Larger Bench of Supreme Court affirms Raheja decision - States can levy sales tax on sale of flat

 

 

The much awaited Larger Bench (comprising 3 members) decision of the Supreme Court (“SC”) on the principles laid down in the case of K Raheja Development Corporation v State of Karnataka (2005-5-SCC-162) (“Raheja Development”) has been pronounced. The key question answered by SC is whether taxing sale of goods by State Governments in an agreement for sale of aflat, which is to be constructed by a developer, is permissible under the Constitution.

In answering this question in the affirmative, it was held that when the agreement between developer and flat purchaser is to construct a flat and eventually sell the flat with fraction of land, it is obvious that such transaction involves activity of construction inasmuch as it is only when the flat is constructed, it can be conveyed. The ultimate transaction between the parties may be sale of flat, but it cannot be said that the characteristics of works contract are not involved in that transaction. Hence, the transaction is liable to appropriate sales tax/ VAT.

Facts of the case

· L&T had entered into development agreements with land owners (to develop and share constructed flats). Out of their share, L&T had entered into agreements of sale with purchasers, wherein on completion of construction, the flats would be handed over to purchasers who will also get undivided interest in land. Karnataka HC upheld the demand of sales tax on amounts collected by L&T from purchasers of flats treating it to be works contract turnover. L&T had appealed to SC against this ruling.

· The two member bench of SC in Larsen and Toubro Limited and Another v State of Karnataka (SLP(C) No 17741 of 2007) (“L&T case”) had observed that if the ratio of Raheja Development is to be accepted, then there would be no difference between works contract and contract for sale as chattel. An agreement to sell entered between developer and prospective purchaser could be for future sale of flat (and not for undertaking construction on behalf of purchaser). The Bench hence referred the Raheja Development case to the Chief Justice with a recommendation for reference to the larger bench for re-consideration.

· Appeals from Maharashtra arise from the judgment of the Division Bench of Bombay HC in the case of Maharashtra Chamber Of Housing Industry vs State Of Maharashtra And Ors (2012-51-VST-168-Bom) (“Maharashtra Chambers”), wherein it was held that works contract have numerous variations and it is not possible to accept the contention that contract for works in the course of which title is transferred to the flat purchaser would cease to be works contract. The Bombay HC had hence upheld the amendment to Section 2(24) of Maharashtra Value Added Tax Act (“MVAT Act”) and Rules 58 and 58(1A) of Maharashtra Value Added Tax Rules (“MVAT Rules”). This ruling of the HC was contended before the SC and the constitutional validity of the expanded Section 2(24) of the MVAT Act as well as Rule 58(1), Rule 58 (1A) of the MVAT Rules was challenged.

The current bench heard and decided on both the above matters

Key contentions of the Appellants

· Applicability of Article 366(29-A) read with Entry 54 of List II will arise only in matters which are otherwise not covered under the ambit of sale and cannot apply to an agreement for sale of immovable property resulting in a conveyance. In Raheja Development, it was incorrectly assumed that definition of works contract under Karnataka Sales Tax Act (“KST Act”) was wide, and the well-known tests to determine whether a particular contract is “works contract” or “contract of sale” have not been adverted to. It was also argued that the dominant intention of the agreement was to sell a flat and not enter into a works contract.

· In case of L&T, the other contentions were that work undertaken is for jointdevelopment of project as a whole, ie work is undertaken by developer for himself and the owner; the construction is not carried out for and on behalf of purchaser; the flat is to be sold as a flat and not an aggregate of its component parts; if a suit for specific performance is filed by flat purchaser against owner/developer, such suit would invariably be for conveyance of title and not for construction of a building.

· The arguments from Maharashtra included that Section 2(24) of MVAT Act and Rules 58 and 58(1A) of MVAT Rules seek to redefine the taxable event by moving away from theory of accretion to transfer of immovable property by way of conveyance and that renders these provisions unconstitutional; that Form V under the Maharashtra Ownership of Flats Act (“MOFA”) is not “works contract”, it only settles terms for sale of property; that Maharashtra has been levying stamp duty on agreement of sale under Entry 25 (as immovable property) and not under Entry 63 (as works contract) and hence the State does not consider agreement for sale to be works contract.

Key contentions of the Revenue

· View taken in Raheja Development case is correct and needs no reconsideration.

· After insertion of Article 366 (29-A)(b) in Constitution, transfer of movable property in works contract is deemed to be sale even though it is not sale as per Sale of Goods Act.

· The term “works contract” is nothing but contract in which one of the parties is obliged to undertake or execute works. Nothing in Article 366(29-A)(b) limits the term “works contract”, and ownership of goods need not pass only by way of accretion or accession to owner of the immovable property.

