By TIOL News Service

NEW DELHI, MAY 07, 2014: THE issue before the Bench is - Whether manufacture, erection, installation and commissioning of lift at customer's premises constitute 'sale' and not 'works contract'. And the Apex Court by Majority rules that it is Works Contract.

Facts of the case

The assessee Kone Elevator India Pvt. Ltd. is engaged in the manufacture, supply and installation of lifts involving civil construction. The Sales Tax Appellate Tribunal, Andhra Pradesh, opined that the nature of work of the assessee was a "works contract", for the erection and commissioning of lift could not be treated as "sale". On a revision being filed, the High Court of Andhra Pradesh affirmed the view of the tribunal and dismissed the Tax Case (Revision) filed by the Revenue. Grieved by the decision of the High Court, the State of Andhra Pradesh moved the Apex Court which in turn overruled the decision of the HC. After the pronouncement in the said case, the State Government called upon the petitioner to submit returns treating the transaction as sale. Similarly, in some other States, proceedings were initiated proposing to reopen the assessments that had already been closed treating the transaction as sale. The said situation compelled the petitioner to prefer the petition under Article 32 of the Constitution. As far as others are concerned, they have preferred the writ petitions or appeals by special leave either challenging the show cause notices or assessment orders passed by the assessing officers or affirmation thereof or against the interim orders passed by the High Court requiring the assessee to deposit certain sum against the demanded amount. That apart, in certain cases, appeals have been preferred assailing the original assessment orders or affirmation thereof on the basis of the judgment in Kone Elevators.

Before the Bench, the senior counsel for the assessee submitted that prior to the decision of this Court in Bharat Sanchar Nigam Ltd. and another v. Union of India and others 2006-TIOL-15-SC-CT-LB, which has been further explained in Larsen and Toubro Limited and another v. State of Karnataka and another 2013-TIOL-46-SC-CT-LB, the law as understood was (a) where a contract was divisible by itself, then the element of sale would be taxed as an ordinary sale of goods, irrespective of the element of service; (b) where a contract was for the supply of goods, and for rendition of services, if the pre-dominant intention of the parties was to supply goods, the element of service would be ignored and the entirety of the contract consideration would be treated as the price of goods supplied and the tax imposed accordingly; and (c) as the law did not provide for dividing, by a legal fiction, a contract of such a nature into a contract for goods and a contract for services, the goods in which property passed from the contractor to the owner could not be brought to tax under the law of sales tax. It was assiduously urged by Mr. Salve that the "predominant intention test" was no longer relevant and after the decision in Larsen and Toubro, supply and installation of lift cannot be treated to be a contract for sale. It was argued that a lift comprised of components or parts [goods] like lift car, motors, ropes, rails, etc. and each of them had its own identity prior to installation and they are assembled/installed to create the working mechanism called lift. The senior counsel contended that the installation of these components/parts with immense skill is rendition of service, for without installation in the building, there was no lift.

Having heard the counsels the Bench held that, Majority View++ having dealt with the submissions advanced by the counsel for various States and the Additional Solicitor General for the Union of India, we shall presently proceed to deal with the correctness of the legal position as stated in Kone Elevators case. In the said case, a three-Judge Bench took note of the submissions on behalf of the Department that the main object of the contract in question was to sell the lifts and the works done by the assessee for installation was incidental to the sale of lifts. It had also taken note of the submission that the legislature has classified the commodity "lift" under Entry 82 of the First Schedule to the Andhra Pradesh General Sales Tax Act, 1957 keeping in mind that the word "installation" was ancillary to the "sale" of lifts. The Court, while dealing with the differentiation between "contract for sale" and "works contract", opined thus: -

"5. It can be treated as well settled that there is no standard formula by which one can distinguish a "contract for sale" from a "works contract". The question is largely one of fact depending upon the terms of the contract including the nature of the obligations to be discharged thereunder and the surrounding circumstances. If the intention is to transfer for a price a chattel in which the transferee had no previous property, then the contract is a contract for sale. Ultimately, the true effect of an accretion made pursuant to a contract has to be judged not by artificial rules but from the intention of the parties to the contract. In a "contract of sale", the main object is the transfer of property and delivery of possession of the property, whereas the main object in a "contract for work" is not the transfer of the property but it is one for work and labour. Another test often to be applied is: when and how the property of the dealer in such a transaction passes to the customer: is it by transfer at the time of delivery of the finished article as a chattel or by accession during the procession of work on fusion to the movable property of the customer? If it is the former, it is a "sale"; if it is the latter, it is a "works contract". Therefore, in judging whether the contract is for a "sale" or for "work and labour", the essence of the contract or the reality of the transaction as a whole has to be taken into consideration. The predominant object of the contract, the circumstances of the case and the custom of the trade provide a guide in deciding whether transaction is a "sale" or a "works contract". Essentially, the question is of interpretation of the "contract". It is settled law that the substance and not the form of the contract is material in determining the nature of transaction. No definite rule can be formulated to determine the question as to whether a particular given contract is a contract for sale of goods or is a works contract. Ultimately, the terms of a given contract would be determinative of the nature of the transaction, whether it is a "sale" or a "works contract". Therefore, this question has to be ascertained on facts of each case, on proper construction of terms and conditions of the contract between the parties."

