Submitted By: Submitted To:

Sagnik Das Bipin Kumar

B.Sc. LL.B (Hons.) Assistant Professor,

Roll No. 886 Faculty of Law.

Semester IV National Law University, Jodhpur.

Case Comment: State of Andhra Pradesh v. M/S Kone Elevators.

TABLE OF CONTENTS

Case Comment: State of Andhra Pradesh v. M/S Kone Elevators..................................................2

Facts.............................................................................................................................................2

Contentions of the Parties............................................................................................................2

Judgment of the Court, Reasoning and Analysis.........................................................................3

Contract of Sale and Contract for Work..........................................................................................6

Deemed Sale- Constitutional Provisions.........................................................................................8

Deemed Sale and Taxation..............................................................................................................9

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CASE COMMENT: STATE OF ANDHRA PRADESH V. M/S KONE ELEVATORS

Facts

M/s Kone Elevators (India) Ltd. [“assessee”] was a unit of M/s Kone Corporation, Finland who

manufactured Hi-tech New Generation Elevators. M/s Kone Corporation, Finland had its

operations spread over 37 countries in the world. The assessee being a registered dealer filed

monthly returns for the months of April and May. It was assessed by the Commercial Tax

Officer under the Andhra Pradesh General Sales Tax Act, 1957. The assessee claimed deductions

of labour charges for composition of tax under section 5G read with section 5F of the Act saying

that nature of the work undertaken by it constituted "works-contract" involving manufacture,

supply, installation and commissioning of elevators and lifts. The assessing authority however,

did not find weight in the assessee’s claims and did not allow for the deductions sought for. On

appeal by the assessee, the Deputy Commissioner, Secunderabad Division, Hyderabad confirmed

the assessment orders and treated the disputed turnover of the assessee as falling under Entry 82

to the First Schedule of the Act to which sales tax could be levied. Entry 82 related to electrical

or hydraulic lifts. This was objected to by the assessee who then filed before the Sales Tax

Appellate Tribunal, Hyderabad. The point which arose before the Tribunal was whether the

transactions related to “works contract” or “contract of sale” of lifts. The Tribunal ruled in favour

of the assessee by holding that the said transactions did not fall under “contract of sale” and

hence sales tax could not be levied on it. It held that the disputed turnover related to the

manufacture, supply, fabrication and erection involved in the works-contract. The original

assessing authority was accordingly directed to allow the deduction of labour charges and to

complete the assessment under section 5G read with section 5F of the 1957 Act, without treating

it under Entry 82 of the first schedule to the Act. The High Court upheld the Tribunal’s verdict

and hence the appeal was preferred to the Supreme Court.

Contentions of the Parties

The Appellants urged that the Legislature had classified the commodity "lift" under Entry 82 of

the first schedule to the Act keeping in mind that the "installation" was ancillary to the "sale" of

lifts. It was urged that the High Court had erred in holding that the installation of the lifts

involved skill and technical know-how, which was to be treated as works-contract. On the other

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hand the assessee, M/S Kone Elevators submitted that they were engaged in the manufacture,

supply, erection, installation and commissioning of lifts by undertaking works-contract; that the

lifts/elevators as such could not be delivered to the customer; that various accessories and

components were required to be taken to the site where after carrying out the civil work, lifts

were installed and commissioned. It was further argued that only after all the parts stood

assembled at site, the lifts came into being; that installation and commissioning of lifts involved

skill and only after installation and commissioning of the lifts, the ownership stood transferred to

the customer. Consequently, the assessee was entitled for deduction of labour charges and was

entitled to composition of tax under section 5G of the said Act.

It was further submitted on behalf of the assessee that manufacture, supply, erection, installation

and commissioning of lifts came under definition of the words "works-contract" under section

2(1)(t) of the Act and, therefore, the tax leviable fell under section 5F of the Act. It was urged

that lifts and elevators could not be delivered like A/Cs as standard units; that manufacture,

supply, erection, installation and commissioning of lifts involved skill and labour as well as

technical know-how. To highlight on the level and amount of skill and know-how that was

required in supply and installation of lifts the assessee placed reliance on the Indian Standards

Institution's specifications and code of practice for installation of lifts and elevators.

