2015 (8) TMI 749 - SC - Service Tax

Service tax cannot be levied on indivisible works contracts before Finance Act 2007 introduction date

Commissioner, Central Excise & Customs Versus M/s Larsen & Toubro Ltd. and others

The SC ruled that service tax cannot be levied on indivisible works contracts prior to 1.6.2007, when the Finance Act, 2007 expressly made such contracts ... Works Contract - Levy of service tax prior to 1.6.2007 - Whether service tax can be levied on indivisible works contracts prior to the introduction, on 1st June, 2007, of the Finance Act, 2007 which expressly makes such works contracts liable to service tax - Held that:- assessees are correct in their submission that a works contract is a separate species of contract distinct from contracts for services simpliciter recognized by the world of commerce and law as such, and has to be taxed separately as such. A close look at the Finance Act, 1994 would show that the five taxable services referred to in the charging Section 65(105) would refer only to service contracts simpliciter and not to composite works contracts. This is clear from the very language of Section 65(105) which defines 'taxable service' as 'any service provided'. All the services referred to in the said sub-clauses are service contracts simpliciter without any other element in them, such as for example, a service contract which is a commissioning and installation, or erection, commissioning and installation contract. In fact, the speech made by the Hon'ble Finance Minister in moving the Bill to tax Composite Indivisible Works Contracts specifically stated:- 'State Governments levy a tax on the transfer of property in goods involved in the execution of a works contract. The value of services in a works contract should attract service tax. Hence, I propose to levy service tax on services involved in the execution of a works contract. However, I also propose an optional composition scheme under which service tax will be levied at only 2 per cent of the total value of the works contract.' Absence of valuation rules to determine the correct value - The Delhi High Court judgment in G.D. Builders [2013 (11) TMI 1004 - DELHI HIGH COURT] unfortunately misread the Mahim Patram's judgment [2007 (2) TMI 73 - SUPREME COURT] of this Court to arrive at the conclusion that it was an authority for the proposition that a tax is leviable even if no rules are framed for assessment of such tax, which is wholly incorrect. The Patna, Madras and Orissa High Courts have, in fact, either struck down machinery provisions or held machinery provisions to bring indivisible works contracts into the service tax net, as inadequate. We need only state that in view of our finding that the said Finance Act lays down no charge or machinery to levy and assess service tax on indivisible composite works contracts, such argument must fail. This is also for the simple reason that there is no subterfuge in entering into composite works contracts containing elements both of transfer of property in goods as well as labour and services. We have been informed by counsel for the revenue that several exemption notifications have been granted qua service tax 'levied' by the 1994 Finance Act. We may only state that whichever judgments which are in appeal before us and have referred to and dealt with such notifications will have to be disregarded. Since the levy itself of service tax has been found to be non-existent, no question of any exemption would arise. Works contract were not chargeable to service tax prior to 1.6.2007 - Decided in favor of assessee. 1. ISSUES PRESENTED and CONSIDEREDThe core legal questions considered by the Court are:(a) Whether service tax could be levied on indivisible composite works contracts prior to the introduction of the Finance Act, 2007, which expressly made such works contracts liable to service tax.(b) Whether the Finance Act, 1994, contains a charge and machinery provisions sufficient to tax the service element in indivisible works contracts before the 2007 amendment.(c) The constitutional validity and applicability of the 46th Amendment to Article 366(29A)(b) regarding the taxability of transfer of property in goods involved in works contracts.(d) The interpretation and effect of the second Gannon Dunkerley judgment (1993) on the valuation and bifurcation of works contracts into goods and service components for taxation purposes.(e) The correctness of the Delhi High Court judgment in G.D. Builders, which held that service tax under various clauses of Section 65(105) of the Finance Act, 1994, could be levied on indivisible works contracts.(f) The applicability of public policy and Contract Act principles, including Section 23 and the Mcdowell judgment, to indivisible works contracts post-1994.(g) The constitutional scheme of taxation under the Seventh Schedule, particularly the mutual exclusivity of State sales tax and Central service tax, and the requirement for clear legislative provisions for levy and assessment of service tax on works contracts.