Supreme Court Clarifies Tax Rates on Works Contracts Before 2006: State of Karnataka vs. Durga Projects Inc. (06 March 2018)

Date of the Judgment: 06 March 2018

Citation: (2018) INSC 172

Judges: Dipak Misra, CJI, A M Khanwilkar, J, Dr D Y Chandrachud, J

Can the government apply a general tax rate to goods used in works contracts, or should each item be taxed at its specific rate? The Supreme Court of India addressed this question in a dispute over tax rates on works contracts in Karnataka before 2006. The core issue was whether the state could levy a uniform tax rate on all goods involved in works contracts before a specific amendment to the Karnataka Value Added Tax Act, 2003, or if the tax should be applied based on the individual rates of the goods. The judgment was delivered by a three-judge bench comprising Chief Justice Dipak Misra and Justices A.M. Khanwilkar and Dr. D.Y. Chandrachud, with the opinion authored by Dr. D.Y. Chandrachud.

Case Background

M/s Durga Projects Inc., the respondent, is a company engaged in executing civil works contracts. They are registered under both the Karnataka Value Added Tax Act, 2003 (KVAT Act) and the Central Sales Tax Act. The company purchases various building materials, including hardware, sand, and bricks, which fall under the Third Schedule of the KVAT Act, declared goods under Section 15 of the CST Act, and other non-scheduled goods, from within and outside the State and from unregistered dealers.

On 31 January 2006, the respondent applied to the Authority for Advance Clarification and Ruling (AAR) seeking clarification on the applicable tax rate for civil works contracts under the KVAT Act. The AAR, on 2 August 2006, ruled that since there was no specific tax rate for works contracts before 31 March 2006, the tax should be levied according to the rates applicable to the sale of individual goods under the KVAT Act. Subsequently, on 7 December 2006, the AAR clarified that iron and steel used in the same form would be taxed at 4%, otherwise at 12.5%.

The Commissioner of Commercial Taxes (Karnataka) later revised the AAR’s orders, stating that the tax should be levied on the taxable turnover of goods involved in the execution of a works contract, not on individual goods. The Commissioner argued that a works contract involves a conglomerate of goods, not individual sales, and that the taxable turnover should be determined after deductions as per Rule 3(2) of the KVAT Rules 2005. This revision led the respondent to appeal to the High Court of Karnataka.

Timeline

Course of Proceedings

The Commissioner of Commercial Taxes (Karnataka) revised the orders of the AAR, holding them to be erroneous and prejudicial to the revenue. The Commissioner stated that in a works contract, there is a deemed sale of a conglomerate of goods, distinct from a normal sale of individual goods. The Commissioner concluded that tax should be levied on the taxable turnover of goods involved in the execution of a works contract, determined after deductions under Rule 3(2) of the KVAT Rules 2005, and not on the individual goods.

Aggrieved by the Commissioner’s order, the respondent filed a sales tax appeal before the High Court of Karnataka. The High Court allowed the appeal, setting aside the revisional order. It held that the sale under a works contract is a deemed sale of goods, no different from a normal sale. Therefore, tax should be levied on the price of the goods and materials used in the works contract, as if there was a sale of goods and materials. The High Court stated that for the period before 1 April 2006, tax should be levied as per Section 3(1) of the KVAT Act and after that date, as per Section 4(1)(c) of the KVAT Act.

The High Court, by its judgment dated 25 September 2014, dismissed the Sales Tax Revision Petitions filed under Section 65(1) of the Karnataka Value Added Tax Act 2003 against the order dated 26 August 2013 of the Karnataka Appellate Tribunal, Bengaluru. While dismissing the revisions, the High Court relied upon its earlier decision dated 29 September 2012 in M/s Durga Projects Inc v State of Karnataka (STA 72 of 2010).

