By TIOL News Service

NEW DELHI, FEB 01, 2015: CONSTITUTIONAL validity of Entry 25 of Schedule VI to the Karnataka Sales Tax Act, 1957 is the subject matter in this appeal. This entry was inserted in the said Act by an amendment which came into effect from 01.07.1989, thereby providing levy of tax for processing and supply of photographs, photo prints and photo negatives . The Karnataka High Court in the M/s Keshoram Surindranath Photo - Bag (P) Ltd case declared the said Entry to be unconstitutional. State of Karnataka had challenged that judgment in the Supreme Court. The Supreme Court dismissed the SLP vide order dated 20.04.2000, following its earlier judgment in the case of Rainbow Colour Lab and Another v. State of Madhya Pradesh and others - 2002-TIOL-373-SC-CT . The reason for holding Entry 25 as unconstitutional was that the contract of processing and supplying of photographs, photo frames and photo negatives was predominantly a service contract with negligible component of goods/material and, therefore, it was beyond the competence of State Legislature given in Entry 25 of List II of Schedule VII of the Constitution to impose sales tax on such a contract.

It so happened that within one year of the judgment in Rainbow Colour Lab's case, three Judges Bench of the Supreme Court rendered another judgment in the case of ACC Ltd. v. Commissioner of Customs - 2002-TIOL-08-SC-CUS-LB, wherein it expressed its doubts about the correctness of the law laid down in Rainbow. During the course of hearing of the present appeal, there was a hot debate on the question as to whether judgment in Rainbow Colour Lab's case was over-ruled in the case of ACC Ltd . case or not.

After the judgment in ACC Ltd. case, a circular instruction was issued by the Commissioner of Commercial Taxes to the assessing authorities to proceed with the assessments as per Entry 25. This became the subject matter of challenge before the High Court of Karnataka in the case of M/s Golden Colour Labs and Studio and others v. The Commissioner of Commercial Taxes . The High Court allowed the writ petition vide judgment dated 30.07.2003 holding that a provision once declared unconstitutional could not be brought to life by mere administrative instructions. However, at the same time, the Court observed that Entry 25, Schedule VI to the Act, declared ultra vires the Constitution in Keshoram's case, cannot be revived automatically, unless there is re-enactment made by the State Legislature to that effect. Emboldened by this observation, the Karnataka State by enactment dated 29.01.2004 reintroduced the Entry 25 with retrospective effect from 01.07.1989, when this provision was inserted by the amendment made in the year 1989 for the first time. Naturally this amendment was also challenged in the High Court. The High Court again quashed the entry and the determined State of Karnataka is before the Supreme Court.

The issues before the Supreme Court are:

1. Whether the State Government is empowered to levy sales tax on the processing and supplying of photographs which is predominantly in the nature of "service" and the element of "goods" therein was minimal.

2. Is the retrospective valid as subjecting the assessees to such a tax from retrospective effect is confiscatory in nature and, therefore, unconstitutional.

The Supreme Court observed that the issue had been decided by the Supreme Court in several judgements and the present Bench could arrive at a conclusion by following those decisions. The Supreme Court referred to some important judgements:

Gannon Dunkerley and Co. and others v. State of Rajasthan and others - 2002-TIOL-493-SC-CT-LB. (Judgement delivered on 01.04.1958) Question involved was as to whether there could be levy of sales tax on the sale of goods involved in the execution of Works Contracts. The assessee, Gannon Dunkerley, was carrying on business as Engineering Contractors and executing the contracts pertaining to construction of building projects, dams, roads and structural contracts of all kinds. In respect of sanitary contracts, 20 per cent was deducted for labour and balance was taken as a turnover of the assessee for the purposes of levying sales tax by the assessing authority. Likewise, in respect of other contracts, 30 per cent was deducted for labour and on balance amount, sales tax was levied treating it as turnover of the assessee under the Madras General Sales Tax Act, 1939. The question which arose for consideration was as to whether there was any sale of goods. The Constitution Bench held that building contract was in the nature of Works Contract and there was no element of sale of goods in such a contract. In its opinion, in a building contract where the agreement between the parties was that the contractor should construct the building according to the specifications contained in the agreement and in consideration received payment as provided therein, there was neither a contract to sell the materials used in the construction nor the property passed therein as movables. It was held that in a building contract, which was one entire and indivisible, there was no sale of goods and it was not within the competence of the Provincial State Legislature to impose tax on the supply of the materials used in such a contract treating it as a sale. The Court, thus, proceeded on the basis that a building contract was indivisible and composite wherein there was no sale of goods and, therefore, the State Legislature was not competent to impose sales tax on the supply of material used in such a contract treating it as a sale. Since, Entry 48 of the List II of Schedule-VII in the Government of India Act, 1935 was under consideration that empowers State Government to levy tax "sale of goods", the Court held that the expression "sale of goods" in the said Entry is to be given the same meaning as given under the Sale of Goods Act, 1930. That would mean that it would be sale of goods only if the two essential ingredients, namely:

(i) an agreement to sell movables for a price, and

(ii) property passing therein pursuant to that agreement, are satisfied.

