kpmg flash news - supreme court affirms the raheja decision on levy of s

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Supreme Court affirms the Raheja decision on levy of sales tax on sale of

flat

27 September 2013

Background

The Supreme Court in the case of Larsen and Toubro1

(larger bench) (the L& T Case) has upheld the decisiongiven by the Supreme Court (two-judge bench) in thecase of K Raheja Development

2(the Raheja case). It

was held in the Raheja case that any agreement enteredinto by the builder / promoter before the completion ofconstruction tantamounts to works contract and hence,liable to Value Added Tax (VAT) / sales tax.

Facts of the case

The correctness of the view taken in the Raheja casewas doubted by the Supreme Court in the case of L& T (two-judge Bench) and accordingly, it wasreferred for re-consideration to the Larger bench forthe following reasons:

The developer had undertaken the contract todevelop the property of the owner. It is notalleged by the department that there is monetaryconsideration involved in the developmentagreement. If the development agreement is not

________________

1

Larsen & Toubro Limited & Anr. v. State of Karnataka & Anr (Civil Appeal No.8672 of 2013)2K. Raheja Development Corporation v. State of Karnataka; (2005) 5 SCC 162

a works contract, could the department relyupon the second contract which is a tripartiteagreement and interpret it to be a workscontract;

If the ratio in the Raheja case is to beaccepted then there would be no differencebetween works contract and a contract forsale of chattel as a chattel; and

According to the definition of works contract,

the contractor must have undertaken thework of construction for and on behalf of theflat purchaser for cash, deferred or any othervaluable consideration but could it be saidthat developer was contractor for theprospective flat purchaser.

There were 26 appeals for re-consideration out ofwhich 14 appeals were from Karnataka and 12were from Maharashtra.

Arguments placed by the petitioners

As per the tripartite agreement, the main object ofthe agreement is to sell and convey fraction ofthe land together with a fully constructed flat onlywhen all the installments have been fully paid.


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The whole idea of inserting the said clause, is to levysales tax on the materials used in the building activity.

Any other interpretation of the same will be contrary tothe two decisions of the Constitution Benches inBuilders Association

5and Gannon Dunkerley-II

6.

The term works contract means a contract in whichone of the parties is obliged to undertake or to executeworks. The expression works is extremely wide andcan either mean the act of bestowing labour or that onwhich the labour is bestowed.

In case of works contract, the ownership of the goodsnot only transfers by way of accretion or accession tothe owner of the immovable property to which they areaffixed or upon which the building is built but alsounder the terms of a contract or by statute. There is no

question of ascertaining the dominant intention of thecontract now since the sale of goods element is adeemed sale under Article 366(29-A)(b) and can betaxed separately.

Article 366(29-A)(b) provides for a situation where thegoods are transferred in the form of immovableproperty.

That transfer of immovable property cannot be taxed asa sale of goods but there is no constitutional bar to taxonly the sale of goods element and separately tax thetransfer of immovable property.

Supreme Court ruling

When an agreement is entered into between thepromoter/developer and the flat purchaser to constructa flat and eventually sell the flat with the fraction of land,it is obvious that such transaction involves the activity ofconstruction in as much as it is only when the flat isconstructed then it can be conveyed. The said activitywill be covered by the term works contract. The termworks contract is nothing but a contract in which oneof the parties is obliged to undertake or to executeworks. Such activity of construction has all thecharacteristics or elements of works contract.

To attract Article 366(29-A)(b) there has to be a workscontract. The term works contract needs to beunderstood in a manner that the Parliament had in itsview at the time of Forty-sixth Amendment and which ismore appropriate to Article 366(29-A)(b). The termworks contract in the said article is amply wide andcannot be confined to a particular understanding of theterm or to a particular form. The term encompasses a

___________________

5Builders Association of India and others v. Union of India and others; (1989) 2 SCC

6456

Gannon Dunkerley & Co. and others v. State of Rajasthan and Others; [(1993) 1

SCC 364]

wide range and many varieties of contract. Thus,even if in a contract, besides the obligations ofsupply of goods and materials and performance oflabour and services, some additional obligationsare imposed, such contract does not cease to be

works contract. Once the characteristics orelements of works contract are satisfied in acontract then irrespective of additional obligations,such contract would be covered by the termworks contract.