(h) The adequacy of machinery provisions for assessment and levy of service tax on works contracts prior to the 2007 amendment.2. ISSUE-WISE DETAILED ANALYSIS(a) Levy of Service Tax on Indivisible Works Contracts Prior to 2007 AmendmentLegal framework and precedents: The Finance Act, 1994 introduced service tax on specified taxable services under Section 65(105). The 46th Amendment to the Constitution introduced Article 366(29A)(b), deeming transfer of property in goods involved in works contracts as sale of goods, thus enabling States to levy sales tax on such transfers. The 2007 Finance Act amendment expressly included works contracts as taxable services under service tax law.Court's reasoning: The Court examined whether the 1994 Act, prior to the 2007 amendment, empowered service tax on indivisible works contracts. It concluded that the 1994 Act only taxed pure service contracts simpliciter and did not contain a charge or machinery provisions for taxing the service element of composite indivisible works contracts. The 2007 amendment was the first to expressly tax works contracts as a service.Application of law to facts: Since the 1994 Act lacked explicit charging and procedural provisions for works contracts, service tax could not be levied on indivisible works contracts prior to 2007.Conclusion: Service tax was not leviable on indivisible works contracts before the 2007 amendment.(b) Constitutional Validity and Effect of the 46th Amendment (Article 366(29A)(b))Legal framework and precedents: The 46th Amendment inserted Article 366(29A)(b) to deem transfer of property in goods involved in works contracts as sale of goods, allowing States to levy sales tax on the goods element. Builders' Assn. of India v. Union of India upheld this amendment.Court's reasoning: The Court emphasized that this amendment created a legal fiction to split indivisible works contracts into two components: transfer of property in goods (taxable by States) and labour and services (taxable by Centre). The Court reiterated that the constitutional scheme requires clear bifurcation to avoid overlap and maintain mutual exclusivity of taxation powers.Application of law to facts: The 46th Amendment did not itself impose service tax on works contracts but enabled States to tax the goods part. The Centre could tax only the service element, but only if legislation clearly provided for it.Conclusion: The 46th Amendment facilitates division of works contracts for taxation but does not itself impose service tax on the service element.(c) Interpretation of the Second Gannon Dunkerley Judgment (1993)Legal framework and precedents: The 1993 Constitution Bench clarified the method of valuation for sales tax on goods involved in works contracts, requiring deduction of labour and service elements from the gross contract value to arrive at the taxable goods value. It laid down eight heads of deduction including labour charges, subcontractor payments, architect fees, machinery hire, consumables, cost of establishment attributable to services, similar expenses, and profits relatable to services.Court's reasoning: The Court held that the value of goods for sales tax purposes excludes all charges attributable to labour and services. The cost of establishment and profits must be apportioned between goods and services. If proper accounts are not maintained, a formula based on fixed percentages may be prescribed by legislation.Application of law to facts: This judgment mandates that any tax on works contracts must carefully bifurcate goods and service components according to the eight heads. Without such bifurcation, the tax would be constitutionally invalid.Conclusion: The second Gannon Dunkerley judgment sets the constitutional and legal standard for bifurcation of works contracts for taxation.(d) Whether the Finance Act, 1994 Contains Charge and Machinery Provisions to Tax Works ContractsLegal framework and precedents: Sections 65(105) and 67 of the Finance Act, 1994, define taxable services and valuation respectively. The 2007 amendment introduced explicit provisions for works contracts and valuation rules (Rule 2A) for bifurcation.Court's reasoning: The Court found that the 1994 Act's charging provisions only applied to pure services and did not provide for deduction of the value of goods transferred in works contracts. The valuation section refers to the gross amount charged for services, not adjusted for goods. The necessary machinery for bifurcation and assessment was absent before 2007.Application of law to facts: Since the 1994 Act lacked express charge and machinery provisions for indivisible works contracts, service tax could not be validly levied on them before 2007.Conclusion: The 1994 Act did not validly tax indivisible works contracts; the 2007 amendment was necessary to introduce such levy and machinery.(e) Critique of the Delhi High Court Judgment in G.D. BuildersLegal framework and precedents: The Delhi High Court held that service tax under various clauses of Section 65(105) could be levied on indivisible works contracts even before 2007, and that absence of rules for computation was procedural and not a bar to levy.Court's reasoning: The Supreme Court found this judgment erroneous on multiple counts: it misread the Mahim Patram judgment which dealt with Central Sales Tax and not service tax; it ignored the second Gannon Dunkerley judgment's detailed bifurcation requirements; and it wrongly held that absence of rules does not affect the validity of the levy.Application of law to facts: The Court held that the Delhi High Court's reliance on the 1994 Act as containing charge and machinery for service tax on indivisible works contracts was incorrect.Conclusion: The Delhi High Court judgment in G.D. Builders is overruled on this point.