Legal Framework

The core legal provisions in question are from the Karnataka Value Added Tax Act, 2003 (KVAT Act) and the Central Sales Tax Act, 1956 (CST Act). The relevant sections of the KVAT Act are:

• Section 3: This is the charging provision, stating that tax shall be levied on every sale of goods in the State by a registered dealer. “The tax shall be levied on every sale of goods in the State by a registered dealer or a dealer liable to be registered, in accordance with the provisions of this Act.”
• Section 2(29): Defines “sale” to include the transfer of property in goods, including those involved in works contracts. “’Sale’ with all its grammatical variation and cognate expressions means every transfer of the property in goods (other than by way of a mortgage, hypothecation, charge or pledge) by one person to another in the course of trade or business for cash or for deferred payment or other valuable consideration and includes, – (b) a transfer of property in goods (whether as goods or in some other form) involved in the execution of a works contract;”
• Section 2(15): Defines “goods” to include all kinds of movable property, materials, commodities, and articles, including those involved in works contracts. “’Goods’ means all kinds of movable property (other than newspaper, actionable claims, stocks and shares and securities) and includes livestock, all materials, commodities and articles (including goods, as goods or in some other form) involved in the execution of a works contract or those goods to be used in the fitting out, improvement or repair of movable property, and all growing crops, grass or things attached to, or forming part of the land which are agreed to be severed before sale or under the contract of sale.”
• Section 4(1): Specifies the liability to tax and the rates thereof. Before the amendment on 1 April 2006, it stated: “Every dealer who is or is required to be registered as specified in Sections 22 and 24, shall be liable to pay tax, on his taxable turnover, (a) in respect of goods mentioned in, (i) Second Schedule, at the rate of one per cent, (ii) Third Schedule, at the rate of four per cent, and (iii) Fourth Schedule, at the rate of twenty per cent. (b) in respect of other goods, at the rate of twelve and one half per cent.”
• Section 4(1)(c): Introduced on 1 April 2006, this clause specifies the tax rate for goods involved in works contracts as per the Sixth Schedule, subject to Sections 14 and 15 of the CST Act. “(c) in respect of transfer of property in goods (whether as goods or in some other form) involved in the execution of works contract specified in column (2) of the Sixth Schedule, subject to Sections 14 and 15 of the Central Sales Tax Act, 1956 (Central Act 74 of 1956), at the rates specified in the corresponding entries in column (3) of the said Schedule.”
• Section 2(34): Defines “taxable turnover” as the turnover on which a dealer is liable to pay tax, after deductions from the total turnover. “’Taxable turnover’ means the turnover on which a dealer shall be liable to pay tax as determined after making such deductions from his total turnover and in such manner as may be prescribed, but shall not include the turnover of purchase or sale in the course of interstate trade or commerce or in the course of export of the goods out of the territory of India or in the course of import of the goods into the territory of India and the value of goods transferred or despatched outside the State otherwise than by way of sale.”
• Section 2(35): Defines “total turnover” as the aggregate turnover of a dealer in all goods at all places of business in the State. “’Total turnover’ means the aggregate turnover in all goods of a dealer at all places of business in the State, whether or not the whole or any portion of such turnover is liable to tax, including the turnover of purchase or sale in the course of interstate trade or commerce or in the course of export of the goods out of the territory of India or in the course of import of the goods into the territory of India and the value of goods transferred or despatched outside the State otherwise than by way of sale.”
• Section 2(36): Defines “turnover” as the aggregate amount for which goods are sold or distributed. “’Turnover’ means the aggregate amount for which goods are sold or distributed or delivered or otherwise disposed of in any of the ways referred to in clause (29) by a dealer, either directly or through another, on his own account or on account of others, whether for cash or for deferred payment or other valuable consideration, and includes the aggregate amount for which goods are purchased from a person not registered under the Act and the value of goods transferred or despatched outside the State otherwise than by way of sale, and subject to such conditions and restrictions as may be prescribed the amount for which goods are sold shall include any sums charged for anything done by the dealer in respect of the goods sold at the time of or before the delivery thereof.”
• Section 7: Specifies the time of sale of goods, stating that in the case of a works contract, the sale is deemed to occur at the time of incorporation of the goods. “Notwithstanding anything contained in the Sale of Goods Act, 1930 (Central Act 3 of 1930), for the purpose of this Act, and subject to subsection (2), the sale of goods shall be deemed to have taken place at the time of transfer of title or possession or incorporation of the goods in the course of execution of any works contract whether or not there is receipt of payment: Provided that where a dealer issues a tax invoice in respect of such sale within fourteen days from the date of the sale, the sale shall be deemed to have taken place at the time the invoice is issued.”

