Understanding applicability of VAT or CST on inter-state works contracts

In this article an attempt has been made to clarify the position in regard to the levy of VAT or CST on inter-state works contracts.

The State Governments have the power under entry 54 of the State List of the Seventh Schedule to the Constitution of India, to levy tax on the sale and purchase of goods within the jurisdiction of such States. In works contracts there is a deemed sales of the goods incorporated in such contracts  to the contractee,
hence the tax on such deemed sales of goods can also be levied by States if such deemed sales happen within the jurisdiction of the States.

The definition of sale in the CST Act was amended in 2002 so as to include within its purview the concept of deemed sales involved in the works contracts. Hence Central Government can also levy CST on such deemed sales involved in the works contracts if such deemed sales is an interstate sales.

 In simple words one can say the powers to tax the movement of goods from one State to another for execution of works contract vest with the Central Government and not with the State Governments.

Taxable event in works contracts: It should be noted that taxable event in case of works contracts is the deemed sales and such deemed sales is considered to have taken place when the goods are incorporated in the works contract. Now the question arises in mind how an inter-state  deemed sales may arise in case of works contracts. This question was also raised in Gannon Dunkerley & Co. Vs State of Rajasthan (1993) 88 STC 204 (SC) , the relevant extracts of the judgement are being produced herebelow::

“On behalf of the States it has been seriously contended that a deemed sale resulting from transfer of property in goods involved in the execution of a works contract can never be a sale in the cource of inter-state trade or commerce and it cannot be an outside sale or sale in the cource of import since the transfer of property in the goods takes place only at the stage when the goods are incorporated in the work and that can take place only at the stage where the work is required to be executed. On behalf of the contractors, on the other hand, it has been urged that a works contract can involve transactions constituting a sale in the cource of inter-state trade and commerce as well as an outside sale or sale in the cource of import and that is a matter which will have to be considered in accordance with the principles contained in section  3, 4 and 5 of the Central Sales Tax  Act, 1956 keeping in view the terms and conditions of the particular contract.”

The Supreme Court after considering a lot of judgments observed as follows:

“We do not propose to go into this controversy because the question whether a deemed sale resulting from  transfer of a particular works contract amounts to a sale in the cource of inter-state trade or commerce under section 3 of the Central Sales Tax Act or an outside sale under section 4 of the Central Sales Tax Act or sale in the cource of import under section 5 of Central Sales Tax Act, has to be decided in the light of the particular terms of the works contract and it cannot be decided in the abstract. As at present advised, we are not in a position to say that in no case, can there be a sale in the cource of inter-state trade or commerce or an outside sale or a sale in the cource of import in respect of a deemed sale resulting from transfer of property in goods involved in the execution of a works contract falling within the ambit of sub-clause (b) of clause (29A) of Article 366 of the Constitution.”

It should be noted that at the time when the above judgement was delivered although the deemed sales involved in the works contracts was included in sub-clause (b) of clause (29A) of article 366 of the Constitution, but at the same time definition of sale as contained in CST Act, 1956 was not amended to provide for the deemed sales in the works contract within its purview, still the Supreme court held that there can be an inter-state deemed sales in works contract but the same cannot be decided in abstract but can be decided in the light of particular terms of every contract.

In 2002 the definition of sales under CST Act was amended to include deemed sales in works contracts, which made the position crystal clear that there can be an inter-state deemed  sales in the works contracts.

The  Punjab & Haryana High Court in Thomson Press (India) Ltd. Vs. State of Haryana (1996) 100 STC 417 (P&H) held that if the inter-state movement of goods arises due to a pre-existing contract then inputs and goods involved in the execution of the works contract shall also be deemed to have moved and the State Government cannot levy tax on deemed sales of such goods. The relevant extracts of the said judgment is being produced herebelow to further understand this issue:

“Wherever the sale or purchase of goods occasions the movement of goods from one State to another, it is deemed to have taken place in the cource of inter-state trade or commerce. In the cases covered by sections 3, 4 and 5 of the Central Sales Tax Act, the State Legislature has no competence to provide for the levy of sales tax. This principle shall apply even in the case of works contract. The position cannot be different by the legal fiction introduced by the State Legislation, in pursuance of the 46^th Amendment. Once the contract occasions the movement of end-product from one State to another, the inputs or the goods involved in the execution of the works contract shall also be deemed to have moved and the levy of sales tax in such a case would be outside the field of legislative competence of the State Legislature. By introducing a fiction, the State Legislature cannot convert a sale in the cource of inter-state trade and commerce into a local sale.

