Similar contracts can have different taxes

Misunderstanding between contract for sale and contract for works & material can affect amount of actual taxation

The distinction between a contract of sale and a works contract has been the subject matter of several judicial decisions. From a taxation point of view the final outcome of the above deliberation is of utmost importance.

Typically, a contract for sale attracts VAT and a contract for pure service would only attract service tax. A works contract on the other hand could attract both VAT as well as service tax, albeit at lower rates (both - VAT laws and service tax provisions - allow reduction of value of services and value of material respectively before applying tax rates).

The definition of works contract under different state VAT laws is much wider than the definition under service tax. This article discusses the key points of differentiation between contract for sale and a works contract.

The most common forms of works contracts are building contracts. These are well understood as works contracts, as is the taxation of these contracts. However, there are several types of contracts involving moveable property, where the distinction between a works contract, a service contract and a sale of goods is more subtle.

Let us take an example of printing contracts to understand the issue in more detail. Say, an author wrote a book and approached a printer to print 1,000 copies of the book. The author designed the entire book and also specified the quality of the paper and material to be used.

The printer has to print those 1,000 books as per the agreed style and quality for a fixed price. There is no doubt in this case as to the intent of the parties. The final printed book is the ultimate product which the author intends to procure. Though the author has provided the content and design, the printer provides the author with 1,000 books.

Further, at no point of time before the actual supply of the 1,000 books does the author have ownership of any of the materials such as the paper used in the books. The printer is solely responsible for the risk and ownership of the material and labour until the printed books are delivered and accepted by the buyer. It is a contract for sale.

Similar would be the case where a firm places an order for printed letterheads or say the visiting cards. The content, logo, trademark, etc, to be printed on the letterheads and visiting cards are specified by the buyer and are its sole property, still the real intention of the buyer is to purchase the printed letterheads and cards in specified quantity and quality at a given price. The buyer had no previous property in the goods before the actual delivery of printed letterheads and cards. This would still be a contract for sale.

However, it is quite common to find people holding a view that this is a works contract. This interpretation stems from the fact that the printer has received considerable input from the customer.

In this thought process, supply of goods off the shelf are a sale while supply of custom-made goods are a works contract.

This being a case of custom built goods (so conventional thinking goes), would constitute a works contract.

Now, say, the buyer wants marriage invitation cards to be printed and supplied the blank cards to the printer for printing. As per contract printer has to print the cards, fold them and put them into a transparent cover bag. Printer is also asked to print name labels and stick them on to the cover bag.

In this case the buyer is the owner of the cards at all times and printer has used labour and material to print and prepare the cards as per the terms of the contract. This is a contract for work and material as against a contract of sale, which is the case in the first example.

The third type of fact pattern, again using a printing contract as an example, involves the customer providing all the material required to the printer. This could include the paper, the ink, etc. The printer uses his machinery to produce the books or the cards as the case may be. This would be a contract for service.

The real test would seem to be who owns the goods. If they are entirely owned by the printer as in the first example, the resultant contract would be one of sale of goods.

If goods owned by the printer are added to goods supplied by customer as in the invitation cards example, the resultant contract would be a works contract. And the goods are entirely supplied by the customer, it would be a contract for service.

Ensuring that one has the facts come out clearly in the contract and that one duly calculates the correct tax is vital under these similar contracts.

The author is Leader, Indirect Tax Practice, PwC India pwctls.nd@in.pwc.com

Supported by Tajinder Singh