Works-contract tax deduction invalid when labour and service components are not excluded from the taxable value.

Unamended section 26(2) of the Madhya Pradesh VAT Act, 2002 was held ultra vires because it operated like the earlier works-contract deduction provision without excluding labour, service and other non-taxable elements from the contract value. The Court applied the settled principle that tax deduction at source on works-contract payments is invalid to that extent if it captures amounts not liable to tax. Deductions made under the provision before amendment were therefore directed to be refunded, subject to adjustment against any tax already payable or assessed. The petitioner's substantive tax liability, if lawfully assessed, was left unaffected.

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Issues: Whether section 26(2) of the Madhya Pradesh VAT Act, 2002, as it stood prior to its amendment by the Madhya Pradesh VAT (Amendment) Act, 2007, was beyond the competence of the State Legislature and whether the deductions made from the petitioner's bills under that provision were liable to be refunded.

Analysis: Section 26(2) of the Madhya Pradesh VAT Act, 2002, in its unamended form, was found to be identically worded to section 35(1) of the Madhya Pradesh Commercial Tax Act, 1994. It did not provide for exclusion of the value of labour and services from the contract value, and deductions were therefore made without such exclusion. The legal position had already been settled by the Full Bench decision relied upon, which held that a provision of this nature, while collecting tax at source from works-contract payments, was invalid to the extent it failed to exclude non-taxable elements and exceeded legislative competence.

Conclusion: The unamended section 26(2) of the Madhya Pradesh VAT Act, 2002 was held to be ultra vires and the deductions made under it prior to the amendment were directed to be refunded, subject to adjustment for any tax already payable or assessed.

Final Conclusion: The challenge succeeded to the extent of the pre-amendment deductions, and the petitioner was granted refund relief for amounts collected under the invalid provision, while the petitioner's substantive tax liability, if lawfully assessed, remained unaffected.

Ratio Decidendi: A deduction-at-source provision for works contracts is invalid if, in determining the amount deductible, it fails to exclude labour and service components and other non-taxable elements from the contract value.

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