FEBRUARY 14, 2017

By Sonal Singh

WHEN the full bench of the Supreme Court in the case Kone Elevator India Pvt. Ltd - 2014-TIOL-57-SC-CT-CB ,while resolving the seminal controversy whether a contract for manufacture, supply and installation of goods is a 'contract for sale of goods' or a 'works contract', discarded the role of 'dominant intention' test by relying upon another full bench decision of the Supreme in the case of Larsen and Toubro Limited - 2013-TIOL-46-SC-CT-LB , one would think that the law is finally settled and that the dominant intention test could be written off for good. However, a closer look at the Model GST Laws and the Constitution Amendment Act, 2016 would reveal that such a conclusion might be rather pre-mature. This article aims at tracing the journey of the dominant intention test with a view to investigate if the same holds any relevance in the GST regime.

Dominant Intention Test-Pre GST

The genesis of the 'dominant intention' test has the celebrated decision of the Supreme Court in the case of Gannon Dunkerley-I - 2002-TIOL-493-SC-CT-LB in the background, wherein it was held that indivisible works contract cannot be subjected to tax under the State Sales Tax laws as it is not within the domain of the assessing authority to artificially dissect such contracts into goods and service constituents. After the said decision of the Apex Court, in various set of circumstances, the assessee and the Courts faced the question whether a particular contract was an indivisible works contract or a contract of sale. The resolution of the dispute at that point of time, needless to mention, was relevant to determine the taxability of the transaction under the state Sales Tax laws. The Supreme Court in the case of M/s Associated Hotels of India Ltd. - 2002-TIOL-65-SC-CT-CB and Hindustan Aeronautics Limited took a view that the distinction depends upon the main object of the parties in the sense that a contract of sale is one whose main object is the transfer of property in, and the delivery of the possession, of a chattel as a chattel to the buyer. Where the principle object of work undertaken by the payee of the price is not the transfer of chattel qua chattel , the contract is one of work and labour.

In order to overcome the decision of the Supreme Court in the case of Gannon Dunkerley-I (supra) , Article 366(29A) was inserted into the Constitution of India vide the Constitution (Forty-sixth Amendment) Act, 1982 as a result of which it was open to the States to segregate works contract into two separate components or contracts by legal fiction, namely contract for sale of goods involved in the works contract and contract for supply of service. Despite the amendment to the Constitution, the question whether a contract for supply and installation of goods is a 'works contract' or a 'contract of sale of goods' continued to be relevant, albeit for a different reason, that in case of former the consideration payable for labour and service would be excluded for levy of sales tax while in the latter the entire sale consideration would be taxable under Sales Tax/VAT laws.

Post the insertion of Article 366(29A), the courts took diverse views on the application of dominant intention test. While in the case of Rainbow Color Lab - 2002-TIOL-373-SC-CT it was held that the division of contract by legal fiction under the amended law 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, in the case of Associated Cement Companies Ltd. - 2002-TIOL-08-SC-CUS-LB the Apex Court opined that the 46th Amendment was made precisely with a view to empower the State to bifurcate the contract and to levy sales tax on the value of the material involved in the execution of the works contract even if the dominant intention of the contract is the rendering of a service. This controversy, however, was fairly settled by the Supreme Court in the case of BSNL - 2006-TIOL-15-SC-CT-LB wherein it was held that after the 46th amendment, the sale element of those contracts which are covered by the six sub-clauses of clause (29A) of Article 366 are separable and may be subjected to sales tax and there is no question of dominant nature test applying.

This view was followed by the Apex Court in the case of Kone Elevators (supra) to hold that once there is a composite contract for supply and installation of goods (lifts in the said case), it has to be treated as works contract notwithstanding the dominant intention of the parties.

Supply and Installation Contracts-Treatment Under GST Regime

At the outset it is worth noting that the significance of the aforementioned decisions holding that dominant intention test is not applicable in respect of transactions covered under Article 366 (29A)of the Constitution of India appears to be prima facie diluted in the Goods and Services Tax ('GST') regime by the very fact that while Article 366 (29A) defines 'tax on sale or purchase of goods', the taxable event under GST is 'supply of goods or of services'.

As regards the Model GST Law, various novel provisions have been inserted by the draftsmen in connection with contracts that involve supply of goods as well as supply of services. First, works contract has been defined under Section 2(110) of the Model GST Law to mean a contract wherein transfer of property in goods is involved in execution of such contract and by virtue of Schedule II to the Model GST Law, the same has been deemed to be in the nature of supply of service.

Secondly, the concept of 'composite supply' has been introduced which means a supply comprising two or more supplies of goods or services, or any combination thereof, which are naturally bundled and supplied in conjunction with each other in the ordinary course of business, one of which is principal supply. Principal supply has been defined to mean the supply which constitutes the pre-dominant element of a composite supply. As per Section 3(5) of the Model GST Law, a composite supply shall be treated as supply of the principal supply forming part of the said composite supply.

Thus, not only has the question of applicability of 'dominant intention test' renewed as a result of change in taxable event, the concept of 'dominant intention' has actually been codified in the form of 'principal supply' under the Model GST Law insofar as composite supplies are concerned.

In the back ground of these provisions the GST implications on supply and installation contracts can be analyzed. If supply and installation contracts, as held by the Supreme Court in the case of Kone Elevators (supra), are to be treated as works contract under the Model GST Law, then such contracts would be service contracts and GST would be levied accordingly. However, interestingly, Section 7 of the Model Integrated GST Act, which provides for the place of supply of goods states that where the goods are assembled or installed at site, the place of supply shall be the place of such installation or assembly.

This throws up a question as to why the provision covering place of supply of goods covers a transaction which being works contract is deemed to be service? Is it because under the Model GST Law the contract for supply and installation is not treated as a works contract i.e. a service at all?Is it that the Model GST Law instead treats the supply-installation contract as composite supply, of which supply of goods part is the pre-dominant supply, thereby making the entire contract as supply of goods? This treatment of a supply and installation contract as goods based on the pre-dominant element would be nothing but a comeback of the dominant intention test in the same form which was laid down by the Apex Court prior to insertion of Article 366(29A) of the Constitution of India and disowned thereafter.

With the dominant intention test making a recall, various goods versus service classification disputes can be anticipated even in the GST regime despite the effort of the draftsmen to minimize such disputes by deeming various contentious transactions of the present regime as goods or services.

[The author is a Principal Associate in Lakshmi kumaran & Sridharan and the views expressed are personal]