The Constitution Amendment : After the above judgement and a series of subsequent judgements, the Parliament amended the Constitution of India by the Constitution (46th Amendment) Act, 1982 which received the assent of the President of India on 02.02.1983. By this amendment, clause (29-A) was inserted in Article 366 of the Constitution, which reads as under:

29A "tax on the sale or purchase of goods" includes -

(a) a tax on the transfer, otherwise than in pursuance of a contract, of property in any goods for cash, deferred payment or other valuable consideration;

(b) a tax on the transfer of property in goods (whether as goods or in some other form) involved in the execution of a works contract;

(c) a tax on the delivery of goods on hire- purchase or any system of payment by instalments;

(d) a tax on the transfer of the right to use any goods for any purpose (whether or not for a specified period) for cash, deferred payment or other valuable consideration;

(e) a tax on the supply of goods by any unincorporated association or body of persons to a member thereof for cash, deferred payment or other valuable consideration;

(f) a tax on the supply, by way of or as part of any service or in any other manner whatsoever, of goods, being food or any other article for human consumption or any drink (whether or not intoxicating), where such supply or service, is for cash, deferred payment or other valuable consideration;

and such transfer, delivery or supply of any goods shall be deemed to be a sale of those goods by the person making the transfer, delivery or supply and a purchase of those goods by the person to whom such transfer, delivery or supply is made;

Builders Association of India and others v. Union of India and others - 2002-TIOL-602-SC-CT. The constitution amendment was challenged in this case. In this judgment, the Constitution Bench specifically noted that the purport and object of the amendment was to enlarge the scope of the expression "tax of sale for purchase of goods" wherever it occurs in the Constitution so that it may include within its ambit any transfer, delivery or supply of goods that may take place under any of the transactions referred to in sub-clauses (a) to (f). With this amendment, the States are empowered to make the Works Contract divisible and tax "sale of goods" component. It clearly follows that the restricted meaning which was assigned to the expression "sale of goods" in Gannon Dunkerley's case is undone by the amendment.

Larsen Toubro and another v. State of Karnataka and another - 2013-TIOL-46-SC-CT-LB, held , "As a result of Clause 29A of Article 366, tax on the sale or purchase of goods may include a tax on the transfer in goods as goods or in a form other than goods involved in the execution of the works contract. It is open to the States to divide the works contract into two separate contracts by legal fiction: (i) contract for sale of goods involved in the works contract and (ii) for supply of labour and service. By the Forty-sixth Amendment, States have been empowered to bifurcate the contract and to levy sales tax on the value of the material in the execution of the works contract.”

In Rainbow Colour Lab & Anr. Vs. State of M.P. and Others - 2002-TIOL-373-SC-CT the Supreme Court held the view that the division of contract after 46th Amendment can be made only if the Works Contract involved a dominant intention to transfer the property in goods and not in contracts where the transfer in property takes place as an incident of contract of service.

ACC Ltd. v. Commissioner of Customs - 2002-TIOL-08-SC-CUS-LB : The Supreme Court held that Gannon Dunkerley was of pre 46th Amendment era which had no relevance after the said Constitutional amendment.

The Supreme Court held that ACC Ltd over ruled Rainbow Colour Lab .

The Supreme Court summed up the issue as:

1. after insertion of clause 29-A in Article 366, the Works Contract which was indivisible one by legal fiction, altered into a contract, is permitted to be bifurcated into two: one for "sale of goods" and other for "services", thereby making goods component of the contract exigible to sales tax.

2. while going into this exercise of divisibility, dominant intention behind such a contract, namely, whether it was for sale of goods or for services, is rendered otiose or immaterial.

3. It follows, as a sequitur, that by virtue of clause 29-A of Article 366, the State Legislature is now empowered to segregate the goods part of the Works Contract and impose sales tax thereupon.

4. Entry 54, List II of the Constitution of India empowers the State Legislature to enact a law taxing sale of goods. Sales tax, being a subject-matter into the State List, the State Legislature has the competency to legislate over the subject.

And so the Supreme Court upheld the controversial entry 25 levying sales tax on processing and supplying of photographs, photo frames and photo negatives.

Retrospective validity : The Supreme Court once again upheld the retrospective legislation. The Supreme Court referred to a 1973 judgement, which held, "a power to legislate includes a power to legislate prospectively as well as retrospectively. In this regard legislative power to impose tax also includes within itself the power to tax retrospectively".

(See 2015-TIOL-08-SC-CT-LB)