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Sub-contract

VASANTH D JAGANATH 
on 08 October 2008

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Back to Back Contract – Case Study
 
Works Contract subject is a maze of complexities.  The judgments given by courts contradict in such a manner that the dealer is perplexed.
 
Case: Mr. M is a main contractor. He receives contract from Mr. C (customer).  Mr. M sub-contract the entire work to Mr. S, the sub-contractor. Mr. M has a profit margin in this transaction. The question is whether Mr.M is transferring any property to Mr.C and whether there is any tax liability on him?  
 
Case Study: The case can be analysed with the background of Supreme Court and High Court decisionrendered on back to back contract under different provisions of the Law.
 
The Hon’ble Supreme Court in the case of State of Andhra Pradesh & Ors Vs Larsen & Tourbo Limited & Ors AIT – 2008 – 301 - SC, held that, based on the principle of accretion, there is no multiple deemed sale. There is only one sale happening from sub-contractor to the contractee.
 
In another case recently decided by the Hon’ble Karnataka High Court in the case of Larsen and Toubro limited Vs Addl. Deputy Commissioner of Commercial Taxes and Another [2008] 16 VST 616 held that Contractor paying money for execution of works by sub-contractor constitutes sale. In calculating the turnover the said amount has to be taken into consideration as representing the turnover in the hands of the main contractor.
 
The author has made an effort to find out the difference of opinion taken by the Courts.
 

Andhra Pradesh & Ors Vs Larsen & Tourbo Limited & Ors AIT – 2008 – 301
Larsen and Toubro limited Vs Addl. Deputy Commissioner of Commercial Taxes and Another [2008] 16 VST 616
Judgement given by Hon’ble Supreme Court
Judgement given by Hon’ble High Court of Karnataka
Principle laid down:
Based on the principle of accretion, there is only one deemed sale from the sub-contractor to the contractee. There cannot be two deemed sale taking place from main contractor to the contractee.
Principle laid down:
The definition of ‘Sale’ being an inclusive definition takes within its ambit, even the value of the work paid by way of cash. In calculating the turnover the said amount has to be taken into consideration as representing the turnover in the hands of the main contractor
Provisions under the judgement relating to the State of Andhra Pradesh
Provisions under the judgement relating to the State of Karnataka
Issue Raised:
Levy of works contract to main contractor
Issue Raised:
Levy of Re-sale tax on main contractor
Important provisions discussed:
a) Charge to tax U/s. 4(7)(a)
b) Treatment of works contracts U/r 17(1)(a)
Important provisions discussed: 
a) Sale U/s 2(1)(t)
b)Total Turnover U/s 2(1)(u2)
Section in Brief:
‘Charge to tax’ U/s. 4(7)(a): Notwithstanding anything contained in the Act,
(a)    Every dealer executing works contracts shall pay tax on the value of goods at the time of incorporation of such goods in the works executed at the rates applicable to the goods under the Act,
 
‘Treatment of works contracts’, Rule 17(1)(a) In the case of contracts not covered by sub-rule (2), (3) and (4) of this rule, the VAT dealer shall pay tax on the value of the goods at the time the goods are incorporated in the works at the rates applicable to the goods.
Section in Brief:
‘Sale’ U/s. 2(1)(t) with all grammatical variations and cognate expressions means every transfer of property in goods other than b y way of mortgage, hypothecation, charge or pledge by one person to another in the course of trade or commerce for cash or for deferred payment or other valuable consideration, and include,-
(i)       ………………………………….,
(ii)     a transfer of property in goods (whether as goods or in some other form) involved in the execution of works contract.
‘Total turnover’ U/s. 2(u2) 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 inter-state 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.
'Turnover’ U/s. 2(v) means the aggregate amount for which goods are bought or sold, or supplied or distributed or delivered or otherwise disposed of in any of the ways referred to in clause (t) 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.
 
 

On reading of the above provisions it is a basic question that arises as to why the courts have taken different views where there are similar transactions involved. 
 
As per the provisions under the Andhra Pradesh Value Added Tax Act, the incidence of levy of tax on transfer of property in goods is at the time of incorporation of such goods in the works executed by every dealer. This provision again has the overriding effect of all other charging section.
 
