RULINGS AND CLARIFICATIONS – In respect of any application filed before it, must pass a speaking order, giving satisfactory reasons for taking a particular decision – Decision bereft of reasons negates concept of ‘Advance Ruling’ – Where the appellant sought whether providing ‘Facade Access system’ amounts to works contract, the authority held that it would be taxable as sale of machinery – Appeal to High Court – After going through contract documents like work orders and invoices, the Court held that the Authority ought to have called for contract documents and then alone given the clarification – Order of authority cryptic, passed without considering nature of contract – Impugned order set-aside and remanded to authority for reconsideration.
Held:
The Authority must pass a speaking order, ft only means, the Authority passing an order must give satisfactory reasons for taking a particular decision. Any decision bereft of the reasoning will not only be arbitrary but also be unjust and certainly would negate the concept of ‘Advance Ruling’, ie., a written confirmation from the taxing authorities in advance in respect of tax implications of a proposed transaction
(B) KARNATAKA SALES TAX ACT, 1957 – SECTION 5B -WORKS CONTRACT – Whether a particular transaction is contract for sale or for works contract – Test, to find out – Nature of contract depends on intention of parties – To be decided on totality of its terms and conditions – Nature of contract predominantly based on facts rather than being a question of law.
The character of a transaction is defined by the nature of the contract entered into by the parties. The nature of contract depends upon the intention of the parties as reflected in the terms and conditions of the contract document. The nature of the contract is decided on the totality of its terms and conditions, i.e., scope and obligation of the parties, contract value and payment terms, insurance coverage, transfer of ownership or title in goods supplied, liquidated damages whether restricted to supply value or not etc. Thus, the nature of a contract is predominately based on facts rather than being a question of law.
JUDGMENT
H.L. Dattu, J.
1. The appellant is a dealer registered under the provisions of the Karnataka Sales Tax Act, 1957 (hereinafter for the sake of brevity referred to as ‘KST Act’). The appellant company is engaged in designing manufacture, sale and installation of building maintenance units like cradles, trolleys, portable jibs, winches, etc. The range of building maintenance products designed, manufactured and sold by the appellant company are mainly used for the exterior maintenance of big buildings. One of the products designed and manufactured by the appellant company is “Facade Access System” which is designed to maintain and clean glass walls, granite and alluminium panels.
2. The appellant company has approached the Authority for clarification and Advance Ruling by filing an application in Form 54 as prescribed under Rule 27-E(1) of the Karnataka Sales Tax Rules (‘Rules’ for short), interalia seeking clarification /advance ruling by framing the following questions.
“(a) Whether the specific designing and fabrication of Facade Access Equipment is a works contract activity falling under the provisions of Section 5B of the KST Act, 1957 and thereby determine under which specific entry, the same falls under the Sixth Schedule to KST act?
(b) If the specific activity of the appellant is not a works contract, then to please determine under which other entry the same falls for the purpose of taxation?”
3. The Advance Ruling Authority, after hearing the representative of the appellant company, by its clarification order No. AR. CLR. Cr. 73/02-03 dated 26.5.2003, has clarified that though the Facade Access System is made per order, the goods in question has the character of machineries and therefore, when sold, it is liable to tax as sale of machinery under Entry 1(iii) (a) of Part ‘M’ of the Second Schedule to KST Act and the basic rate of tax applicable is 12% and the understanding of the appellant company that it is works contract is not correct.
4. The appellant company is now before this Court in this appeal filed under Section 24(1) of the Act, being aggrieved by the aforesaid clarification issued by the Advance Ruling Authority.
5. Sri Aravind Kamath, learned Counsel for the appellant company would submit that the appellant company on the request made by each, customer, conducts inspection of the building, understands the specific requirement, specifically designs and manufactures the “Facade Access System” to suit the specific requirement of the customer and such Facade Access Systems are not manufactured in advance and sold off the shelf by the appellant company, since each building requires custom made and specifically designed Facade Access System. Therefore, what is manufactured for one customer would not essentially be suitable for another customer. Therefore, the understanding of the Advance Ruling Authority that the Facade Access System though manufactured to the specific requirement and design of the customer, the transaction is a sale of machinery and liable for single point levy under Section 5(3)(a) of the Act at 12% and not a works contract as defined under Section 2(v-I) of the Act, is not only erroneous and goes against the concept of works contract. To substantiate his contention, the learned Counsel has produced before us, the brochures to demonstrate how Facade Access System works and also a few purchase orders/work orders placed by the purchasers for design, supply and fixing of Facade Access System.