Additionally, Rule 3 of the KVAT Rules 2005 provides for the determination of total and taxable turnover, with specific provisions for works contracts under Rule 3(1)(c) and deductions under Rule 3(2), including labour charges. The legal framework also involves the interpretation of Article 366(29A)(b) of the Constitution, which allows states to tax the transfer of property in goods involved in the execution of works contracts.

Arguments

Arguments on behalf of the State of Karnataka:

• The KVAT Act envisaged a levy of tax on works contracts even before 01.04.2006. The definitions of sale, goods, turnover, total turnover, and taxable turnover were part of the legislation from the beginning.

• The rate of tax for works contracts prior to 01.04.2006 falls under Section 4(1)(b), the residual entry, which applies to “other goods” not specified in any schedules. Goods incorporated in a works contract are considered “goods” under Section 2(15) of the KVAT Act.

• In a deemed sale, the value of the contract is taken as the amount of goods sold, as incorporated in Rule 3(c) of the KVAT Rules 2005.

• The concept of ‘total turnover’ in a deemed sale is the total consideration for the transfer of property in goods, which is distinct from the ‘total turnover’ in a normal sale, where it is the value of each good.

• Tax should not be levied on individual goods within a works contract, as this would contradict the Act and Rules, which provide a distinct procedure for computing tax on works contracts. The relevant provisions are Rule 3(1)(c) read with Sections 4(1), 2(34), 2(35), and 2(36) of the KVAT Act.

• Taxing individual goods would render the scheme of the Act prior to 01.04.2006 unworkable and would effectively abolish the levy on works contracts before that date.

• The respondent’s argument would render Section 2(29) read with Rule 3(1)(c) of the KVAT Act redundant. The taxable event is the incorporation of goods in the works contract (Section 7), so the rate of taxation should not be determined anterior to this event.

• There is a presumption against redundancy of a statutory provision. The argument for taxing individual goods separately in a works contract would be against settled canons of interpretation, as nothing can be read into a taxing statute. They cited Balabhagas Hulaschand v State of Orissa, (1976) 2 SCC 44 and Bansal Wire Industries Ltd. V State of Uttar Pradesh, (2011) 6 SCC 545 to support this.

Arguments on behalf of the Respondent (M/s Durga Projects Inc.):

• In Gannon Dunkerly & Co v State of Rajasthan (1993) 1 SCC 364, the Supreme Court held that State legislatures may tax goods involved in works contracts at a uniform rate, different from rates applicable to individual goods.

• The KVAT Act came into force on 1 May 2005. Although Gannon Dunkerly & Co (supra) allowed for a uniform rate, Karnataka did not implement it until the amendment on 1 April 2006. Thus, no provision existed for a uniform rate on all goods in works contracts until 31 March 2006.

• Section 4 was amended on 1 April 2006, introducing clause (c), which provided for a uniform rate of tax on goods in works contracts, depending on the description of the works contract in the Sixth Schedule. Before this amendment, there was no uniform rate.

• For declared goods, Section 4(1)(a)(ii) provided a 4% tax rate on goods in the Third Schedule, which included iron and steel under Serial No. 20. Goods not in the Third Schedule were taxed at 12.5% under Section 4(1)(b).

• After 01.04.2006, Section 4(1)(c) is subject to Sections 14 and 15 of the CST Act for declared goods. Declared goods are taxed at rates mentioned in Section 15 of the CST Act, while other goods are taxed at a uniform rate under the Sixth Schedule. This amendment is not disputed for the period after 01.04.2006.

• The applicable tax rates before 31.03.2006 were: (a) 4% for declared goods under Section 4(1)(a)(ii) read with Serial No. 20 of the Third Schedule, (b) rates mentioned in the Second, Third, or Fourth Schedules for goods mentioned therein, and (c) 12.5% for other goods under Section 4(1)(b).

• The expression “other goods” in Section 4(1)(b) covers goods not covered by Section 4(1)(a). Goods specifically covered by the Second, Third, or Fourth Schedules, such as iron and steel, cannot be consigned to the residual category of “other goods.” This is supported by Dunlop India Ltd. v Union of India (1976) 2 SCC 241 and Bharat Forge and Press Industries Pvt. Ltd. v CCE (1990) 1 SCC 532.

