Supreme Court Clarifies Reimbursement of Sales Tax in Works Contracts: State of Orissa vs. M/S B. Engineers & Builders Ltd. (2020) INSC 381 (5 June 2020)

LEGAL ISSUE: Whether contractors are entitled to reimbursement of sales tax on works contracts under specific contractual clauses.

CASE TYPE: Contract Law, Tax Law.

Case Name: State of Orissa vs. M/S B. Engineers & Builders Ltd. & Ors.

[Judgment Date]: 5 June 2020

Introduction

Date of the Judgment: 5 June 2020

Citation: (2020) INSC 381

Judges: A.M. Khanwilkar, J., Indira Banerjee, J., Dinesh Maheshwari, J.

Can a state government deny reimbursement of sales tax to contractors for works contracts, despite a clause in the contract that stipulates such reimbursement? The Supreme Court of India recently addressed this question in a case concerning the State of Orissa and a construction company. The core issue revolved around the interpretation of contractual clauses and the legal framework governing sales tax on works contracts. The judgment was delivered by a three-judge bench comprising Justices A.M. Khanwilkar, Indira Banerjee, and Dinesh Maheshwari, with Justice Dinesh Maheshwari authoring the opinion.

Case Background

M/S B. Engineers & Builders Ltd., a company engaged in undertaking various works contracts, responded to tenders floated by different offices of the Government of Orissa. After being determined as the lowest tenderer, the company was awarded contracts from time to time. These contracts included stipulations regarding taxes in Clause 45 of the General Conditions of Contract (GCC). Specifically, Clause 45.2 stated that any Central or State sales tax and other taxes on completed items of works (excluding penalties) paid by the contractor would be reimbursed by the employer upon proof of payment and production of an assessment certificate.

The sales tax regime in Orissa is governed by the Orissa Sales Tax Act, 1947. Amendments in 1984 and 1985, following the Constitution (Forty-sixth Amendment) Act, 1982, included the definition of “works contract” and expanded the definition of “sale” to include the transfer of property in goods involved in the execution of a works contract. The rate of tax on works contracts was initially fixed at 4%.

Initially, the Government of Orissa, through a circular dated 04 November 1986, directed that sales tax paid by contractors would be reimbursed if the contract included a clause for such reimbursement. Consequently, the contractor company received reimbursement for the assessment years 1995-1996 to 1997-1998. However, the tax rate was later increased to 8%.

Subsequently, the government issued a circular on 27 January 2000, stating that the reimbursement of sales tax was under consideration, and no reimbursements should be made until further clarification. Finally, on 07 November 2001, the government issued a circular stating that completed items of works were not subject to sales tax, and therefore, no reimbursement was due. This led to the contractor company filing a writ petition seeking reimbursement and challenging the circulars.

Timeline

Course of Proceedings

The contractor company filed a writ petition in the High Court of Judicature at Orissa, challenging the circulars dated 07 November 2001 and 19 June 2002, and seeking reimbursement of sales tax. The High Court ruled in favor of the contractor, quashing the circular dated 07 November 2001, and directed the government to grant reimbursement as per Clause 45.2 of the GCC. The High Court held that the sales tax was levied on the actual turnover of the works contract, not on the materials procured by the contractor. The State of Orissa then appealed the High Court’s decision to the Supreme Court of India.

Legal Framework

The legal framework for this case is rooted in the Constitution of India and the Orissa Sales Tax Act, 1947.

✓ Article 366(29-A) of the Constitution of India: This clause, inserted by the Constitution (Forty-sixth Amendment) Act, 1982, defines “tax on the sale or purchase of goods” to include a tax on the transfer of property in goods involved in the execution of a works contract. This amendment allowed states to levy sales tax on the value of goods used in works contracts.