Judgment of the Court, Reasoning and Analysis

The Court stated that it was well settled that there was no set-formula by which one could

distinguish a “contract of sale” from a “works contract”. The question was largely one of fact

depending upon the terms of the contract including the nature of the obligations to be discharged

thereunder and the surrounding facts and circumstances. If the intention was to transfer for a

price a chattel in which the transferee had no previous property, then the contract would be a

contract for sale. Ultimately, the true effect of an accretion made pursuant to a contract had to be

“judged not by artificial rules but from the intention of the parties to the contract.” In a "contract

of sale", the main object was the transfer of property and delivery of possession of the property,

whereas the main object in a "contract for work" was not the transfer of the property but it would

be one for work and labour.

Another test that the Court was: when and how the property of the dealer in such a transaction

passes to the customer: was it by transfer at the time of delivery of the finished article as a chattel

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or by accession during the procession of work on fusion to the movable property of the

customer? If it were to be the former, it would be a sale; if it were the latter, it would a works-

contract. Therefore, in judging whether the contract was for a sale or for work and labour, the

essence of the contract or the reality of the transaction as a whole must be taken into

consideration. The predominant object of the contract, the circumstances of the case and the

customs of the trade help in deciding whether transaction was a sale or a works- contract.  

Essentially the question boiled down to the interpretation of the contract and the intention of the

parties to the contract. Thus the substance and not the form of the contract was material in

determining the nature of the transaction. There could thus be no definite rule to determine the

question as to whether a given contract was a contract of sale or works contract. The question

had to be determined on facts of each case and on proper construction of the terms and

conditions of the contract between the parties.

The Court then looked into the definition of “sale” under Section 2(1)(n) of the Act which

included “every transfer of the property in goods (whether as such goods or in any other form in

pursuance of a contract or otherwise).” These words were intended to include non-conventional

sale transactions as specified in Clause 29A of Article 366 of the Constitution, which was

introduced by the 46th Amendment. Before this amendment was introduced the expression “sale

of goods” occurring in Entry 48 of List II of the Government of India Act was interpreted by the

Supreme Court in State of Madras v. Gannon Dunkerly.1 The Court held that the essential

ingredients of a “sale” were an agreement to sell movables for a price, and property passing

therein pursuant to that agreement. It was held that in a building contract which was composite

and indivisible, there was no sale of goods as there could be no agreement to sell materials as

such and moreover, the property did not pass as movables. In order to enlarge the concept of sale

and to allow the State Legislatures the power to tax transactions simulating sales but not

conforming to the concept of sale under the Sale of Goods Act, the 46 th Constitutional

Amendment was passed and clause 29A was inserted in Article 366. Thus, the Andhra Pradesh

Legislature changed the definition of “sale” in line with the amendment so as to bring

transactions within the purview of sales tax, which would otherwise not be considered “sale” in

the strict sense of the term as per the law laid down in the Gannon Dunkerly case. Under the

1 AIR 1958 SC 560.

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impugned Act, in order to constitute a sale a person who carried on the business of buying,

selling etc. and a sale in the course of business were the two requirements.

The Court cited the case of Hindustan Shipyard v. State of Andhra Pradesh2 and stated that if the

thing to be delivered had any individual existence before the delivery as the sole property of the

party who was to deliver it, then it would be a sale. If the bulk of material used in construction

belonged to the manufacturer who sold the end- product for a price, then it would be a strong

reason to believe that the contract was in substance one for the sale of goods and not one for

labour. However this was not a decisive or clinching test. Apart from the bulk of the material the

relative importance of the material and the work, skill and labour of the party also had to be

taken into account. If the skill and labour were only incidentally used the delivery of the end

product by the seller to the buyer would constitute a sale. On the other hand, if the main object of

the contract was to avail the skill and labour of the seller then even though some material or

components may incidentally have been used during the process of the end-product being

brought into existence by the investment of skill and labour of the supplier, the transaction would

be a contract for work and labour.

