Back to back sub-contracting- No VAT leviable on profit element of main contractor

Case Law Citation- Surya Constructions Vs. Commercial Tax Officer (WC & LT) & State Of Kerala (Kerala High Court at Ernakulam), WP(C).No. 11716 of 2010 (L), Date of Judgement- 10-11-2014

In the construction and real estate industry it is common practice for the Contractors to sub contract the whole of the contract for execution on back to back basis. While sub-contracting on back to back basis the main contractor retains its profit element from the total consideration received from the contractee. In such case the question which arises whether such profit element is subject to any tax under VAT.

The question was well answered by Kerala High Court in Surya Constructions vs CTO and State of Kerala, wherein the writ petition was filed before the Kerala HC to resolve the issue of taxability of profit element of main contractor, where the entire work was sub-contracted for execution.

HC after hearing both sides and considering the facts of the case, referred to SC rulling in State of Andhra Pradesh vs Larsen and Tourbo Limited [(2008) 17 VST 1 (SC) in which SC observed:

“………even if there is no privity of contract between the contractee and the sub-contractor, that would not do away the principle of transfer of property by the sub-contractor by employing the same on the property belonging to the contractee. This reasoning is based on the principle of accretion of property in goods. It is subject to the contract to the contrary…..in such a case the work executed by a sub-contractor, results in a single transaction and not multiple transactions. This reasoning is also borne out by section 4(7) which refers to value of goods at the time of incorporation in the works executed. In our view, if the argument of the Department is to be accepted it would result in plurality of deemed sales which would be contrary to article  366(29A)(b) of the Constitution as held by the impugned judgment of the High Court. Moreover, it may result in double taxation which may make the said 2005 Act vulnerable to challenge as violative of articles 14, 19(1)(g) and 265 of the Constitution of India as held by the High Court in its impugned judgment.”

HC observed that the sub-contractor discharged the tax liability in respect of entire work that was sub-contracted and the amounts retained by assessee, from out of payments made by the contractee, represented only the profit element that accrued to it in the capacity as a main contractor.

HC further stated that it was clear no tax was payable by assessee on the portion of work sub-contracted by it and the tax payment demanded by Revenue pertained only to that part retained as profit by assessee. It was further held that assessee was not liable to pay any tax under Kerala VAT ACt, as there was no sale of material in the execution of works contract that emanated from assessee to contractee/awarder. In the absence of any taxable even under Kerala VAT Act, Revenue could not have demanded tax on the amounts retained by assessee as profit and therefore the demand was illegal and unsustainable.

Thus two things can be concluded from the above judgement one is in back to back sub-contacting there is no sale of material in execution of works contract from main contractor to contractee and  other is, main contractor is not liable to pay any VAT on the profit element retained by him as the same is not value addition on the deemed sales of material incorporated in the execution of works contract.

Direct Link to Download Full Text of the Kerala High Court Judgment

http://judis.nic.in/judis_kerala/Judge_Result_Disp.asp?MyChk=378841