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Work Contracts Under GST Law: Is The 46th Constitutional Amendment In Consonance

This article is pertaining to the developments under Indian law with regard to work contracts and its taxation aspects. It should be recorded here that the Seventh schedule of Constitution of India is a classic evident of federal character of Indian Constitution.

The Power to legislate is clearly laid and separated by List-I, List-II and List-III. However, despite the lengthiest written constitution in the World, the constitution of India has faced various criticism and as a consequence the constitutional developments been made.

This topic would restrict the area to the constitutional issue of taxed on sale or purchase of goods. With this regard, the author would try to line up the issue with the help of a landmark Judgment M/S. Kone Elevator India Pvt. Ltd v. State of T.N. & Ors on 6 May, 2014.

Facts:
  1. The Petitioner is engaged in manufacturing, supply and installation of lifts involving civil construction.
  2. For Ay 1995-96, the sales tax department of state of Andhra Pradesh has assessed the petitioner and held the contract for manufacture, supply and installation of lifts is a contract of sale and sales tax levied on totality without deducting the portion towards labor and services.
  3. Petitioner appealed to the tribunal which held that the nature of contract in present case is a work contract only and not a contract of sale.
  4. The Department filed revision petition before High Court of Andhra Pradesh which upheld the decision of tribunal.
  5. The Department filed special leave petition before supreme court in State of A.P. v. Kone Elevator which via judgment dated 17.02.2005 has overturned the decision of High Court and held that the nature of contract is a contract of sale.
  6. Thereafter, the state government has asked the petitioner to submit the return considered the transaction as sale. Similarly, proceedings were reopened in many states which were closed due to considered them as work contract.
  7. This situation has compelled the petitioner to approach supreme court under article 32 of constitution to re-consider the decision of 3 Judge Bench in matter of State of A.P. v. Kone Elevator while others are concerned , they came before supreme court either by way of writs, SLP or appeal from High Court. Though the objection raised pertaining to non-maintainability as the issue has been heard and decided (Res-judicata) already but same been rejected.
  8. The Hon’ble Supreme court has noted the petitioner contention that 2005 judgment by 3 judge bench has not considered the various other 3 judge bench decisions of Hon’ble apex court. Hence, the Court admitted the petition in matter of Kone Elevator v. State of T.N. , along-with other petitions and to remove the controversy raised due to conflicting decisions has referred the same before constitutional bench. (Reference to larger bench by smaller bench)

    Petitioner is under reference thus no issue of maintainability can be raised at this stage and now the matter is posted for arguments
Issues Involved:
  1. Whether the test of Dominant nature has application in order to determine the nature of contract as work contract or contract of sale?
  2. Whether the decision rendered in State of A.P. v. Kone Elevators has correctly laid down the law ?
  3. Whether the contract of manufacture, supply and installation of lift is a work contract?

Petitioner Contentions:
  1. The Counsel for the petitioner would admitting any fact upon it proceed with the prima facie but crucial observation that the 46th amendment has given legislative competency to the state government to taxed the transfer of property in goods in work contracts as tax on sale and purchase of goods . What remain a controversy under present case is if it’s a case of contract of sale or work contract.
  2. The petitioner would require the attention of bench towards situation of Pre-46th amendment and in order to understand the true intent behind 46th amendment :

    # on the footing of Government of India act, 1935, the constitution of India was considered to be given a wider interpretation on sale of goods. However, in Gannon Dunkerley's case, the Supreme Court 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. This means that in order to be taxed as a contract of sale , a contract has to fulfill following conditions namely ,Agreement to sell, parties competent to contract, mutual assent and transfer of property in goods from one of the parties to the contract to the other party and price.

    # In the case of Hindustan Aeronautics Ltd., the question arise whether the manufacture and supply of coaches to the railway is a work contract to which it was held that it purely depends upon terms of contract.


    # Further, In case of Sentinel Rolling Shutters and Engg. Co., the question arise whether a contract of erection of rolling shutter is a work contract to which it was held that it depends upon namely- terms of contract, incidental existence , main object, customs of trade , circumstance of transaction and divisibility of contract.

    # Further the decision of M/s Associated Hotels wherein Supreme court relaying upon English precedents has held that the supply of food and drink to guest residing in hotel is not sale.

    # The decision of Northern India Cateres has even went on to held that both whether as a whole meal to insider or to guest outsider, it wouldn’t be consider as sale for reason being there is no transfer of property in goods.

    Such a practice was giving revenue loss to the state governments and thus in order to curb such a loophole and to give uniformity over the concept, the recommendation of 61st report of law commission were accepted and accordingly , the parliament has inserted article 366 (29A) via 46th amendment.

  3. The petitioner humbly submit before Hon’ble Forum that insertion of Article 366(29A) (b) via 46th Amendment , the Pre-dominant test have no longer relevance to determine if a contract is work contract or contract of sale. The same has been clarified in B.S.N.L Case (2006) which is also been quoted in L&T Case.

  4. The Counsel further submit that in L&T Case, it has been clarified that post 46th amendment , the narrow meaning of work contract in Gannon Dunkerley no longer survives. Further, it has also been clarified that once the characters of work contract are satisfied then any additional obligations incorporated in contract would not take away the nature of contract as a work contract.

  5. All it need is to prove the basic characters of a work contract – by showing mix essence of both goods and services. thereafter, none of tests need to be apply as the intent behind applying test was only in case when contracts were inseparable. After 366(22A)(b), the need to apply such is vanished away as the deeming fiction has given power to tax the transfer property in goods in execution of work contract . Thus, it all it require is to prove it’s a work contract and the moment the same is proved, it is not prudent to went thereafter into the issue.

