2015 (8) TMI 749 - SC - Service Tax

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

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 ... Indivisible works contract - separation of goods and service elements in works contracts - requirement of a charging provision and assessor's machinery for a valid tax - Article 366(29A)(b) artificial divisibility of works contracts - constitutional exclusivity of taxation powers of Centre and States - valuation by deducting service component from gross works-contract value (Gannon Dunkerley rule) - absence of service-tax charge and machinery for composite works contracts prior to 1 June 2007 - Service Tax (Determination of Value) Rules / Rule 2A scheme for bifurcationIndivisible works contract - absence of service-tax charge and machinery for composite works contracts prior to 1 June 2007 - Service tax could not be validly levied on indivisible composite works contracts prior to the Finance Act, 2007 - HELD THAT: - The Court held that prior to the 2007 amendment there was no specific charging provision and concomitant machinery in the Finance Act, 1994 to bring indivisible works contracts within the service-tax net. The taxing provisions in Section 65(105) and Section 66 pertained to services simpliciter and the valuation provision in Section 67 took the gross amount charged for a taxable service; they did not provide for deduction of the value of property in goods transferred in execution of a works contract. Absent a clear statutory charge and workable assessment machinery that segregated the goods component from the service component in accordance with the jurisprudence on works contracts, a levy would transgress the States' field and be constitutionally infirm. Consequently, service tax on indivisible works contracts did not exist before the 2007 amendment introducing an express works-contract charging provision and related rules. [Paras 20, 24, 41, 44, 45]Service tax on indivisible works contracts is not leviable under the Finance Act, 1994 prior to the 2007 amendment; the assessees' appeals are allowed on this point.Valuation by deducting service component from gross works-contract value (Gannon Dunkerley rule) - Service Tax (Determination of Value) Rules / Rule 2A scheme for bifurcation - How the goods and service components of a works contract must be bifurcated for taxation and the role of Rule 2A - HELD THAT: - Relying on the Constitution-Bench decisions in Gannon Dunkerley and its progeny, the Court reiterated that the legal fiction introduced by Article 366(29A)(b) requires determining the value of goods involved in execution of a works contract by starting from the gross contract value and deducting specified heads attributable to labour and services (labour charges, sub-contractor payments, planning/design fees, hire of machinery, consumables, cost of establishment relatable to services, other similar expenses relatable to services, and profit relatable to services). Where books are inadequate, the legislature may prescribe percentage formulas. The Court observed that the post-2007 statutory scheme and Rule 2A reflect this method and are constitutionally permissible because they effect the necessary bifurcation; by contrast, the pre-2007 Finance Act lacked such bifurcation and machinery. [Paras 14, 15, 26]The correct method of bifurcation follows the Gannon Dunkerley principles; Rule 2A and the post-2007 statutory scheme conform to that approach, whereas the pre-2007 charging provisions did not.Constitutional exclusivity of taxation powers of Centre and States - requirement of a charging provision and assessor's machinery for a valid tax - Impact of the constitutional division of taxation powers on taxing composite works contracts and necessity of clear legislative scheme - HELD THAT: - The Court emphasised the mutual exclusivity of the Centre's and States' taxation powers: States may tax the transfer of property in goods, the Centre may tax only the service element. If a central levy on services were to include any element of transfer of property in goods, it would intrude upon the State field and be constitutionally invalid. Consistent with earlier precedents, the Court held that a taxing enactment must clearly specify the taxable event, the person liable, the rate and the measure; absence or vagueness of machinery for assessment renders the levy unenforceable. Therefore, a central statute seeking to tax works contracts must provide a clear charge and workable assessment machinery that ensures no goods-element is taxed by the Centre. [Paras 16, 21, 23, 24]Taxation of composite works contracts must respect the Centre-State division and be backed by a clear charging provision and workable machinery; in their absence the levy is constitutionally unsustainable.G.D. Builders (Delhi High Court) misreading of precedents - requirement of rules/machinery for valuation and assessment - Whether the Delhi High Court decision in G.D. Builders correctly held that Section 65(105) and Section 67 sufficed to levy service tax on indivisible works contracts pre-2007 - HELD THAT: - The Court found the Delhi High Court's conclusion erroneous. G.D. Builders treated existing sub-clauses of Section 65(105) as sufficient to tax indivisible works contracts and held that absence of rules for computation did not affect validity. The Supreme Court explained that Mahim Patram (cited in G.D. Builders) concerned central sales tax machinery and did not support the proposition that a tax is leviable without any rules or mechanism. Further, G.D. Builders overlooked the Gannon Dunkerley requirements for detailed bifurcation. Consequently the Delhi High Court's conclusion that the Finance Act, 1994 contained both charge and machinery for taxing indivisible works contracts was rejected. [Paras 31, 32, 33, 34, 41]The Delhi High Court's decision in G.D. Builders is incorrect; the Finance Act, 1994 did not contain the necessary charge and machinery to tax indivisible works contracts before 2007.Public policy and Section 23 of the Contract Act / McDowell principle - no subterfuge in composite works contracts - Whether post-1994 indivisible works contracts are void as against public policy or render service tax leviable under McDowell and Section 23 - HELD THAT: - The Court rejected the revenue's contention that indivisible works contracts entered into after 1994 were arrangements intended to evade tax and hence contrary to public policy invoking Section 23 of the Contract Act and McDowell. Given the Court's principal finding that the Finance Act, 1994 lacked a charge and machinery to tax indivisible works contracts, there was no basis to treat such contracts as unlawful subterfuges for purposes of service-tax imposition. The Court also observed there was nothing inherently illicit in entering into composite contracts containing both goods and services elements. [Paras 42, 43]The contention that post-1994 indivisible works contracts are void as being contrary to public policy or taxable under McDowell is rejected.Final Conclusion: The appeals of the assessees are allowed and the appeals of the revenue are dismissed: service tax could not be validly levied on indivisible composite works contracts under the Finance Act, 1994 prior to the 2007 amendment because the 1994 Act did not contain the specific charge and workable machinery required to segregate and assess the goods and service elements in accordance with established precedent; the post-2007 statutory amendments and rules, which expressly address works contracts and provide valuation machinery, are the appropriate means to tax the service component. 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.