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TDS on inter-State works contract

Prashant Raizada

Composite contracts wherein material and labour are transferred by the contractor

to the contractee during execution of a contract are termed as works contract. Mostof the State VAT legislation , having regard to the effective recovery of tax, requirein respect of contractors that any person making payment of any valuableconsideration to them for the execution of the works contract in the State shall, atthe time of making payment, deduct works contract tax in advance.

Issue of debate

The issue of debate is whether tax should be deducted by the contractee at the timeof making payment to the contractor for inter-State works contract. Though inter-

State works contract is not defined in the VAT legislation, such contracts are taxableunder Central Sales Tax Act.

States are empowered to levy taxes on the sale or purchase of goods, other thannewspapers, by virtue of entry 54 of List II of the Seventh Schedule read with Article

246 of the Constitution. The 46th Amendment to the Constitution introduced, interalia, clause (29A) (b) in Article 366 of the Constitution, as a result, tax on thepurchase or sale of goods included a tax on the transfer of property in goods

(whether as goods or in some other form) involved in the execution of a workscontract.

Article 286 (1) of the Constitution states that no law of a State shall impose, orauthorise the imposition of, a tax on the sale or purchase of goods where such sale

or purchase takes place outside the State or in the course of import of goods into, orexport of goods out of the territory of India. Article 286(2) of the Constitutionauthorises Parliament by law to formulate principles for determining when a sale orpurchase of goods takes place in any of the ways mentioned in sub-article (1).

Principles set out

Acting upon this power, Parliament has set out in Sections 3, 4 and 5 of the CentralSales Tax Act, 1956, principles for determining when a sale or purchase of goodscan be said to take place in the course of inter-State trade or commerce, when a

sale or purchase of goods can be said to take place outside the State and when asale or purchase of goods can be said to take place in the course of import orexport.

Goods involved in a works contract have been included in the definition of sale w.e.f.May 11, 2002. For inter-State works contract, it is essential that the goods shouldhave moved from one State to another in pursuance of a contract of sale. Thuscontracts wherein goods occasion the movement in pursuant to an existing works

contract are taxable under CST Act.

The Supreme Court, in Gannon Dunkerley and Co. vs State of Rajasthan (1993 88STC 204 SC), has held that it is necessary to exclude from the value of a workscontract the value of goods which are not taxable by States in view of Sec tions 3, 4

and 5 of the CST Act.

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The Guwahati High Court, in Projects and Services Centre vs State of Tripura (199182 STC 89 Guwahati), held that inter-State purchases of goods used in execution of

a works contract will not be subjected to local sales tax levy if:

The movement of goods from one State to another is the result of an incident of

contract;

The goods transferred from the supplier must be the same goods as ordered by thecontractee through the contractor;

There must be a privity of contract between the supplier and the contractee.

Further, the three-member Bench of the Supreme Court in Steel Authority of IndiaLtd vs State of Orissa (2000 118 STC 297), while interpreting Section 13AA of theOrissa Sales Tax Act, held that a provision designated to collect tax in advancewithout excluding transaction falling outside the purview of the State Act is not

sustainable. Therefore, so long as the provision authorises the State Government to

deduct tax on the entire amount, including the turnover covered by inter-State saleand sales on import it is unsustainable.

Arbitrary powers

The Supreme Court decision in Nathpa Jhakri Jt. Venture vs State of HimachalPradesh (2000 118 STC 306) is apposite.

The court struck down Section 12-A and Rule 31 A of the Himachal Pradesh GeneralSales Tax Act, 1968 and observed that: Though the object of the provision is tomeet the tax in respect of the transactions on all works contract on the valuable

consideration payable for the transfer of property in goods involved in the executionof the works contract, the effect of the provision is that, irrespective of whether thesales are inter-State sales or outside sales or export sales which are outside thepreview of the State Act and those transactions in respect of which no tax can belevied even in terms of the enactment itself, such deductions have to be made in thebills or invoices of the contractors.

Therefore, we must hold that arbitrary and uncanalised powers have been

conferred on the concerned person to deduct up to 4 per cent from the sum payableto the works contractor irrespective of whether ultimately the transaction is liable forpayment to any sales tax at all. In that view of the matter, we have no hesitation in

rejecting the contention advanced on behalf of the State.

It wont be out of place to mention the Supreme Court decision in Bhawani CottonMills Ltd vs State of Punjab (1967 20 STC 290) wherein the apex court said that if aperson is not liable for payment of tax at all, at any time, the collection of a tax fromhim, with a possible contingency of refund at a later stage, will not make the originallevy valid; because, if particular sales or purchases are exempt from taxationaltogether, they can never be taken into account, at any stage, for the purpose ofcalculating or arriving at the taxable turnover and for levying tax.

Thus there is no doubt that if a person is not liable for payment of tax, inasmuch ason completion of the assessment refund can be obtained at a later stage, is no

solace and hence tax should not be deducted at all in scenarios where the person isnot liable to tax.

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The Kerala High Court in Siemens Ltd vs State of Kerala and Others (2002 128 STC452) followed the aforesaid judgments of the Supreme Court and held that sub-

section 7B of Section 7 of the Kerala Sales Tax Act and rule 22A (2) of the KeralaSales Tax Rules are ultra vires and as beyond the legislative competence of theState so long as they enable the State to collect tax inclusive of turnover covered by

inter-State sales, sales in the course of import, sales outside the State, etc., forwhich the State has no jurisdiction to collect sales tax.

Thus, without doubt provisions for deduction of works contract tax at source, asenumerated in most of the local VAT legislation of States, are not applicable forinter-State works contract. Further, as the CST Act does not have any similarprovision for deduction of tax at source in the case of a works contract, inter-Stateworks contract are not subject to any deduction of tax at source. It may be notedthat the VAT legislation of some States has provisions with regard to tax collected assource (TCS).(The author is Senior Manager, Deloitte Haskins and Sells. The views are personal.)