;
(2) ‘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;
(3) A sale or purchase of goods shall be deemed to take place in the course of inter-State trade or commerce if the sale or purchase-
a. occasions the movement of goods from one State to another; or
b. is effected by a transfer of documents of title to the goods during their movement from one State to another.
Document of title to goods, as defined in the Sale of Goods Act, 1930, refers to the consignment note, railway receipt, bill of lading etc and transfer of the original, negotiable copy of the document of title by the consignee to another person is considered as transfer of the relevant goods if the parties so desire.
In the case of works contracts the deemed sale evidencing transfer of property is not as goods as such, often referred to as chattel qua chattel, as understood under the Sale of Goods Act, 1930, but such transfer is by way of accession and accretion of the relevant goods, often in some other form, involved in the execution of such works contract.
In terms of section 6 (2) of the CST Act, 1956 exemption from tax has been given in respect of sales under section 3 (b) during inter-State movement i.e. to "any subsequent sale during such movement effected by a transfer of documents of title to such goods".
We are concerned with this type of claim of exemption where the transfer of property is evidenced by the transfer of documents of title to the goods during the inter-State movement, i.e. starting from the time the goods are delivered to the common carrier for transportation and up to the time the goods are taken delivery from such transporter.
The usual finding is that the contracts are on turnkey basis which are also known as EPC contracts. The consideration for the supply of goods involved in the works contract and that for supply of service are separately mentioned in the contract. The contractor dealer receives payments on the basis of payment schedule incorporated in the relevant works contract where a portion of the value of goods delivered at the work-site is paid and the full payment is dependent upon successful implementation of the whole project often after performance guarantee test. In the case of inter-state purchase by the contractor dealer the relevant purchase invoice is raised on him but the excise invoice is raised directly on the contractee to enable it to get CENVAT credit.
Article 366 (29A) of the Constitution relates to "tax on sale or purchase of goods" and not to "sale or purchase of goods" per se. The extended definition does not actually enlarge the definition of sale of goods under the Sale of Goods Act, 1930 –– the inclusive definition incorporating the deeming provisions only enlarges the scope of taxation on sale or purchase of goods to rope in other types of transactions not covered in Sale of Goods Act. So transfer of property in execution of works contracts is not envisaged as a sale simpliciter as understood in the context of the Sale of Goods Act, 1930.
An owner of property has a bundle of rights in it, namely, right to possess, right to use and enjoy, right to consume, to destroy, to alienate or transfer, etc. Transfer of property in goods connotes transfer of all such rights together and not transfer of only a few of such rights. In the cases in hand the contractee does not have the right to consume, to destroy, to alienate or transfer the goods upon mere delivery of the goods from the common carrier -- such goods must also be re-delivered to the contractor for use in execution of works contract.
In the instant case the purchaser never has the right to dispose off such goods in any other manner without handing them over to the contractor dealer for incorporation into the contract. In terms of section 4 of the Sale of Goods Act, 1930 the sale evidencing the transfer of property in goods is made only when the contractual liability in respect of such goods are fulfilled by the seller by undertaking such activities as are required to be done in respect of such goods. The transfer of property should be absolute and not a mere delivery of goods. Let us consider the example of sale of modular furniture, say a wardrobe, which is delivered in a knockdown condition to the customer's place and thereafter the seller's person fixes the same and the complete wardrobe is sold. Before such fixing the customer may hold the goods as the custodian of the goods delivered to him but there is no transfer of property in such goods and the sale is effected only in respect of the completed wardrobe as per the contract. The contractor-dealer is required to complete the installation, testing and successful operation of the machinery supplied and by providing performance guarantee in respect of the same. So the contract essentially envisages transfer of property in such goods only by way of accession and accretion in execution of the works contract and not a mere delivery of such goods as chattel qua chattel.
Claim for deduction for sub-contracts vis-a-vis claim under section 6(2) of the CST Act: –
In the case of Larsen & Toubro Ltd vs. State of Andhra Pradesh reported in [ 2008 ] 17 VST 1 the Hon’ble Supreme Court has been pleased to decide, inter alia, as follows : --
“It is important to note that each of the sub-contractors of L&T is registered dealer. None of them are unregistered. …………………… where VAT dealer awards any part of the contract to a sub-contractor, such sub-contractor shall issue a tax invoice to the contractor for the value of the goods at the time of incorporation in such sub-contract. The tax charged in the tax invoice issued by the sub-contractor shall be accounted by him in his returns. Therefore, the scheme indicates that there is a "deemed sale" by the dealer executing the work, i.e., the sub-contractor. It is only the sub-contractor who effects transfer of property in goods as no goods vests in the respondent company (contractor) so as to be the subject-matter of a retransfer. By virtue of Article 366(29A)(b) of the Constitution once the work is assigned by the contractor (L&T), the only transfer of property in goods is by the sub-contractor(s) who is a registered dealer in this case and who claims to have paid taxes under the Act on the goods involved in the execution of the works. Once the work is assigned by L&T to its sub-contractor(s), L&T ceases to execute the works contract in the sense contemplated by Article 366(29A)(b) because property passes by accretion and there is no property in goods with the contractor which is capable of a retransfer, whether as goods or in some other form.”
