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. Most of the State VAT legislation , having regard to the effective recovery of tax, require in respect of contractors that any person making payment of any valuable consideration to them for the execution of the works contract in the State shall, at the 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 time of making payment to the contractor for inter-State works contract. Though interState works contract is not defined in the VAT legislation, such contracts are taxable under Central Sales Tax Act. States are empowered to levy taxes on the sale or purchase of goods, other than newspapers, 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, inter alia, clause (29A) (b) in Article 366 of the Constitution, as a result, tax on the purchase 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 works contract. Article 286 (1) of the Constitution states that no law of a State shall impose, or authorise 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, or export of goods out of the territory of India. Article 286(2) of the Constitution authorises Parliament by law to formulate principles for determining when a sale or purchase 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 Central Sales Tax Act, 1956, principles for determining when a sale or purchase of goods can 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 a sale or purchase of goods can be said to take place in the course of import or export. 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 should have moved from one State to another in pursuance of a contract of sale. Thus contracts 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 88 STC 204 SC), has held that it is necessary to exclude from the value of a works contract the value of goods which are not taxable by States in view of Sec tions 3, 4 and 5 of the CST Act.

The Guwahati High Court, in Projects and Services Centre vs State of Tripura (1991 82 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 the contractee 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 India Ltd vs State of Orissa (2000 118 STC 297), while interpreting Section 13AA of the Orissa Sales Tax Act, held that a provision designated to collect tax in advance without 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 sale and sales on import it is unsustainable.
Arbitrary powers

The Supreme Court decision in Nathpa Jhakri Jt. Venture vs State of Himachal Pradesh (2000 118 STC 306) is apposite. The court struck down Section 12-A and Rule 31 A of the Himachal Pradesh General Sales Tax Act, 1968 and observed that: Though the object of the provision is to meet 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 execution of the works contract, the effect of the provision is that, irrespective of whether the sales are inter-State sales or outside sales or export sales which are outside the preview of the State Act and those transactions in respect of which no tax can be levied even in terms of the enactment itself, such deductions have to be made in the bills 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 payable to the works contractor irrespective of whether ultimately the transaction is liable for payment 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 Cotton Mills Ltd vs State of Punjab (1967 20 STC 290) wherein the apex court said that if a person is not liable for payment of tax at all, at any time, the collection of a tax from him, with a possible contingency of refund at a later stage, will not make the original levy valid; because, if particular sales or purchases are exempt from taxation altogether, they can never be taken into account, at any stage, for the purpose of calculating 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 as on 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 is not liable to tax.

The Kerala High Court in Siemens Ltd vs State of Kerala and Others (2002 128 STC 452) followed the aforesaid judgments of the Supreme Court and held that subsection 7B of Section 7 of the Kerala Sales Tax Act and rule 22A (2) of the Kerala Sales Tax Rules are ultra vires and as beyond the legislative competence of the State 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., for which the State has no jurisdiction to collect sales tax. Thus, without doubt provisions for deduction of works contract tax at source, as enumerated in most of the local VAT legislation of States, are not applicable for inter-State works contract. Further, as the CST Act does not have any similar provision for deduction of tax at source in the case of a works contract, inter-State works contract are not subject to any deduction of tax at source. It may be noted that the VAT legislation of some States has provisions with regard to tax collected as source (TCS). (The author is Senior Manager, Deloitte Haskins and Sells. The views are personal.)