Taxation

Larsen & Toubro Limited v. State of Karnataka

On 26^th September 2013, the Apex Court pronounced a landmark judgement regarding the validity of the imposition of service tax on composite works contracts under various sub-clauses of S. 65(105) as existed prior to 1-7-2012. The main issue, in this case, was, does the two-Judge Bench decision of this Court in Raheja Development laid down the correct legal position.

The question that in Larsen and Toubro, a two-Judge Bench of this Court has referred the matter for consideration by the larger Bench was also considered. In the referral order dated 19.8.2008, the two-Judge Bench, after noticing the relevant provisions of the Karnataka Sales Tax Act, 1957 and the difference  b/w a contract of sale and a works contract, made the reference to the larger Bench. The present article shall discuss the aspects of this case.  

Larsen & Toubro Limited v. State of Karnataka: Case Analysis

Before discussing the facts of the present case, it is important to examine the decision in the Raheja Case, as the present case questions the correctness of the same.

The case was about the levy of sales tax in the case of property development. The appellants carried the business of real estate development and allied contracts.

They entered into development agreements with owners of lands, and, post the approval of the plan, they constructed and entered into agreements of sale with intended purchasers.

The agreement also provided that the intended purchaser would also get undivided interest in the land, also.

The issue is whether the developer is liable to pay sales tax.

Analysis of Raheja Case

While analysing the case, the court observed the following

• The definition of a Works contract is very wide
• “Any agreement for carrying out either for  deferred payment, cash  or for any other valuable consideration the building or construction of any movable and immovable property”
• The definition doesn’t restrict that construction should be for the owner of the property. Therefore there is the imposition of sales tax on the agreements entered prior to the completion of construction.
• This decision was against the line of decisions with the  assessee
• A factual position similar to Raheja came before SC in L&T

Facts of the Case

• The ECC division of Larsen and Toubro ( in short, “L&T”) is involved in property development along with the owners of vacant sites. On 19^th October 1995, L&T entered into a development agreement with Dinesh Ranka, who was the owner of the land with survey nos. 90/1, 91, 92 (Part), 94, 95 and 96/1 (Part) together measuring 34 acres, all situated at Kothanur Village, Begur Hobli, Bangalore South Taluk, Bangalore, for constructing a multi-storeyed apartment complex. The owner was required to contribute his land, and L&T was required to construct the apartment complex. Post the development, 25% of the total space was to belong to the owner and 75% to L&T.
• There was the execution of a power of attorney by the owner of the land in favour of L&T to enable it for the negotiation and booking of orders from the prospective purchasers for allotment of the built-up area.
• Accordingly, L&T entered into agreements of sale with intended purchasers, which stated that upon the completion of the construction, the apartments would be handed over to the purchasers, who shall get an undivided interest in the land as well. Sale deeds, thus, were executed in favour of the intended purchasers by L&T and the owner.
• On 12.07.2005, the business premises of L&T were inspected by the Deputy Commissioner of Commercial Taxes (Intelligence-1) South Zone, Koramangala, Bangalore (hereinafter referred to as the ‘Deputy Commissioner’) and a detailed statement of the Finance Manager was recorded.
• On 21^st December 2005, the Deputy Commissioner called upon L&T to furnish the details of the development project. L&T furnished details on 24.07.2005 and 26.09.2005.
• On 04^th October .2005, the Deputy Commissioner issued a show cause notice on L&T stating that it was liable to tax according to the decision of this Court in Raheja Development.  
• L&T responded to the show cause notice and submitted preliminary objections on 10.10.2005. By a further communication dated 10.11.2005, L&T objected to the assessment of tax for the development of projects by it.
• The L&T inter alia submitted that the development agreement was not a works contract per se on account of the reasons: (a) the agreement was to develop and market flats to customers; (b) the intent and purpose of the agreement were to develop the property by the petitioners on the one hand and the land owner on the other; (c) the construction and development of the said land involved no monetary consideration; and (d) the only consideration was that upon the completion of the entire project, L&T would be entitled to 75 per cent of the same.
• Again on 04.01.2006, an inspection was carried out in the business premises of L&T, and certain documents like agreement copies and other documents relating to the transactions of the sale of flats were seized for the purposes of further investigation and verification.
• On 02^nd February 2006, the Deputy Commissioner served upon L&T a further notice proposing to tax the sale of materials used in the construction of flats on the ground that it was entitled to 75 per cent of the share of the projects. L&T filed detailed objections to this notice as well.
• On 03.07.2006, the Deputy Commissioner issued provisional assessment orders under Section 28(6) of the Karnataka Sales Tax Act, 1957 (for short, ‘KST Act’) for the years 2000-01 to 2004-05. Along with the provisional orders, the Deputy Commissioner also issued demand notices raising a total demand of Rs. 3,99,28,636/-.
• Initially, a writ petition was preferred by  L&T before this Court challenging the above demands, but the same was withdrawn, and a writ petition under Article 226¹ of the Constitution of India was filed before the Karnataka High Court.

