The expanding scope of taxation of services has raised pertinent issues regarding taxation of transactions which may involve element of services along with supply of goods. There may be contract for work involving use of materials in the performance of the work or rendering of services.

The powers of taxation by the Central Government and the States are defined under the Constitution of India. While States are enabled to levy tax on the sale or purchase of goods under entry 54 of the List II of the Seventh Schedule to the Constitution, the Central Government has assumed powers to tax services under residuary entry 97 of List I of the Seventh Schedule. With these powers in mind the State legislatures as well as the Central Government have incorporated safeguards in their respective legislations to refrain from encroaching upon domain of each other. However, at times the distinction between ‘goods’ and ‘services’ is obliterated thus resulting in multiple taxation of the same transaction.

The State sales tax enactments provide for exclusion of any service incidental or anciliary to sales from charge of sales tax. In most States, definition of ‘sale price’ allow for deduction of the charges for installation, commissioning, insurance and freight and forwarding in relation to the sale, provided the same are separately charged or recovered.

Similarly, in the respect of entire and indivisible works contracts, the Supreme Court in the case of Gannon Dunkerley & Co. Ltd. vs. State of Rajasthan (1993 – 88 Sales Tax Cases, page 204) has held that States are empowered to levy tax only on the goods and materials supplied in the execution of the work and not on services. According to the Supreme Court, the value of the goods involved in the execution of a works contract will have to be determined by taking into account the value of the entire works contract and deducting therefrom the charges towards labour and services which would cover; (a) labour charges for execution of the works; (b) amount paid to a sub-contractor for labour and services; (c) charges for planning, designing and architect’s fees; (d) charges for obtaining on hire or otherwise machinery and tools used for the execution of the works contract; (e) cost of consumables such as water, electricity, fuel, etc., used in the execution of the works contract the property in which is not transferred in the course of execution of a works contract; (f) cost of establishment of the contractor to the extent it is relatable to supply of labour and services; (g) other similar expenses relatable to supply of labour and services; (h) profit earned by the contractor to the extent it is relatable to supply of labour and services. The sales tax enactments of most States also provide for excluding the consideration for the above while determining the turnover exigible to sales tax.

As a corollary, the service tax provisions also provide for excluding the consideration for goods from charge of service tax in terms of section 67. Also, vide Notification No. 12/2003-ST dated 20-6-2003, the value of the goods and materials sold to the recipient of services is exempt subject to the condition that there is documentary proof indicating the value of the goods and materials.

The above provisions may be applied with clarity in the case of sales simplicitor, for example, sale of machinery where the incidental services are installation and commissioning, insurance, freight and forwarding, etc. While the consideration for sale of machinery would be exigible to sales tax, there would be liability for payment of service tax on the incidental services.

However, the application of these provisions in the case of contracts for work involving supply of services and use of materials is fraught with complications and uncertainties. The Supreme Court, in the case of Government of Andhra Pradesh vs. Guntur Tobaccos Ltd. (1965 – 16 Sales Tax Cases, page 240) has identified three forms of contract for work in the execution of which goods are used. The contract may be for work to be done for remuneration and for supply of materials used in the execution of the works for a price; it may be a contract for work in which the use of materials is accessory or incidental to the execution of the work; or it may be a contract for work and use or supply of materials though not accessory to the execution of the contract is voluntary or gratuitous. According to the Supreme Court, in the last class there is no sale because though property passes it does not pass for a price. Whether a contract is of the first or the second class depends upon the circumstances; if it is of the first, it is a composite contract for work and sale of goods; where it is of the second category, it is a contract for execution of work not involving sale of goods.

In the third form of contract, the supply of goods and materials being gratuitous, there will be no liability for payment of sales tax though the transaction will be subject to service tax. The first class of contracts involving supply of materials and rendering of services will be subjected to sales tax to the extent of the price of the materials and to service tax on the remuneration for the services to be rendered. However, it will be essential to segregate the price for the supply of goods and rendering of services and to establish the same with documentary evidence. In the second class of contracts where the use of materials is accessory or incidental to the execution of the work, usually no segregation of the price towards materials and services is possible thus leading to liability for both sales tax as well as service tax, for example, annual maintenance contracts, construction service, photography, telephone services, etc.

So is double taxation possible?

The Supreme Court has approved the ‘aspect theory’ of taxation for the purpose of levy of sales tax and service tax on the same transaction. In the case of State of Uttar Pradesh vs. Union of India (DoT) (2003 – 130 Sales Tax Cases, page 1) the Supreme Court has held that it is possible, an activity may be service for purposes of one Act and sale for purposes of another Act. It may also be that in a given case, on the facts of that case, a particular activity can be treated as "service" but in a different fact-situation the same could be sale under the same statute. In respect of levy of service tax and sales tax telephone services, the Supreme Court observed "It was in 1994 that service tax was levied for the first time as per chapter V of the Finance Act, 1994. Section 66 thereof created charge of service tax in regard to taxable services. "Service tax" is defined in clause (34) of section 65 to mean tax chargeable under the provisions of that chapter. "Taxable service" is defined [under sub-clause (b) of clause (41) of section 65] to mean any service provided to, inter alia, a subscriber by the telegraph authority in relation to a telephone connection. No provision of the U.P. Act or the said Finance Act, 1994 or the Constitution of India is brought to our notice to hold that rentals collected by the DoT from the subscriber cannot be subjected to tax as is done under the U.P. Act. Merely because service tax is imposed by the Parliament under the said Finance Act in respect of telephone connection to a subscriber, is no ground to hold that the State cannot levy tax under the U.P. Act."

