Critical Analysis of Inter-State Works Contract

After amendment to the constitution by inserting Article 366(29A) providing definition of the term “taxes on sale or purchase of goods” to include deemed sales, States were empowered to levy tax on sale or purchase of goods involved in execution of works contracts. However, the power of States to levy tax on deemed sales including works contract sales are subject to restrictions contained in Article 286 of the Constitution of India. Under Article 286 State has no power to levy tax on –

i) sale or purchase of goods effected in the course of inter-State trade or commerce,

ii) sale or purchase of goods effected in the course of export,

iii) sale or purchase of goods effected in the course of import and

iv) sale or purchase of goods effected outside the State.

Further, power of States to levy tax on sale or purchase of goods of special importance, in the course of inter-State trade and commerce is subject to further restrictions as may be prescribed by the Parliament.

The Central Sales Tax Act, 1956 (hereinafter referred to as the Act) provides for levy of tax on inter-State sales as well as determines rules when any sale or purchase of goods shall be deemed to be effected in thecourse of inter-State trade or commerce, import or export and outside the State. It also provides the list of goods of special importance and contains restrictions on power of States to levy tax on sale or purchase of such declared goods.

The SC in case of Gannon and Dunkerley 73 STC 373, as also later in 88 STC 204 held for the first time that power of States to levy tax on deemed sale or purchase of goods is subject to restrictions provided in Article 286. Accordingly, States have no power to levy tax on deemed sale or purchase of goods effected in the course of inter-State trade or commerce, import, export or effected outside the State. Although CST Act was not amended, the provisions of CST Act determining;–

– situs of sale,

– when sale or purchase of goods is deemed to be effected in the course of inter-State trade or commerce, and

– when sale or purchase of goods is deemed to be effected in the course of import or export shall apply to deemed sales.

At the same time, no tax was payable under the CST Act on deemed sale of goods effected in the course of inter-State trade as the definition of sale provided in the Act did not include such deemed sales.

The Finance Act, 2002 amended CST Act, 1956, from 11-5-2002 by substituting section 2 (g), the scope of definition of the term ‘sale’ is widened. The definition of the term ‘sale’ is brought at par with definition of the term ‘Taxes on sales’ contained in Article 366(29A) of the Constitution of India.

No corresponding or consequential amendment was made in other provisions of the Act by the said Finance Act.

The definition of the term “sale price” of the CST Act was amended by the Finance Act, 2005 from 13-5-2005, whereby a proviso was inserted in section 2(h) ofthe Act. Accordingly, for works contract sales, the Central Government is given power to prescribe by way of rule to determine the sale price of goods in a prescribed manner by making such deduction from the total consideration for the workscontract as may be prescribed. Till date no such rules are prescribed.

Similarly, sub-clause (ja) is inserted in section 2 of the CST Act by Finance Act, 2005 defining the term “works contract”.

Inter-State sale-S.3

i) Section 3 of the CST Act, provides for principals to determine when a sale or purchase of goods takes place in the course of inter-State trade or commerce.

We have settled law and principles on provisions of section 3 of Central Sales Tax Act, 1956 to determine when sale of goods takes place in thecourse of inter-State trade or commerce. These principles have been applied by the courts in case of deemed sales like works contract and lease transactions. After the amendment to CST Act, 1956, by Finance Act, 2002, the position is very clear for application of provisions of section 3 to the deemed sales.

ii) Salient feature of inter-State sales

The salient feature of inter-State sales on the basis of rulings of various courts are as under:

   1. The contract of sale occasions movement of goods from one State to another.
   2. The movement of goods has occasioned under a contract of a sale.
   3. The property in goods may pass in the same State. In other words it is not necessary that property in goods must pass in the other State.
   4. The movement of goods may precede the sale or the movement followed by a sale.
   5. There may be an express term or covenant for inter-State movement of goods in the contract itself or may be implied from the facts of the case.
   6. Situs of a sale is immaterial for determining the inter-State nature of sale.
   7. There must be an inextricable link between movement of the goods from one State to another and the contract of sale.
   8. Inter-State stock transfer to branch against specific order or against contract of a sale, occasions inter-State movement of goods and are inter-State sale.

i) U/s 3(b) of CST Act, a sale which is effected by transfer of document of title to the goods while the goods are in transit, is also an inter-State sale.

ii) Inter-State Works Contract sales

The provisions of section 3 also apply to works contract sales. The test to determine inter-State sales depends upon inter-State movement of goods under the contract of a sale.