6. The learned Govt. Advocate by placing reliance on the decision of the Apex Court in the case of HINDUSTAN SHIPYARD LIMITED v. STATE OF ANDHRA PRADESH, (2000) 119 STC 533 would, contend that the transaction of the appellant company is pure and simple sale of machinery and not works contract as contended by the appellant company.
7. The question that falls for our consideration and decision in this appeal is whether the design, supply and installation of Facade Access System to the specification and requirement of the customer would come within the definition of “works contract” as defined under Section 2(v-I) of the Act or is it a sale of machinery as clarified by the Advance Ruling Authority?
8. At the outset, we intend to state that the appellant company has not produced any contract that is entered into between the appellant company and its customers. The learned Counsel Sri Aravind Kamath would submit that the terms and conditions mentioned in the purchase orders/work orders / invoices itself are the terms and conditions of the contract entered between the appellant company and its customers and therefore, we intend to notice certain conditions in one or two purchase orders placed by the appellant company’s customers for fabrications, installation and supply of goods in question.
9. The Facade Access System is a simple machine made to order for the purpose of window cleaning, ledges, cleaning, etc. The goods in question is manufactured and supplied to the specific design and requirement of customers. The purchase orders placed by the contractee in some cases is composite works contract for the design, supply and installation of equipments’ like parapet jib, bracket sets and single man cradle and the price payable for supply is inclusive of all taxes. In some cases, no advance amount is paid by the contractee and in some cases, 20 % advance is paid along with the purchase order and the balance amount requires to be paid only after erection and installation of the equipment. The appellant company has also produced before us another type of work order placed by yet another customer namely, Millenia Realtors Pvt. Ltd. The work order is for supply and fixing of Facade Access System at the place of the contractee. The work order/ contract between the parties is for supply and fixing of Facade Access System. The contract value mutually agreed is Rs. 11,00,000/- (Rupees Eleven Lakhs only), which includes all taxes, duties, including sales tax on works contract. The terms of payment includes payment of interim bills and payment of final bills. In so far as payment of interim bills, 75% of the bill amount requires to be paid by the contractee after scrutiny by its site representative within 15 days and the balance amount to be released within 30 days from the date of submission and the final bills requires to be settled within 30 days after receipt of final measurements, reconciliation and bill from contractee. Clause 7 of the work order provides for payment schedule. Out of the total price, 60% requires to be paid against actual material supply at site, 30% against prorate erection and 10% after commissioning. The work order/contract, vide Clause 9 provides for retention money. Under this clause, the contractee is authorised to retain 5% of the gross value of the work done as retention money from the interim and final payment certificates till virtual completion of the work and the retention money will not bear any interest. Secondly, 50% of the total retention money shall be released to the contractor after virtual completion of the work after issue of taking over certificate by the employer against a bank guarantee for an equal amount, validity of which should cover the entire defects liability period and lastly, 50% of the retention money shall be released to the contractor after expiry of the “defects liability period”. The balance 50% of the retention money shall be released to the contractor after expiry of the defects liability period and the defects liability period is 12 months from the date of issue of “taking over certificate’, Clause 14 of the work order provides for technical and it is as under:
“(a) It shall be the responsibility of contractor for proper designing of anchor bolts, perm track, rollers, etc. All design parameter have to be approved by the Structural Consultants of Employer. Further, Contractor has to furnish warranty for satisfactory and safe performance of the system for twenty years.
(b) The system designed and provided by Contractor to be suitable to receive the cleaning system.
(c) Pull tests for anchor bolts and any other filled tests required by the Employer shall be conducted by the Contractor at no extra cost.”
10. The reason why we have mentioned in detail the different types of work orders that are placed for supply of Facade Access System by the purchasers with the appellant company, is only to suggest that the character of a transaction is defined by the nature of the contract entered into by the parties. The nature of contract depends upon the intention of the parties as reflected in the terms and conditions of the contract document. The nature of the contract is decided on the totality of its terms and conditions, i.e., scope and obligation of the parties, contract value and payment terms, insurance coverage, transfer of ownership or title in goods supplied, liquidated damages whether restricted to supply value or not etc. Thus, the nature of a contract is predominately based on facts rather than being a question of law. The Supreme Court in the case of HINDUSTAN SHIP YARD LTD. v. STATE OF ANDHRA PRADESH(SUPRA), has observed that there is a distinction between a contract of sale and works contract. No straight – jacket formula can be made available nor can such quick witted tests devised as would be infallible. In sum and substance, the view of the Apex Court is that it is the nature of the contract is deciding factor to determine whether the transaction between the parties is a contract of sale or works contract. The Court has observed in the said decision that:
“6. The distinction between a contract of sale and a works contract are not free from difficulty and has been subject matter of several judicial decisions. No straight – jacket formula can be made available nor can such quick – witted tests devised as would be infallible. It is all a question of determining the intention of the parties by culling out the same on an overall reading of the several terms and conditions of a contract. In State of Gujarat v. Variety Body Builders – (1976) 38 STC 176, this Court observed that there is no standard formula by which one can distinguish a contract of sale from a contract for work and labour. There may be many common features in both the contracts, some neutral in a particular contract, and yet certain clinching terms in a given case may fortify a conclusion one way or the other. It will depend upon the facts and circumstances of each case. The question is not always easy and has for all times vexed jurists all over.”
