2025 (11) TMI 117 - SC - VAT / Sales Tax

Payments to subcontractors deductible from main contractor's taxable value for VAT under Section 15(1), accretion theory applied (1)

Authority For Clarification and Advance Rulings, Karnataka & Anr. Versus M/s. Skyline Construction And Housing Pvt. Ltd.

SC dismissed the appeal, holding that for VAT on works contracts the amount paid to subcontractors must be deducted from the main contractor's total ... Reduction of amount paid to sub-contractor from total consideration while calculating the tax payable under the VAT Act in respect of works contract - no specific provision under the VAT Act granting such deduction - HELD THAT:- It is well established that in a works contract the property in goods passes through theory of accretion. The nature of a building construction contract was very succinctly explained by this Court in its decision rendered in the case of State of Madras v/s Gannon Dunkerley and Co. (Madras) Ltd. [1958 (4) TMI 42 - SUPREME COURT] where it was held that 'The contract is, that the bankrupt shall build a house; that he shall make, amongst other things, window-frames for the house, and fix them in the house, subject to the approbation of a surveyor; and it was never intended by this contract, that the articles so to be fixed should become the property of the defendants, until they were fixed to the freehold.' In Larsen and Toubro Ltd. [2016 (9) TMI 519 - SUPREME COURT] the question was one relating to the tax liability of a contractor in case where contract is awarded to a sub-contractor. This Court held that since in execution of works contract, sales take place on the principle of accretion, the sales are directly from the sub-contractor to the contractee even though the contract is between the main contractor and the contractee and even if the sub-contractor does not have contractual relationship with the contractee. In the present case the issue is of interpretation and not of constitutionality. The Notification dated 23.3.2005 issued u/s 15(1) the VAT Act provided that tax was payable by the dealer at the rate of 4% of the total consideration for the works contract executed by him. To the extent the contract was executed through subcontractors, it cannot be said that the works contract was executed by the main contractor. Hence the total consideration for works contract executed by the main contractor can be derived only if the payments made to the sub-contractors are reduced. The view taken by the High Court that the payment made to the sub-contractors is required to be deducted for determining taxable value for the purpose of calculating tax under Section 15(1) of the VAT Act is in accordance with law. Deduction of payment made to the sub-contractor cannot be equated with input tax credit as argued by the State as in the case of sub-contractor the value goes out of the charging provision itself as to that extent the deemed sale is made directly by sub-contractor to contractee. Appeal dismissed. ISSUES PRESENTED AND CONSIDERED 1. Whether, for the purpose of computing liability to pay tax by a dealer executing works contracts under Section 15 of the Karnataka Value Added Tax Act, 2003 for the relevant period, the 'total consideration for the works contract executed' by the principal (main) contractor includes amounts paid by the principal contractor to sub-contractors as consideration for portions of the work executed by such sub-contractors. 2. Whether a principal contractor is entitled to deduct payments made to sub-contractors from its total consideration for the works contract when opting for composition under Section 15, and if so, whether such deduction is permissible only when the sub-contractor is a registered dealer and has accounted for and paid tax on such amounts. ISSUE-WISE DETAILED ANALYSIS - Issue 1: Inclusion of payments to subcontractors in 'total consideration' for composition under Section 15 Legal framework: Section 15 provides for payment of tax by way of composition on 'total turnover or on the total consideration for the works contracts executed' and contains specific sub-clauses dealing with dealers executing works contracts (including clauses prescribing deductions in certain situations). Definitions: 'total turnover', 'turnover', and 'works contract' are relevant (Sections 2(35), 2(36), 2(37)); levy provisions in Sections 3 and 4 provide the charging scheme. Precedent treatment: The Court relied on established principles from prior decisions on works contracts: (a) property in goods used in a works contract passes by the theory of accretion (works contract materials become part of immovable property on incorporation); (b) after constitutional amendment treating transfer of property in goods involved in works contracts as 'sale', sales under a works contract may be deemed sales by the sub-contractor to the contractee where the sub-contractor effects the incorporation (i.e., transfer by accretion). The decision in the authority addressing contracts awarded to sub-contractors was followed, holding that sales are directly from the sub-contractor to the contractee, even without privity of contract, and that execution by a sub-contractor results in a single deemed sale. Interpretation and reasoning: The Court held