NOVEMBER 15, 2004 

By P K Sahu

JUDICIARY has been confronted with situations where it has to be decided whether the arrangement between parties constitutes single, composite contract or multiple of contracts. A composite contract is one, which has constituent elements, some of which, if undertaken separately, would have been taxed, and some not.

In India, the cases relating to composite contracts arose under sales tax legislation. The sales tax authorities tried to levy sales tax on the goods used in works contract. In the State of Madras v. Gannon Dunkerley & Co. (Madras) Ltd., (1958) 9 Simon's Tax Cases 353 (SC), the Supreme Court held that a building contract is one entire and indivisible contract; there is no sale of goods as a separate contract. A series of judgements of the High Courts and the Supreme Court followed this case taking the same view. Subsequently, 46th Amendment to the Constitution introduced the concept of deemed sale for the purpose of levying sales tax on transfer of property in goods used in works contracts. For sales tax, indivisible works contracts have been made divisible.

The moot question is whether the service tax authorities can levy service tax on any component of a composite service on the ground that it answers the description of a taxable service.

In UK & continental Europe, value added tax on supply of goods and services is levied. Whether any segment of a composite transaction can be subjected to tax has come-up in question before the European courts. One such issue was referred to the European Court of Justice by the House of Lords, U.K., for guidance. The ECJ, in Card Protection Plan Ltd v Customs and Excise Commissioners [1999] Simon's Tax Cases, 270 ECJ, ruled that there was a single supply where one element constituted the principal service and others were merely ancillary, in that they did not constitute for customers aims in themselves, but simply a means of better enjoying the principal service. What constitutes a single supply in economic sense should not be artificially split. This guidance of ECJ was followed by the House of Lords in Card protection Plan Ltd v Customs and Excise Commissioners [2001] Simon's Tax Cases 174 HL.

No service tax on composite contracts

The Supreme Court has endorsed the view taken by CESTAT that in turnkey works contracts, any segment cannot be vivisected from the rest of the contract for levying service tax (2003-TIOL-110-CESTAT-DEL). It has dismissed the SLP filed by Commissioner of Central Excise, Vadodara, against the CESTAT's decision in M/s Daelim Industial. Co. Ltd. vs. CCE, Vadodara (2004-TIOL-66-SC-ST). In this case the CESTAT has held that an EPC contract is a works contract and not a consultancy contract. Even if drawings and designs are part of the activities under the turnkey contract, this cannot be segregated from the composite contract for separate tax treatment. The amount shown in the price break-up against residuary process design and detailed engineering is only for billing schedule. No service tax is payable as this activity does not constitute a separate, independent service.

The Tribunal has followed this view in its subsequent decision in M/s Larsen & Toubro Ltd. vs CCE., Cochin. In this case, the Department had contended that the Tribunal had not considered the Department's circular No. 49/11/2002-ST dated 18.12.2002 Daelim case. After considering this circular, the Tribunal found no reason to depart from the Daelim decision. In this circular, the CBEC had clarified that the work of drawings /designs, erection and Commissioning is in the nature of services provided by a 'consulting engineer' and hence taxable under service tax provisions. Recently, the CBEC has changed its stand as regards erection and commissioning activities of a turnkey contract. In Circular No. 79/9/2004-ST dated 13.05.2004, it has clarified that such activities would not fall in consulting engineer's service. It has not given any specific reason as to why such activities do not constitute taxable service by a consulting engineer.

Incidentally, commissioning and installation service has been introduced as independent taxable service effective from 01.07.2003. Erection service has become a taxable service through the Finance Act (No.2), 2004. If drawing/design activity is not taxable service, being part of a composite contract, then the same logic would apply to commissioning/installation/erection activity if it is part of an all-inclusive, turnkey contract, in view of the Supreme Court's endorsement of CESTAT's view.

46th Constitution Amendment

After the decisions of the CESTAT in the cases of Daelim and L&T, the Central Excise Department has been taking a fresh stand that after 46th Constitutional Amendment of 1984, works contract is divisible. In response to this, I would argue that these judgments are strictly in the context of sales tax law. Nowhere in these judgments has the Supreme Court held that composite contracts are divisible under other laws. The 46th Amendment defines 'tax on sale or purchase of goods', an expression appearing in the Constitution in the context of levy of sales tax under entry 54 of List II of the Seventh Schedule to the Constitution. This has no impact on laws other than law on sale or purchase of goods. The amendment has introduced the concept of 'deemed sales'. It does not alter the meaning of 'sale' in Sale of Goods Act or other enactments, including the law on service tax.

In Geo Miller & Co. (P) Ltd. vs. State of M. P., (2004) 5 SCC 209, the Supreme Court has held that the legal fiction introduced by the 46th Constitutional amendment does not define 'sale'. The legal fiction is meant for entry 54 of List II of the Seventh Schedule to the Constitution and can not be extended for the purpose of entry 52 of List II. Extending this logic, it can be argued that the effect of the amendment does not extend to entry 97 of List I, from which the Parliament has derived power to levy service tax. Hence, CBEC does not have a case that after the 46th Constitutional Amendment, a composite contract has become divisible for service tax.

(The author is a Delhi-based Advocate )