For execution of a works contract, the followingthree conditions must be fulfilled:

there must be a works contract,

the goods should have been involved in the

execution of a works contract and

the property in those goods must betransferred to a third party either as goods orin some other form.

That the transfer of property in goods (whether asgoods or in some other form) involved in theexecution of a works contract. The expression insome other form in the bracket is of utmostsignificance as by this expression the ordinaryunderstanding of the term goods has beenenlarged by bringing within its fold goods in a form

other than goods. Goods in some other formwould thus mean goods which have ceased to bechattels or movables or merchandise and becomeattached or embedded to earth. In other words,goods which have by incorporation become part ofimmovable property are deemed as goods.

Where a contract comprises of both a workscontract and a transfer of immovable property,such contract does not denude it of its characteras works contract. The term works contract in

Article 366 (29-A)(b) takes within its fold all genreof works contract and is not restricted to one

specie of contract to provide for labour andservices alone. Nothing in Article 366(29-A)(b)limits the term works contract. Building contractsare species of the works contract.

The dominant nature test has no application. Evenif the dominant intention of the contract is not totransfer the property in goods and rather it isrendering of service or the ultimate transaction istransfer of immovable property, then also it isopen to the States to levy sales tax on thematerials used in such contract if such contractotherwise has elements of works contract.


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Taxing the sale of goods element in a works contractunder Article 366(29-A)(b) read with Entry 54 List II ispermissible even after incorporation of goods provided

tax is directed to the value of goods and does notpurport to tax the transfer of immovable property.

In tripartite agreement between the owner of the land,the developer and the flat purchaser, there is nothingwrong if the transaction is treated as a compositecontract comprising of both a works contract and atransfer of immovable property and levy sales tax onthe value of the material involved in execution of theworks contract.

The argument that flat is to be sold as a flat and not anaggregate of its component parts is already negated by

the Constitution Bench in the case of BuildersAssociation.

If the developer has undertaken to build for theprospective purchaser, then to that extent, the contractis works contract and there is deemed sale of material(goods) used in the construction of building and merelybecause the builder has a right of lien in the event duemonies are not paid does not alter the character ofcontract being works contract.

The activity of construction undertaken by the developer

would be works contract only from the stage thedeveloper enters into a contract with the flat purchaser.The value addition made to the goods transferred afterthe agreement is entered into with the flat purchasercan only be made chargeable to tax by the StateGovernment.

Taxing the sale of goods element in a works contract ispermissible even after incorporation of goods providedtax is directed to the value of goods at the time ofincorporation and does not purport to tax the transfer ofimmovable property. The mode of valuation of goodsprovided in Rule 58(1A) has to be read in the manner

that meets this criteria and we read down Rule 58(1-A)accordingly. The Maharashtra Government has to bringclarity in Rule 58 (1-A) as indicated above. Subject tothis, validity of Rule 58(1-A) of MVAT Rules issustained.

Our comments

This decision concludes the much litigated interpretation ofthe levy of VAT / sales tax on agreements for sale of under-construction property. There will still be challenges inrespect of valuation of the goods in which the propertypasses with reference to the completion of the constructionat the time of when the agreement is entered into.

The clarification directed to be issued by theMaharashtra Government in respect of Rule 58(1A)will be awaited to ascertain the implications thereof.

Another implication of the decision is the widerinterpretation to the meaning of the phrase workscontract as well as the inapplicability of the dominantnature test, which could bring within the tax net,transactions of services with use of incidental orancillary materials.


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kpmg flash news - supreme court affirms the raheja decision on levy of s

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