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Taxation of works contracts

S Madhavan 

A recently reported decision of the Kerala High Court, in the context of taxation of works contracts under the State sales tax//VAT laws, brings an interesting point of law to the fore. The point of law in question is as to whether in computing the taxable turnover of a works contractor under the above laws, a deduction ought to be granted with regard to deprecation on machinery used in the works, given the specific wordings of the provisions relating to such deductions, bearing in mind of course that what is sought to be taxed under these laws is the value of goods, the property in which passes from the works contractor to the contractee, based on the principle of accretion.

By way of context, the 46th amendment to the Constitution, vide insertion of Article 366(29A) thereto, empowered the States to levy and collect a tax on specified categories of deemed sales such as works contracts. Further, the consideration for which the work is contracted to be executed by the works contractor comprises several elements in the nature of both goods and services and evidently the tax is to be necessarily restricted to the value of goods used in the works contract and the property in which is passing, as result. Consequently, the Supreme Court, in its landmark decision in Gannon Dunkerley.& Co. Vs. State of Rajasthan (1993) 88 STC-204), had stipulated the various deductions from the turnover for arriving at the precise value of such goods on which the works contract tax was payable. Most State sales tax/VAT laws have consequently enumerated the permissible deductions from the taxable turnover, in order to arrive at the base on which the tax ought to be computed.

In the recent case in point, the Kerala High Court, in State of Kerala Vs. Thampi & Company (2011 41 VST 1078), had to deal with the claim by the contractor for a deduction on account of depreciation of plant and machinery used in the works contract, in the light of the relevant provisions of the Kerala sales tax laws which were, inter alia, worded as follows:-

all amounts towards labour charges and other service charges such as “ i) ...

ii) charges for obtaining on hire or otherwise, machinery and tools used for the execution of the works contract”;

It was contended by the assessee that the expression in question i.e. “charges for obtaining on hire or otherwise, machinery and tools used for the execution of the works contract” extended to depreciation as well, since the words “or otherwise” used thereunder would envisage deduction for self owned machinery used in the execution of the works contract. It was argued that since in respect of machinery, the contractor was free to purchase it and use it in the works, hire charges as well as deprecation were necessarily of similar nature as both related to the use of the machinery.

The Court however disallowed this plea on the ground that what was allowable as a deduction was only in the nature of actual expenditure incurred by the contractor and notional charges such as depreciation would not qualify. The Court held that if the legislature had intended to provide for deduction for depreciation, it would have specifically provided for it under the relevant provisions. It held that the expression “charges for obtaining on hire or otherwise” could only mean any charges paid for obtaining machinery on any terms other than hire and this certainly did not extend to depreciation, as it was only a notional expense related to amortization of machinery.

The above decision, although reported recently, was rendered in June 2009. Interestingly, in another decision pertaining to very similar facts, the Karnataka High Court, in its decision in Larsen & Toubro Ltd. Vs. State of Karnataka (2010 34 VST 53), arrived at a diametrically opposite conclusion. This decision was rendered in September 2009 i.e. three months subsequent to the Kerala High Court decision, although reported a full year earlier than the Kerala High Court decision. Interestingly, the Karnataka High Court did not take note of the Kerala High Court decision, perhaps because its attention was not brought to the above decision as it had not been reported at the time. Nevertheless, the High Court took note of the various landmark decisions on taxability of works contracts under sales tax law, including that of Builders Association of India Vs. UOI (1989 73 STC 370) as well as the Gannon Dunkerley case (supra), both of the Supreme Court. The Karnataka High Court decision was far more extensive than the Kerala High Court decision and went into great detail as to what were the deductions that ought to be taken into account in computing the turnover of a works contractor, keeping in mind the principles laid down by the Supreme Court in the Gannon Dunkerley case (supra). It is interesting to note that the relevant provisions of the Karnataka sales tax law were very similarly worded to those in the Kerala sales tax law referred to above.

It was argued by the appellants that the relevant expression ought to extend to a case of deduction for depreciation on self owned machinery used in the works contract. This was precisely the argument of the petitioner in the Kerala High Court decision as well. It was stated that the petitioner had utilized his own machinery in the works which he would have otherwise hired. It was argued that since the machinery was so used, the end price of the contract, which was fixed and determined, necessarily factored in the wear and tear of such machinery and since depreciation related to such proportionate wear and tear, it was deductible. It was also argued that depreciation would also qualify under the expression “other similar expenses relatable to supply of labour and services”, occurring in another part of the same provision relating to such deductions. On the other hand, the Government of Karnataka submitted that the provisions in question did not enable the assessee to put forth any such claim since depreciation was not an expenditure and was merely a notional charge and since the word “deprecation” was not to be found anywhere in the provisions in question, no deduction was permissible on that account. It was also argued that the Supreme Court’s decision in the Gannon Dunkerley case did not support the claim for deduction for deprecation since all such deductions were statutorily regulated and there could be no scope to claim a deduction which was not expressly specified.

The Karnataka High Court came to the conclusion, on a consideration of all arguments, that the claim for depreciation was justified. It held that the entire exercise of computing the taxable turnover for the purpose of levy of the tax was to ascertain the precise value of the goods in respect of which title was transferred from the contractor to the client, upon execution of the works. Hence, the tax could not be levied on a base that would extend to anything over and above the value of such goods, even if the word ‘deprecation’ was not present in the provisions. The Court held that necessary cognizance ought to be taken of all costs and expenses incurred by the works contractor in relation to the works, including those relating to depreciation, since the provisions of the Karnataka law were only a sequel to the Constitutional provisions, vide Article 366(29A), which enabled such taxation and which related to a tax on the transfer of the property in goods involved in the execution of a works contract. The Court held that the above objective could only be met if the charge was confined to the value of property in goods involved in the execution of the works contract. So long as the claim for deprecation was based on the above principle , it would qualify, notwithstanding that the word “deprecation” itself did not figure either in the decision of the Supreme Court in the Gannon Dunkerley case (supra) or in the relevant provisions of the Karnataka law. It went on to state that the extent of usage of the machinery in the execution of the works was to be determined on the facts of the case and the deduction for deprecation computed accordingly.

We thus have two diametrically opposite decisions of the Indian High Courts on an interesting point of law, based on similar provisions and similar underlying facts. Consequently, the matter is currently being litigated by works contractors in various fora and it seems that until we have a definitive decision on the point by the Supreme Court, such litigation will continue. It is to be seen whether the GST will obviate the problem.

(The author is executive director, PricewaterhouseCoopers ) 
Supported by
Satish S and Rahul Renavikar

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First Published: Mon, July 11 2011. 00:51 IST