Whether the charges collected towards the services for evolution of prototype conceptual design (i.e. creation of concept), on which service tax had been paid under the Finance Act, 1994 as amended from time to time is liable to tax under the Karnataka Value Added Tax Act, 2003 is the question involved in this appeal before the Supreme Court.
Appellant is an advertising agency. It creates original concept and design advertising material for their clients and design brochures, annual reports etc. Further facts are not relevant – let’s get straight to what the Supreme Court observed.
The fact that the appellant is a service provider is not in dispute. It is also not in dispute that the orders received by it to provide such services is party specific and issue specific; be it for issuance of a brochure or a year book or for any other purpose.
Appellant, in their returns, made three categorical divisions in regard to its tax liabilities: –
(1) The amount of service tax on the specific design and production;
(2) The amount of Kerala Sales Tax on the specified item on the first sale; and
(3) when certain items are outsourced, the tax payable on resale of the said goods in terms of Section 6(4) of the Kerala Sales Tax Act.
The Tribunal as also the High Court opined that the contract was an indivisible one. The effect of such an indivisible contract, vis -a- vis work contract came up for consideration before the Court in The State of Madras v. Gannon Dunkerley & Co., ( Madras ) Ltd. wherein it was clearly held :
To avoid misconception, it must be stated that the above conclusion has reference to works contracts, which are entire and indivisible, as the contracts of the respondents have been held by the learned Judges of the Court below to be. The several forms which such kinds of contracts can assume are set out in Hudson on Building Contracts, at p.165 . It is possible that the parties might enter into distinct and for money consideration and the other for payment of remuneration for services and for work done.
The question came for consideration again in Builders Association of India & Ors. v. Union of India & Ors. and M/s.Gannon Dunkerley & Co. & Ors. v. State of Rajasthan & Ors. It had been laid down that the effect of amendment by introduction of clause 29A in Article 366 is that by legal fiction, certain indivisible contracts are deemed to be divisible into contract of sale of goods and contract of service. In Gannon Dunkerley case, it had been held:
Keeping in view the legal fiction introduced by the Forty-sixth Amendment whereby the works contract which was entire and indivisible has been altered into a contract which is divisible into one for sale of goods and other for supply of labour and services, the value of the goods involved in the execution of a works contract on which tax is leviable must exclude the charges which appertain to the contract for supply of labour and services.
A Constitution Bench in Tata Consultancy Services opined that having regard to the definition of the term goods contained in clause (12) of Article 366 of the Constitution of India, a software programme may consist of various commands which enable the computer to perform a designated task. The copyright in that programme may remain with the originator of the programme, but the moment copies are made and marketed, it becomes goods, which are susceptible to sales tax. In regard to the element of intellectual property, it was held that the same having been incorporated on a media, for purposes of transfer, both tangible and intangible property capable of being transmitted, transferred, delivered, stored and possessed etc. would come within the purview thereof.
The question yet again came up for consideration before a Three Judge Bench of the Supreme Court in Bharat Sanchar Nigam Ltd. v. Union of India wherein it was held;
44. Of all the different kinds of composite transactions the drafters of the Forty-sixth Amendment chose three specific situations, a works contract, a hire-purchase contract and a catering contract to bring them within the fiction of a deemed sale. Of these three, the first and third involve a kind of service and sale at the same time. Apart from these two cases where splitting of the service and supply has been constitutionally permitted in sub-clauses ( b ) and ( f ) of clause (29-A) of Article 366, there is no other service which has been permitted to be so split.
For example, the sub-clauses of Article 366(29-A) do not cover hospital services. Therefore, if during the treatment of a patient in a hospital, he or she is given a pill, can the Sales Tax Authorities tax the transaction as a sale? Doctors, lawyers and other professionals render service in the course of which can it be said that there is a sale of goods when a doctor writes out and hands over a prescription or a lawyer drafts a document and delivers it to his/her client? Strictly speaking, with the payment of fees, consideration does pass from the patient or client to the doctor or lawyer for the documents in both cases.