Rule 17(1)(a) under APVAT also specifies that, in the case of works contract other than works contract specified in rule (2), (3) and (4) of rule 17 dealer shall pay tax at the time of goods are incorporated in the work.
 
On combined reading of the above provisions it is understood that, the incidence of levy of tax arises at the time of incorporation of goods in the work. On the other hand it is the person executing the work who is liable to pay tax at the time of incorporation of goods in the work. In this case, it is the sub-contractor who executes the work.   Before executing work it is sub-contractor who owns the goods. When executing the work [i.e., incorporation of goods] it is the contractee who becomes the owner of the goods.   In between contractor never become the owner of the goods, therefore it is not true that, sale is taking place from main contractor without ownership rights on the goods. It has also been dealt in the above judgement that, in case of deemed sales there cannot be double deemed sale.
 
On the other hand the Hon’ble Karnataka High Court has taken the view that, the ‘Turnover’ definition where it stars with “aggregate amount for which goods are bought or sold, or supplied or distributed or delivered or otherwise disposed of in any of the ways referred to in clause (t) by a dealer, either directly or through another”
 
It means an amount received or receivable for transfer or property in goods in the execution of works contract, either directly or through another is a sale. 
 
By analyzing the above interpretations, the author is of the view that, the courts have come to the different view in respect of similar transaction because of the importance of the provisions of law as depicted under the relevant laws. Otherwise the principles with regard to transfer of property in goods, between the main contractor, sub-contractor and contractee should be one and the same. This can be observed from the following comparison of the provisions of APVAT Act, and KVAT Act.
 

Section in Brief:
‘Charge to tax’ U/s. 4(7)(a): Notwithstanding anything contained in the Act,
(b)   Every dealer executing works contracts shall pay tax on the value of goods at the time of incorporation of such goods in the works executed at the rates applicable to the goods under the Act,
 
‘Treatment of works contracts’, Rule 17(1)(a) In the case of contracts not covered by sub-rule (2), (3) and (4) of this rule, the VAT dealer shall pay tax on the value of the goods at the time the goods are incorporated in the works at the rates applicable to the goods.
Section in Brief:
‘Levy of Tax’ U/s. 3(1): 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
 
‘Liability tax and rates thereof U/s. 4(1) (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 …………………..,

 
On reading of the above provisions, the view taken by the Hon’ble Supreme Court that, under works contract there is only one deemed sales and not more than one based on the principle of accretion is not applicable when we are applying the provisions of KVAT Act. This is because of the following reasons;
 
a)      The charging section, though which is different for works contractor, but has not got separated from the main section. [i.e., both section 3 and section 4 are consistent that, tax shall be levied on dealer on every sale of goods based the nature and type of sale]
 
b)     There is no obstante or overriding provision in charging section.
 
c)      The definition of ‘Turnover’ is not only restricted to transfer of property in the goods by a person executing works contract, but also applicable to person who has entrusted such -kind of work to sub-contractor.
 
d)      Under VAT, the levy of tax is multipoint. The tax is leviable on value addition. If the Hon’ble Supreme Court view is applied, the main contractor may not be liable for value addition made for entrusting works contract to the sub-contractor. This is has been explain as under:
 
Contractor entered into an agreement for construction of building for Rs.100/-. In turn the Contractor entrust the job to sub-contractor for Rs.80/-. In this case the value addition made by the main contractor is Rs.20/-. As per Hon’ble Supreme Court Judgement where the there is only one deemed sales, only sub-contractor is liable to tax on Rs.80/- after deducting labour charges. There is no sale happening from main contractor to the contractee for the difference value of Rs.20/- which represents the transfer of property in goods executed by the sub-contractor.
 
The author is of the view that, the principle laid down by the Hon’ble Karnataka High Court is considered to be more suitable and appropriate even under the VAT law, where the main contractor is liable to pay tax on the value addition made for entrusting the job to sub-contractor. Even though the main contractor is not executing the work directly, there is a sale taking place from main contractor to the contractee by virtue of entering into contract with the sub-contractor in pursuance of the main contract. Finally it is concluded that, the view taken by the Hon’ble Supreme Court may lead to litigation with respect to value addition made by the main contractor for levy of tax.



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