Works contract valuation: proportionate depreciation and establishment expenses are deductible, but client-supplied materials remain taxable.

Under the Karnataka Sales Tax works contract valuation rules, proportionate depreciation on plant and machinery used in execution is treated as deductible because the levy must remain confined to the value of goods transferred, and the deduction scheme must be read consistently with that limit. Interest charged by clients, postage, telephone and telex charges, and vehicle tax are also deductible as establishment expenses relatable to the supply of labour and services. By contrast, materials supplied by the client and used in executing the works contract are includible in the contractor's taxable turnover for turnover tax. The stated result is that the contractor obtained relief on the first two heads, while inclusion of client-supplied materials was upheld.

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Issues: (i) Whether proportionate depreciation on plant and machinery owned and used in executing works contracts is deductible while computing taxable turnover. (ii) Whether interest charged by clients, postage, telephone and telex expenses, and vehicle tax are deductible as part of the cost of establishment relatable to supply of labour and services. (iii) Whether the value of materials supplied by the client for use in execution of the works contract is includible in the contractor's taxable turnover for levy of turnover tax.

Issue (i): Whether proportionate depreciation on plant and machinery owned and used in executing works contracts is deductible while computing taxable turnover.

Analysis: The charging provision under Section 5-B of the Karnataka Sales Tax Act, 1957, read with Rule 6 of the Karnataka Sales Tax Rules, 1957, permits levy only on the value of goods involved in the execution of the works contract. The deduction mechanism under Rule 6(4)(n)(iv) and Explanation I must therefore be construed so that the tax base does not extend beyond the value of the goods. Although the word "depreciation" does not expressly occur in the rule or in the Supreme Court's formulation of deductible items in Gannon Dunkerley, the wear and tear represented by proportionate depreciation is functionally akin to charges for obtaining on hire or otherwise machinery and tools used in execution of the works contract, and falls within the broader class of similar expenses relatable to supply of labour and services. A contrary construction would risk making the charging provision unconstitutional by taxing amounts beyond the value of goods.

Conclusion: Proportionate depreciation is deductible, and the issue is decided in favour of the assessee.

Issue (ii): Whether interest charged by clients, postage, telephone and telex expenses, and vehicle tax are deductible as part of the cost of establishment relatable to supply of labour and services.

Analysis: These outgoings are connected with the contractor's establishment and operations in executing the works contract. Rule 6(4)(n)(iv) and Explanation I recognise cost of establishment to the extent relatable to supply of labour and services, together with other similar expenses relatable to such supply, as deductible from the works contract value. The expenses in question are of the same character as establishment overheads contemplated by the constitutional and statutory scheme governing works contract valuation, and they cannot be included in the taxable turnover if the levy is to remain confined to the value of goods transferred.

Conclusion: The deductions are allowable, and the issue is decided in favour of the assessee.

Issue (iii): Whether the value of materials supplied by the client for use in execution of the works contract is includible in the contractor's taxable turnover for levy of turnover tax.

Analysis: The court applied the settled position that under Article 366(29-A)(b) of the Constitution of India and the corresponding works contract charging provision, materials supplied by the client and used in execution of the contract form part of the taxable turnover of the contractor for purposes of turnover tax. The Supreme Court's later exposition on inclusion of such supplied goods concluded the point against the assessee.

Conclusion: The value of client-supplied materials is includible in taxable turnover, and this issue is decided against the assessee.

Final Conclusion: The revision succeeded in substance because the disallowance of depreciation and establishment-related deductions was set aside, while the inclusion of client-supplied materials in turnover tax was upheld.

Ratio Decidendi: In valuing works contracts for sales tax, the levy must be confined to the value of goods transferred in execution of the contract, and deductions under the valuation rule must be construed to exclude proportionate machinery depreciation and establishment expenses relatable to labour and services.

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