Analysis of Kone elevators judgement

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This judgement takes one through the judgement of Kone Elevators in great detail. Various contentions, arguments and the final verdict of the court have been adequately covered in this judgement.

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Analysis of Kone elevators judgement

  1. 1. Analysis of Supreme Court Judgement – Kone Elevators (2014) www.consultconstruction.com
  2. 2. www.consultconstruction.com Consult Construction is a consulting firm with all governance, compliance and IT related services related to the construction sector under one roof. Focus Areas :- Corporate Governance Management Audit Project Budgeting and Monitoring Indirect Tax Compliances Corporate Training Information Technology and Allied Services ISO Implementation
  3. 3. www.consultconstruction.com Indirect Tax Services Advice on the applicability and levy of Service Tax, CST and State VAT on Contracts entered into or proposed to be entered into by the company. Assistance in the structuring of transactions and agreements in relation to inter-state and intra-state sales to optimise the tax incidence Conduct tax based health checks to determine the service tax & Multi State - VAT implications on the operations, Giving Multi State VAT opinions
  4. 4. FACTS IN THE CASE OF SUPREME COURT JUDGEMENT OF KONE ELEVATOR INDIA PVT LTD. • Appellants are in the Elevator & Escalator Industry • They provide innovative and eco-efficient solutions for elevators, escalators and automatic building doors.
  5. 5. Facts Contd…. • They were responsible for bringing the elevators to site in knocked down state and carry out assembly on site • The customer was contractually bound to prepare the site by performing the civil works for preparing the lift pit, hoistway and arrange for power supply • Assessee’s contractual obligation vis-à-vis installation involved completion of mechanical erection, electrical wiring testing and commissioning of the lift • Assessee’s installation obligations started only upon prior intimation from the customer that site was ready
  6. 6. www.consultconstruction.com Definition of Works Contract • Sec 2(43) defines as – – “Works Contract” includes any agreement for carrying out for cash, deferred payment or other valuable consideration, building construction, manufacture, processing, fabrication, erection, installation, fitting out, improvement, modification, repair or commissioning of any movable or immovable property.
  7. 7. www.consultconstruction.com Judgment by Three-Judge Bench
  8. 8. www.consultconstruction.com Observations By the Bench • Main Object was to sell lifts. • The skill & labour employed (towards assembly & installation) was merely incidental & ancillary. • Lift has been classified as a commodity under Entry 82 of the First Schedule to the AP General Sales tax Act • No Standard Formula to distinguish between sale & works Contract. It mainly depends on – Predominant object or the essence & the terms of individual contract – Intent of the parties & circumstances of the case. – The custom of the trade, which become guiding factors in deciding whether a transaction is a sale or a works contract.
  9. 9. www.consultconstruction.com Observations By the Bench • Contract of sale, main object is transfer of property & delivery of possession of goods. • M<ain object in a contract for work is not the transfer of property but it is for the work & labour. • Customer took the onus or preparing and making ready the site for installation of lift. The contract was divided into 2 parts – work part was assigned to the customer & supply portion was assigned to the Kone Elevator. Such supply Included installation. • Reliance was placed on the decision of Supreme Court in the case of Hindustan Shipyard Ltd. Vs State of AP wherein following principle was laid down – – If the major component of the end product is the material consumed in producing the chattel to be delivered & skill & labour are employed for converting main components into the end product by the seller constitutes the sale. On the other hand, if the main object is to avail skill & labour of the seller, through some material or components may be incidentally used during the process of bringing end product into existence by investing skill & labour, it would be a contract for work.
  10. 10. www.consultconstruction.com Observations By the Bench • The Three- judge Bench of the Supreme Court held that supply & Installation of Lift Constituted sale & not works contract. • But by an order dated 13 February 2008 Three- judge Bench of the Supreme Court while dealing with the writ petition by Kone Elevator India Pvt Ltd. Vs State of Tamil Nadu and others, along with several Special Leave Petitions, thought it appropriate that the appropriate that the controversy should be resolved by the Larger bench
  11. 11. www.consultconstruction.com Key contentions of the Appellants
  12. 12. www.consultconstruction.com Key contentions of the Appellants • In case of BSNL vs UOI further explained in L&T vs State of Karnataka • Contract divisible by itself, then the element of sale would be taxed as an ordinary sale of goods, irrespective of the element of service. • where a contract was for the supply of goods, and for rendition of services, if the pre-dominant intention of the parties was to supply goods, the element of service would be ignored and the entirety of the contract consideration would be treated as the price of goods supplied and the tax imposed accordingly.