In the facts of the present case, it was agreed between the parties that the customer would

approve the drawings and would approve the drawings and make machine room for the power

supply in order to commence installation of the lift by the assessee. The contractual obligations

of the assessee regarding installation included employing labour to complete the mechanical

erection, electrical wiring testing and commissioning of the lift. The assessee had agreed that the

installation would commence only after the lifts had arrived at the site and upon intimation from

the customer that the site was ready as per the drawings. As soon as the lift was to be installed,

the customer was to take over. Also any material supplied by the assessee would remain their

property till the lift was handed over to the customer. The contract in question also consisted of

certain obligations on the part of the customers under which the customer was to undertake the

work of civil constructions relating to the installation of the lift. There were other obligations that

the customer had to undertake under the contract as per the delivery schedule.

Having examined the provisions of the contract the Court concluded that the customer was

required to do the actual work at the site for installation of the lift. Thus the onus of preparation

2 (2001) 119 STC 533.

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of the site and making it ready for installation of the lift was on the customer. The assessee

would undertake installation only if the site was made ready by the customer. Also under the

contract the assessee reserved the right to charge the customer for delays in providing these

facilities. Thus the contract was divided into two parts: the “work” to be initially done in

accordance with the specifications laid down by the assessee, this was to be done by the

customer and the “supply” of the lift which was to be done by the assessee. The work part was

clearly assigned to the customer as a part of the contract and the supply part was to be performed

by the assessee. Therefore, contractual obligation of the assessee was only to supply and install

the lift, while the customer's obligation was to undertake the word connected in keeping the site

ready for installation. Thus on an analysis of the contract, it was clear that the contract was one

of sale and not for services or work, and that any “work” involved was only incidental to the

main transaction, which was a transaction for sale. Moreover, the assessee company was clearly

in the business of manufacturing and supplying lifts and hence the second element of the

provision’s requirements was also satisfied.  Therefore, the delivery of the end-product by the

assessee to the customer constituted a "sale" and not a "works- contract". It was thus a sale under

Entry 82 of the first schedule to the Act.

CONTRACT OF SALE AND CONTRACT FOR WORK

There has been extensive literature and jurisprudence on the distinction between contract of sale

and contract for works. The distinguishing line between the two is often very thin in practice and

cannot be easily made out. The Supreme Court in Commissioner of Sales Tax Madhya Pradesh

v. Purshottam Premji3 had considered the distinction between the two. It held that the primary

difference between a contract for sale and a contract for works is that in the former there is no

involvement of property. It may so happen that the person performing work or rendering services

used a part or even the whole of materials as his property. But the thing produced as a whole has

individual existence as the sole property at a time before delivery and the party who produced it,

and the property passes therein only under the contract in goods relating to the performance of

the contract is not sufficient to constitute a sale. In order to constitute a sale, there must be an

implied or express agreement relating to the sale of goods and completion of the agreement by

the passing of title in the goods to be sold under the contract. Ultimately, this distinction has to

3 [1970] 2 STC 287.

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be made on judging the true effect of the transaction, the element of usage of skill and know-how

of the person by the customer, and the ascertainment of the true intention of the parties from the

respective facts and circumstances of the case. Mere passing of property in an article or

commodity during the course of performance of the transaction in question does not render the

transaction automatically to be a transaction of sale. Even in a contract for services, it is possible

that articles or materials may have been used by the person executing the work and property in

such materials may pass to the other party, the consumer. But this will remain as a contract for

works and will not amount to contract for sale. In every case the Court must determine what the

intention of the parties as and what was the primary object of the transaction. In some cases,

there might be separate agreements forming part of the same transaction where one agreement is

for sale and the other is for contract of services. In that event the transaction would not be one

and indivisible but would be severable into contract of service and the contract of sale.

