Works Contract and Medical Prosthetics under Taxation Law
JULY 08, 2020
By Nitin Ranjan
THE concept of a 'Works Contract', i.e. a contract to provide both service and goods is extremely relevant to Business today. It also has an interesting history of Indirect Taxation associated with it. Recently, in a Writ Petition judgment of MIOT Hospitals Ltd. Vs The State of Tamil Nadu (W.P.No.2982 of 2012) - 2020-TIOL-1010-HC-MAD-VAT, the Madras High Court has upheld a demand of Value Added Tax (VAT) as per the TNVAT-Act, 2006 on stents, valves, medicines, x-ray and other goods used while treating there in house patients, etc. under the category of 'Works Contract'. This was held to be a separate sale from the Medical Services for which exemption is provided under Government Order (Manuscript Series) No 976 dated 28.03.1959 where the exempted was for:
"Sales of medicines by hospitals, nursing homes and dispensaries run by the Government or by the Medical Practitioners themselves or paid Medical Practitioners and which are dispensing medicines to their patients only,whether consultation fee is charged or not."
2. Lex Mercatoria ("Merchant Law") must be as pragmatic and flexible as possible while following the practices of merchants. It generally happens that Businesses outsource several parts of their business processes where the goods while being owned by the Business are being worked on by the Contractor. For example, a Builder might outsource the Paint Job of his buildings to a Contractor who provides both the paint and the manpower service associated with this contract. In the Pre-GST era, the plenary areas of taxation for Centre and States were that on Sale of Goods for States and the Provisioning of Services under the Residuary powers under List I of the Constitution. Hence there was a lack of clarity as to who will be taxing such composite contracts which could not be categorized neatly in a Sales or a Service? The essential ingredients of Tax as held in Govind Saran Ganga Saran vs Commissioner Of Sales Tax - 2002-TIOL-589-SC-CT Case by the Supreme Court were:
a. A character of imposition given by a taxable event
b. The Person on whom tax is imposed
c. The Rate of Tax to be imposed
d. The Value on which such rate would be imposed
Here we have to examine the presence of these essential ingredients in any demand for taxation.
3. Dominant Intention Era:- One of the first major cases in taxation of works contract was the State of Madras Vs. Gannon Dunkerley & Co Ltd. - 2002-TIOL-493-SC-CT-LB where the Larger Bench of the Supreme Court held that the dominant intention was that of to provide services and the delivery of the goods being incidental the same was not subject to Sales Tax. Here the concept of 'sales' as defined in the Goods Sales Act, 1930 was held to not include such composite cases where the goods had not been explicitly held to be sold. In the absence of any Service Tax levy, such a works contract would not be taxable under any law.
4. Post this judgment, the Sixty-First Law Commission Report discussed the need to introduce a concept of 'deemed sale' to tax such composite transaction through a constitutional amendment as the power to tax sales of goods by States was obtained from the powers provided in List of the Constitution itself. Subsequently, through the 46th Amendment to the constitution Article 366(29) was introduced
Clause (29A) to Article 366 as introduced by the 46th Amendment to the Constitution is reproduced below:-
"366. (29-A) 'tax on the sale or purchase of goods' includes -
(a) a tax on the transfer, otherwise than in pursuance of a contract, of property in any goods for cash, deferred payment or other valuable consideration;
(b) a tax on the transfer of property in goods (whether as goods or in some other form) involved in the execution of a works contract;
(c) a tax on the delivery of goods on hire-purchase or any system of payment by instalments;
(d) a tax on the transfer of the right to use any goods for any purpose (whether or not for a specified period) for cash, deferred payment or other valuable consideration;
(e) a tax on the supply of goods by any unincorporated association or body of persons to a member thereof for cash, deferred payment or other valuable consideration;
(f) a tax on the supply, by way of or as part of any service or in any other manner whatsoever, of goods, being Food or any other article for human consumption or any Drink (whether or not intoxicating), where such supply or Service, is for cash, deferred payment or other valuable Consideration, and such transfer, delivery or supply of any goods shall be deemed to be a sale of those goods by the person making the transfer, delivery or supply and a purchase of those goods by the person to whom such transfer, delivery or supply is made;"
5. Subsequently, changes were made in the respective Sales Tax Acts of States in the definition of 'sales' to reflect this position and the definition of 'Works Contract' was expanded to include "processing, fabrication, erection, installation, fitting out, improvement, modification, repair or commissioning of any movable or immovable property". These were the relevant definitions applicable in this case which made such composite contracts liable to Sales Tax (VAT). In the BSNL Judgement vs Union of India - 2006-TIOL-15-SC-ST-LB judgment of the Larger Bench of the Supreme Court has held that the 46th constitutional Amendment intended to tax such contracts after the judgment of Ganon Dunkerley case (supra).