  13. 13. www.consultconstruction.com • The law did not provide for dividing, by a legal fiction, a contract of such a nature into a contract for goods and a contract for services, the goods in which property passed from the contractor to the owner could not be brought to tax under the law of sales tax. It is assiduously urged that the “predominant intention test” is no longer relevant. Key contentions of the Appellants
  14. 14. www.consultconstruction.com • Supply and Installation of lift cannot be treated to be a contract for sale because :- – Lift comprises of components or parts [goods] like lift car, motors, ropes, rails, etc. and each of them has its own identity prior to installation and they are assembled/installed to create the working mechanism called lift. – The installation of these components/parts with immense skill is rendition of service, for without installation in the building, there is no lift. Key contentions of the Appellants
  15. 15. www.consultconstruction.com • Referring to the Bombay Lifts Act, 1939, the Bombay Lifts Rules, 1958 and Bombay Lifts (Amendment) Rules, 2010 He has drawn our attention to the dictionary clause as has been defined in clause 3(c) :- – “lift” which mean a “hoisting mechanism” equipped with a car which moves in a substantially vertical direction, is worked by power and is designed to carry passengers or goods or both. – “lift installation” which includes the lift car, the lift way, the lift way enclosure and the operating mechanism of the lift and all ropes, cables, wires and plant, directly connected with the operation of the lift Key contentions of the Appellants
  16. 16. www.consultconstruction.com • He has also placed reliance on following Sections :- – Section 4 - permission to erect a lift – Section 5 - license to use a lift – Section 7 – Lift not to be operated without a license • The manufacture, supply and the installation are controlled by the statutory provisions under an enactment of the legislature and also the rules made in consonance with the Act which would reflect that immense skill is required for such installation and the separate parts of the lift are not sold like goods, but it only becomes operational after it is installed, adjusted, tested and commissioned in a building. Key contentions of the Appellants
  17. 17. www.consultconstruction.com Key contentions of the Revenue
  18. 18. www.consultconstruction.com Key contentions of the Revenue - Mr. K.N. Bhat ( State of Karnataka ) • Contract of lift is a works contract, • Lifts are assembled and manufactured to suit the requirement and not something sold out of shelf. • The goods and the components used in the manufacturing and installation of a lift are subject to taxation • The element of labour and service involved cannot be treated as goods.
  19. 19. www.consultconstruction.com • Part of manufacture carried out at the project site and skill and labour deployed there is manufacture. • Manufactures components and then completes the manufacture of the lift at the site • retains ownership in the components as property while producing the completed lift, it is a case of pure manufacture. • erection, commissioning and assembling of parts and components amount to manufacture. Key contentions of the Revenue - Mr. Rakesh Dwivedi ( State of Orissa )
  20. 20. www.consultconstruction.com Key contentions of the Revenue Mr. R.Venkataramani ( State of TN & AP) • Lift as a system the work of installation merely fulfills the erection and functional. • The act of installation is to bring the goods to use and hence, it is the culmination of the act of sale. • A Lift or Elevator is an identifiable good transferred to the purchaser certain amount of labour is required to bring it to its usable state and cannot be regarded as a works contract.
  21. 21. www.consultconstruction.com Key contentions of the Revenue Ms. Hemantika Wahi & Mr. Preetesh Kumar (State of Gujarat) • The traditional tests for determining whether a contract is a works contract or not would continue to apply. • The sale of goods involved in the execution of a works contract is quite distinct from the works performed while executing a sale of goods contract • Dominant nature test or other test approved in Larsen and Toubro (supra) are still relevant
  22. 22. www.consultconstruction.com Key contentions of the Revenue Dr. Manish Singhvi (State of Rajasthan) • If a particular item is to be fixed in the immovable property, then the property passes on as an immovable property and, therefore, cannot be construed as a sale. • Reliance has been placed on the Constitution Bench decisions in Patnaik & Co. (supra) and Hindustan Shipyard Ltd. v. State of A.P.[(2000) 6 SCC 579].