Generally when a contract is made to make a chattel and deliver it, it is a contract of sale, but that

is not always the case. The test would be whether the thing to be delivered has any individual

existence before delivery as the sole property of the party who is to deliver it. 4 Some examples

mentioned in Pollock and Mulla5 are:

1) A promises to make a set of false teeth for B with materials wholly found by A and B

promises to pay for them when made. This is a contract for the sale of goods.6

2) A orders a jacket from B. After inspecting several skins, he chooses a colour and selects a

style for the jacket. The price is also agreed. This is a contract for the sale of goods.7

3) A promises to carve a block of marble belonging to B into a statue. This is not a contract

of sale.

4) A promises to print and deliver to B five hundred copies of a manuscript which B

entrusted to him for that purpose, on paper and with ink furnished by A. This is a contract

for work and not for the sale of goods.8

5) A carries on business as a photographer and sells the photographs to his customers. This

is a sale of goods.9

4 Union of India v. CI Manufacturing Co. AIR 1977 SC 1537, 1542.5 POLLOCK & MULLA, THE SALE OF GOODS ACT 72 (8th ed. 2010).6 Barreto v. Pruce AIR 1939 Nag 19.7 Marcel Furriers Ltd v. Tapper [1953] 1 All ER 15.8 Clay v. Yates (1856) 1 H&N 73.9 Ghosh v. State of Bihar (1961) Pat 272.

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In cases where there is no sale, there is never a time when the thing produced is as a whole the

maker’s absolute property, even though all the materials may have been his property. Although

the contract may be a contract to do work and not an order for a specific article, yet the property

in the article produced may pass to the party giving the order.

The question whether a contract of sale or work often crops up in the proceedings for assessment

under the sales tax laws for deciding whether the transaction was eligible to tax.10 The above case

also dealt with such a scenario. One of the important tests in such cases is to find out whether the

contract is primarily a contract for supply of materials at a price agreed to between the parties for

the materials so supplied and the work or service rendered is incidental to the execution of the

contract. But where a contract is primarily a contract for work and the labour and materials are

supplied in execution of such contract, there is no contract for sale of the materials, but it is a

work contract. The fact that it is only by doing work and labour on the materials that they acquire

commercial identity is prima facie indicative of a work contract.

In the present case, the Court makes a distinction between contract of sale and work contract

based on what the essence of the contract was in the present facts and circumstances. It judged

the reliance of the consumer on the skill and technical know-how of the assessee. The Court

found that it is not the bulk of material alone but the relative importance of the material as

regards the skill and labour of the assessee. The Court noted that under the contract, the

arrangements before installation of the lift was to be made by the customer and hence any skill

and labour on the part of the assessee was only incidental to the main transaction, which was one

of sale.

DEEMED SALE- CONSTITUTIONAL PROVISIONS

In the case of State of Madras v. Gannon Dunkerly11 the Supreme Court held that the expression

‘sale of goods’ as used in the entries in the Seventh Schedule to the Constitution of India had the

same meaning as within the Sale of Goods Act. It held that in order to be subject to the levy of

sales tax, a transaction should have the following ingredients, namely, parties competent to

contract, mutual assent, and transfer of property in goods from one of the parties to the contract

to the other party thereto for a price. This decision was followed in State of Punjab v. Associated 10 POLLOCK & MULLA, THE SALE OF GOODS ACT 74 (8th ed. 2010).11 AIR 1958 SC 560.