The provision reads as follows:

“(29-A) “tax on the sale or purchase of goods” includes-
(a)… … …
(b)a tax on the transfer of property in goods (whether as goods or in some other form) involved in the execution of a works contract;
(c)to (f) … … …”

✓ Orissa Sales Tax Act, 1947: This act, as amended, defines “sale” to include the transfer of property in goods involved in works contracts. It also defines “works contract” and specifies the method for calculating the taxable turnover in respect of such contracts.

✓ Section 2(g) of the Orissa Sales Tax Act, 1947: Defines “Sale” to include transfer of property in goods involved in the execution of a works contract.

The provision reads as follows:

“Section 2(g) “Sale” means with all its grammatical variations and cognate expression, any transfer of property in goods for cash or deferred, payment or other valuable consideration and includes,–
(i)… … …
(ii)(ii) transfer of property in goods (whether as goods or in some other form) involved in the execution of a works contract;
(iii) to (vi) … … … ”

✓ Section 2(jj) of the Orissa Sales Tax Act, 1947: Defines “Works Contract” to include any agreement for carrying out construction, building, etc.

The provision reads as follows:

“Section 2(jj)- “Works Contract” includes any agreement for carrying out, for cash or deferred payment or other valuable consideration, the building, construction, manufacture, processing, fabrication, erection, installation, fitting out, improvement, modification, repair or commissioning of any moveable or immoveable property.”

✓ Section 5(2)(AA) of the Orissa Sales Tax Act, 1947: This section specifies that the taxable turnover for works contracts is the gross value received, less the amount of labor and service charges.

The provision reads as follows:

“S.5(2)(AA)- Notwithstanding anything contained in sub-section (2)(A), “taxable turnover” in respect of:
(i) ‘works contract’ shall be deemed to be the gross value received or receivable by dealer for carrying out such contract, less the amount of labour charges and service charges incurred for the execution of this contract… … …”

These provisions allow the State of Orissa to levy sales tax on the value of goods used in works contracts, but not on the entire contract value.

Arguments

The arguments presented by both sides are detailed below:

Appellant (State of Orissa) Arguments:

• The State argued that the forty-sixth amendment to the Constitution created a legal fiction, treating works contracts as deemed sales, where sales tax is only leviable on the value of goods used in the execution of the contract.

• The State contended that “completed item of work” refers to the completion of the entire works contract, not to individual stages of work. Therefore, sales tax is not leviable on the “completed item of work” which is an immovable property, but on the taxable turnover which is the value of the goods used in the works contract.

• The State argued that the contractor is liable to pay sales tax on the value of goods used in the works contract. This amount is either deducted from the contractor’s running bills or paid directly by the contractor to the Sales Tax Department. Therefore, no reimbursement is required.

• The State emphasized Clause 13.3 of the Instructions to Bidders (ITB) and Clause 45.1 of the General Conditions of Contract (GCC), which state that the bid price includes all duties, taxes, and levies, including sales tax. Thus, the claim for reimbursement is not valid.

• The State argued that Clause 45.2 of the GCC applies only to sales tax on a “completed item of work,” which, in the context of a construction project, is an immovable property not subject to sales tax.

• The State contended that the circular dated 04 November 1986, which allowed reimbursement, was based on an incorrect understanding of Clause 45.2. The subsequent circulars dated 07 November 2001 and 19 June 2002 clarified that Clause 45.2 applies only to sales tax on “completed item of work” and that sales tax levied under Section 5(2)(AA) of the Act of 1947 is not reimbursable.

Respondent (M/S B. Engineers & Builders Ltd.) Arguments:

• The contractor argued that the sales tax deductions from the running bills were made on a deemed sale on turnover basis, not item-wise. Therefore, the recovery of sales tax is covered by Clause 45.2 of the GCC, which entitles them to reimbursement.

• The contractor referred to the decision of the Supreme Court in Gannon Dunkerley (supra) and the provisions of Section 5 (2) (AA) of the Act of 1947, stating that the deduction of sales tax on a turnover basis presupposes the existence of a sale. Therefore, they are entitled to reimbursement.