On the issue of treating the same transaction as ‘sale’ as well as ‘service’, the Kerala High Court in the case of Escotal Mobile Communications Ltd. vs. Union of India (2002 – 126 Sales Tax Cases, page 475) has observed "In our view, there is conceptual confusion here by not keeping the taxable event in mind. The taxable event for sales tax is the "sale" as understood in section 2(xxi) together with all explanations under the KGST Act. The taxable event for levy of service tax is the "taxable service" as understood within the meaning of section 65(72)(b) of the Finance Act. Mr. Ravindranatha Menon contends that it would be impossible that the same transaction can be treated both as "sale" and as "service". If that were to be done, then the legislation would be bad for the vice of double taxation, in the submission of the learned counsel……The difficulty as apprehended by Mr. Menon is purely chimerical. Every transaction may have different aspects. It is open to a Legislature or more than one Legislatures to impose a tax on that particular "aspect" of the transaction which is within its legislative competence. Doing so is perfectly permissible………… The transaction of selling the SIM card to the subscriber is also a part of the "service" rendered by the service provider to the subscriber. Hence, while the State Legislature is competent to impose tax on "sale" by a legislation relatable to entry 54 of List II of Seventh Schedule, the tax on the aspect of "services" rendered not being relatable to any entry in the State List, would be within the legislative competence of Parliament under article 248 read with entry 97 of List I of the Seventh Schedule to the Constitution."

The Supreme Court in its recent decision in the case of Tamil Nadu Kalyana Mandapam Association vs. Union of India (2004 – 267 Income Tax Reports, page 9) has, in respect of tax on catering services, held that levy of service tax on catering services does not amount to tax on sale and purchase of goods. In respect of Article 366(29A)(f), the Supreme Court held that it only permits States to impose a tax on the supply of food and drink by whatever mode it may be made. It does not conceptually or otherwise include the supply of services within the definition of sale and purchase of goods. This is apparent from the phrase in the sub-article, namely "such transfer, delivery or supply of any goods shall be deemed to be a sale of those goods." In other words, the operative words in the said sub-article are supply of goods and it is only supply of food and drinks and other articles of human consumption that is deemed to be a sale or purchase of goods. The concept of catering admittedly includes the concept of rendering service. The fact that tax on the sale of the goods involved in the said service can be levied does not mean that service tax cannot be levied on the service aspect of catering.

Wide meaning of the term ‘goods’

The difficulty is compounded by the wide meaning of the term "goods". The term "goods" is defined in Article 366(12) of the Constitution of India as "all materials, commodities and articles", which includes both tangible and intangible/incorporeal property which is capable of abstraction, consumption and use and which can be transmitted, transferred, delivered, stored, possessed etc. In view of this definition, a transaction may meet with the definition of ‘goods’ under the sales tax laws while retaining its ‘service’ character. The Supreme Court in the case of DoT (supra) has held that telephone connection and all other accessories which give access to the telephone exchange with or without instruments are "goods". At the same time, it has held that when the DoT provides a telephone to a subscriber, it installs instrument, accessories and gives necessary connection which enables him to access the whole system to avail of the service by making out-going calls and receiving incoming calls whether local, STD or ISD and that is compendiously termed as "service".

Similarly, the Supreme Court in the case of Associated Cement Companies Ltd. vs. Commissioner of Customs (2001–128 ELT, page 21/2001–124 STC, 59), while deciding the chargeability of the customs duty on designs imported into India, has observed "It is true that what the appellants had wanted was technical advice or information technology. Payment was to be made for this intangible asset. But the moment the information or advice is put on a media, whether paper or diskettes or any other thing, then what is supplied becomes chattel. It is in respect of the drawings, designs, etc. which are received that payment is made to the foreign collaborators. It is these papers or diskettes, etc. containing the technological advice, which are paid for and used. The foreign collaborators part with them in lieu of money. It is, therefore, sold by them as chattel for use by the India importer. The drawings, designs, manuals, etc. so received are goods on which customs duty could be levied." (124 STC, page 77)

This decision has been approved by the Supreme Court in the case of Tata Consultancy Services vs. State of Andhra Pradesh (Civil Appeal No. 2582 of 1998 decided on 5-11-2004). In this case, the Supreme Court has held that software packages are goods though it has not expressed any opinion on unbranded or customized software.

Also, the Bombay High Court in the case of Abdulgafar A. Nadiadwala vs. Asstt. Commissioner of Income Tax (2004 – 188 Current Tax Reporter, page 232) has held that when the assessee had purchased telecasting rights of various decoders and had recorded on beta-cam tape and entered into an agreement with Star TV for transfer of telecasting rights for Asian region for a period of five years, the transaction can conveniently be described as article or thing falling within the sweep of the word ‘goods’ or ‘merchandise’. It was therefore held that the beta-cam tape, which has incorporeal rights, is a ‘goods’ or ‘merchandise’ for the purposes of section 80HHC of the Income-tax Act, 1961.

Transactions taxable under Service Tax as well as under Sales Tax/Works Contract Tax provisions

The following is an illustrative list of transactions which are taxable under both the enactments/provisions.

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