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Hotels of India Ltd.12 and AV Meiyappan v. CIT.13 This position led to the avoidance of tax in

various ways and eventually the Law Commission of India in a report in 1974 recommended a

Constitutional amendment, which led to the 46th Constitutional Amendment of 1982 and the

insertion of clause 29-A in Article 366 of the Constitution. Each of the sub-clauses of Article 366

(29-A) serve to bring transactions where one or more of the essential ingredients of a sale as

defined in the Sale of Goods Act are absent, within the ambit of purchase and sale for the

purposes of levy of sales tax.14 However Gannon Dunkerly still holds the field in some respects

considering that excepting the categories given in Article 366, the meaning of “sales” remains

unaltered. Thus for all the other transactions which are not provided within the ambit of clause

29-A, it would have to conform to the meaning of “sales” as within the Sale of Goods Act for the

purpose of levying sales tax.15 In BSNL v. Union of India16 the Supreme Court held that after the

46th Amendment, those contracts covered by clause 29-A are subject to sales tax by the

respective States, which falls under Entry 54 of List II. In such cases the tests for deciding

whether a contract is for sale or not will not apply. Thus the case of Rainbow Colour Lab v. State

of Madhya Pradesh17 is not good law. Also it held that this observation in Associated Cements v.

Commissioner of Customs18 in not obiter and is binding.

In the present case as well, in view of the amendment, the Uttar Pradesh Legislature had

amended the definition of “sale” in their sales tax legislation. This was also done by other States

such as Tamil Nadu and West Bengal.19

DEEMED SALE AND TAXATION

A recent Kerala High Court judgment20 notes that under VAT law there is no distinction between

sales and deemed sales in terms of levy of tax. In fact, the tax rate applicable for deemed sales of

a movable asset is equivalent to the tax rate applicable for the sales of the very asset. This

decision also affirms that only VAT can be levied on deemed sales. Though the High Court has 12 (1972) 1 SCC 472.13 (1967) 20 STC 115 (Mad).14 POLLOCK & MULLA, THE SALE OF GOODS ACT 91 (8th ed. 2011).15 Bharat Sanchar Nigam Ltd v. Union of India (2006) 3 SCC 1, ¶43.16 Id.17 (2000) 2 SCC 385.18(2001) 4 SCC 593. 19 Sunrise Associates v. Govt. of NCT of Delhi.20  2012-TIOL-1032-HC-KERALA-VAT available at <http://www.taxindiaonline.com/RC2/subCatDesc.php3?subCatDisp_Id=51&filename=legal/hc/2012/2012-TIOL-1032-HC-KERALA-VAT.htm>

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not decided the constitutional validity of the levy of service tax on deemed sales transactions, it

is very clear that this decision does have a lot of persuasive impact on the service tax law

concerning the levy of service tax on deemed sales transactions.

As already stated, the definition of sale in sales taxing statutes was the same as used in the Sale

of Goods Act, till the time of the 46 th Amendment. The validity of the Forty-sixth amendment of

the Constitution came directly before the Supreme Court in Builders Association of India v.

Union of India21 because, on the passing of the 

Forty-sixth amendment the State Governments commenced provisions contained in the proviso

to article 368(2) of the Constitution in that resolutions had been passed by the Legislatures of 12

states. It was held that the object of the Forty-sixth Amendment was to convert what is not

a sale into a sale. Originally, a transfer of property in goods involved in the execution of works

contract was held to be not a sale. Such a sale is now deemed by fiction of law to be a sale and is

made taxable. In no other respect does the Forty-sixth amendment enlarge the power of the State

to levy sales tax. It was in order to overcome the effect of Gannon Dunkerly that the Parliament

amended article 366 by introducing sub-clause (b) of clause (29-A). Sub-clause (b) of clause (29-

A) states that 'tax on the sale or purchase of goods' includes amoung other things a tax on the

transfer of property in the goods (whether as goods or in some other form) involved in the

execution of a works contract. It does not say that a tax on the sale or purchase of goods included

a tax on the amount paid for the execution of a works contract. It refers to a tax on the transfer of

property in goods (whether as goods or in some other form) involved in the execution of a work

contract.22 While referring to the transfer, delivery or supply of any goods that takes place as per

sub-clauses (a) to (f) of clause (29-A), the latter part of clause (29-A) says that '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 and a purchase of those goods by the person to whom such

transfer, deliver or supply is made. Hence, a transfer of property in goods under sub-clause (b) of

clause (29-A) is deemed to be a sale of goods involved in the execution of works contract by the

person making the transfer and a purchase of those goods by the person to whom such transfer is

made.23 The object of the new definition introduced in clause (29-A) of article 366 of the 21 1989 SCALE (2)768.22 Builders Association Of India v. State Of Karnataka (1990) 79 STC 442 (Kar).23 Binani Industries Limited v. Assistant Commissioner  (2003) 129 STC 199 (Kar).