++ after so stating, the three-Judge Bench adverted to the definitions in the State Act, referred to the decision in Gannon Dunkerley-I, placed reliance on the decision in Hindustan Shipyard Ltd. and, analyzing the principle stated therein, observed thus: -

"9. In the case of Hindustan Shipyard Ltd. v. State of A.P. this Court held that if the thing to be delivered has any individual existence before the delivery as the sole property of the party who is to deliver it, then it is a sale. If the bulk of material used in construction belongs to the manufacturer who sells the end product for a price, then it is a strong pointer to the conclusion that the contract is in substance one for the sale of goods and not one for labour. However, the test is not decisive. It is not the bulk of the material alone but the relative importance of the material qua the work, skill and labour of the payee which also has to be seen. If the major component of the end product is the material consumed in producing the chattel to be delivered and skill and labour are employed for converting the main components into the end products, the skill and labour are only incidentally used, the delivery of the end product by the seller to the buyer would constitute a sale. On the other hand, if the main object of the contract is to avail the skill and labour of the seller though some material or components may be incidentally used during the process of the end product being brought into existence by the investment of skill and labour of the supplier, the transaction would be a contract for work and labour."

++ applying the above test, the Judges referred to the terms of the contract and took note of the fact that the entire onus of preparation and making ready of the site for installation of lift was on the customer. It was agreed that under no circumstances would the assessee undertake installation of lift if the site was not kept ready by the customer inasmuch as under clause 4(g) of the "Customers Contractual Obligations", the assessee reserved the right to charge the customer for delay in providing the required facilities. The Court observed that these facts clearly indicated that the assessee divided the execution of the contract into two parts, namely, "the work" to be initially done in accordance with the specifications laid down by the assessee and "the supply" of lift by the assessee. "The work" part in the contract was assigned to the customer and "the supply" part was assigned to the assessee and the said "supply" part included installation of lift. Therefore, the learned Judges further observed that the contractual obligation of the assessee was only to supply and install the lift, while the customer s obligation was to undertake the work connected in keeping the site ready for installation as per the drawings. The Court took note of the contractual obligations of the customer and the fact that the assessee undertook exclusive installation of the lifts manufactured and brought to the site in knocked-down state to be assembled by the assessee and ruled that it was clear that the transaction in question was a contract of "sale" and not a "works contract". The Court perused the brochure of the assessee Company and noticed that the assessee was in the business of manufacturing of various types of lifts, namely, passenger lifts, freight elevators, transport elevators and scenic lifts and a combined study of the above models, mentioned in the brochure, indicated that the assessee had been exhibiting various models of lifts for sale and the said lifts were being sold in various colours with various capacities and variable voltage. From the further analysis, it is manifest that the Court took into account the fact that it was open for a prospective buyer to place purchase order for supply of lifts as per his convenience and choice and ruled that the assessee, on facts, satisfied the twin requirements to attract the charge of tax under the 1957 Act, namely, that it carried on business of selling the lifts and elevators and it had sold the lifts and elevators during the relevant period in the course of its business. To strengthen the conclusion, it has been held that the major component of the end product is the material consumed in producing the lift to be delivered and the skill and labour employed for converting the main components into the end product are only incidentally used;++ from the aforesaid decision, it is perceptible that the three-Judge Bench has drawn distinction between the contract for sale and works contract and, in that context, the essence of the contract or reality of the transaction as a whole, regard being had to the predominant object of the contract, the circumstances of the case and the custom of the trade have been taken into consideration. In that context, the learned Judges have opined that it is not the bulk of the material alone but the relevant importance of the material qua the work, skill and labour of the payee which also has to be seen and if the major component of the end product is the material consumed in producing the chattel to be delivered and skill and labour are employed for converting the main components into the end product, the skill and labour are only incidentally used and the delivery of the end product by the seller to the buyer would constitute a sale. On the aforesaid principle, the three-Judge Bench has finally ruled that a dealer carries on business of selling lifts and elevators and the major component of the end product is the material consumed in producing the lift to be delivered and the skill and labour employed for converting the main components into the end product are incidentally used and, therefore, the delivery of the end product by the assessee qua the customer has to be constituted as a sale and not a works contract;++ to understand the reasons ascribed in the said decision, it is requisite to appreciate the principle relating to the overwhelming component test or major component test. We have already referred to the decision in Bharat Sanchar wherein it has been clearly stated that the dominant nature test has no application. The said principle has been reiterated in Larsen and Toubro by stating thus: -

