2010 (6) TMI 737 - HC - VAT and Sales Tax

Constitutional validity of section 4(1)(c) and Schedule VI, item 23 of the Karnataka Value Added Tax Act, 2003 and the Explanation appended to rule 3(1) of the Karnataka Value Added Tax Rules, 2005 challenged Held that - Writ petitions are allowed. It is declared that section 4(1)(c) read with serial No. 23 of the Sixth Schedule to the KVAT Act does not enable the respondents to levy tax at the rate of 12.5 per cent in respect of declared goods used in the same form, in the execution of works contracts, which fall under section 14 of the Central Sales Tax Act, 1956. Consequently, proceedings initiated or concluded in respect of the petitioners seeking to levy tax, as questioned above, are hereby quashed to that extent. Explanation to rule 3(a) to (g) of the KVAT Rules is contrary to section 4(1)(c) of the KVAT Act and article 366(29A)(b) of the Constitution of India and is hence, unconstitutional and invalid. Consequently, the levy of tax and penalty on advances received by the petitioner in W.P. Nos. 29046 to 29048 of 2009 at annexure A thereof is hereby quashed.

Issues Involved:
1. Competence of the State Government to levy tax on the transfer of property in goods involved in the execution of works contracts, particularly when the goods are "declared goods."
2. Validity of the Explanation to Rule 3(1) of the Karnataka Value Added Tax (KVAT) Rules regarding advances paid to contractors.

Issue-wise Detailed Analysis:

1. Competence of the State Government to Levy Tax on Declared Goods:

The petitioners challenged the constitutional validity of Section 4(1)(c) and Schedule VI, item 23 of the Karnataka Value Added Tax Act, 2003 (KVAT Act) and the Explanation appended to Rule 3(1) of the Karnataka Value Added Tax Rules, 2005 (KVAT Rules). They contended that the State's power to levy value-added tax (VAT) on sales and purchases of goods is found under Entry 54 of List II under Schedule VII to the Constitution of India.

The Supreme Court in *State of Madras v. Gannon Dunkerley & Co. (Madras) Ltd.* [1958] 9 STC 353 (SC) held that a building contract, which is entire and indivisible, did not involve any sale of goods. Consequently, no sales tax could be levied on the amount received under a works contract. This led to the introduction of clause (29A) into Article 366 of the Constitution by the 46th Amendment, 1982, which expanded the definition of "tax on the sale or purchase of goods" to include works contracts.

The constitutional validity of the 46th Amendment was upheld in *Builders Association of India v. Union of India* [1989] 73 STC 370 (SC), which stated that the expression "tax on the sale or purchase of goods" in Entry 54 of the State List includes a tax on the transfer of property in goods involved in the execution of a works contract. This was reiterated in *Gannon Dunkerley & Co. v. State of Rajasthan* [1993] 88 STC 204 (SC), emphasizing that the legislative power of the State Legislatures under Entry 54 is subject to limitations under Article 286 and Sections 3, 4, 5, 14, and 15 of the Central Sales Tax Act, 1956 (CST Act).

Section 4(1)(c) of the KVAT Act, introduced from April 1, 2006, sought to levy taxes on works contracts, specifying the rate of tax under the Sixth Schedule. The petitioners argued that this provision did not override the main charging section and was inapplicable to declared goods listed under Section 14 of the CST Act, such as iron and steel, which are taxed at four percent.

The court observed that the levy of tax by the State Government on declared goods is subject to the conditions and restrictions in Section 15 of the CST Act, which limits the tax to four percent and at one stage only. The court concluded that Section 4(1)(c) read with serial No. 23 of the Sixth Schedule to the KVAT Act does not authorize the levy of tax at 12.5 percent on declared goods used in works contracts.

2. Validity of the Explanation to Rule 3(1) of the KVAT Rules:

The petitioners also challenged the Explanation to Rule 3(1) of the KVAT Rules, which required advances paid to contractors to be included in the total turnover in the month in which the execution of works commenced. They argued that this provision was unconstitutional as it imposed tax on advances even before the goods were incorporated into the works.

The court noted that Section 7 of the KVAT Act creates a legal fiction regarding the point of time the sale of goods is completed, which could be when payment is received as advance, when an invoice is raised, or when the goods are incorporated into the property of the contractee. However, the Explanation to Rule 3(1) contradicted the charging section and the definitions of "taxable turnover," "total turnover," and "turnover" under the Act. It also conflicted with Article 366(29A)(b) of the Constitution.

The court declared the Explanation to Rule 3(1) unconstitutional and invalid. Consequently, the levy of tax and penalty on advances received by the petitioner was quashed.

Order:

The writ petitions were allowed with the following orders:
(a) Section 4(1)(c) read with serial No. 23 of the Sixth Schedule to the KVAT Act does not enable the respondents to levy tax at the rate of 12.5 percent on declared goods used in the same form in the execution of works contracts. Proceedings seeking to levy such tax were quashed.
(b) The Explanation to Rule 3(1)(a) to (g) of the KVAT Rules was declared unconstitutional and invalid. Consequently, the levy of tax and penalty on advances received by the petitioner was quashed.

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