In the case of a proper sub-contract for execution of works contract, transfer of property in goods is made directly by the sub-contractor to the main contractee. The whole reasoning is based on the premise that transfer of property is by way of accession or accretion to the contractee's property so that "there is no property in goods with the contractor which is capable of a retransfer, whether as goods or in some other form".
So when there is claim of exemption for subsequent sale under section 6(2) of the CST Act, 1956, where admittedly the transfer of property is not by way of accession or accretion to the contractee's property, i.e. where the transfer of property in goods is claimed to be by way of transfer of document of title to the goods during their inter-state movement according to the purportedly divisible contract with the contractee, there is no scope of claim for deduction on account of works done by sub-contractors in respect of the same divisible contract.
In respect of the contracts executed the dealer's claim is that the same are divisible contracts where the sale of goods has been treated separately involving sale simpliciter as understood in the context of Sale of Goods Act, 1930 and a separate consideration for the supply of services. In respect of a single work order, where purportedly supply of goods and supply of service are disjoint as already separately specified, the dealer --
(a) has purportedly made sales simpliciter involving transfer of property in goods during inter-state movement of such goods;
(b) has admittedly executed on his own a portion of relevant works contract involving transfer of property in goods; and
(c) has assigned another portion to sub-contractors for execution of the relevant works contract and has claimed deduction for the same as the relevant transfer of property in goods has been made directly by such sub-contractors to the main contractee.
It is noted that the contractor-dealer has not at all assigned the entire work to the sub-contractors who have made the relevant transfer of property in all the required goods in execution of works contract directly to the contractee. The sub-contractors have been assigned only a portion of the works contract. So, the dealer himself has acted in such a way that the so-called divisible contracts for sale of goods and for supply of labour has been merged by its own volition where it has made sales simpliciter for one part while another part was performed by way of execution of works contract involving transfer of property in goods.
It is very significant to note that if the original contract is not an indivisible works contract at all in the first place then the scope of giving sub-contracts involving transfer of property by such sub-contractors directly to the original contractee in execution of works contract does not arise.
In this case, as evident from the actions by the instant dealer itself, the essence of the original contract is only that of an indivisible works contract involving both transfer of property in goods and supply of service in execution of such indivisible works contract where such transfer of property in goods is by way of accession or accretion to the contractee's property. Only in that case the scope of sub-contract involving transfer of property in goods by such sub-contractors directly to the original contractee in execution of such works contract arises. Otherwise there would have been sub-contracts for sales simpliciter of the required goods to the instant dealer and a further resale by the instant dealer to the ultimate customer and both the transactions involve transfer of property in goods and hence both become taxable. In other words, if the transfer of property in goods is actually envisaged before incorporation of such goods by way of accretion and accession then the sub-contract, if any, should also envisage transfer of property similarly and in that case there will be two taxable transactions.
Moreover, it is evident from the decision of Hon’ble Supreme Court that the transaction is exempted only where transfer of property in goods is made by the sub-contractor directly to the main contractee. Let us consider the case where the main contractor has a works contract for supply and installation of a large machinery. The main contractor may give sub-contract for supply and fitting of a part, say a motor, to be fitted into the main machinery. If the sub-contractor executes the works contract of transfer of property in the motor and thereafter the main machinery is supplied and installed by the main contractor, then there will actually be two deemed sales by execution of works contracts -- sale of the motor from the sub-contractor to the main contractor and thereafter the sale of the main machinery by installation by the main contractor to the ultimate contractee. In that case the transfer of property in the goods, i.e. motor, by the sub-contractor is never to the ultimate contractee. So the exemption for sub-contract is not at all a blanket exemption in all the cases, rather in view of the decision of the Hon’ble Supreme Court it is available only when the transfer of property in goods is directly by the sub-contractor to the ultimate contractee and for this purpose the terms of the sub-contract and the invoice issued by the sub-contractor to the main contractor are required to be properly analysed to ascertain the factual aspects relating to transfer of property in goods in execution of the works contracts.