Arguments by Petitioners

• As per the tripartite agreement, the main objective is selling and conveying a fraction of the land together with constructed flat after the payment of all the instalments.
• The construction isn’t carried out for the purchaser but carried out by the owner for exploiting the best prices.
• The flat is sold as flats and not as an aggregate of component parts
• The title to the property is taken only after the completion of the work.
• The developer won’t undertake construction on behalf of flat buyers, even if the constructions are done without pre-booking
• The developer isn’t the contractor of the flat purchaser
• The flat purchaser doesn’t have any role in conceptualising the project
• Ownership of material remains with the contractor, and it passes only on the conveyance of flat
• Accretion happens in the hands of the developer rather than the buyer. When constructed flat is transferred or sold, it becomes the sale of immovable property, and the theory of accretion does not arise.
• The construction-linked payment schedule is nothing but a method of payment of instalments.

Arguments by States

• Views taken in Raheja are correct and need no reconsideration
• Article 366(29A) of the Indian constitution has been inserted to provide a remedy arising from the decision of Gannon Dunkrely-1 where levying tax on works contract was unconstitutional
• Three conditions are that there must be a works contract, the goods have been involved in the execution of the contract, and the property in those goods must have been transferred to a third party either as goods or in some other form
• The term works contract refers to a contract in which one of the parties is obligated for undertaking or executing works.
• There isn’t any question of ascertaining the dominant intention of the contract as the sale of goods element is deemed sale under Article 366(29-A) (b) and can be taxed separately.
• The transfer of immovable property can’t be taxed as a sale of goods, but there isn’t any constitutional bar to tax only the sale of goods element and separately tax the transfer of immovable property.

Ruling of the Apex Court

• When an agreement is entered into between the promoter and the flat purchaser for constructing a flat and eventually selling the flat, the said activity is considered a works contract and the conditions of such a contract are satisfied in this case.
• Goods in some other form imply that the goods have ceased to be chattels or movables and become attached to the earth. Therefore goods which have by incorporation become part of immovable property are deemed as goods.
• Building contracts are species of works contracts, and the dominant nature test isn’t applicable.
• A Tripartite agreement between the owner of the land, the developer and the flat purchaser is a composite contract comprising both a works contract and the sale of immovable property.
• If the builder has undertaken the task to build for the prospective buyer and then to that extent, it is a works contract.
• The activity of construction undertaken by the developer will be works contract only from the stage the developer enters into a contract with the flat purchaser.

Conclusion

The larger Bench of the apex court held that any agreement for selling immovable property entered into before the construction would fall within the purview of the term ‘works contract’, allowing state governments the power to impose value-added tax (VAT) on such contracts.

Read Our Article: Karnataka HC stays ED Order Seizing Xiaomi India assets

1. https://indiankanoon.org/doc/1712542/