  23. 23. www.consultconstruction.com Key contentions of the Revenue Mr. P.N. Mishra (State of Haryana) • Supply and installation of the lift is a contract for sale and not a works contract. • He has laid emphasis on the specification laid down in the terms and conditions of the contract in which the customer is obliged to undertake certain work of civil construction • He has brought on record an order of assessment for the assessment year 2009-2010 from which it is quite vivid that the assessing officer has treated the transaction as a sale adopting the principle stated in Kone Elevators case. • A Gazette Notification providing 15% tax on labour, service and other like charges as percentage of total value of the contract to show that it has been so done keeping in view the nature of composite contract.
  24. 24. www.consultconstruction.com Key contentions of the Revenue Mr. P.P. Malhotra (Additional Solicitor General of India appearing for Union of India) • Parts of the lift are assembled at the site in accordance with its design and requirement of the building which may include the floor levels and the lift has to open on different floors or otherwise depending upon the requirement. • It is not a mere case of sale and according to the expanded definition of tax on sale, “tax” is leviable only on the transfer of property in goods, whether in goods or in some other form, involved in the execution of work and no sales tax is leviable on the execution of works contract. Thus, the stand of the Union of India is that supply and installation of lift is not a contract for sale but a works contract. • Stand of the Union of India is that supply and installation of lift is not a contract for sale but a works contract
  25. 25. www.consultconstruction.com Ruling of the Supreme Court
  26. 26. www.consultconstruction.com Ruling of the Supreme Court • A five-judge bench was appointed to refer the case. • Decision was taken by keeping in mind – • Majority View • Minority View
  27. 27. www.consultconstruction.com Ruling of the Supreme Court Majority View • Referring to the decision given by the Bombay High Court way back in 1969 in Otis Elevators case, wherein it was held that – – the contract for manufacture, supply, installation & commissioning of lifts is an indivisible contract for the erection & installations of the lifts. – Materials Furnished were only in the execution of the work Contract and there was no sale of the goods.
  28. 28. www.consultconstruction.com Ruling of the Supreme Court Majority View • With reference to the above decision following observations were made :- • It makes it limpid, how many facets are to be taken care of for the purpose of installation of the elevator, regard being had to its technical facet, safety device & actual operation. • It has taken note of the fact that upon installation of the lift in the building, it becomes a permanent fixture in the premises & that the involvement of technical skill and experience pertain to the precision in execution for rendering satisfactory service & the obligation to maintain which are integral to the supply & installation.
  29. 29. www.consultconstruction.com Ruling of the Supreme Court Majority View • Bench then proceeded to deal with the correctness of the legal position as stated by the three-Judge bench of the Supreme Court in Kone Elevator case & made the following observations before passing the final order – • The “dominant nature test” or “overwhelming component test” or “the degree of labour & service test”, are really not applicable. If the contract is a composite one which falls under the definition of works contract as engrafted under clause (29A)(b) of Article 366 of the Constitution, the incidental part as regards labour & service pales into total insignificance for the purpose of determining the nature of the contract. • The Principal logic of applying the incidental facet of labour & service is not correct
  30. 30. www.consultconstruction.com Ruling of the Supreme Court Majority View • Once there is a composite contract for supply & installation, it has to be treated as a works contract as it is not a chattel sold as a chattel. • Conclusion:- – It is based on the bedrock of incidental service for delivery. It would not be legally correct to make such a distinction in respect of lift, for the contract itself profoundly speaks of obligation to supply goods and materials as well as installation of the lift which obviously conveys performance of the lift which obviously conveys performance of labour & service Hence fundamental characteristics of works contract are satisfied. – Thus analysed we conclude and hold that the decision rendered in Kone Elevator does not correctly lay down the law and it is accordingly overruled
  31. 31. www.consultconstruction.com Ruling of the Supreme Court Minority View • Out of five-judge bench, Justice F.M. Ibrahim Kalifulla passed a dissenting order stating that – The manufacture, supply & installation of lifts/elevators come under the definition of sale & not works contract, as the installation mentioned in the contract, has very insignificant relation to the consideration agreed upon between the parties. – It was further observed by him that it is like doing some incidental work for fixing a fan or an air conditioner.
