1. State Legislatures and Parliament derive power to levy taxes from the Constitution. Entry 54 of list II of the 7th schedule to the Constitution has authorized the States to levy tax on the transactions of sales or purchases, which reads as under:

   "Taxes on the sale or purchase of goods other than newspaper, subject to the provisions of Entry 92A of list I of 7th schedule".

   Entry 92A of list I of the 7th schedule which deals with the powers vested in Parliament reads as under:

   "Taxes on the sale or purchase of goods other than newspapers where such sale or purchase takes place in the course of interstate trade or commerce".

2. The Supreme Court in the case of State of Madras vs Gannon Dunkerley & Co. (1958) 9 STC 353 held that the expression ‘sale of goods’ as used in the entries in the 7th schedule to the Constitution had the same meaning as in the ‘Sale of Goods Act’. Thus a transaction in order to be subjected to levy of Sales Tax under entry 92A of Union list or entry 54 of State list should have the following ingredients :

   1. parties competent to contract

   2. mutual assent – free volition

   3. Transfer of property in goods from seller to the buyer for a valuable consideration paid or payable; i.e., a sale of chattle qua chattle.

   4. Agreement to transfer the property should be of same thing in which ultimately the property passes.

   Most important ingredient being an agreement to sell movable for a price and property passing therein as movable.

3. In a building contract which is one, entire and indivisible, there is no sale of goods (movable) and hence it is not competent for state legislature to impose tax on the supply of the materials used in the execution of the contract by treating it as a sale, even by giving artificial definition in the enactment. Parties to the contract may enter into distinct and separate contracts, one for the transfer of materials for money consideration and other for payment of remuneration for service and for the work done. In such a case, there are really two agreements, though there is a single instrument embodying them and the power of the state to separate the agreement to sell, from the agreement to do the work and render services and to impose tax thereon cannot be questioned. Thus in a building contract at the time when movables were used in the work there was no passing of property in such movables as movables as such, but property in such movable used in the work passed to the owner of the building or land not as goods but only as an accretion to the building or land. In Works Contract, property in goods does not pass chattel qua chattel but in some other form. Therefore, it is not a sale of the goods and the State Government could not levy tax on transfer of property in goods involved in the execution of works contract.

4. States craving for more and more revenue approached the Centre for getting powers to levy tax on transfer of property in goods in indivisible contract also. Centre on the recommendations of Law Commission introduced a bill for amending the Constitution for that purpose. Parliament passed the Bill as 46th Constitutional Amendment Act in the year 1983.

   The amended definition included inter alia tax on the transfer of property in goods (whether as goods or in some other form) involved in execution of works contract.

5. This amendment permitted State Government to levy tax on the transfer of property in goods involved in execution of works contract.

   In exercise of the powers contained in the Constitution, the State of Maharashtra for the first time enacted a separate law to levy tax on works contract w.e.f. 1-10-1986 which is popularly known as Works Contract Tax Act, 1985. Accordingly tax @4% was leviable on total amount of consideration received by a contractor without deduction of labour charges, architect fees etc. Most of other States also provided in their Acts to levy tax on entire consideration received by contractor.

   As a result of this, various writ petitions were filed before different High Courts which were subsequently transferred to the Supreme Court. In the case of Builders Association of India (73 STC 370) the SC had occasion to decide the Constitutional validity and power of State Government to levy tax on works contract under the amended Constitution.

6. It was held by the Supreme Court in Builders’ Association as under:

   1. Amendment to the Constitution is legal.

   2. As a result of amendment to the Constitution, the state legislatures were competent to levy tax on transfer of property in goods involved in execution of works contract.

   3. This power of levy of tax is subject to restrictions and conditions contained in Article 286 of the Constitution and incorporated in sections 3, 4, 5, 14 and 15 of the CST Act.; i.e., no tax can be levied by states on interstate works contract (WC) or WC in the course of import or export. Levy of tax on declared goods must be at single point and not exceeding 4%, etc.

   4. The State Legislature is not competent to levy tax on entire consideration but only on that part related to transfer of goods involved in execution of works contract.

   5. Thereafter, in the case of Gannon Dunkerley & Co. (88 STC 204), the Supreme Court further explained the decision in the Builders’ case and enumerated the deductions which can be made from the total contract price received by contractors as under:

      1. Labour charges for the execution of the work.

      2. Amounts paid to a sub-contractor for labour and services.

      3. Charges for planning, designing and architect’s fees.

      4. Charges for obtaining on hire the machinery and tools used in the execution of the works contract.

      5. Cost of consumables such as water, electricity, fuel, etc. The property in the goods do not pass during the execution of WC.

      6. Transportation charges for transport of goods to the place of work.

      7. Cost of establishment relatable to supply of labour and services.

      8. Profits earned by the contractor to the extent relatable to supply of labour and services.

      9. The list is not exhaustive but illustrative. Any further amount can also be deducted if it is not received for or related to transfer of property in goods.