"87. It seems to us (and that is the view taken in some of the decisions) that a contract may involve both a contract of work and labour and a contract of sale of goods. In our opinion, the distinction between contract for sale of goods and contract for work (or service) has almost diminished in the matters of composite contract involving both a contract of work/labour and a contract for sale for the purposes of Article 366(29-A)(b). Now by legal fiction under Article 366(29-A)(b), it is permissible to make such contract divisible by separating the transfer of property in goods as goods or in some other form from the contract of work and labour. A transfer of property in goods under clause (29-A) (b) of Article 366 is deemed to be a sale of goods involved in the execution of a works contract by the person making the transfer and the purchase of those goods by the person to whom such transfer is made. For this reason, the traditional decisions which hold that the substance of the contract must be seen have lost their significance. What was viewed traditionally has to be now understood in light of the philosophy of Article 366(29-A)." xxx xxx xxx "97.5. A contract may involve both a contract of work and labour and a contract for sale. In such composite contract, the distinction between contract for sale of goods and contract for work (or service) is virtually diminished.

97.6. The dominant nature test has no application and the traditional decisions which have held that the substance of the contract must be seen have lost their significance where transactions are of the nature contemplated in Article 366(29-A). Even if the dominant intention of the contract is not to transfer the property in goods and rather it is rendering of service or the ultimate transaction is transfer of immovable property, then also it is open to the States to levy sales tax on the materials used in such contract if such contract otherwise has elements of works contract. The enforceability test is also not determinative."

++ it is also necessary to state here that in Larsen and Toubro, the question arose whether taxing of sale of goods in an agreement for sale of flat which is to be constructed by the developer-promoter is permissible under the Constitution. The three-Judge Bench opined that though the ultimate transaction between the parties may be sale of the flat, yet it cannot be said that the characteristics of works contract are not involved in that transaction because the term "works contract" is nothing but a contract in which one of the parties is obliged to undertake or to execute the work and such an activity of construction bears all the characteristics and elements of works contract. In that context, in paragraph 107 of the decision, reliance was placed on Builders Association (supra) wherein the contention that a flat is sold as a flat and not as an aggregate of its component parts was negated on the ground that the properties that were transferred to the owner in the execution of the works contract are not goods involved in the execution of the works contract, but a conglomerate, that is, the entire building which is actually constructed;++ the aforesaid analysis has to be understood on the anvil of Article 366 (29A) of the Constitution. In this regard, we may fruitfully reproduce a passage from Builders Association case: -

"& After the 46th Amendment the works contract which was an indivisible one is by a legal fiction altered into a contract which is divisible into one for sale of goods and the other for supply of labour and services. After the 46th Amendment, it has become possible for the States to levy sales tax on the value of goods involved in a works contract in the same way in which the sales tax was leviable on the price of the goods and materials supplied in a building contract which had been entered into in two distinct and separate parts as stated above."

++ explaining the said passage, the Constitution Bench, in Gannon Dunkerley-II (supra), has opined thus:-

"This would mean that as a result of the Fortysixth Amendment, the contract which was single and indivisible has been altered by a legal fiction into a contract which is divisible into one for sale of goods and other for supply of labour and services and as a result such a contract which was single and indivisible has been brought on a par with a contract containing two separate agreements."

++ it has been further observed therein as follows: -

"36. If the legal fiction introduced by Article 366(29-A)(b) is carried to its logical end it follows that even in a single and indivisible works contract there is a deemed sale of the goods which are involved in the execution of a works contract. Such a deemed sale has all the incidents of a sale of goods involved in the execution of a works contract where the contract is divisible into one for sale of goods and the other for supply of labour and services."

++ considered on the touchstone of the aforesaid two Constitution Bench decisions, we are of the convinced opinion that the principles stated in Larsen and Toubro (supra) as reproduced by us hereinabove, do correctly enunciate the legal position. Therefore, "the dominant nature test" or "overwhelming component test" or "the degree of labour and service test" are really not applicable. If the contract is a composite one which falls under the definition of works contracts as engrafted under clause (29A)(b) of Article 366 of the Constitution, the incidental part as regards labour and service pales into total insignificance for the purpose of determining the nature of the contract;