It is thus evident that the claim of exemption on account of sub-contracts relating to execution of works contract involving transfer of property in goods by such sub-contractors by way of accession and accretion directly to the property of the main contractee and the claim of transfer of property in goods by way of transfer of document of title to such goods during their inter-state movement can not coexist in respect of the very same work order, more so when admittedly the dealer himself has also made transfer of property in goods by way of accession and accretion for such single work order.
Ascertaining the true nature of the transaction:–
The taxable event is transfer of property in goods. Such transfer of property may be in the form of sales simpliciter as understood under the Sale of Goods Act, 1930, or in the form of accretion or accession in execution of a works contract. The crux is the determination of the point of occurrence of the taxable event, i.e. when such transfer of property in goods is made -- whether the transfer of property in goods is made (i) when the goods are during their inter-state movement, or (ii) when they are delivered at site, or (iii) when they are incorporated in the works contract by way of accession or accretion. This decision is to be arrived at on the basis of the relevant contracts and the performance thereof.
At the outset it is noted that mere specification of the consideration for the goods and that for the services does not ipso facto make a contract divisible one. Let us consider the example involving installation of an air-conditioner. A person may contact the supplier for purchase of an air-conditioner, say for `25,000/- and at the same time may enter into another contract for installation thereof at his residence for `1200/-. Another person may have a single contract for the same at the consolidated amount of `26,200/- . A 3rd person may have a contract for supply of a custom-built air-conditioning system and installation thereof wherein the considerations are separately specified at `25,000/- for the goods and `1200/- for the service respectively. Undisputedly the 2nd contract, i.e. the single consolidated contract for `26,200/- is a works contract. Let us consider that in the first case the seller delivers the goods to the purchaser at his residence for installation within the next 3 or 4 days. If any loss or damage is done to the air-conditioner within this time of 3 or 4 days, the loss is to be borne by the purchaser since transfer of property has already been made to him by the completion of the sale transaction. The intended installation thereof is a subsequent event not affecting the passing of title to the goods. In the 3rd case the supplier may store some goods, whether as finished goods or in knockdown condition, and the intended air-conditioning system comes into existence by way of on-site assembling and installation. The supplier has to replace any defective or non-matching parts or to supply such fittings or goods (e.g. puddings, nails, clips etc) which are required to make the system operational though the same may not have not been specifically mentioned in the contract. Any loss to the goods during storage or installation is to be borne by the supplier (or his agent) since there is no transfer of property in goods until the installation involving accretion or accession to the purchaser’s property is made. The purchaser is interested in getting a complete and fully functional air-conditioning system installed in his residence – not mere delivery of some goods and that too in knockdown condition.
The observations of Justice Shah in Carl Still G. m. b. H. & Another vs. The State of Bihar [(1961) 12 STC 449 (SC)] 5-member Bench, was as follows:–
“Relying upon the decision of this court in Gannon Dunkerley's case, the appellants contend that the amount received by them under the contract dated December 19, 1953, is not liable to be assessed to sales tax. But the question whether the contract is a pure works contract or a composite contract has never been investigated. Undoubtedly, the formal document evidencing the contract suggests, prima facie, that it is a works contract, but in assessing liability to tax, the taxing authority is not restricted merely to the letter of the document; he has to enquire into the true nature of the transaction on all the relevant materials and to ascertain whether it partakes of the nature of the transaction which the statute renders taxable. He is, in ascertaining the true nature of the contract, also entitled to consider how the contract was performed.”
It is very significant to note that the above highlights the importance of ascertaining the true nature of the contract including the performance thereof rather than solely relying merely on the words of contract document.
In Carl Still G. m. b. H. & Another vs. The State of Bihar [(1961) 12 STC 449 (SC)] there was a clause for supply of materials and that the property in such materials would pass to the contractee as soon as such materials were brought to the site. The Apex Court observed that “Clause 15 of the agreement specified that ‘the Owner shall not be liable for any loss or damage which may happen to or in respect of such materials and plant by the same being lost, stolen or injured or destroyed by fire, tempest or otherwise for which the contractor will be liable…..’.
Then after referring to the decision in Firm of Peare lal Hari Singh v. State of Punjab (1958) 9 STC 412 (SC), it was held that –
“In the present case, cl. 15 is even clearer that no sale of materials, as such, was intended, because it expressly provides that if they were destroyed by fire, tempest or otherwise, the loss would fall not on the owner, which must be the result if the property is taken to have been absolutely transferred to it, but on the contractor. If, as held by us, cl. 15 does not embody an agreement for the sale of materials as such, there is no contract of sale with respect to them and s. 9 of the Sale of Goods Act can have no application.”