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Constitution was, therefore, to enlarge the scope of 'tax on sale or purchase of goods' wherever it

occurs in the Constitution so that it may include within its scope the transfer delivery or supply

of goods that may take place under any of the transactions referred to in sub-clauses (a) to (f)

thereof wherever such transfer, delivery or supply becomes subject to levy of sales tax.24 The

provisions of Sales Tax Acts of various States and their relation with “deemed sales” was also

considered by the Supreme Court in the case of 20th Century Finance Corporation v. State of

Maharashtra.25 The dominant object in a contract is held to be not relevant and the value of the

goods involved in a contract is held liable to tax under Article 366 (29A) of the Constitution of

India.26

A question came up for consideration before the Supreme Court in the case of builders, that if the

land is provided by the land owners to the builders for the construction of the flats and the

builders constructs the flats after the allotment and taking the money in installments, the Apex

Court held that such contract would be works contract and the value of the goods would be liable

to tax in the case of K. Raheja Development Corporation vs. State of Karnataka.27 The

appropriate legislature by creating legal fiction can fix site of sale. The States however, in

exercise of power under Entry 54 of List II read with Article 366 (29-A) (d) are not competent to

levy sales tax on the transfer of right to use goods, which is deemed sale, if such sale takes place

outside the State or is a sale in the course of inter-State trade or Commerce or is a sale in the

course of import or export.28

Actual delivery of the goods is not necessary for effecting the transfer of the right to use the

goods but the goods must be available at the time of transfer must be deliverable and delivered at

some state. It is assumed at the time of execution of any agreement to transfer the right to use

that the goods are available and deliverable. If the goods or what is claimed to be goods by the

respondents are not deliverable at all by the service providers to the subscribers the question of

the right to use those goods would not arise.29 Thus for being a transfer of right to use the goods

24 Id.25 2000 UPTC 593.26 Bharat Sanchar Nigam Limited v. Union of India (2006) 3 SCC 1.27 (2005) 5 SCC 162.28 Supra n.25.29 Justice Rajes Kumar, Speech Delivered in the Seminar Session of 27 th U. P. Tax Bar Conference, Faizabad, 6th

January 2007.

12

the goods must be deliverable and should be delivered at some stage thus delivery of the goods at

some stage is a condition precedent for the transfer of right to use the goods.30

The Supreme Court has also allowed the States to come out with an alternative method to levy

Sales Tax on Works contract, if to arrive at material value is difficult. The states have come out

with a alternative method called as “Composition Tax” method to tax the indivisible works

contract, which is a non-legal /alternative method. The small percentage like 1%, 2%, 4%, 8% as

Composition Tax is levied but on the total contract price without any deduction which is

available in the legal options under the State Sales Tax / VAT Acts. After, the said amendment to

the Constitution certain States a namely Maharashtra & Delhi have come out with separate

`Works Contract’ Acts. The other states incorporated the separate provision to levy Sales Tax on

the deemed sales in the works contracts. Under the State Sales Tax Acts or separate Works

Contract Acts, No contractor or contractee were entitled to claim any set off of Sales Tax paid to

their vendors. There was a double taxation in the hands of contractors in the Sales Tax Regime

otherwise.31

30 Media Communications v. Govt. of Andhra Pradesh (1997) 105 STC 227 AP.31 Dhampur Sugar Mills Ltd v. Commissioner of Trade Tax (2006) 5 SCC 624.