• The contractor contended that the circular dated 07 November 2001, which denied reimbursement, was against statutory provisions and contractual stipulations.

The innovativeness of the arguments lies in the interpretation of the term “completed item of work” and how it relates to the sales tax levied on works contracts. The State tried to interpret it as the final immovable property, while the contractor argued it refers to the completed stages of work for which tax is levied on a turnover basis.

Issues Framed by the Supreme Court

The Supreme Court framed the following issues for consideration:

1. Whether the contractor company is entitled to claim reimbursement of the amount of sales tax levied in respect of the works contracts executed by it on the strength of the stipulations contained in Clause 45.2 of GCC of NCB bid documents.
2. Whether the appellant State can resist the right so claimed by the contractor company with reference to the principles enunciated in the cited decisions and on the basis of the assertions that in the context of a works contract, there is no sales tax on the “completed item of work” which is an immovable property and that in works contract, the contractor may have to pay sales tax assessed on the items which go into the work but, such amount of sales tax is not reimbursable because the contractor is supposed to have provided for the same in its rates, as envisaged by Clauses 13.3 of ITB and 45.1 of GCC.

Treatment of the Issue by the Court

The following table demonstrates as to how the Court decided the issues:

Authorities

The Supreme Court considered the following authorities:

Judgment

The Supreme Court held that the contractor company was entitled to the reimbursement of sales tax as per Clause 45.2 of the GCC. The court rejected the State’s arguments that the term “completed item of work” referred to the entire immovable property and that the contractor was not entitled to reimbursement due to Clauses 13.3 of ITB and 45.1 of GCC.

How each submission made by the Parties was treated by the Court?

How each authority was viewed by the Court?

The following authorities were considered by the Court:

• Builders’ Association of India and Ors. v. Union of India and Ors.: (1989) 2 SCC 645: The Supreme Court relied on this case to explain the nature of composite contracts and the power of states to levy sales tax on goods used in works contracts.
• Gannon Dunkerley and Co. and Ors. v. State of Rajasthan and Ors.: (1993) 1 SCC 364: The Court used this case to understand the legal fiction created by Article 366(29-A) of the Constitution and the limitations on the state’s power to levy sales tax.
• State of U.P. and Ors. v. P.N.C. Construction C. Ltd. and Ors.: (2007) 7 SCC 320: This case was used to explain the concept of “value addition” after the Forty-sixth Amendment and how it allows states to levy sales tax on the value of goods involved in a works contract.
• Article 366(29-A) of the Constitution of India: The Court considered this provision to understand the definition of “tax on the sale or purchase of goods” and the inclusion of tax on the transfer of property in goods involved in the execution of a works contract.
• Section 2(g) of the Orissa Sales Tax Act, 1947: The Court referred to this provision to define “sale” and to include the transfer of property in goods involved in the execution of a works contract.
• Section 2(jj) of the Orissa Sales Tax Act, 1947: The Court referred to this provision to define “works contract”.
• Section 5(2)(AA) of the Orissa Sales Tax Act, 1947: The Court referred to this provision to specify that the taxable turnover for works contracts is the gross value received, less the amount of labor and service charges.

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily influenced by the following factors:

• Contractual Obligation: The Court emphasized that the terms of the contract, specifically Clause 45.2 of the GCC, clearly stipulated that the contractor would be reimbursed for sales tax paid on completed items of work.
• Interpretation of “Completed Item of Work”: The Court interpreted this term to mean the completion of a particular item of work, not the entire project as an immovable property.
• Statutory Compliance: The Court noted that the sales tax was levied on the “taxable turnover” of the works contract, as per Section 5(2)(AA) of the Orissa Sales Tax Act, 1947, and not on the entire contract value.
• Rejection of State’s Arguments: The Court rejected the State’s arguments that the contractor was not entitled to reimbursement due to Clauses 13.3 of ITB and 45.1 of GCC, stating that these clauses did not negate the reimbursement clause in 45.2.
• Consistency in Application: The Court observed that the State had been deducting sales tax on the works contract turnover from the running bills as per the second part of Clause 45.2, and therefore, it was only logical that the first part of the clause, which stipulated reimbursement, should also be applied.

