There are two components in every works contract one is material component and other is labour component. Material incorporated in a works contract is considered as deemed sales to the contractee and hence is liable to VAT or sales tax. To arrive at the material component involved in a works contract deductions for labour component are allowed.
In Gannon and Dunkerley & co. Vs State of Rajsthan 88 STC 204, Hon’ble Supreme Court after a long discussion elaborated inclusive list of labour deductions which are to be allowed while arriving at deemed sales of material in a works contract.
These labour deductions are as follows:
(a) labour charges for execution of the works;
(b) amount paid to a sub-contractor for labour and services;
(c) charges for planning designing and architect’s fees;
(d) charges for obtaining on hire or otherwise machinery and tools used for the execution of the works contract;
(e) cost of consumable such as water, electricity, fuel. etc. used in the execution of the works contract the properly in which is not transferred in the course of execution of a works contract; and
(f) cost of establishment of the contractor to the extent it is relatable to supply of labour and services;
(g) other similar expenses relatable to supply of labour and service
(h) profit earned by the contractor to the extent it is relatable to supply of labour and services.
In almost all the States VAT laws have been legislated keeping in view the above deductions, to be allowed from a works contract to arrive at the deemed sales of material.
The deductions mentioned above are not exhaustive as is clear from the clause (g) above.Therefore any deduction which is relatable to labour and services although not mentioned clearly, would be allowed from the works contract to arrived at the deemed sales.
Whether depreciation on machinery and tools used in the execution of works contract can be allowed as labour deduction from the value of a works contract, is a question being addressed here.
Depreciation on machinery and tools used in the execution of works contract is not being clearly mentioned above nor have been mentioned in relevant Rule 15(4) of Punjab VAT Rules, 2005. However “charges for obtaining on hire or otherwise machinery and tools used in the execution of the works contract, the property, which is not being transferred in the course of a works contract”, is being clearly mentioned.
If a contractor hires machinery and tools used in the execution of a works contract then such hire charges are allowed as deduction from the works contract, but if a contractor uses his own machinery and tools in the execution of a works contract, which he otherwise could have hired from outside, then depericiation on such machinery and tools should be allowed.
In the process of execution of the works, the machinery and tools are worn down and depreciated in value. As the end price, i.e., the value of the contract is always fixed or determined factoring this wear and tear to the machinery and tools as a consequence of using them for the execution of the works contract, the value of the proportionate wear and tear of the machinery which is otherwise identified as depreciation had to be necessarily permitted as a deduction on the premise that it is equivalent to the hire charges as was provided in clause (d) above and also is to be understood as one within the scope of “other similar expenses relatable to the supply of labour and services”.
Similar view was also upheld in 34 VST 53 (Karn HC DB). In this case while allowing the deduction for depreciation on machinery and tools used in the execution of a works contract it was held:
“Untill and unless all other components in the value of the works contract other than the value of the property in goods passing from the contractor to the client on the execution of works contract were excluded, the transaction did not fit into the definition of clause (29A) of article 366. Therefore, the Commissioner and the Tribunal were in error in disallowing the claim made by the dealer, towards proportionate depericiation of the machinery and tools owned by the dealer to the extent they had been exclusively used for the execution of the works contract.”
Thus in light of the decision of the above judgement and reasoning given therein depreciation on machinery and tools owned by the contractor, used in the execution of a works contract should be allowed while arriving at the deemed sales of goods incorporated in a works contract.