++ coming back to Kone Elevators, it is perceivable that the three-Judge Bench has referred to the statutory provisions of the 1957 Act and thereafter referred to the decision in Hindustan Shipyard Ltd., and has further taken note of the customers obligation to do the civil construction and the time schedule for delivery and thereafter proceeded to state about the major component facet and how the skill and labour employed for converting the main components into the end product was only incidental and arrived at the conclusion that it was a contract for sale. The principal logic applied, i.e., the incidental facet of labour and service, according to us, is not correct. It may be noted here that in all the cases that have been brought before us, there is a composite contract for the purchase and installation of the lift. The price quoted is a composite one for both. As has been held by the High Court of Bombay in Otis Elevator (supra), various technical aspects go into the installation of the lift. There has to be a safety device. In certain States, it is controlled by the legislative enactment and the rules. In certain States, it is not, but the fact remains that a lift is installed on certain norms and parameters keeping in view numerous factors. The installation requires considerable skill and experience. The labour and service element is obvious. What has been taken note of in Kone Elevators (supra) is that the company had brochures for various types of lifts and one is required to place order, regard being had to the building, and also make certain preparatory work. But it is not in dispute that the preparatory work has to be done taking into consideration as to how the lift is going to be attached to the building. The nature of the contracts clearly exposit that they are contracts for supply and installation of the lift where labour and service element is involved. Individually manufactured goods such as lift car, motors, ropes, rails, etc. are the components of the lift which are eventually installed at the site for the lift to operate in the building. In constitutional terms, it is transfer either in goods or some other form. In fact, after the goods are assembled and installed with skill and labour at the site, it becomes a permanent fixture of the building. Involvement of the skill has been elaborately dealt with by the High Court of Bombay in Otis Elevator (supra) and the factual position is undisputable and irrespective of whether installation is regulated by statutory law or not, the result would be the same. We may hasten to add that this position is stated in respect of a composite contract which requires the contractor to install a lift in a building. It is necessary to state here that if there are two contracts, namely, purchase of the components of the lift from a dealer, it would be a contract for sale and similarly, if separate contract is entered into for installation, that would be a contract for labour and service. But, a pregnant one, once there is a composite contract for supply and installation, it has to be treated as a works contract, for it is not a sale of goods/chattel simpliciter. It is not chattel sold as chattel or, for that matter, a chattel being attached to another chattel. Therefore, it would not be appropriate to term it as a contract for sale on the bedrock that the components are brought to the site, i.e., building, and prepared for delivery. The conclusion, as has been reached in Kone Elevators (supra), is based on the bedrock of incidental service for delivery. It would not be legally correct to make such a distinction in respect of lift, for the contract itself profoundly speaks of obligation to supply goods and materials as well as installation of the lift which obviously conveys performance of labour and service. Hence, the fundamental characteristics of works contract are satisfied. Thus analysed, we conclude and hold that the decision rendered in Kone Elevators 2005-TIOL-30-SC-CT-LB does not correctly lay down the law and it is, accordingly, overruled;

++ ordinarily, after so stating, we would have directed the matter to be listed before the appropriate Division Bench. However, it is not necessary to do so in this batch of cases inasmuch as the writ petitions have been filed either against the show-cause notices where cases have been reopened or against the orders of assessment framed by the assessing officers and civil appeals filed against certain assessment orders or affirmation thereof which are based on the decision of the three-Judge Bench in Kone Elevators case. Considering the factual matrix, we direct that the show-cause notices, which have been issued by taking recourse to reopening of assessment, shall stand quashed. The assessment orders which have been framed and are under assail before this Court are set aside. It is necessary to state here that where the assessments have been framed and have attained finality and are not pending in appeal, they shall be treated to have been closed, and where the assessments are challenged in appeal or revision, the same shall be decided in accordance with the decision rendered by us.

Minority View by Justice Fakkir Mohamed Ibrahim Kalifulla

++ even after the 46th Amendment, if Article 366 (29A)(b) is to be invoked, as a necessary concomitant, it must be shown that the terms of the contract would lead to a conclusion that it is a 'Works Contract'. In other words, unless a contract is proved to be a 'Works Contract' by virtue of the terms agreed as between the parties, invocation of Article 366 (29A)(b) of the Constitution, cannot be made. Alternatively, if the terms of the contract disclose or lead to a definite conclusion that it is not a 'Works Contract', but one of outright sale, the same will have to be declared as a 'Sale' attracting the provisions of the relevant sales tax enactments. Therefore, based on the conclusions arrived at and having applied the above principles to the case on hand, and having regard to the nature of the terms of the contract displayed, it will have to be held that the manufacture, supply and installation of LIFTS/ELEVATORS comes under the definition of 'Sale' and not 'Works Contract' and the decision in Kone Elevators (India) Pvt. Ltd. has been correctly decided. 

(See 2014-TIOL-57-SC-CT-CB)