''THE least initial deviation from the truth is multiplied later a thousandfold that, someday, the deviation becomes the truth!”

- Inspired from the words of Aristotle

Unlike the Central Excise and Customs, the Service tax does not have many Supreme Court judgements in its wallet. Today, most of the Service tax issues are slowly crawling along the courtrooms of CESTAT and it may take some more years for them to enter the corridors of Supreme Court. But the very few Apex court judgements pronounced on Service tax have become landmark decisions, e.g. Laghu Udyog, L.H Sugar, etc. In this piece, let us discuss about a celebrated decision of the Apex Court on the Service tax.

“Daelim” and “vivisection” have become the most popular words in the Service Tax world! Today, be it in any composite or turnkey contracts, these are the buzzwords! That too, in mega turnkey contracts, everybody, from pundits to sundries, takes asylum of this judgement and summarily conclude that there is no service tax payable in respect of “Works contracts”! Is it so? Does the ratio of the Daelim judgement exonerate all composite turnkey contracts from the ambit of Service tax? In other words, whether the “Works contracts”, per se, are not liable to service tax? Let us delve a bit deep.

Before proceeding further, let us first understand the facts, circumstances and the essence of the Daelim decision (2003-TIOL-110-CESTAT-DEL).

Facts: M/s Daelim was awarded a contract for construction of a diesel hydro-desulphurisation plant, way back in a period before 2001 (as the SCN is issued in 2001, the contract shall be on or before 2001). The contract was on lump sum turnkey basis. The lump sum price had an Indian rupee payment of about Rs. 184 crores and an US $ payment of about 2.2 crores. The contract involved various ingredients, such as, residual process design, detailed engineering, procurement, supply, construction, fabrication, erection, installation, testing commissioning and mechanical guarantee.

Allegation: M/s Daelim were demanded to pay service tax on the residual process design and detailed engineering, involved in the commissioning of plant, under the category of “consulting engineers”.

Arguments: The contract was a Works contract and the designs drawing in question were incidental to the execution of such Works contract. Rendering of any consultancy services was not involved at all, in as much as, the drawings were made for their own purpose, for the execution of the Works contract. Separate elements of works were costed individually as per the contract terms only for the purpose of facilitating periodic installment payments.

Decision: The clauses of the contract appear to be a “Works contract” on turnkey basis and not a “Consultancy contract”. It is well settled that a “Works contract” cannot be vivisected and a part of it cannot be subjected to tax.

Ratio: When the composite contract for a lump sum payment is not taxable as a whole then one cannot “vivisect” (vivisection - to cut open a body while still alive) the contract into components and tax a particular component.

Inference: It is not that all the works contracts, per se, are not taxable but if the main contract is not taxable, then one cannot split such contract and tax a particular component of it.

The Apex Court affirmed the above judgement stating, “We see no reason to interfere. The Special Leave Petition is dismissed” (2004-TIOL-66-SC-ST). With the above decision being affirmed by the Hon’ble Supreme Court, all lower fora dismissed the “vivisected” allegations of the Revenue.

From the Daelim decision the following relevant points are evident, namely,

++ The main contract was a Works contract on turnkey basis, which was not taxable, per se.

++ It was a composite contract for a lump sum payment. The break-up of prices was for the billing schedule, which was used for release for progressive payments.

The reasoning of the Hon’ble Tribunal in the Daelim case was based on the above important facts. As stated above, the Daelim issue was pertaining to a period on or before 2001, whereas, the service tax on the Erection, Commissioning and Installation (ECI) services and the Construction services, were levied only from 2003 and 2004, respectively. In other words, neither the ECI services nor the Construction Services were taxable services at the relevant period of the Daelim issue. Most of the mega turnkey projects are either ECI or construction contracts and, as on date, both of them are taxable services. Thus, today, there may not be a relevant application of the Daelim ratio to the composite / turnkey contracts of either ECI or construction services. In other words, today, as the ECI and the Construction services are taxable services, there is no requirement of any “vivisection” of the composite contracts and hence the application of the Daelim ratio may not be appropriate.

Further, as it could be seen from the Daelim’s case, it was a lump sum payment contract and only for release of progressive payments, the billing was made separately for the individual elements like, completion of residual engineering, design etc. In other words, the terms of release of payment was based on the stages of completion of the different stages of work. This is a prevailing commercial practice and also called as rising of “running bills”. Thus the contract in the Daelim’s case was a only a composite lump sum contract and the split payments received on the individual elements of the work shall not alter the nature of the contract. But there are other contracts, which are not for a lump sum payment, but are individually priced. There may be a contract in which there is a scope for supply of materials and also provision of different services. For example, if in a Works contract, there is a lump sum price of Rs. X for the supply of materials, Rs. Y for the residual design and detailed engineering and Rs. Z for the Construction or ECI portion separately, what would be the status of such contracts? Are they taxable or not? It could be seen that, there is no requirement of any “vivisection” in such case as the individual services are themselves self-identified and separately priced in the contracts. For the reasons discussed above, it appears that the Daelim ratio shall not be applicable to the above example. But in a very interesting case, following the Daelim ratio, the Hon’ble Tribunal has held otherwise {Ref: CCE, Vadodara vs M/s Larsen & Toubro Ltd & M/s Petrofac International Ltd (2006-TIOL-490-CESTAT-MUM).

Before parting…

To us, the above case is a repeat of the historic Wimbledon finals in 1980. In the marathon duel, if the Counsel for the appellants has played like the legendary Bjorn Borg, the SDR Mr. Ajay Saxena has played like the effervescent John McEnroe. Maybe, Mc lost the 1980 finals. But in 1981, it was all Mc! The Hon’ble Supreme Court has already admitted the department appeal in a similar case {2005 (182) E.L.T. A149 (S.C.)}. So, dear department, all the best!