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