OCTOBER 21, 2014

By Abhijit Saha, Director (Indirect Tax), BDO India

IN State of AP v Kone Elevators - 2005-TIOL-30-SC-CT-LB a three member bench of the Supreme Court observed that 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. In view 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, it is clear that the transaction in question was a contract of 'sale' and not a 'works-contract'.

It was also 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 was only incidentally used and, therefore, the delivery of the end-product by the assessee to the customer constituted a 'sale' and not a 'works-contract'. This judgement was delivered in 2005.

The issue was referred to a Constitution Bench of Five Judges.The Constitution Bench (Five Member Bench) delivered its landmark judgement in 2014 reversing the decision of the three member bench decision made in 2005 (after a lapse of ten years) and held that it is a works contract and not a contract for sale. - 2014-TIOL-57-SC-CT-CB

Four judges subscribed to a majority judgement while another judge gave a dissenting judgement. The Majority of four judges held that "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. 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.

It was concluded that the decision rendered in Kone Elevators by the three-judge bench does not correctly lay down the law and it is, accordingly, overruled.

Now the question which needs to be addressed is:

++ What happens when a judgement of a three-member bench of the Supreme Court is overruled by a bench of five judges? Does the new judgement get retrospective effect? After all, the five judge bench is only clarifying the law and so perhaps has the effect from the beginning of law itself, but if I have been following the law as laid down by three hon'ble judges of the highest court in the country, can I be stuck with a liability because after ten years a larger bench of five judges feels that the three judges did not interpret the law correctly?

++ What is the valuation methodology for excise duty; works contract service tax and works contract VAT?

Author's View:

As per author's view, there has to be an application of the Doctrine of Promissory Estoppel in respect of the retrospective effect of the decision of the court. Tax payer cannot be subjected to incremental liability because of the mistake of the Court of Law. If a Larger Bench decision of the Supreme Court has been overruled by a Constitutional Bench of the Supreme Court, the net effect is that the decision of the Larger Bench of the Supreme Court was wrong. Can the tax payer suffer for the wrong decision of the Larger Bench of the Supreme Court? The Doctrine of Natural Justice and Equity demands that the tax payer should not be liable to any incremental liability because of the wrong decision of the Larger Bench of the Supreme Court which has been overruled by the Constitutional bench of the Supreme Court.

The applicability of the provision of Article 141 of the Constitution of India (which states that the decision of the Supreme Court is the law of the country) has to be revisited to define as to which decision of the Supreme Court is the law of the country? Division Bench or Larger Bench or the Constitutional Bench decision of the Supreme Court? Accordingly the enforceability of the said decision has to be determined in the light of the Doctrine of Promissory Estoppel.