45. The reason why these services do not involve a sale for the purposes of Entry 54 of List II is, as we see it, for reasons ultimately attributable to the principles enunciated in Gannon Dunkerley case 5, namely, if there is an instrument of contract which may be composite in form in any case other than the exceptions in Article 366(29-A), unless the transaction in truth represents two distinct and separate contracts and is discernible as such, then the State would not have the power to separate the agreement to sell from the agreement to render service, and impose tax on the sale. The test therefore for composite contracts other than those mentioned in Article 366(29-A) continues to be: Did the partie s have in mind or intend separate rights arising out of the sale of goods. If there was no such intention there is no sale even if the contract could be disintegrated.
The test for deciding whether a contract falls into one category or the other is to as what is the substance of the contract. We will, for the want of a better phrase, call this the dominant nature test.
50. What are the goods in a sales transaction, therefore, remains primarily a matter of contract and intention. The seller and such purchaser would have to be ad idem as to the subject-matter of sale or purchase. The court would have to arrive at the conclusion as to what the parties had intended when they entered into a particular transaction of sale, as being the subject-matter of sale or purchase. In arriving at a conclusion the court would have to approach the matter from the point of view of a reasonable person of average intelligence.
20. We may, at this juncture, also notice the decision of this Court in Associated Cement Company (supra).
The question which arose for consideration by the Supreme Court in Associated Cement Company , was as to whether any intellectual property contained in a software would be subject to custom duty within the meaning of Section 2(22) of the Customs Act, defining goods. A three Judge Bench of the Court sought to make a distinction between such a contingency arising under the Customs Act involving a works contract and a contract of sale stating :
32. In the sales tax cases referred to hereinabove no doubt the question which arose was whether in a works contract, where there was a supply of materials and services in an indivisible contract, but there the question had arisen because the States powers prior to the Forty-sixth Amendment to the Constitution, were not entitled to bifurcate or split up the contract for the purpose of levying sales tax on the element of moveable goods involved in the contract. Apart from the decision in Rainbow Colour Lab case, which does not appear to be correct, the other decisions cited related to the pre-Forty-sixth Amendment period. Furthermore, the provisions of the Customs Act and the Tariff Act are clear and unambiguous. Any moveable articles, irrespective of what they may be or may contain, would be goods as defined in Section 2(22) of the Customs Act.
Therefore the decision of Associated Cement Company seeks to make a distinction between cases arising out of works contract where sales tax is liable to be paid and the cases under the Customs Act.
The Supreme Court observed that in none of the above cases covered the concept of works contract involving both service as also supply of goods constituting a sale.
In Tata Consultancy as also in Associated Cement Company , what was in issue was the value of the goods and only for the said purpose, the Court went by the definition thereof both under the Customs Act as also the Sales Tax Act to hold that the same must have the attributes of its utility, capability of being bought and sold and capability of being transmitted, transferred, delivered, stored and possessed. As software was found to be having the said attributes, they were held to be goods.
Indivisible contract vs composite contract?
In the case at hand, the Supreme Court is faced with a different problem. Appellant admittedly is a service provider. When it provides for service, it is assessable to a tax known as service tax. Such tax is leviable by reason of a Parliamentary statute.
The Supreme Court observed,
(1) In the matter of interpretation of a taxing statute, as also other statutes where the applicability of Article 246 of the Constitution of India, read with Seventh Schedule thereof is in question, the Court may have to take recourse to various theories including aspect theory.
(2) A distinction must be borne in mind between an indivisible contract and a composite contract. If in a contract, an element to provide service is contained, the purport and object for which the Constitution had to be amended and clause 29A had to be inserted in Article 366, must be kept in mind. a legal fiction is created by reason of the said provision.
(3) Such a legal fiction, as is well known, should be applied only to the extent for which it was enacted. It, although must be given its full effect but the same would not mean that it should be applied beyond a point which was not contemplated by the legislature or which would lead to an anomaly or absurdity.
(4) The Court, while interpreting a statute, must bear in mind that the legislature was supposed to know law and the legislation enacted is a reasonable one. The Court must also bear in mind that where the application of a Parliamentary and a Legislative Act comes up for consideration; endeavours shall be made to see that provisions of both the acts are made applicable.
(5) Payments of service tax as also the VAT are mutually exclusive. Therefore, they should be held to be applicable having regard to the respective parameters of service tax and the sales tax as envisaged in a composite contract as contra distinguished from an indivisible contract.
(6) It may consist of different elements providing for attracting different nature of levy. It is, therefore, difficult to hold that in a case of this nature, sales tax would be payable on the value of the entire contract; irrespective of the element of service provided.