11. In the aforesaid decision, the Court has categorized three categories of contracts and has observed which one of the categories would fit into contract for sale or contract of work and labour. The Court has noticed that”
“There may be three categories of contracts : (1) The contract may be for work to be done for remuneration and for supply of materials used in the execution of the work for a price ; (ii) It may be a contract for work in which the use of the materials is ancillary or incidental to the execution of the work; and (iii) It may be a contract for supply of goods where some work is required to be done a incidental to the sale. The first contract is a composite contract consisting of two contracts one of which is for the sale of goods and the other is for work and labour. The second is clearly a contract for work and labour not involving sale of goods. The third is a contact for sale where the goods are sold as chattels and the work done is merely incidental to the sale.”
12. The Supreme Court in the said decision, after noticing the observations made by learned Authors on Sale of Goods Act and the case laws decided by the Supreme Court on the topic at issue, has laid down the principles to distinguish between a contract for sale and contract for work and labour. It is relevant to notice the observations made by the Supreme Court therein. They are as under:
14. The principles deducible from the several decided cases may be summed up as under:
(1) It is difficult to lay down any rule or inflexible rule applicable alike to all transactions so as to distinguish between a contract for sale and a contract for work and labour.
(2) Transfer of property of goods for a price is the linchpin of the definition of “sale”. Whether a particular contract is one of sale of goods Or for work and labour depends upon the main object of the parties found out from an overview of the terms of the contract, the circumstances of the transactions and the custom of the trade. It is the substance of the contract document/s and not merely the form, which has to be looked into. The Court may form an opinion that the contract is one whose main object is transfer of property in a chattel as a chattel to the buyer, though some work may be required to be done under the contract as ancillary or incidental to the sale, then it is a sale. If the primary object of the contract is the carrying out of work by bestowal of labour and services and materials are incidentally used in execution of such work then the contract is one for work and labour.
(3) If the thing to be delivered has any individual existence before the delivery as the sole property of the party, who is to deliver it, then it is a sale. If A may transfer property for a price in a thing in which B had the previous property then the contract is a contract for sale. On the other hand, where the main object of work undertaking by the payee of the price is not the transfer of a chattal qua chattel, the contract is one for work and labour.
(4) The bulk of material used in construction belongs to the manufacturer who sells the end-product for a price, then it is a strong pointer to a conclusion that the contract is in substance one for the sale of goods and not one for work and labour. However, the test is not decisive. It is not the bulk of the material alone but the relative importance of the material qua the work, skill and labour of the payee, which have to be weighed. If the major component of the end-product is the material consumed in producing the chattel to be delivered and the skill and labour are employed for converting the main components into the end-products, the skill and labour are only incidentally used and hence the delivery of the end-product by the seller to the buyer would constitute a sale. On the other hand, if the main object of the contract is to avail the skill and labour of the seller though some material or components may be incidentally used during the process of the end-product being brought into existence by the investment of skill and labour of the supplier, the transaction would be a contract for work and labour.”
13. The case of the appellant company before the Advance Ruling Authority was that it is engaged in manufacture and sale of Facade Access System, which is designed and made after considering the specific and precise requirement of a customer. Therefore, according to the appellant company, the activity of designing and fabricating Facade Access System is nothing but works contract as defined under Section 2(v-I) of the Act. Since the appellant company had some doubt in this regard and in particular to the rate of tax payable on the activity earned on by it, the appellant company has approached the Advance Ruling Authority, to clarify whether the specific designing and fabrication of Facade Access System equipments is a works contract activity falling under the provisions of Section 5-B of the Act and if it not so, then to inform them under which other Entry the transaction falls for the purpose of taxation.