that where portions of a works contract are physically executed by sub-contractors, the property in the goods incorporated passes to the contractee by accretion as and when incorporated by the sub-contractor. Therefore the deemed transfer in respect of those goods is effectively a sale by the sub-contractor to the contractee, not a separate deemed sale by the main contractor. Accepting the Department's contention that both (i) a deemed sale from the main contractor to the contractee and (ii) a deemed sale from the sub-contractor to the main contractor could coexist would result in plurality of deemed sales and risk double taxation, contrary to the understanding of Article 366(29-A)(b) (as incorporated in the tax code) and earlier case law. The statutory scheme (Section 15 read with the Notification prescribing composition rates) contemplates composition on the total consideration 'for the works contracts executed by him'; where execution is through sub-contractors, the works contract is not executed by the main contractor to that extent. Ratio vs. Obiter: Ratio - The principle that in cases where work is executed by sub-contractors, the amounts paid to sub-contractors are not part of the main contractor's 'total consideration' for composition purposes (because the deemed sale in respect of goods incorporated is from the sub-contractor to the contractee by accretion), and including such amounts would occasion double taxation. Obiter - ancillary observations distinguishing other lines of authority and constitutional competence remarks insofar as not necessary to the statutory interpretation. Conclusion: Payments made by the main contractor to sub-contractors for portions of works executed by the sub-contractors are not includible in the main contractor's 'total consideration' for works contracts executed by him for the purpose of computing composition liability under Section 15 for the relevant period. ISSUE-WISE DETAILED ANALYSIS - Issue 2: Entitlement to deduction of payments made to subcontractors and conditions for such deduction Legal framework: Section 15(1) and, in particular, clauses (5)(b) and related provisions specify consequences and deductions in the case of a dealer executing works contracts who opts for composition. The Notification under Section 15(1) (dated 23.3.2005) prescribed a composition rate (4%) on 'total consideration for the works contract executed' by the dealer. Section 2 definitions and Sections 3-4 inform the charging structure. Precedent treatment: The Court treated the High Court's approach as consistent with the line of authorities explaining accretion and the nature of deemed sales in sub-contract scenarios. A prior decision upholding an alternate scheme of composition as constitutionally valid was distinguished as addressing constitutionality and optional alternative computation, not the interpretation issue at hand. Interpretation and reasoning: The Court read Section 15(1) in conjunction with the Notification and the principles of accretion to conclude that where execution is through a sub-contractor, the main contractor cannot be said to have executed that portion of the works; therefore the composition base for the main contractor excludes amounts paid to sub-contractors. The statutory provision further contemplates a specific deduction from the composition base in respect of amounts payable to sub-contractors, subject to proof that the sub-contractor is a registered dealer and that the amounts are included in the sub-contractor's return (i.e., the safeguards against abuse and to prevent loss of revenue). The Court rejected the State's submission equating such deduction with input tax credit, holding instead that the value effectively falls outside the charging provision as to the main contractor because the deemed sale occurs directly by the sub-contractor to the contractee. Ratio vs. Obiter: Ratio - A principal contractor opting for composition under Section 15 is entitled to deduct amounts payable to sub-contractors from its total consideration for works executed, provided the sub-contractor is a registered dealer and has accounted for and paid tax (or included the amounts in its return), as those amounts relate to deemed sales by the sub-contractor to the contractee. Obiter - observations on the non-applicability of certain precedents and on the distinct conceptual treatment from input tax credit are explanatory but support the primary ratio. Conclusion: Deduction of payments made to sub-contractors is permissible for computing composition liability under Section 15(1) for the relevant period, conditionally limited to amounts paid to sub-contractors who are registered dealers and who have included those amounts in their returns (i.e., accounted for and paid tax). Such deduction is not equivalent to input tax credit but arises because the deemed sale is attributable to the sub-contractor. DISPOSITION The Court affirmed the view that amounts paid to sub-contractors must be deducted from the main contractor's total consideration for works contracts executed when computing composition tax under Section 15 for the period in question, subject to the condition that the sub-contractor is a registered dealer and has accounted for the amounts. The appeal was dismissed.