Deduction for Sub-Contractor

Query: Recently Supreme Court has decided the treatment to be given to payments made to the sub-contractor. Whether because of said judgment the margin in the hands of main (principal) contractor will get excluded from levy of tax, particularly in relation to MVAT Act?

Reply: In relation to Works Contract a very peculiar situation arises. The contractee awards contract to the main contractor. The main contractor may sub-contract the same work to the sub-contractor keeping its margin in between. Main Contractor may not be using any of its goods in relation to margin retained by it. The issue is whether main contractor is required to discharge liability on such margin under Sales Tax Laws.

There can be debate on the issue as to whether there are two sales under Works Contract i.e. one from the sub-contractor to main contractor and another from main contractor to contractee. However, this issue has now been put to rest by the judgment of Hon. Supreme Court in case of
State of Andhra Pradesh vs. Larsen and Toubro Ltd. (17 VST 1)(SC). In this judgment Supreme Court categorically held that there is only one transfer of property that is from sub-contractor to the contractee.

The further issue is, what is the taxable quantum, in such type of situation. Since the transfer of property is by sub-contractor and main contractor is not using its own goods, which are getting transferred to the contractee, can it be said only price realised by sub-contractor is only taxable quantum and margin retained by main contractor is not liable to sales tax.

There is no direct answer in the above judgment. There is further recent judgment of Hon. Supreme Court in case of
Larsen and Toubro Ltd. vs. Additional Deputy Commissioner of Commercial Taxes and Ors. (Civil Appeal Nos. 2956 of 2007, 2318 of 2013 and 7241 of 2016 dated 5-9-2016)(SC). In this judgment, the issue was about computation of turnover for attracting turnover tax under the Karnataka Sales Tax Act. Hon. Supreme Court after referring to facts, observed as under:

“17. After bestowing our due consideration to the respective submissions, we find that the position taken by the assessee has to prevail, which appears to be meritorious. This result follows even from the bare perusal of the Karnataka Act and Rules. For this purpose, it becomes important to refer to Clause (c) of sub-rule (1) of Rule 6 of the Karnataka Sales Tax Rules, 1957. Rule 6 deals with determination of total and taxable turnover and Clause (c) reads as under:

6. Determination of total and taxable turnover.-
(1) The total turnover of a dealer, for the purposes of the Act, shall be the aggregate of –

xx xx xx

(c) The total amount paid or payable to the dealer as the consideration for transfer of property in goods (whether as goods or in some other form) involved in the execution of works contract; and includes any amount paid as advance to the dealer as a part of such consideration.

xx xx xx

18. What is significant is that total amount paid or payable to the dealer as a consideration for 'transfer of property in goods', which is involved in execution of the works contract, is to be treated as 'total turnover'. This Rule, thus, specifically restricts the total turnover in respect of those goods, alone, where the property has been transferred. Thus, transfer of property in goods, becomes necessary event and unless there is a transfer of property, the amount paid is not to be included in the total turnover. The amount paid to the sub-contractor is not for transfer of property in goods. When matter is examined from this angle, the ratio laid down by this Court in the Andhra Pradesh judgment clearly applies in as much as in that case also the Court noticed that
Section 4(7) of the Andhra Pradesh Act indicated that the taxable event is the transfer of property in goods involved in the execution of a works contract and the said transfer of property in such goods takes place when the goods are incorporated in the works. The Court held that the value of the goods which constitute the measure for the levy of tax is the value of goods at the time of the incorporation of the goods in the works. The Court further found that same was the position contained in Rule 17(1)(a) of the Andhra Pradesh Value Added Tax Rules, 2005.

19. It is not in dispute that the facts and the issue involved were identical, i.e. the assessee had assigned parts of the construction work to sub-contractors who were registered dealers. These sub-contractors had purchased goods and chattels like bricks, cement and steel and, where necessary, supply and erect equipments such as lifts, hoists, etc. The materials were brought to the site and they remain the property of the sub-contractor. The site was occupied by the sub-contractor and the materials were erected by the sub-contractor. In this backdrop, after taking note of some provisions of the Andhra Pradesh Act, the Court explained the legal position in the following manner:

16. By virtue of Article 366(29-A)(b) of the Constitution, once the work is assigned by the contractor (L&T), the only transfer of property in goods is by the sub-contractor(s) who is a registered dealer in this case and who claims to have paid taxes under the Act on the goods involved in the execution of the works. Once the work is assigned by L&T to its sub-contractor(s), L&T ceases to execute the works contract in the sense contemplated by Article 366(29-A)(b) because property passes by accretion and there is no property in goods with the contractor which is capable of a retransfer, whether as goods or in some other form.