Clause (29A) which was added in Article 366 by the 46^th Amendment only embodies an enabling provision. It doesnot, ipso facto authorize the State Legislature to levy taxes on the sale or purchase of goods where such sale or purchase takes place in the cource of inter-state trade and commerce.”

Thus the High Court in the above case made it clear that if a pre-existing works contract occasions the interstate movement of goods then such goods shall be deemed to have been incorporated in such works contract inter-state, on which no tax can be levied by the State Governments. Hence the deduction of inter-state sale or purchase of goods in pursuance of a pre-existing works contract should be allowed while calculating the deemed sales within the State jurisdiction, if such contract has occasioned such interstate movement of goods.

Now the question is when a contract can said to be occasioning the inter-state movement of goods incorporated in the works contract. In my view this depends a lot on the terms of every contract and also on the facts of each case.

For example if a contractor manufactures some goods in his own state in pursuance of a works contract to be executed in another state, in accordance with the terms and specification of the contractee and thereafter, sends such goods to the other state for incorporation in the works contract, then it will be considered as contract occasioning the inter-state movement of goods, hence only CST liability will arise on the deemed sales of such goods incorporated in the interstate works contract.

Some case laws are provided herebelow to further understand when a works contract occasions the interstate movement of goods:

The assessee received gray fabric from outside the State to process into dyed and printing fabric and after processing, it dispatched the same to the dispatching State. It was held that movement of cloth is occasioned by the contract of sale within the meaning of section 3 of the CST Act and the transaction amounts to an inter-state sale- East India Cotton Mfg. Co. Ltd. Vs. State of Haryana (1993) 90 STC 221 (P&H).

Printing of lottery tickets was held to be a works contract transaction because the petitioner could not have sold the lottery tickets in the market to any person and those involved not only expertise but also confidentiality. When the petitioner in Haryana prints lottery tickets, in pursuance of a contract with the State of Haryana, the provisions of the Haryana General Sales Tax Act in so far as these provide for levy of sales tax on the inputs involved in the execution of a works contract, shall be applicable. However, when the petitioner prints lottery tickets at the asking of a State other than Haryana, the position is different and provisions of Central Sales Tax Act shall apply-Thomson Press (India) Ltd. Vs. State of Haryana (1996) 100 STC 417 (P&H).

If the purchases are made specifically for the execution of the contract, then the intervention of the branch office of a contractor in the movement of the goods from outside the State, for the execution of the contract inside the State, will not change the character of a transaction and it will remain as an inter-state sale- Media Communications vs. Govt of A.P. (1997) 105 STC 227 (AP), case followed- Sahney Steel and Press Works Ltd. Vs. CTO (1985) 60 STC 301 (SC).

The petitioner entered into an agreement for supply and installations of elevators at a site in Punjab, Goods moved from Delhi to Punjab in semi-knocked down condition for installation at site kept ready as per drawings and designed by the consignee. It was held that it is an agrerement for sale between the parties instead of works contract. Further installation of lift was incidental to sale and it is an inter-state sale from Delhi, not taxable under The Punjab VAT Act.-E.C.E Industries Ltd. Vs State of Punjab (2008) 14 VST 40 (P&H).

 The petitioner purchased materials in several States outside the State of Tripura and also placed orders for supply of materials on Tripura for use in the execution of a works contract in Tripura. The terms of the contract stipulated movement of goods from such other States to the State of Tripura. The petitioner was of the view that the supplies of materials made from outside the State were inter-state sales. The Superintendent of Taxes, on the ground that the actual transfer of property in materials used in the contract took place in Tripura, assessed under the Tripura Sales Tax Act. Allowing the writ petition, the High Court held that the sales in question were inter-state sales. The fact that the use of the materials was made in a works contract or the property in the materials passed in the State of Tripura did not in any way affect the inter-state nature of the transaction.-Projects and Services Centre vs. State of Tripura (1991) 82 STC 89 (Gau).

Conclusion: From the above discussion and cases referred in my view, it can be safely concluded that the inter-state sale or purchase of goods made in pursuance of a pre-existing works contract and executed in such works contract, shall be deemed as sale or purchase in the course of inter-state trade and there cannot be any local deemed sales in such case, hence the deduction of such sale or purchase should be allowed while calculating local deemed sales.

However the terms of contract and facts of each case play a decisive role in determining the inter-state deemed sales in works contracts. Therefore it is advisable that contracts should be drafted with utmost care and help of an expert tax professional in the field of works contract must be taken while drafting such contracts, which can be invaluable and can also help avoiding unnecessary litigation to a great extent