  32. 32. www.consultconstruction.com Ruling of the Supreme Court • By way of a majority view, the Constitution Bench has overruled the above judgment now & held that a Composite contract for supply & installation of lifts has to be treated as a works contract & not as a sale of goods / chattel simpliciter
  33. 33. www.consultconstruction.com Concepts from the above Case • The works contract is an indivisible contract but, by legal fiction, is divided into two parts, one for sale of goods, and the other for supply of labour and services. • The concept of “dominant nature test” or, for that matter, the “degree of intention test” or “overwhelming component test” for treating a contract as a works contract is not applicable; • The term “works contract” as used in Clause (29A) of Article 366 of the Constitution takes in its sweep all genre of works contract and is not to be narrowly construed to cover one species of contract to provide for labour and service alone; and • Once the characteristics of works contract are met with in contract entered into between the parties, any additional obligation incorporated in the contract would not change the nature of the contract.
  34. 34. www.consultconstruction.com Important Case Laws Discussed in this Judgment
  35. 35. www.consultconstruction.com • To Undo the base of Constitution Bench Decision the 46th Amendment – Clause (29A) in Article 366 of the Constitution was brought into effect - • “366 (29A) “tax on the sale or purchase of goods” includes – • a tax on the transfer, otherwise than in pursuance of a contract, of property in any goods for cash, deferred payment or other valuable consideration; • a tax on the transfer of property, in goods (whether as goods or in some other form) involved in the execution of a works contract; • a tax on the delivery of goods on hire purchase or any system of payment by instalments; State of Madras v. Gannon Dunkerley & Co. (Madras) Ltd
  36. 36. www.consultconstruction.com – a tax on the transfer of the right to use any goods for any purpose (whether or not for a specified period) for cash, deferred payment or other valuable consideration; – a tax on the supply of goods by any unincorporated association or body of persons to a member thereof for cash, deferred payment or other valuable consideration; – a tax on the supply, by way of or as part of any service or in any other manner whatsoever, of goods, being food or any other article for human consumption or any drink (whether or not intoxicating), where such supply or service, is for cash, deferred payment or other valuable consideration, and such transfer, delivery or supply of any goods shall be deemed to be a sale of those goods by the person making the transfer, delivery or supply and a purchase or those goods by the person to whom such transfer, delivery or supply is made;” State of Madras v. Gannon Dunkerley & Co. (Madras) Ltd
  37. 37. www.consultconstruction.com Hindustan Shipyard Ltd.vs State of AP • The Two-Judge Bench set out three categories of contracts and explained the contours and also opined namely, – 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; it may be a contract for work in which the use of the materials is accessory or incidental to the execution of the work; and – It may be a contract for supply of goods where some work is required to be done as incidental to the sale. • Thereafter, it opined that 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; and • The third is a contract for sale where the goods are sold as chattels and the work done is merely incidental to the sale
  38. 38. www.consultconstruction.com Bharat Sanchar Nigam Ltd. and another v. Union of India and others • Three-Judge Bench was concerned with the question of the nature of the transaction with regard to whether mobile phone connections which are enjoyed, is a sale or is a service or both. • The context pertained to the meaning of the term “goods” under Article 366(29A), yet the Court referred to the case in Associated Cement Companies Ltd. v. Commissioner of Customs[(2001) 4 SCC 593] and stated thus – – After the Forty-sixth Amendment, the sale element of those contracts which are covered by the six sub-clauses of clause (29- A) of Article 366 are separable and may be subjected to sales tax by the States under Entry 54 of List II and there is no question of the dominant nature test applying. – Therefore when in 2005 C.K. Jidheesh v. Union of India[(2005) 13 SCC 37] held that the aforesaid observations in Associated Cement were merely obiter and that Rainbow Colour Lab v. State of M.P.[(2000) 2 SCC 385] was still good law, it was not correct.”
  39. 39. www.consultconstruction.com Implications
  40. 40. www.consultconstruction.com VAT • Supreme court announced in 2005 that supply & installation of lift constituted Sale and not Works Contract. • So VAT Paid on whole amount • Now it is declared as works contract • Demand refund
  41. 41. www.consultconstruction.com Service Tax • There will be no major effect on payment of service tax • Previously no service tax was paid • As works contract service tax will be paid on labour portion
  42. 42. www.consultconstruction.com Income Tax • When earlier announced that it constituted sale so no TDS had to be paid. • In case of Works Contract TDS will be paid.
  43. 43. www.consultconstruction.com Subscribe to our E-Bulletin email - info@consultconstruction.com or visit our website – www.consultconstruction.com • VAT and Service Tax updates for the construction / Project sector companies. • Legislative changes and major case laws under the State VAT Laws and under Service Tax law affecting the construction /Project Sector. • In addition our brief analysis and comments on the various developments.

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