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9 May 2014

2013mber 2012

EY Tax Alert
Constitution (five-Judge) Bench of Supreme Court overrules the decision of its earlier
three-Judge Bench decision in case of Kone Elevator India Pvt Ltd. by holding that a
contract for supply and installation of Lifts is a Works Contract and not a contract of
Sale.

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This Tax Alert gives an update on the recent decision of the five-Judge
Constitution Bench of the Supreme Court in the case of Kone Elevator India Pvt.
Ltd. vs. State of Tamil Nadu & Ors. which has reversed the earlier judgment
passed by the three-Judge Bench on the characterization of transaction of
supply and installation of lifts by elevator companies.
The three-Judge Bench had earlier held that the transaction of supply and
installation of lifts constituted contract for sale of goods.
By way of a majority view, the Constitution Bench has overruled the said
judgment now and held that composite contract for supply and installation of
lifts has to be treated as a works contract and not as a sale of goods / chattel
simpliciter.
While deciding the subject issue, Constitution Bench also referred to several
landmark judgements such as Gannon Dunkerley, Larsen and Toubro and Bharat
Sanchar Nigam Ltd. and others.

AP wherein following principle was


laid down :

Background and facts

The three-Judge Bench of the Supreme


Court in the case of State of Andhra
Pradesh vs. Kone Elevator India Pvt Ltd.2
had held that the supply and installation
of lifts constituted sale and not works
contract. While arriving at the said
conclusion, the Bench had observed as
follows :

Main object of the contract was to


sell lifts, and the skill and labour
employed (towards assembly and
installation) for converting the main
components into the end product
was merely incidental and ancillary.

Lift has been classified as a


commodity under Entry 82 of the
First schedule to the AP General
Sales tax Act.

There is no standard formula to


distinguish between sale and works
contract. It mainly depends on (i)
predominant object or the essence
and terms of individual contract, (ii)
intent of the parties and the
circumstances of the case and (iii)
the custom of the trade, which
become guiding factors in deciding
whether a transaction is a sale or a
works contract.
In a contract of sale, main object is
transfer of property and delivery of
possession of goods. On the other
hand, main object in a contract for
work is not the transfer of property
but it is one for the work and labour.
Customer took the onus of
preparing and making ready the site
for installation of lift. The contract
was divided into two parts work
part was assigned to the customer
and supply portion was assigned to
Kone Elevator. Such supply included
installation.

the

Constitution Bench referred to the


decision given by the Bombay High Court
way back in 1969 in Otis Elevators case4,
wherein it was held that the contract for
the manufacture, supply, installation and
commissioning of lifts was an indivisible
contract
for the erection
and
installation of lifts. Materials furnished
were only in execution of the works
contract and there was no sale of goods.

With reference to the said decision,


Bench made the following observations :

Reliance was placed on the decision


of Supreme Court in case of
Hindustan Shipyard Ltd. v. State of

[2005 (181) ELT156]

By an order dated 13 February 2008,


three-Judge Bench of the Supreme
Court, while dealing with the writ
petition preferred by Kone Elevator India
Pvt. Ltd. vs. State of Tamil Nadu and
others 3 , along with several Special
Leave Petitions, thought it appropriate
that the controversy should be resolved
by the Larger Bench.

Majority View of
Constitution Bench

3
2

If the major component of the end


product is the material consumed in
producing the chattel to be
delivered and skill and labour are
employed for converting main
components into the end product,
then skill and labour are only
incidentally used, the delivery of the
end
product
by
the
seller
constitutes a sale. On the other
hand, if the main object of the
contract is to avail skill and labour
of the seller, though some material
or components may be incidentally
used during the process of bringing
end product into existence by
investing skill and labour, it would
be a contract for work.

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

(2010) 14 SCC 788


[(1969) 24 STC 525 (Bom)]

Hence, fundamental characteristics


of works contract are satisfied.

technical facet, safety device and


actual operation.

It has taken note of the fact that


upon the installation of the lift in the
building, it becomes a permanent
fixture in the premises and that the
involvement of technical skill and
experience pertain to the precision
in
execution
for
rendering
satisfactory
service
and
the
obligation to maintain which are
integral to the supply and
installation.

Minority View
Out of five-Judge constitution bench,

Justice F.M. Ibrahim Kalifulla passed a


dissenting order stating that the
manufacture, supply and installation of
lifts/elevators come under the definition
of sale and not works contract as the
installation though mentioned in the
contract, has very insignificant relation to
the consideration agreed upon between
the parties.

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,
and made the following observations
before passing the final order:

"The dominant nature test" or


"overwhelming component test" or
"the degree of labour and service
test", are really not applicable. If
the contract is a composite one
which falls under the definition of
works contracts as engrafted under
clause (29A)(b) of Article 366 of the
Constitution, the incidental part as
regards labour and 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 and
service is not correct.

Once there is a composite contract


for supply and installation, it has to
be treated as a works contract as it
is not a chattel sold as chattel.

The conclusion, as has been


reached in Kone Elevator (supra), 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 labour and service.

Thus analysed, we conclude and


hold that the decision rendered in
Kone Elevator (supra) does not
correctly lay down the law and it is,
accordingly, overruled.

It was further observed by him that it is

like doing some incidental work for fixing


a fan or an Air Conditioner.

Final Order of Constitution


Bench

Keeping in view the conclusions of the


majority, the Bench held that the
decision rendered in State of Andhra
Pradesh vs. Kone Elevator, does not
correctly lay down the law and it is
accordingly overruled.

Comments
With the pronouncement of the order
by the Constitution Bench of the
Supreme Court - that the contract
for supply and installation of lifts is a
works contract and not a sale
contract the controversial issue
seems to have been set at rest.
This judgement will provide some
relief to the elevator companies as
the net tax cost is likely to be
reduced.

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