17. The question which is raised before us is whether the turnover of the sub-contractors (whose names are also given in the original writ petition) is to be added to the turnover of L&T. In other words, the question which we are required to answer is whether the goods employed by the sub-contractors occur in the form of a single deemed sale or multiple deemed sales. In our view, the principle of law in this regard is clarified by this Court in Builders' Assn. of India as under: (SCC p. 673, para 36).

36 … Ordinarily unless there is a contract to the contrary in the case of a works contract, the property in the goods used in the construction of a building passes to the owner of the land on which the building is constructed, when the goods or materials used are incorporated in the building.

(Emphasis supplied by us)

18. As stated above, according to the Department, there are two deemed sales, one from the main contractor to the contractee and the other from
sub-contractor(s) to the main contractor, in the event of the contractee not having any privity of contract with the sub-contractor(s).

19. If one keeps in mind the above quoted observation of this Court in Builders' Assn. of India the position becomes clear, namely, that even if there is no privity of contract between the contractee and the sub-contractor, that would not do away with the principle of transfer of property by the sub-contractor by employing the same on the property belonging to the contractee. This reasoning is based on the principle of accretion of property in goods. It is subject to the contract to the contrary. Thus, in our view, in such a case, the work executed by a sub-contractor, results in a single transaction and not as multiple transactions. This reasoning is also borne out by Section 4(7) which refers to the value of goods at the time of incorporation in the works executed. In our view, if the argument of the Department is to be accepted, it would result in plurality of deemed sales which would be contrary to Article 366(29-A)(b) of the Constitution as held by the impugned judgment of the High Court. Moreover, it may result in double taxation which may make the said 2005 Act vulnerable to challenge as violative of Articles 14, 19(1)(g) and 265 of the Constitution of India as held by the High Court in its impugned judgment.

This raison d'etre shall apply, in full force, while answering the question even in the context of the Karnataka Act.â€

It can be seen that Hon. Supreme Court has directed not to consider the payments or value of the sub-contracted work for computation of turnover. From above judgment, no inference can be drawn that the margin of the main contractor is also not liable to sales tax. The margin in the hands of main contractor is also towards works contract execution. One school of thought can be that the margin is towards services only and hence no liability to VAT. The other school of thought can be that the margin consists of margin towards goods and labour which are two components of works contract. If, this theory is accepted, then, the margin in the proportion of goods will be liable to sales tax.

Even in general the contractee is paying to the main contractor towards goods and services acquired by it by awarding works contract to the main contractor. So that is the price which is liable to sales tax. However, for avoiding double taxation the deduction towards sub contractor is contemplated. This is also what comes out from above judgments of Hon. Supreme Court.

If this situation is applied to the MVAT Provisions, it can be seen that there is specific provision in relation to main contractor and sub-contractor.

Section 45(4) of MVAT Act provides as under:

“45. Certain agents liable to tax for sales on behalf of principal –

(1) to (3)

(4) Where any sale has been effected by way of transfer of property in goods (whether as goods or in some other form) involved in the execution of a works contract and the contractor has executed the works contract awarded to him, through a sub-contractor, directly or otherwise, then notwithstanding anything contained in any law or agreement to the contrary, the relationship between the contractor and the person who has actually executed the works contract or part of it as a sub-contractor shall be deemed to be that of the principal and agent and accordingly,-…"

Thus, there is specific provision deeming both parties as one party. It can be said that the principle laid down by Hon. Supreme Court in above judgments is already implemented in MVAT Act. The works contract is deemed to be one transaction, executed by both together with contractee. The result is that the whole price received towards contract from contractee becomes the price for the contract and liability is required to be discharged with relation to such price. To avoid double taxation, deduction is already contemplated by providing Forms 406, 407, 408 and 409, as may be applicable.

It can also be noted that in Rule 58(1) also deduction is provided towards payment to sub-contractor.

Thus, it can be said that the principles laid down by Supreme Court are already in operation under MVAT Act. However, from the combined reading of all the provisions, it is difficult to say that the principal contractor will not be liable to VAT on the margin amount retained by the main contractor. Further analysis on this issue is possible, however all aspects are not discussed here for sake of brevity. As per present position under MVAT
Act, the margin is liable to tax in the hands of main contractor