Wednesday, August 12, 2009

Contracts of Sale, Works Contracts, and TDS

Tax deducted at source (TDS) has proved to be a controversial area of law for quite some time now. One issue that has most recently come to light is likely to have enormous commercial significance – under what circumstances is a company obliged to treat an ordinary transaction as a “works contract” and not a “sale of goods” with the consequent liability to deduct TDS?

The governing provision is s. 194C of the Income Tax Act, 1961. It provides that any person responsible for paying any sum to any resident for carrying out any work in pursuance of a specified contract shall be liable to provide for TDS on that payment. The crucial question, therefore, is the meaning of the expression “carrying out any work”. In 1972, the Supreme Court, in a landmark judgment (State of Punjab v. Associated Hotels, AIR 1972 SC 1131, answered this question as follows:

…where the principal objective of work undertaken by the payee of the price is not the transfer of a chattel qua chattel the contract is of work and labour. The test is whether or not the work and labour bestowed end in anything that can properly become the subject of sale…neither the ownership of the materials nor the value of skill and labour as compared with the value of the materials is conclusive although such matters may be taken into consideration in determining in the circumstances of a particular case, whether the contract is, in substance, one of work and labour or one for the sale of a chattel. A building contract or a contract under which a movable is fixed to another chattel or on the land where the intention plainly is not to sell the article but to improve the land or the chattel and the consideration is not for the transfer of the chattel, but for the labour and work done and the material furnished, the contract will be one of work and labour…”

This was in contrast to the requirements under the traditional law of the sale of goods, particularly before the 46th Constitutional amendment, that the existence of “goods”, the intention to transfer title to those goods and actual transfer of title are necessary to consider the transaction a sale (State of Madras v. Gannon Dunkerley, AIR 1958 SC 560). However, disagreement still persisted, and in an attempt to resolve it, the CBDT issued a circular in 1994 stating expressly that s. 194C does not apply to a “sale of goods”. Following this, attempts to extend the reach of s. 194C to professional services, commission agents etc. were struck down by the Bombay and Delhi High Courts. In 2005, the Supreme Court once again affirmed the test laid down in Associated Hotels, and added that any determination of the nature of a transaction had to take commercial reality and the intention of the parties into account (State of Andhra Pradesh v. Kone Elevators, (2005) 3 SCC 389).

Applying these principles, a transaction where the customer supplied the plans and specifications and had the right to trial runs before delivery was still considered a sale. Similarly, a transaction where the Orissa Government agreed to supply a chassis to a contractor who was to build a bus was considered a contract for the sale of the bus to the Orissa Government. In both cases, the parties intended to buy the article in question. On the other hand, making photostat copies of a document and delivering it to the customer is not a contract for the “sale of paper” because the object of the transaction, in the minds of the parties, is the provision of photocopying services, and not the supply of paper. In other words, the passing of title must be “ancillary” to the contract for performance of work for it to constitute a contract for work (Hindustan Aeronautics v. State of Karnataka, AIR 1984 SC 744).

The reason this issue has become relevant now is that the Supreme Court has issued notice last week to Samsung India on its liability to provide for TDS. Samsung outsources the manufacture of certain goods to other manufacturers, and the IT Department has argued in its written submissions that the other manufacturers are not at liberty to dispose of the goods, to use a different process of manufacture etc., and that the contract in substance is one for works. This is a question of fact that is likely to be closely contested, for the transaction does appear, at first sight, to resemble a contract for works. The Delhi High Court had found in favour of Samsung. A Business Standard report is available here.

The Supreme Court’s verdict is likely to be of great interest to several companies, given the difference it makes to TDS liability. For example, if the Department prevails in the Supreme Court, Samsung faces a TDS bill of about Rs. 1.7 crore for one assessment year.

1 comment:

vswaminathan said...

As is known, a similar point of dispute has often arisen in the realty sector. But, that is not in reference to TDS under the IT Act, but is on the question whether a given transaction is of the nature of a ‘works contact’ so as to attract sales tax/VAT, or of a ‘sale’ on which only stamp duty is payable. One will find interesting discussions in court cases dealing with the said controversy.
Incidentally, how the referred gray area has come to be exploited by some unscrupulous players in the field may be found highlighted in a couple of feedbacks to Business Line reproduced below:
1. "Lacunae in VAT legislation..." (20 June 2009)
"Value Added Tax (VAT) has been implemented to avoid cascading effect and usher-in better tax administration to compete in a globalising marketplace. The Government has initiated steps to phase-out Central Sales Tax (CST). It has reduced CST against Concessional Form from 4 per cent to 2 per cent, year on year. It has also abolished ‘FormD’"
" ……… Ultimately, it is the consumer, and not the manufacturer or the Government, who loses out."
In the write-up, no doubt, its writer has focused on certain lacunae in the legislation on VAT, which has presumably the unintended (but not unanticipated) potentials for inequity and irregularities in its administration and enforcement. In doing so, he has confined himself mainly to one aspect-namely, manufactured goods and its consumers.
Nonetheless, it is any body's guess as to how many of us are aware, or really unaware (for reasons known only to them), of frauds commonly and unscrupulously perpetrated / perpetuated and foisted upon the hapless consumer public in several other sectors where the VAT law is equally of relevance or comes into play.
To mention one, - the notorious realty sector.
To briefly pinpoint, but by way a poser so as to provoke one to give one's own thoughts and due consideration:
Why a builder, say, of an 'Apartment' building, which he puts up for 'sale' as such, and on which, therefore, the buyer has to necessarily pay a significantly large amount of Stamp Duty, - is at all justified in adding to / or including as a component in, the agreed basic price for the 'Apartment', the element of VAT (that too, on an arbitrary basis)?
No doubt, the age old maxim is - IGNORANCE OF LAW IS NO EXCUSE. But, in our times, it has, for almost all purposes, been chosen to be given the go bye. Be that as it may, is it not a matter of common sense, and of larger concern, for one to sit and deliberate - IS IGNORANCE REALLY A BLISS - that too, any longer; and an absolute one at that.
2. THIS REFERS TO THE YET ANOTHER RECENT ARTICLE (8 August 2009)- The hassle of pinpointing value addition
“Even now, the ultimate customer ends up paying tax on full value harking back to the pre-VAT era.”
It is not simply just that; as pinpointed in my attached earlier feedback, a buyer of an 'apartment', as one gathers from a personal survey, often, if not mostly, ends up paying (in fact, he does not mind or is bothered about it), both VAT and Stamp duty under what in law is a 'Sale' (of apartment) transaction. HOW IS THAT!