The sentiment analysis shows that the Court was significantly influenced by the contractual obligations and the correct interpretation of the term “completed item of work”. The ratio analysis indicates that the legal considerations played a more significant role than the factual aspects in the Court’s decision.

Logical Reasoning

The Court considered alternative interpretations but rejected them, emphasizing that the plain language of Clause 45.2, read in conjunction with the statutory provisions, clearly entitled the contractor to reimbursement. The Court also noted the inconsistency in the State’s actions, where deductions were made for sales tax on works contract turnover but reimbursement was denied.

The Court’s decision was that the contractor was entitled to reimbursement of the sales tax paid on the taxable turnover of the works contracts. The reasons were:

• The contractual clause (45.2 of GCC) explicitly provided for reimbursement of sales tax.
• The expression “completed item of work” refers to the completion of a particular item of work, not the entire project.
• The sales tax was levied on the taxable turnover of the works contract, as per the Orissa Sales Tax Act, 1947.
• The State was inconsistent in applying Clause 45.2 by deducting sales tax but denying reimbursement.

The Court quoted the following from the judgment:

“Contextually read, it is but apparent that the expression “completed item of work” in Clause 45.2 ibid., signifies the intent that reimbursement would be permissible only after execution of a particular item of work has been completed and accomplished.”

“It is not far to seek, and is rather evident on a bare reading of Clause 45.2 in its entirety, that it is to apply in relation to the sales tax on works contract too.”

“In our view, on a plain reading of the aforesaid relevant terms of the contract, it is clear that while the contractor cannot claim any payment towards the taxes/duties/royalties etc. on the goods/materials purchased by it for performance of the contract but that does not disentitle the contractor from claiming reimbursement of the sales tax levied upon it by the employer, of course after proof of payment/assessment.”

There were no dissenting opinions in this case. The judgment was delivered by a three-judge bench, and the opinion was authored by Justice Dinesh Maheshwari.

The Court’s reasoning was based on a careful interpretation of the contractual clauses and the relevant statutory provisions. The Court emphasized that the terms of the contract should be given effect to unless there is a clear ambiguity or violation of law. The Court also highlighted the importance of a consistent application of contractual terms.

This judgment clarifies that contractual clauses for reimbursement of sales tax must be honored and that the state cannot deny such reimbursement based on a narrow interpretation of the term “completed item of work.” It also underscores the importance of consistent application of contractual terms and statutory provisions.

The implications of this judgment are significant for contractors involved in works contracts, as it provides clarity on the interpretation of reimbursement clauses and ensures that they are not denied their rightful dues. It also serves as a reminder to state governments to adhere to the terms of their contracts and statutory provisions while dealing with contractors.

Conclusion

The Supreme Court’s judgment in the case of State of Orissa vs. M/S B. Engineers & Builders Ltd. clarifies the legal position on the reimbursement of sales tax in works contracts. The court held that contractors are entitled to reimbursement of sales tax on completed items of work, as per the contractual terms, and that the state cannot deny such reimbursement based on a narrow interpretation of the term “completed item of work.”

The judgment underscores the importance of adhering to contractual obligations and statutory provisions. It also highlights the need for a consistent application of contractual terms and a fair interpretation of legal provisions.

Key Takeaways:

• Contractual clauses for reimbursement of sales tax must be honored.
• The term “completed item of work” refers to the completion of a particular item of work, not the entire project.
• State governments must adhere to the terms of their contracts and statutory provisions.
• A consistent application of contractual terms is essential.

This judgment provides a clear legal framework for contractors and state governments in relation to sales tax reimbursement in works contracts, promoting transparency and fairness in contractual dealings.