In view of the above, the 3rd contract referred to in the above examples, where the risk lies with the supplier till handing over of the fully functional air-conditioning system, becomes a works contract even though separate amounts might have been specified for the goods and the services.
The nature of the contract is also reflected in the terms of payment. Even in the case of separate specification of value for the supply of goods such payment is in instalments with reference to several stages including the stage of "completion of erection and commissioning", "synchronisation", "against Commercial Operation milestone”, “completion of supply” and “upon Performance Guarantee Test” etc.
The chronological specification of the stages as above for payment of contract price establishes that the full amount of consideration for envisaged admitted supply of the goods becomes payable only after completion of erection and commissioning, synchronisation and performance testing of the entire system. Thus instead of sales simpliciter the transfer of property in goods is by way of accession and accretion of the goods involved in execution of works contract.
The claim for sale by transfer of document of title to goods during their inter-state movement envisages a one-to-one correspondence between the goods purchased and the goods sold. Accordingly there is also parity between the sale price and the corresponding purchase price of the same goods. It is often seen in respect of claim of purported sales under section 6 (2) of the CST Act, 1956 that there is extremely wide variation between the purchase and sale prices. It is evident that there is absolutely no parity in the purchase and sale prices as reflected in the ratio of the sale price and the purchase price – the rate of profit is unexplainably high which is quite indicative that the purported sales under section 6 (2) as evidenced in the relevant sale invoices could never be of the very same goods in the very same form -- the transfer of property in the relevant goods was never made by transfer of the document of title to the goods. The sale price disclosed in the relevant sale invoice is simply an ad hoc figure irrespective of the nature and quantity of the goods and it is not at all the valuable consideration as quid pro quo in respect of the goods.
Further Legal aspects regarding works contracts:-
Whether the contract for setting up a complete project is one single indivisible works contract or whether it consists of separate contracts for sales of goods and for services needs to be considered in proper juridical perspective and in the context of the relevant work orders and the nature of performance. In 1958, a 5-Member Bench the Supreme Court decided in the State Of Madras Vs. Gannon Dunkerley & Co (Madras) Ltd case, [1958 AIR 560], that supplies of goods, transferred in course of an indivisible works contract, were not liable to sales tax as there was no contract of sale per se and any supply of material was incidental to that indivisible contract for works; hence there was no sale as envisaged under the Sale of Goods Act, 1930.
After the 46th Amendment to the Constitution the value of goods supplied in execution of a works contract has been made taxable under sales tax laws by creating a legal fiction whereby “transfer of property in goods (whether as goods or in some other form) involved in execution of a works contract” has been deemed to be a sale for the purpose of sales tax. In the context of civil construction work of buildings, bridges etc the transfer is of an immovable property which can not be regarded as transfer of property in goods per se without the aid of the deeming provision.
Transfer of property in goods which have not been "involved” in the “execution” of a works contract can never be contemplated within the ambit of Article 366 (29A) (b).
If the value of the goods involved in execution of works contract is specified separately the tax is to be imposed on that value and if it is not shown separately then the value is to be ascertained on the basis of the guidelines provided in the decisions of the Honourable Supreme Court. But the 46th Amendment to the Constitution does not enlarge the scope of “sale” to include such transfer of property in goods involved in execution of works contract. So after the 46th Amendment what is a works contract still remains a works contract and has not become a contract of sale of goods under the Sale of Goods Act, 1930 — the amendment only authorises levy of sales tax on the value of goods transferred by accession and accretion in execution of a works contract.
So the concept of sale of goods by transfer of document of title to such goods during their inter-state movement which is akin to the Sale of Goods Act, 1930 is not applicable to a sale which takes place by way of transfer of property in goods (whether as goods or in some other form) by accession and accretion to contactee’s property in execution of a works contract.
So the concept of sale of goods by transfer of document of title to such goods during their inter-state movement which is akin to the Sale of Goods Act, 1930 is not applicable to a sale which takes place by way of transfer of property in goods (whether as goods or in some other form) by accession and accretion to contactee’s property in execution of a works contract.