6. In Service Tax Law, The definition of Works Contract is similar to that in VAT Law. The service portion of such a contract was sought to be taxed as a Deemed Service as per Section 65E(4).In the landmark case Service Tax Case of Kone Elevators [State of A.P. v. Kone Elevators (India) Ltd., - 2005-TIOL-30-SC-CT-LB Elevators the scope Works Contract was examined fully by the Apex court and it was against held that the definition of Works Contract is wide and leaves wide latitude to tax indivisible composite contracts which had elements of goods and services. The fact that there was preparatory work done and the lift was delivered in the building did not take away from the fact that the composite contract signed had intended to provide both the lift (goods) and the installation(service). The issue of having Local Regulations does not take away from the fact that the nature of the contract as such. Apex Court has already held in the T.N. Kalyana Mandapam Assn. v. Union of India, - 2004-TIOL-36-SC-ST case that 'service' as held under common parlance is not the same as the service which is to be taxed under Service tax law. We also can refer to the observations referred in the Mafatlal case by the Apex Court :
"In the matter of taxation laws, the court permits great latitude to the discretion of the legislature. The State is allowed to pick and choose districts, objects, persons, methods and even rates for taxation, if it does so reasonably. The courts view the laws relating to economic activities with greater latitude than other matters."
These rulings have confirmed the validity if levy of Service Tax on 'Works Contract' service.
7. The Court held that the Ratio of the BSNL Vs UOI (supra) was not applicable here as it was a case of 'Transfer of Goods For Use' (sim cards). Here, the case was that of a 'Works Contract'. There was also an issue of the obiter dicta given in Para 44 of the BSNL Judgement(supra) where it was stated that:-
"Of all the different kinds of composite transactions, the drafters of the 46th Amendment chose three specific situations, a works contract, a hire purchase contract, and a catering contract to bring within the fiction of a deemed sale. Of these three, the first and third involve a kind of service and sale at the same time. Apart from these two cases where splitting of the service and supply has been Constitutionally permitted in Clauses (b) and (g) of Clause 29A of Art. 366, there is no other service that has been permitted to be so split. For example the clauses of Art. 366(29A) do not cover hospital services. Therefore, if during the treatment of a patient in a hospital, he or she is given a pill, can the sales tax authorities tax the transaction as a sale? Doctors, lawyers and other professionals render service in the course of which can it be said that there is a sale of goods when a doctor writes out and hands over a prescription or a lawyer drafts a document and delivers it to his/her client? Strictly speaking with the payment of fees, consideration does pass from the patient or client to the doctor or lawyer for the documents in both cases."
There are two contentions raised in this para which are to be addressed:
i. The limited scope of 'Works Contract' as per Article 366(29A)?
ii. The Taxability of VAT on Medical Treatment?
Also, following the BSNL decision (supra) there were four high court decisions where Sales Tax was not held to be leviable on Medical prosthetics, CT Scan, etc. which were:-
i) M/s. Tata Main Hospital Vs State of Jharkhand and others, [Writ Petition (T) No. 2442 of 2006 – Jharkhand High Court]
(ii) M/s. International Hospital Pvt. Ltd., Vs State of UP and others [ 2014-TIOL-551-HC-ALL-CT
(iii) M/s. Fortis Health Care Ltd and other Vs State of Punjab and others, - 2015-TIOL-466-HC-P&H-VAT
(iv) Aswini Hospital Pvt. Ltd., and others Vs Intelligence Officer, Squad No.1, Thrissur and Others, WP(C).No. 7129 of 2008 (W)
8. Another concept considered in the BSNL case(supra) was the Aspect Theory of taxation which states that "one subject for any aspect maybe taxed by one legislation and for another aspect of an event maybe taxed by another legislative power. In practice, this concept is similar to the 'Pith and Substance' concept. The judgment said that this theory is not applicable for Work Contract post the 46th Amendment as the contract now, could not be spilt as a legal fiction into two contracts for goods and services and different taxes could have been levied on these portions. It may be noted that taxation regulations are considered 'rag-bag' acts with all self-contained regulations of limitations, definitions, etc. Hence we see that the Dominant Intention Era had come to an end. We see an aberration to this trend in the Rainbow Colour Labs Judgement - 2002-TIOL-373-SC-CT, where the Supreme Court again upheld the relevance of the dominant intention. Subsequently though, this judgement was overturned in the case of Associate Cements vs Commissioner of Customs - 2002-TIOL-08-SC-CUS-LB. Also, the Apex Court held that the Ratio of Rainbow Colour Labs (supra) was not according to the Earlier Constitutional Bench's ruling in the Builder's Assn vs. Union of India - 2002-TIOL-602-SC-CT-CB.
