Works contract taxation must respect constitutional exclusions; sub-contractor withholding was invalid for double deduction and arbitrary collection.

A State levy on works contracts was constitutionally limited by Article 286 and the rules governing State taxation of sales; it had to exclude inter-State, outside-State, import and export transactions and allow mandatory deductions for labour, service and other constitutionally required components. Because the charging provision and computation rule did not adequately provide those exclusions and deductions, they were declared invalid. Deduction at source was accepted as a permissible collection device in principle, but the sub-contractor withholding mechanism was struck down as arbitrary and prone to double deduction, double taxation, and penal consequences. The contractor-level deduction mechanism remained valid as an ancillary mode of collection.

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Issues: (i) Whether the provision imposing tax on the transfer of property in goods involved in the execution of works contracts and the corresponding rule prescribing the method of computation were constitutionally valid; (ii) Whether the provision requiring deduction of tax at source from payments to contractors and sub-contractors was valid.

Issue (i): Whether the provision imposing tax on the transfer of property in goods involved in the execution of works contracts and the corresponding rule prescribing the method of computation were constitutionally valid.

Analysis: The constitutional amendment enabled the States to tax transfers of property in goods involved in works contracts, but such levy remained subject to the restrictions flowing from Article 286 and the discipline governing State taxation under entry 54 of List II. A valid works-contract levy had to exclude transactions falling under inter-State sale, outside-State sale, import and export, and also had to give effect to the statutory restrictions applicable to declared goods. The impugned charging provision and rule did not provide for all legally required deductions, including labour and service components and other exclusions mandated by the constitutional scheme. A taxing provision that leaves essential deductions unresolved or incomplete cannot be upheld merely because some deductions are available in the rule.

Conclusion: The charging provision and the corresponding rule were held invalid and unconstitutional.

Issue (ii): Whether the provision requiring deduction of tax at source from payments to contractors and sub-contractors was valid.

Analysis: Deduction at source was accepted as a permissible mode of collection in principle, but the sub-contractor deduction mechanism created duplication and operated without any workable safeguard for avoiding double deduction and downstream penal consequences. The provision dealing with deductions from payments made to sub-contractors was treated as unreasonable and arbitrary because it resulted in double taxation in the chain of works execution and imposed compulsory withholding and deposit obligations backed by penalty and interest. In contrast, the deduction mechanism applied to payments by the contractee to the contractor was treated as a valid ancillary measure of collection.

Conclusion: The deduction-at-source provision was upheld in part, but the sub-contractor deduction and the connected consequential provisions were struck down.

Final Conclusion: The writ petitions succeeded substantially, with the works-contract charging framework and the sub-contractor withholding scheme being declared invalid, while the contractor-level deduction at source was not wholly interdicted.

Ratio Decidendi: A State levy on works contracts must conform to the constitutional limitations on sales tax and must expressly accommodate all mandatory exclusions and deductions, and a collection mechanism that produces double taxation or operates without a workable legal basis is liable to be struck down.

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