In case of works contract sales, inter-State movement of goods takes place of goods with which works contract is executed as well as processed goods. In both cases, a sale is deemed to have effected in the course of inter-State trade and liable to pay tax under the CST Act.

The Gauhati High Court in case of M/s Projects and Services (82 STC 89) held that when contract is undertaken by a contractor situated outside the State of Tripura and goods are brought in to the State of Tripura from the place outside the State for execution of the workscontract in the State, it is an inter-State sale.

The Punjab & Haryana High Court, in case of M/s Hindustan Thompson Printing Press (100 STC 417) held that when lottery tickets are printed in the State of Haryana and delivered to a dealer in other State then it is an inter-State sale.

The Maharashtra Tribunal in M/s. Bhandari Metal SA 1619/94 dt. 23-1-1998 (Ref. rejected on 31-3-2001) followed decision of East India Cotton Mfg. (90 STC 221) and held that when dealer in Maharashtra received goods from the other State dealer for processing and after process, the processed goods are delivered to him outside the State, then it is an inter-State sale.

Generally, for the purpose of determining inter-State sale, the inter-State movement of goods in which property is passed, is to be considered. However, for determining inter-State workscontract sales, Courts in case of Hindustan Thompson 100 STC 417 and other cases have considered the inter-State movement of processed goods also, although no property in such goods is passed.

In view of above, the inter-State works contract sale takes place when not only the contract occasions inter-State movement of goods with which contract is executed but also when it occasions inter-State movement of processed goods.

v) Sale by transfer of document of title to the goods S-3(b).

Under section 3 (b) of the Act, any sale effected by transfer of document of title to the goods while goods are in transit from one State to anothet is also an inter-State sale and exempt from payment of tax under section 6 (2) ofthe Act. The issue is whether there can be such inter-State works contract sale?

In case of works contract, the property in goods passes as and when goods are used in works contract and not on delivery of goods. Section 3 (b) of the Act provides for passing of property in goods in a particular manner; i.e., by transfer of document of title to the goods. Unless, the property in goods passes by transfer of document of title to the goods, while it is in transit from one State to another the provisions of section 3(b) and section 6(2) are not applicable.

As discussed above, in case of works contract, the property in goods does not pass by transfer of document of title to the goods but it passes as and when goods are used in works contract. Therefore, the provisions of sections 3 (b) and 6(2) do not apply to works contract sales. As such, the exemption from payment of tax cannot be claimed and tax will have to be payable on such transaction.

However in such cases, it is possible to contend that contract is not an indivisible works contract but divisible contract involving sale of goods by transfer of document of title to the goods as such exempt from payment of tax under section 6(2) of the CST Act, subject to production of required form C and E-I.

Sale in the course of import or export – Section 5

Under section 5 of the CST Act, no tax is payable on any sale or purchase of goods which occasions import of goods into India or export of goods outside India. Further any sale of goods effected by transfer of document of title to the goods before it crosses the custom frontier of India, popularly known as High seas sale, is also exempt from payment of tax under section 5(2) of the Act. Under section 5(3) of the CST Act, any sale of goods to the exports to comply terms of any pre existing export order is also exempt from payment of tax, subject to production of form H.

The provisions of section 5 apply to works contract sales also, even prior to amendment to section 2(g) of the Act from 11-5-2002. Because, the exemption under section 5 is in fact under article 286 of the Constitution and section 5 of the Act only provides rules for determining when any sale or purchase of goods shall be deemed to be effected in the course of import or export. The SC in case of Gannon and Dunkerly 73 STC 373 held that power of State to levy tax on sale or purchase of goods including deemed sales is subject to restrictions contained in article 286 of the Constitution of India. Therefore, State has no power to levy any tax on deemed sale of goods including works contract sales covered by section 5 of the Act.