9. For addressing these issues, The Madras High Court has principally relied on the L&T case where it was categorically held that post the 46th Constitutional Amendment the scope of works contact was not limited but much wider. It was stated by the Apex Court that:-
"Even in a single and indivisible works contract, by virtue of the legal fiction introduced by Article 366(29-A)( b ), there is a deemed sale of goods which are involved in the execution of the works contract? Such a deemed sale has all the incidents of the sale of goods involved in the execution of a works contract where the contract is divisible into one for the sale of goods and the other for supply of labour and services. In other words, the single and indivisible contract, now by the Forty-sixth Amendment has been brought on a par with a contract containing two separate agreements and the States now have power to levy sales tax on the value of the material in the execution of works contract."
10. In the Larsen and Tubro vs State of Karnataka - 2013-TIOL-46-SC-CT-LB case, which is a later judgment has the Supreme Court not accepting the narrow definition given to 'Works Contract' given in the obiter dicta of the BSNL judgment (supra) and has instead expanded the scope of 'Works Contract' to include all types of composite contracts having both goods and service components. This judgment was driven by the legislative intent of the 46th amendment and the updated definition of 'works contract' in VAT Laws. For Medical Services, the stents, valves, medicines, x-ray and other goods were held to be separate from the Medical Advice, medicine sold. Hence, using the above arguments we can find the following reasons given by the Madras High Court stated that of not accepting the Four High court Decisions:-
i. The Observations on medical services were not being binding on the Madras High Court.
ii. The Obiter Dicta in BSNL case was not correctly laid down and the same having been overturned by the L&T Judgement
iii. Also that the definition of sales has been expanded to include 'deemed sales' which are not as per the Goods Sales Act, 1930.
iv. BSNL judgement as about 'Transfer of Goods For Use' and hence had been incorrectly followed by the High Courts in the case of 'Works Contract'.
11. The defense had also pleaded that the transfer of the prosthetics to the patient did not mean the transfer of ownership and fundamentally the Law of persons and the Law of Property were Two Sections of Law. The Court did not agree with this proposition holding that it was a case of Law of Property only. The medical prosthetics were not only in the possession of the physiology of the patient but were also in the ownership of the patient now and the ingredients of a Works Contract were being fulfilled.
12. In the GST era, the issue of Works Contract is simplified as the charging section (Section 9 of the CGST/SGST Act) makes no distinction between goods and services. Also, the term 'works contract' has been limited to an immovable property only now. Under GST, 'Health Care Services' as have been exempted from the levy of duty as per Notification No. 12/2017-CT (Rate) dtd, 28-06-2017. Also, it has been clarified that by Circular No. 32/06/2018-GST dt 12.02.2018, when Food, Rooms are provide with Health Care Services' they would be exempt from duty as per the concept of Composite Supply in GST. But when Medicines, Prosthetics, Etc. were to be sold with a Medical Service the question would need to be solved on a case to case basis. In the Advance Authority Ruling Order in case of M/s. Shifa Hospitals in AAR, TamilNadu - 2019-TIOL-422-AAR-GST it has been held that the same would be decided on a case to case basis. The reasoning was as per the concept of 'Mixed' or 'Composite' supply as per Section 8 of the GST Act which states that:
The tax liability on a composite or a mixed supply shall be determined in the following manner, namely:-
(a) a composite supply comprising two or more supplies, one of which is a principal supply, shall be treated as a supply of such principal supply; and
(b) a mixed supply comprising two or more supplies shall be treated as a supply of that particular supply which attracts the highest rate of tax.
It has been clarified by CBIC, that for a supply to be considered 'Composite' the multiple components have to be naturally bundled in the normal course of business. Whereas in a Mixed supply, the bundling is not in the normal course, the tax rate would be that of the highest rate and hence even the Medical Supply could also be considered taxable. Bundling has, therefore, become an issue that has sent businesses to the Drawing Board as it can have very far-reaching consequences and it could lead to Taxation Litigation in the coming times.
[The author is an Officer of the Indian Revenue Services (Customs and Indirect Taxes) posted as Deputy Commissioner in the Office of Principal Commissioner (A.R.), CESTAT, Mumbai. The views expressed are strictly personal.]
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