      10. Where the contractor has not maintained proper accounts to ascertain the charges deductible as above, legislature is competent to prescribe certain percentage depending on the various types of contracts as deduction from the total value of the contract to arrive at taxable value.

      11. Legislature can fix uniform rate of tax for various goods used in the execution of the contract, which rate maybe different from rates of tax fixed in respect of sales or purchases of those goods as a separate article in the local acts.

   (a) Labour charges for the execution of the work.(b) Amounts paid to a sub-contractor for labour and services.(c) Charges for planning, designing and architect’s fees.(d) Charges for obtaining on hire the machinery and tools used in the execution of the works contract.(e) Cost of consumables such as water, electricity, fuel, etc. The property in the goods do not pass during the execution of WC.(f) Transportation charges for transport of goods to the place of work.(g) Cost of establishment relatable to supply of labour and services.(h) Profits earned by the contractor to the extent relatable to supply of labour and services.(i) The list is not exhaustive but illustrative. Any further amount can also be deducted if it is not received for or related to transfer of property in goods.(j) Where the contractor has not maintained proper accounts to ascertain the charges deductible as above, legislature is competent to prescribe certain percentage depending on the various types of contracts as deduction from the total value of the contract to arrive at taxable value.(k) Legislature can fix uniform rate of tax for various goods used in the execution of the contract, which rate maybe different from rates of tax fixed in respect of sales or purchases of those goods as a separate article in the local acts.

   Thus, the Supreme Court has held that what can be taxed under the Works Contract Tax Act is only the property which passes on during the execution of works contract.

7. Different States have provided different methodologies to meet the above directives. State like Gujarat has provided for a percentage thumb rule in respect of deductions from the contract value from different types of contract. Maharashtra has equated ‘sale price’ with the ‘purchase price’ of the value of the goods in which the property passes during the execution of works contract. Section 6 of the Maharashtra Works Contract Tax Act provides tax payable as under:

   Purchase price of the goods in which the property passes during the execution of works contract

   Less : purchases of declared goods used and passed in the same form

   Balance taxable @15% or

   If the goods manufactured and used in works contract (as per schedule), schedule rate (under the Works Contract Tax Act).

   With this background, some issues on the subject in respect to ‘construction contract’ is discussed hereunder.
    

The property in goods passes obviously from contractor to contractee (owner) not by way of sale but by way of accretion to immovable property like land, building or by accession to a movable property of the owner or in the process of blending of liquids supplied by the contractee (owner).

The passing of property should be during the course of execution of the contract. This is very important. The Supreme Court has held that property in such goods passes as and when materials are used. The taxable event takes place at the time of use. Sale is complete at that event of accretion, accession or blending and not at the end of the contract or on bringing of the goods on site. Bills maybe raised when materials are brought on site or by stages, which has nothing to do with passing of property in goods. Any condition in the contract about passing of property contrary to law will be of no consequence. General Law will prevail. Thus in the case of running contracts only price attributable to use of materials for a year of assessment will be liable to tax.
 

Divisible vs indivisible contract
A contract is subject to conditions and understanding between the parties to the contract. Therefore, if the parties to the contract desire to transfer the property by way of ‘sale’ simpliciter and also provide for separate contract for rendering services, the first contract will be covered by the Sale of Goods Act and accordingly governed by provisions of the sales tax law (The Bombay Sales Tax Act in the State of Maharashtra). Such contracts are termed as divisible contract. However, if the contract is a composite one, requiring supply of goods as well as for work and labour, the contract is a indivisible contract exigible to tax as works contract.
 

Composition scheme
Supreme Court in case of Gannon Dunkerley (cited supra) has given guidelines and interpreted the framework under which the state can levy tax on works contract. It is practically difficult, at times, to arrive at the ‘sale price’ after claiming various deductions from the ‘contract price’ as provided by the Supreme Court (Refer to paragraph No. 1.6 above). Therefore, states have provided for composition scheme where under an amount in lieu of sales tax is charged as a lump sum on the contract value. This is purely an optional scheme available to the contractor and the same have been constitutionally held valid by various courts.

Different States provide for composition rates between 2% and 5% of contract value. Maharashtra has provided two composition schemes,

1. 4% of the contract value or

2. 8% of (contract value minus purchases from registered dealer in the State of Maharashtra). 

It maybe once again highlighted here that the labour contracts involving no transfer of property does not come under the purview of works contract tax.
 

Tax liability of contractor
The contractor has two types of liability under the sales tax laws.

1. Purchase tax on purchases from unregistered dealer and used in execution of works contract and sales tax on sale of scrap and unserviceable materials.