  6. It should be recorded here that the present contract talks about obligation to supply goods and materials (transfer of property in goods in other form) as well as installation of lift which means it involve labor and service. Thus, the fundamental character of work contract is fulfilled.

  7. It should be recorded here that the decision of 3 judge bench in State of A.P. v. Kone Elevators is not correct in law as same was based upon the various tests enumerated pre 46th amendment one of them was the pre-dominant test. The Counsel drawing the attention of bench on famous legal maxim- Allegari non debuit qued probatum non relevant . (1 CHAN. C. —That ought not to be alleged which, if proved, would not be relevant. It should be recorded here that post 46th amendment, such a test is of no application as now the language of Article 366(22A)(b) is clear and unambiguous and the intent behind such an amendment was to maintain the uniformity and to remove the past tests to prove a contract as a work contract. Now if to accept the said decision as correct in law, the same would be equivalent to going back to the base problem created before 46th amendment and hence there would be no meaning of said amendment. Thus, the said decision is not correct in law.

  8. The 46th amendment act has removed the traditional concept of divisible and indivisible contract. After insertion of 366(22A)(b), it has created a legal deeming fiction according to which in each case, where there is a transfer of property in goods, either as good or otherwise in execution of work contract, it would be considered as a work contract. Thus, earlier decisions which were based upon the fact of divisibility and indivisibility of contract are of no relevance post 46th amendment as now the law maker has placed both of them at par and has by creating a legal deeming fiction, even if they are seem as indivisible, the transaction of transfer of property in good either as good or otherwise can be separated and taxed. 46th amendment has empowered the states to tax the value of goods involved in a work contract in same manner as it did when contracts were separable.

  9. The dominant test has no application and even if dominant intent is not to transfer of property in goods but of render the service or ultimate transaction is of transfer of immovable property even then it is open to states to taxed the material (goods) used in such contract if such contract otherwise has elements of works contract.


    Position Under GST Law:
  10. Section 2(119) of CGST Act, 2017 according to which works contract” means a contract for building, construction, fabrication, completion, erection, installation, fitting out, improvement, modification, repair, maintenance, renovation, alteration or commissioning of any immovable property wherein transfer of property in goods (whether as goods or in some other form) is involved in the execution of such contract.
  11. Further, Section 2(30), composite supply would mean a supply made by a taxable person to a recipient consisting of two or more taxable supplies of goods or services or both, or any combination thereof, which are naturally bundled and supplied in conjunction with each other in the ordinary course of business, one of which is a principal supply.
  12. Further, Section 2(74), mixed supply means two or more individual supplies of goods or services, or any combination thereof, made in conjunction with each other by a taxable person for a single price where such supply does not constitute a composite supply.
  13. Section 2(119) and section 8 of CGST Act,2017 to be read with schedule II Para 6(a) , has provided that the work contract is a composite supply and in case of composite supply, the taxed is to be made of the principal supply. Thus, the said definition is taking the route of so called pre-dominant test/ test of main object and same is not in limine with established position post 46th amendment.

Conclusion:
Thus, on basis of abovementioned submissions, it is submit that such provisions under CGST Act are unconstitutional on following grounds:
  • Firstly, the definition of work contract is restricted to immovable property only.
  • Secondly, Though the Work contract is called as composite supply but the taxation of composite supply is left to the test of principal supply/ pre-dominant test or main object test which is against the correct position of law. Applying such a test is against the spirit of 46th amendment and precedent set in L&T and BSNL case.
  • Thirdly, the tax rates for mixed supply and composite supply is different. By limiting the definition of work contract only to immovable property and thereafter left it to test of main object and by creating a definition of mixed supply and created high tax rate on same is unjust and arbitrary because in ordinary sense , the composite contract is very wide and cover both movable and immovable property with services. However, by limiting the definition of work contract, the rest of cases (which ordinarily would fall within work contract) would fall into mixed supply and taxed with higher rate.
  • Fourthly, the new test of naturally bundled in ordinary course of business is created in order to find if it’s a mixed supply or composite supply (work contract). It should be recorded here that such a test is nothing but rename version of so called test of customs of trade evolved in case of Sentinel Rolling Shutters and Engg. Co. Since all such past tests are of no relevance after 46th amendment and thus by re-forming such a test is arbitrary and against the object of 46th amendment.
  1. It is a well-established principle that what cannot be done directly cannot be done indirectly.
  2. Against the object and intent of 46th amendment and thus unconstitutional. The Intent of 46th amendment is the history for its enactment.
  3. A law which is outside the scheme of constitution can be a law in letter but no in spirit. Such a law doesn’t qualify the constitutionalism and constitutionalism is a basic structure of the Indian constitution. How it is basic structure because equality , democracy, rule of law are basic structure and they are also the components of constitutionalism.

Disclaimer:
The views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any agency of the Indian government. Examples of analysis performed within this article are only examples. They should not be utilized in real-world analytic products as they are based only on very limited and dated open source information. Assumptions made within the analysis are not reflective of the position of any Indian government State.

References:
  1. https://www.constitution.org/cons/india/tamnd46.htm
  2. https://www.india.gov.in/my-government/constitution-india/amendments/constitution-india-forty-sixth-amendment-act-1982
  3. https://indiankanoon.org/search/?formInput=46th%20amendment
  4. http://idtc-icai.s3.amazonaws.com/download/knowledgeShare18-19/Effect-of-retention-Article-Constitution-after-GST.pdf

Written By Shubham Budhiraja - The author is company secretary by qualification and has completed its CS management trainee with a reputed corporate law firm. Further, he is a Second Year Law student at faculty of law, University of Delhi. He is enrolled as Para Legal volunteer with Delhi State Legal Service authority and is an active Participant in Moot Court.
Ph no: +919654055315
Email: [email protected], [email protected] 

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