· There is no question of ascertaining dominant intention of contract since sale of goods element is deemed sale under Article 366(29-A)(b) and can be taxed separately. A composite contract comprising both works contract and transfer of immovable property does not denude it of its character as works contract.

· Different aspects of same transaction can involve more than one taxable event. Transfer of immovable property cannot be taxed as sale of goods but there is no constitutional bar to tax only sale of goods element.

· Explanation b(ii) in section 2(24) of MVAT Act has been rightly held to be constitutional, as it offers diverse options for valuation of sale of goods element in works contract and each of these options are consistent with methods approved by the SC in Gannon Dunkerley& Co and others v State of Rajasthan and Others (1993-1-SCC-364) (“Gannon Dunkerley-II”). Further, Rule 58A and Rule 58(1A) of the MVAT Rules are constitutionally valid, as these provisions are consistent with principles laid down in Gannon Dunkerley-II.

· As long as there is obligation to construct under agreement between Developer and flat purchaser (in case of Maharashtra, being agreement under MOFA) deemed sale of goods involved in execution of such works contract can be taxed even after incorporation of goods in works and when property passes as between developer and flat purchaser.

Ruling of the Supreme Court

· The SC summarised the following legal position with respect to deemed sale of goods in works contracts:

i. “Tax on sale or purchase of goods” in Entry 54 in List II of Seventh Schedule when read with definition clause 29-A of Article 366 includes tax on transfer of property in goods, whether as goods or in the form other than goods involved in execution of works contract.

ii. Three conditions to be fulfilled to tax deemed sale of goods in works contract:

- there must be a works contract;

- goods should have been involved in execution of works contract; and,

- property in those goods must be transferred to third party either as goods or in some other form.

iii. For purpose of Article 366 (29-A)(b), in building contracts or any construction contracts, if consideration is received, all the above conditions are satisfied because in performance of a contract for construction of building, goods (chattels) like cement, concrete, steel, bricks etc are intended to be incorporated in the structure, and, even though they lost their identity as goods, this factor does not prevent them from being goods.

iv. A contract comprising both works contract and transfer of immovable property, does not denude it of its character as works contract. The term “works contract” in Article 366 (29-A)(b) takes within its fold all genre of works contract and is not restricted to one species of contract to provide for labour and services alone. Building contracts are species of works contract.

v. The dominant nature test has no application in any contract that has element of works contract specified, and traditional decisions which have held that substance of contract must be seen, have lost their significance.

vi. Transfer of property in goods under Article 366 29-A(b) is deemed to be sale of goods involved in execution of works contract by person making transfer and purchase of those goods by person to whom such transfer is made.

vii. The single and indivisible contract has been brought on par with contract containing two separate agreements and States now have power to levy sales tax on value of material used in execution of works contract.

viii. Value of goods which can constitute the measure for levy of tax has to be value of goods at time of incorporation of goods in works, even though property passes as between developer and flat purchaser after incorporation of goods.

· SC answered the crucial question of whether the view taken in Raheja Development on the definition of “works contract” in KST Act is legally justified, in the affirmative, and held that:

- Argument that flat purchaser is entitled to transfer of flat and conveyance of fraction of land only when all installments have been fully paid, which shows that agreement between developer and flat purchaser is for sale of flat and not to appoint developer as contractor of flat purchaser, is devoid of merit. It is thus, not correct to say that work is undertaken by developer for himself and the owner and construction is not carried for and on behalf of purchaser.

- There is nothing wrong even if transaction is treated as composite contract comprising of both works contract and transfer of immovable property and levy sales tax on value of material involved in execution of works contract. Hence, observation in referral order that if ratio in Raheja Development is to be accepted then there would be no difference between works contract and contract for sale of chattel as chattel, overlooks the legal position.

· SC also clarified that activity of construction undertaken by developer would be works contract only from the stage the developer enters into contract with flat purchaser. Value addition made to goods transferred after agreement is entered into with flat purchaser can only be made chargeable to tax by States.

· It was also held that if at the time of construction and until construction was completed, there was no contract for construction of building with flat purchaser, the goods used in construction cannot be deemed to have been sold by developer, since at that time, there is no purchaser. The fact that building is intended for sale ultimately after construction does not make any difference.

· With regard to Constitutional validity of MVAT provisions, the SC held that:

- Amendment in explanation b(ii) to Section 2(24) was brought because of judgment of SC in Raheja Development and as the judgment lays down correct legal position, there is no merit in challenge to constitutional validity of the provisions.

- However, wrt rule 58(1A), the SC held that mode of valuation of goods provided in Rule 58(1A) has to be read to include value of goods only at the time of incorporation even though property in goods passes later. Accordingly, the said rule was read down to this limited extent by the SC