The Supreme Court has decided about taxability in works contracts in a series of cases and some major ones are –
a) Pandit Banarsi Das Bhanot vs. The State of Madhya Pradesh & Others [1958 AIR 909] (5-Member Bench)
b) Firm of Peare Lal Hari Singh vs. State of Punjub [1958 AIR 664] (5-Member Bench)
c) Carl Still G. m. b. H. & Another vs. The State of Bihar & Others [1961 AIR 1615] (5-Member Bench)
d) State of Rajasthan vs. Man Industrial Corporation Ltd. [1969 AIR 1245]
e) Vanguard Rolling Shutters and Steel Works Ltd. vs. Commissioner of Sales Tax, U.P. [1977 AIR 1505]
f) Sentinel Rolling Shutters & Engineering Co. (P) Ltd. vs. Commissioner of Sales Tax, Maharashtra [1979 AIR 1747]
g) Ram Singh & Sons Eng. Works vs. Commissioner of Sales Tax, U.P. [1979 AIR 545]
h) Hindustan Aeronautics Limited vs. State of Karnataka [1984 AIR 744]
The ‘turnkey contracts’ or ‘EPC contracts’ are, by definition, composite works contracts where supply of material cannot be de-linked from services namely, erection, commissioning, civil work and performance testing. Taking over of the plant takes place only after successful completion of performance tests. The intention of the parties is to set up a complete operative plant. No scheme for purchase of plant & machinery or equipments or steel/cement for civil works is envisaged otherwise than as a part of the entire project implementation.
In Carl Still G. m. b. H. & Another [1961 AIR 1615] which is very similar to the present case, it was found –
“The point for determination, therefore, is whether on its true construction, the contract in question is a combination of two distinct agreements, one to sell materials and the other to supply labour and services, or whether it, is only one agreement entire and indivisible for execution of the works. We will now refer to the relevant portion of the agreement dated December 19, 1953. The preamble to the agreement states that the Owner had agreed with the contractor that the latter was to set up a complete coke oven battery ready for production as well as by-products plants according to specifications given therein, that the installation was to be made at a site selected by the Owner and that the contractor was to "erect and construct buildings, plants and machineries and deliver and supply accessories and articles from Germany and also locally from India and render services fully described in the First Schedule......... for an all-inclusive price of Rs. 2,31,50,000." Then cl. I provides that the contractor shall execute and complete the works mentioned in the Schedule, and cl. 2 that the Owner shall pay to the contractor for executing the contract the sum of Rs. 2,31,50,000. Clause 4 requires the contractor to "provide all labour, materials, machinery, plant, tools, tackles and other implements for performing the works in a workman-like manner." Under cl. 11, the contractor guarantees "to accomplish full production within 22 months from the 15th September, 1952" and further undertakes to fulfill the guarantees prescribed in Schedule II to the agreement "to the satisfaction of the Owner within a period of three months from the date of accomplishment of full production."
The Court held that–
“It is clear from the above clauses that the subject matter of the agreement was the installation of the coke oven battery and it accessories, that ……… the price agreed to be paid for the execution of those works, and that there was no agreement for the sale of materials, as such, by the appellants to the Owner. In other words, the agreement in question is a contract entire and indivisible for the construction of specified works for a lump sum and not a contract of sale of materials as such.”
In the case in hand there is an overall contract price for the whole work and the amount is further break-up into a supply consideration and a consideration for the services. But there would have been no scope for sales of materials separately if the contractor did not incorporate those materials in the works. The case quoted above is instructive here for treating the turn key contract as an indivisible works contract rejecting the dealer’s treatment of the supply of equipments and steel/cement for civil works separately. The transfer of equipments and steel/cement for civil works occurs by way of accretion or accession only, when those are incorporated in the works. The so-called ‘contract for sales’ has no separate existence and only incidental to the works contract for setting up a complete project ready for operation at the turn of a key. Thus there was no ‘sale simpliciter’ of equipments from the dealer and there was no ‘transfer of title’ in the equipments as alleged. In terms of the contract the transfer is made only when the contractee takes over a fully operative plant after successful testing of its performance which is the essence of a ‘turn-key’ contract.
It is often claimed that the transfer of material to contractees is covered under S.3(b) of the CST Act as per the judgment of the Apex Court in the Gannon Dunkerley case (1993) 88 STC 204 (SC). The claim is not tenable if we read the relevant part of the judgment [88 STC 230] as quoted below:
"We do not propose to go into this controversy because the question whether a deemed sale resulting from transfer of property in goods involved in the execution of a particular works contract amounts to a sale in the course of inter-State trade or commerce under Section 3 of the Central Sales Tax Act or an outside sale under Section 4 of the Central Sales Tax Act or a sale in the course of import under Section 5 of the Central Sales Tax Act has to be decided in the light of the particular terms of the works contract and it cannot be decided in the abstract.”
Thus in terms of the nature of contracts discussed here, the contention about sales under section 6(2) cannot be accepted as the sales were made by way of accession and accretion of the goods in execution of works contracts but never by transfer of document of title to the goods during their inter-state movement.
Part II follows