2. Works contract tax on the execution of works contract as discussed above.

The contractors also take on hire construction machinery like road roller, concrete mixing machine, cranes, dumper trucks etc. On such machineries taken on hire the contractors are liable to pay lease tax (if applicable) on their contracts of hire. It maybe noted here that such contracts of hire, where the control and possession of these equipments rests with the owner of such equipments, no lease tax is payable. The phrase ‘control and possession’ is referred herein connotes eg. in case of crane, the operator of the crane hiring company operates the crane and effective possession is not parted by the hiring company.
 

Developer – Contractor – Flat purchase
Typically, developer appoints contractors for construction of building and thereafter sells flats/premises to the customers. In such a situation developer gets the construction done through the contractor and sells immovable property to the customer. Therefore, the developer is not liable to any tax on his sales. At the same time, he does not purchase any building material in his name and accordingly not liable for any tax on the purchase side. The developer actually pays works contract tax when the same is charged by the contractor in his running bills.

2. Extra work
   At times the flat purchaser enters into another agreement with the developer whereunder he agrees for additional work (amenities) to be carried out by the developer at a price. In such a situation the developer becomes the principal contractor to this extent and if he gets the work done through his contractor, the contractor becomes the sub-contractor working under the developer. Here, the developer is liable for registration as well as payment of tax under the Works Contract Tax Act.
    

The term ‘construction contract’ defined by the State of Maharashtra by a notification dt. 8-3-2000 (Ref: WCA-25.00/C.R.-39/Taxation-1) gives some idea as to what could be covered under the term ‘construction contract’.

1. "Contracts for construction of.—
   (1) Buildings, (2) Road, (3) Runways, (4) Bridges, Flyover bridges, Railway overbridges, (5) Dams, (6) Tunnels, (7) Canals, (8) Barrages, (9) Diversions, (10) Railtracts, (11) Causeways, Subways, Spillways, (12) Water Supply schemes, (13) Sewerage works, (14) Drainage works, (15) Swimming pools, (16) Water purification plants.

2. Any contract incidental or ancillary to the contracts mentioned in paragraph A above, if such contracts are awarded and executed before the completion of the said contracts mentioned in A above."
   A turnkey contract for construction and installation of plant can also be termed as ‘construction contract’. The High Court of Allahabad had taken such a view while interpretation of the term civil contract for rate of composition to be applied to a turnkey project.
   (Refer Purolator India Ltd. 105:STC:373).
    

The TDS is to be deducted at the time of payment (not on providing for the same). The TDS provisions are applicable to the employers of contract (awarder of contract) of the following class,

1. Central and State Governments

2. An industrial, commercial and trading undertaking, company, State and Central corporation.

3. Local authority

4. Co-operative society

5. Registered dealer under the BST Act

6. Insurance or financial corporation/company, banks etc.

It maybe noted that works contract TDS provision is not applicable on payments made such as advance, mobilisation amount, machinery advance etc. TDS on this is to be deducted only when this advance is adjusted against any payment made against any bill. The scheme provides for issuance of certificate and claim of credit for TDS cut by the awarder.
 

Interstate Works Contract
The 46th amendment to the Constitution made in the year 1983 enabled the State Governments and the Central Government to levy tax on transaction of works contract and other deemed sale transactions. Majority of the States including the State of Maharashtra enacted the provisions to levy and collect tax on such transactions. However, Central Government did not amend the provisions of the Central Sales Tax Act, 1956 (CST Act) till 11-5-2002. Accordingly, contracts of works wherein the movement of goods has occasioned because of the contractual obligation from one state to another, no CST was payable under the CST Act till 11-5-2002.

The definition of sale under the CST Act is now amended to also include transactions of works contract along with other deemed sales transactions w.e.f. 11-5-2002. Therefore, the contracts which require movement of material from one state to another for execution of contract in the other state will be liable to tax under the CST Act and not under the local act even though the property in the goods has passed in the other State.

It is likely that some material say cement and steel is moved from one State to another and thereafter is used along with other material for execution in the other state. In such a situation, the value of cement and steel so moved from one state to another will be liable to works contract tax under the CST provisions and the balance contract will have to be offered for taxation under the local State Sales Tax Act. The modalities of taxation of ‘interstate’ works contract are still not free from doubt. Various representations have been made on the subject before the State and Central authorities.

2. Issuance of ‘C’ forms
   Before the amendment to the CST Act, courts have taken different view in respect of issuance of declaration in form ‘C’ for concessional rate of interstate purchase used for execution of works contract. However, after the amendment to the CST Act, it can be safely concluded that ‘C’ form can be utilised to make purchases of raw material, consumables and capital assets used for execution of works contract.
    

Taxation of works contract is a very complicated piece of legislation and reams of paper is written on this subject. In this article I have tried to highlight the legislative history and some aspects of taxation in respect of construction contract. Some references have been made to provisions of the Maharashtra Works Contract Tax Act. Inputs and feedback on the subject is welcome.