The Constitutional Bench of the Hon’ble Supreme Court (SC), over-ruling the earlier decision of  three-member Bench re State of A.P. v. Kone Elevators (India) Ltd1, has held that the activity of  manufacture, erection, installation and commissioning of lift is indeed a ‘works contract’ and not  a ‘contract for sale of goods’.

In order to appreciate this decision of the Apex Court, it is necessary to delve into the genesis  of evolution of the law with respect to ‘works contract’. It all started with the decision of the Supreme Court re State of Madras vs Gannon Dunkerley & Co.2 wherein the Apex Court  held that the term ‘sale of goods’ involves transfer of property in movables from the buyer to the  seller for a price, pursuant to an agreement to sell. It was further held that a building  construction contract is an indivisible contract involving supply of goods and services and supply  of materials used in such a contract cannot be treated as ‘sale of goods’.

This was followed by a plethora of decisions wherein it was held that an indivisible contract of  sale of goods and provision of service could not be vivisected just to make one portion i.e. sale  of goods, subject to sales tax. To undo this legal position, the Parliament brought in the 46th  Amendment to the Constitution by incorporating Clause (29A) in Article 366. This granted States the  power to levy tax, inter alia, on activities like works contract, treating the sale as sale of  goods.

After this Constitutional amendment, the States have amended their legislations pertaining to levy  of sales tax  on works contract. However, this incorporation of Article 366 (29A) of the  Constitution as well as the changes made by State legislations were first challenged re Builders’  Association of India and Other vs Union of India and Others3 which upheld the amendment so made.  The SC also opined that the States had the power segregate the value of goods used in the execution  of works contract by a legal fiction to make it exigible to sales tax. Even recently, the SC re Larsen and Toubro Limited and another vs State of Karnataka and another4  clearly laid down that ‘dominant intention test’ is not at all material to determine whether or not  there was any intention to transfer property in goods in the agreement. It held that even if the  dominant intention was not to transfer the property in goods and rather it is the rendering of services or the ultimate transaction is transfer of immovable  property, even then  it is open for the States to levy sales tax on materials used in such  contracts if it otherwise has elements of works contract.

Thus, the basic concepts that clearly emerge out of the various decision of Apex Court are (a) 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; (b) 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; (c) 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 (d) 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.

The Larger Bench of the SC in the case of Kone Elevators (India) Ltd. held that a contract for  supply and installation of lift is a composite contract for supply of goods as well  as provision  of service and that the service element is obvious is such a contract. Thus, the activity of supply  and installation of lift would constitute to be a works contract. The Larger Bench, thus, reversed its earlier decision based on the logic that the major component  was the lift and that the skill and labour employed was only incidental to the supply of lift and  that this is a contract for sale of goods.

The judgment5, passed by a 4:1 majority, will have far reaching consequences in indirect tax  matters and is expected to bring a welcome respite to one and all in the industry sectors including  real estate, infrastructure and many sectors where works contract take place. This would also help  in resolving a large number of pending litigations.

Manoj Kumar Mishra