The Commissioner of Sales Tax in case of Mazgaon Dockyard (DDQ dt. 31-10-1995) allowed the claim of the dealer for exemption under section 5(2) of the Act and held that when under the contract, the good are imported by the contractor under the specific terms of the contract and used in works contract then it has occasioned movement of goods from outside India and exempt under section 5(2) of the CST Act.

Levy of CST on Works Contract sales

i) After the amendment by Finance Act, 2002, by substitution of definition of ‘sale’ to include “deemed sales including works contract sales”, it is possible to levy tax under the CST Act on deemed sales taking place in the case of inter-State trade.

ii) The levy of tax is provided in section 6 of the Act. As per section 6 of the Act, every dealer from the date notified by the Government, not earlier than 30 days, is liable to pay the tax. In exercise of the power, the Government of India had issued notification No. SRO 940A dated 26-3-1957 notifying 1-7-1957 as the date from which tax was payable under the Act. Subject to provisions of section 6 (2), the tax is payable on turnover of sales at the rate of tax as per provisions of section 8 of the Act.

iii) Works Contract – Section 2(ja)

The term ‘works contract’ is defined in section 2(ja) of the Act. Accordingly, ‘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. Therefore any inter-State sale of goods involved in execution of works contract as defined in section 2(ja) is liable to pay tax under the Act.

iv) Sale Price / Turnover of sales – Ss-2 (h) and (j)

The tax under the CST Act is payable on turnover of sales. The term ‘turnover of sales’ is defined in section 2(j) to mean aggregate of the sale price received or receivable for sale of the goods. The term ‘sale price’ is defined in section 2(h) to mean amount paid or payable for sale or purchase of goods etc. Pursuant to the amendment by Finance Act, 2002, no consequential amendment was made in these clauses. The Finance Act, 2005 inserted a proviso to section 2(h) giving power to the Government to prescribe manner of determination of sale price by making deductions from total consideration, as may be prescribed. Till date no such rules are prescribed.

In absence of such rules, whether CST is payable on entire contract value?

The SC in case of 2nd Gannon Dunkerley’s case 88 STC 204 held that in case of works contract, tax is payable on value of goods deemed to be sold while executing works contract. The entire contract value is not taxable. The deductions for labour and other services are to be made from total contract value for determining value of goods sold for levy of tax.

In view of above decision of SC, States have provided rules to determine sale price of goods in case of works contract sales.

The SC in case of M/s. Mahim Patram 6 VST 248 (SC) held that till Rules are prescribed by government to determine sale price of works contract sales, State rules shall be applicable to determine sale price of the goods for levy of tax under the CST Act.

Therefore, in Maharashtra, provision of rule 58 shall apply for determination of sale price for levy of CST.

v) Issue of Form C

As a result of amendment by Finance Act, 2002, the dealer can issue Form C for purchase of goods in the course of inter-State trade for the purpose of works contract sales. Prior to the amendment by administrative circular, the Commissioner of Sales Tax in Maharashtra had allowed the purchase of goods on C form to the contractor for purchase of goods which are used in works contract on which tax is paid under the earlier Works Contract Act. After the amendment to definition of “sale” to include “deemed sales”, the dealer is entitled to issue Form C as the term “sale” appearing in section 8 will also include works contract sales.

At the same time while purchasing any goods, by way of works contract which are involved in execution of works contract for use in manufacturing or processing of goods or packing of goods for sale or resale etc., the C form can be issued by the employer.

vi) Rate of tax – S.8

As per section 8 of the Act, in case of sales not supported with Form C or D the tax is payable at the rate applicable inside the appropriate State under the General Sales Tax laws. The tax will be payable at the rate of tax payable under the local Act applicable to the goods sold.

As discussed earlier, in works contract sales, tax is payable on the sale of goods which takes place as and when goods are used in works contract. Therefore, for the purpose of determination of rate of tax, the form of goods in which sale takes place is to be considered. In case of sale of goods against Form C, at present, rate of tax is 2%. In any other case, rate of tax will be local rate of tax applicable to the goods sold.

Under section 8 of the Act, sales to the SEZ or developer of SEZ, is exempt from payment of tax against Form I. This provision is applicable to works contract sales also. Accordingly, no tax is payable under the Act on inter-State works contract sales to SEZ unit or developer of SEZ against Form I.