14. The Advance Ruling Authority without even considering the nature of contract between the appellant company and the contractee, in a most causal way, has clarified to the appellant company that its transaction with its customers is nothing but sale of machinery and therefore, exigible to tax under Entry 1 (iii) (a) of Part ‘M’ of Second Schedule to the Act and the rate of tax applicable is at 12%.
15. Section 4 of the Act was inserted by Karnataka Act No. 5/ 2002, with effect from 1.4.2002. This Section provides for Clarification and Advance Rulings by an Authority constituted by the Commissioner of Commercial Taxes. The two key words in the provision are ‘clarification’ and ‘advance rulings’. The clarification is with regard to rate of tax applicable under KST Act in respect of any goods liable to tax under the Act. The Advance Ruling can be in regard to exigibility to tax a transaction undertaken or proposed to be undertaken by a dealer registered under the Act. The language employed in Section 4(1) of the Act clearly gives an indication that the Authority constituted under the Act can decide on questions of law as also questions of fact.
The application for an advance ruling is required to be made in the prescribed form, ie., in Form – 54 as provided in Rule 27-E(1) of the Rules. The application can be withdrawn within 30 days from the date of the application.
Sub-section (4) of Section 4 of the Act envisages the procedure to be followed by the Authority on receipt of an application. On receipt of an application seeking an advance ruling, the Authority shall forward a copy of the application to the concerned assessing authority or registering authority and if it considers necessary, direct the aforesaid authorities to furnish relevant information or records.
The most important part of this Section is Sub-section (5), which says that the Authority after examining the application and any records called for, either allow or reject the application by passing an order. There are two provisos appended to this sub-section. The first proviso to Sub-section (5) of Section 4 of the mandates that the Authority shall not allow the application where the question raised in the application is already pending before any officer or Authority of the Department or Appellate Tribunal or any Court, or relates to a transaction or issue which it designed apparently for the avoidance of tax. The second proviso to Sub-section (5) of Section 4 of the Act enacts, firstly, the principles of natural justice ‘audi alterm partem’, that is to say, that the Authority shall not reject any application without affording a reasonable opportunity of being heard to the applicant and secondly, it ordains that where an application is rejected by the Authority, the reason for such rejection must be stated in its order. In other words, the Authority must pass a speaking order. It only means, the Authority passing an order must give satisfactory reasons for taking a particular decision. Any decision bereft of reasoning will not only be arbitrary but also be unjust and certainly would negate the concept of ‘Advance Ruling’, ie., a written confirmation from the taxing authorities in advance in respect of tax implications of a proposed transaction.
16. We do not intend to notice the other sub-sections of Section 4 of the Act for the disposal of the present case.
17. Now coming back to the impugned order, the appellant company by paying a hefty fee of Rs. 1,000/- on the application filed before the Advance Ruling Authority has sought a clarification, firstly, whether the nature of business and manufacturing activity carried on by it would come within the definition of ‘works contract’ and exigible to tax under the specific charging provision, namely, Section 5-B of the Act and consequently to clarify under which specific Entry under Fifth Schedule to the Act is activity could be fitted into. Secondly, if the activity of the applicant is not a works contract, then to clarify under which other Entry the same falls for the purpose of taxation under the Act. The Advance Ruling Authority after hearing the representative of the appellant company has passed a cryptic order, without even considering the nature of the contract between the appellant company and its customers. In our opinion, a sweeping generalization could not have been made in respect of all types of contracts that the Appellant Company has entered into with its employers. The Advance Ruling Authority should have called upon the appellant company to produce the purchase orders placed by its customers and the contract that has been entered into by them with the contractee and then only should have answered the clarification sought for by the appellant company, keeping in view the essential distinction brought out by the authoritative pronouncement on the issue by the Apex Court, wherein it is observed that there is a distinction between a contract of sale and works contract and no straight-jacket formula could be applied. Since the Advance Ruling Authority has not considered any one of the aspects which we have noticed above, we have no other alternative but to set aside the impugned order dated 26.5.2003 and remand the mater to the Advance Ruling Authority to pass a fresh order in accordance with law, keeping in view the settled legal principles enunciated by the Apex Court in the case of HINDUSTAN SHIPYARD LIMITED v. STATE OF ANDHRA PRADESH and the observations made by us in the course of our order.
18. Accordingly, the following:
ORDER I. Appeal is party allowed. II. The impugned order passed by the Advance Ruling Authority in No. AR.CLR.CR.73/02-03 dated 26.5.2003 is set aside. III The matter is remanded back to the Advance Ruling Authority to reconsider the application filed by the appellant company in accordance with law. III. In the facts and circumstances of the case, parties are directed to bear their own costs. Ordered accordingly.