(f) Constitutional Scheme and Exclusivity of Taxation PowersLegal framework and precedents: Article 246 and the Seventh Schedule entries allocate exclusive taxation powers to Centre and States. The Court reiterated that overlapping taxation on the same transaction is constitutionally impermissible.Court's reasoning: The Court emphasized that service tax can only be levied on the service element of works contracts, and sales tax on the goods element. Any levy that includes elements of both without clear bifurcation violates constitutional principles.Application of law to facts: The absence of bifurcation and machinery in the 1994 Act for indivisible works contracts means that any attempt to levy service tax on such contracts before 2007 would transgress constitutional boundaries.Conclusion: The constitutional scheme mandates clear separation of goods and services elements for valid taxation.(g) Adequacy of Machinery Provisions for Assessment and LevyLegal framework and precedents: The Court referred to a series of judgments emphasizing the necessity of clear machinery and procedural provisions in any taxing statute to ensure fairness and legality of assessment and collection.Court's reasoning: The Court noted that the 1994 Act lacked machinery provisions to determine the service element in indivisible works contracts, rendering any such levy arbitrary and unconstitutional. The Court cited precedents where absence of machinery led to invalidation of tax provisions.Application of law to facts: The Court found that only after the 2007 amendment and the framing of valuation rules could service tax be validly levied on works contracts.Conclusion: Machinery provisions are indispensable for valid tax imposition; their absence invalidates the levy.(h) Public Policy and Contract Act ArgumentsLegal framework and precedents: The revenue contended that indivisible works contracts post-1994 were contrary to public policy under Section 23 of the Indian Contract Act and the Mcdowell judgment.Court's reasoning: The Court rejected this argument, holding that since no valid service tax charge existed on indivisible works contracts before 2007, the contracts could not be deemed illegal or contrary to public policy on this ground. There was no subterfuge in composite contracts containing goods and service elements.Conclusion: The public policy argument fails in the absence of a valid tax charge.3. SIGNIFICANT HOLDINGS'To sum up, the expression 'sale of goods' in Entry 48 is a nomen juris, its essential ingredients being an agreement to sell movables for a price and property passing therein pursuant to that agreement. In a building contract which is, as in the present case, one, entire and indivisible - and that is its norm, there is no sale of goods, and it is not within the competence of the Provincial Legislature under Entry 48 to impose a tax on the supply of the materials used in such a contract treating it as a sale.''Keeping in view the legal fiction introduced by the Forty-sixth Amendment whereby the works contract which was entire and indivisible has been altered into a contract which is divisible into one for sale of goods and other for supply of labour and services, the value of the goods involved in the execution of a works contract on which tax is leviable must exclude the charges which appertain to the contract for supply of labour and services.''The cost of establishment of the contractor which is relatable to supply of labour and services cannot be included in the value of the goods involved in the execution of a contract and the cost of establishment which is relatable to supply of material involved in the execution of the works contract only can be included in the value of the goods.''The value of the goods involved in the execution of a works contract will, therefore, have to be determined by taking into account the value of the entire works contract and deducting therefrom the charges towards labour and services which would cover ... [eight heads of deduction].''The scheme and this scheme alone which complies with constitutional requirements in that it bifurcates a composite indivisible works contract and takes care to see that no element attributable to the property in goods transferred pursuant to such contract, enters into computation of service tax.''The Finance Act, 1994 does not contain a charge or machinery provisions for levy and assessment of service tax on indivisible composite works contracts. The 2007 amendment was necessary to introduce such charge and machinery.''The Delhi High Court judgment in G.D. Builders is wholly incorrect in its conclusion that the Finance Act, 1994 contains both the charge and machinery for levy and assessment of service tax on indivisible works contracts.''A taxing statute must clearly and unambiguously convey the three components of the tax law i.e. the subject of the tax, the person who is liable to pay the tax and the rate at which the tax is to be paid. If there is any ambiguity regarding any of these ingredients in a taxation statute then there is no tax in law.''The absence of machinery provisions for assessment and levy of tax renders the taxing statute unconstitutional and unenforceable.''There is no subterfuge in entering into composite works contracts containing elements both of transfer of property in goods as well as labour and services.'Final determination: Service tax could not be levied on indivisible works contracts prior to the 2007 amendment. The Finance Act, 1994 lacked the necessary charge and machinery provisions to tax such contracts. The 2007 amendment and associated rules were essential to validly impose service tax on the service element of works contracts. The Delhi High Court's contrary conclusion is overruled. The constitutional scheme requires clear bifurcation of goods and service elements for taxation by States and Centre respectively, and the absence of such bifurcation and machinery invalidates any levy.