• Despite the ruling in Gannon Dunkerly’s case (supra), the KVAT Act did not provide a uniform rate until 01.04.2006. The provision for a uniform rate was inserted only from 01.04.2006, making it applicable only from that date.

• For declared goods under Section 14 of the CST Act, the tax rate is as mentioned in Section 15 of the CST Act, both before and after 31.03.2006. This was under Section 4(1)(a) read with Serial No. 20 of the Third Schedule before 31.03.2006, and under Section 4(1)(c) after 01.04.2006.

• Tax on declared goods, even when supplied in works contracts, is subject to the restrictions and conditions in Section 15 of the CST Act, as mandated by Article 286(3)(b) of the Constitution. This is also incorporated in the KVAT Act, both before and after 31.03.2006.

• VAT enactments in other states show that some states opted for a uniform tax rate on all goods in works contracts, while others provided different rates. Examples include Andhra Pradesh, Delhi, Odisha, and Tamil Nadu.

Submissions Table

Issues Framed by the Supreme Court

The core issue before the Supreme Court was:

1. What is the applicable rate of tax on goods involved in the execution of works contracts under the Karnataka Value Added Tax Act, 2003 (KVAT Act) before the amendment of Section 4(1)(c) on 1 April 2006?

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 dismissed the appeal filed by the State of Karnataka, upholding the High Court’s decision. The Court held that prior to 1 April 2006, the tax on goods involved in works contracts should be levied based on the individual rates applicable to those goods, not at a uniform rate.

How each authority was viewed by the Court?

✓ Gannon Dunkerly & Co v State of Rajasthan (1993) 1 SCC 364* – The Court acknowledged that this case allowed states to impose a uniform rate on goods in works contracts, but clarified that it did not mandate such a rate. The Court noted that the Karnataka legislature had not opted for a uniform rate until 1 April 2006.

✓ Dunlop India Ltd. v Union of India (1976) 2 SCC 241* and Bharat Forge and Press Industries Pvt. Ltd. v CCE (1990) 1 SCC 532* – These cases were used to support the principle that a residual entry in a tax statute should only be applied when specific entries do not apply.

✓ HPL Chemicals Ltd. v CCE (2006) 5 SCC 208* – This case was also used to reiterate the principle that a residual entry should not be used when specific entries are available.

✓ Balabhagas Hulaschand v State of Orissa, (1(1976) 2 SCC 44* and Bansal Wire Industries Ltd. V State of Uttar Pradesh, (2011) 6 SCC 545* – These were cited by the State to argue against redundancy and to emphasize that nothing can be read into a taxing statute. However, the Court distinguished these cases and held that the interpretation was not against settled canons of interpretation.

✓ Sections of the KVAT Act and Rules – The Court interpreted these provisions to conclude that the legislature had not provided a uniform rate for works contracts before 1 April 2006, and that the tax should be levied on individual goods based on their specific rates. The Court also held that the legislature had to specifically amend the law to provide for a uniform rate and that the legislature had not done so prior to 01.04.2006.

Ratio Decidendi

The ratio decidendi of this case is that, prior to the amendment of Section 4(1)(c) of the Karnataka Value Added Tax Act, 2003 (KVAT Act) on 1 April 2006, the tax on goods involved in works contracts should be levied based on the individual rates applicable to those goods, not at a uniform rate. The residual entry in Section 4(1)(b) of the KVAT Act cannot be interpreted to provide a uniform rate for works contracts before the amendment. The legislature had to specifically amend the law to provide for a uniform rate and that the legislature had not done so prior to 01.04.2006.

Flowchart of the Decision

Conclusion

The Supreme Court’s decision in State of Karnataka vs. Durga Projects Inc. clarified that before the amendment of Section 4(1)(c) of the Karnataka Value Added Tax Act, 2003 on 1 April 2006, the tax on goods involved in works contracts should be levied based on the individual rates applicable to those goods, not at a uniform rate. The Court held that Section 4(1)(b) of the KVAT Act was a residual entry and did not provide a uniform rate for works contracts before the amendment. This judgment established a clear legal principle for determining tax rates on works contracts in Karnataka before the specific amendment, ensuring that each good was taxed at its own rate, rather than a blanket rate. This ruling has significant implications for the taxation of works contracts during that period and underscores the importance of specific legislative provisions for such tax matters.