WORKS CONTRACT

Works Contract can be understood to be a contract wherein one party agrees to perform some
work for the other party using his specialised skill or labour. In pursuance of such work, the
party may use some goods and materials for the completion of the task. Some parties may
agree to enter into two separate contracts for such work i.e. one for sale of the goods that
would be used and second for the supply of services. However, in most cases, works
contracts are composite contracts of sale and services which are indivisible in nature.
Under CISG, such composite works contracts are governed by Article 3(2). The Convention
calls for valuation of the two components of the contract – if the services component forms a
preponderant part of the contract – the Convention does not apply to it. Otherwise, it applies
to the entirety of the contract.
Works contract has been defined in section 65B of the Finance Act, 1994 as a contract
wherein transfer of property in goods involved in the execution of such contract is leviable
to tax as sale of goods and such contract is for the purpose of carrying out construction,
erection, commissioning, installation, completion, fitting out, repair, maintenance,
renovation, alteration of any moveable or immoveable property or for carrying out any
other similar activity or a part thereof in relation to such property.
1. Goods Contract v Services Contract
There are some distinct difference between a contract for sale of goods and a contract for
supply of labour and services. Various tests have also been created to distinguish between the
two in complex contracts.
 State of Rajasthan v. Man Industrial Corporation [(1969) 1 SCC 567]
When a person performs a “contract for work or service”, he/she does not have any property
in the thing produced as a whole. However, in “contract for sale of goods”, the property
produced has an individual existence that is owned by the party producing it and it is through
the agreement and the corresponding conditions for payment of consideration and delivery
terms that the property and it title gets transferred to the other party.
 Hindustan Shipyard Ltd. V. State of AP [(2000) 6 SCC 579] – Dominant Intention test
The following principles were laid down to make a distinction between these two contracts:
i. There can be no strait jacket formula to distinguish one contract from the other.
ii. Transfer of property of goods for money consideration is a distinguishing factor for
sale.
iii. The nature of contract can be extrapolated from the substance of the contract and
not the form. The main object of the parties to the contract, the terms of the
contract, circumstances of the contract and the customs of the trade can be
looked into. If the dominant character of the contract is for supply of services, it
will be contract for service even if there is incidental use and sale of goods
involved.

In a contract for construction, the nature of the work done by the manufacturer
under the contract must be analysed. If the manufacturer is contracting a building
 by supplying bulk of the materials being used and the supply of labour and services
is incidental, then it can be held to be a contract for sale of goods.
iv. Whether the property in question has an individual existence whose title is held by
one and the contract facilitates the transfer of the same to the other party.
The Court categorised contracts into three kinds:
i. Contract for work to be done for renumeration and for the supply of materials used in
execution of the work: this a composite contract consisting of a contract for sale of
goods and contract for work and labour.
ii. Contract wherein the use of materials is ancilliary and incidental to the execution of
the work: this is a contract for work or services
iii. Contract wherein supply of skill and labour is ancilliary and incidental to the sale:
this is a contract for sale of goods.

 State of AP v. Kone Elevators

Another test to distinguish between the two kinds of contracts is the time and manner in
which delivery is made. If the property is transferred at the time of delivery, it is a sale. In
case of contract for work, the work done fuses with the property of the customer and the final
product gets acceded to the party.

2. Works Contract in India

 State of Madras v. Gannon Dunkerley [AIR 1958 SC 560] – Constitutionally

superseded
The issue was regarding the interpretation of Item 48 of List II of Schedule VII: “Taxes on
the sale”. The Court took a narrow view of the terms “sale of goods” to limit its definition to
what is present in the Indian Sale of Goods Act. According to the bench, the pre-requisites for
a contract for sale of goods should be:
i. Capacity to contract
ii. Agreement for transfer of title of goods
iii. Money Consideration
iv. Transfer of property from one to the other as the end result.
Therefore, if there has been no agreement between competent parties to transfer property
from one to the other, even if the title gets transferred, it will not be “sale of goods”. It is
contrary to principles of law to enter into an agreement for some distinct object but expect the
sale of some other object. In a building contract, the agreement is to construct a building
according to certain specifications; this agreement does not forsee the sale of the materials
used in the construction and neither does it posit to allow for transfer of those materials as
moveables.
In conclusion, the bench suggested that building contracts and other work contracts - which
as a whole are an indivisible entity of contract for service and contract for sale of goods –
could be broken down into two separate contracts for services and goods. In this way, the
State would be able to levy tax on the sale of materials used in construction contracts.
 46th Amendment of the Constitution
In order to dilute the implications of Gannon Dunkerley, the 46th Amendment inserted Article
366(29A) mentioned herein.
Article 366(29A): tax on the sale or purchase of goods includes
(a) a tax on the transfer, otherwise than in pursuance of a contact, of property in any goods
for cash, deferred payment or other valuable consideration;
(b) a tax on the transfer of property in goods (whether as goods or in some other form)
invoked in the execution of a works contract;
(c) a tax on the delivery of goods on hire purchase or any system of payment by instalments;
(d) 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;
(e) 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;
(f) 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 of those
goods by the person to whom such transfer, delivery or supply is made.
 Builders Association of India v. Union of India [(1989) 2 SCC 645]
This case supplements and elucidates the scope of the amendment. The tax on the sale and
purchase of goods is not to be levied on the total turnover from works contract but on the
transfer of property in goods – whether as goods or in some other form used in execution of a
works contract. This transfer of goods for the purpose of executing a works contract is
deemed to be sale of goods such that the title gets transferred from one person to the other
party of the contract. This is a legal fiction created by the Article.
The goods transferred to the other party are the ones used in execution of the contract and this
has to be distinguished from the entire building so constructed by it. The Article does not
transfer the right in the immoveable property on which works contract is executed but it
applies to the goods used in such construction.
 Rainbow Colour Lab v. State of MP [(2000) 2 SCC 385] – Overruled
In this case, the dominant intention test was applied on the contract. Works Contract consists
of two contracts i.e. contract for sale of goods and contract for work or services. Article
366(29A) acts as a splitter of indivisible works contract into these two distinct contracts by
legal fiction. However, works contracts are subject to the dominant intention test i.e. if the
sale of goods is merely incidental to the contract for supply of labour and skills, then it will
continue to be a contract for service. These incidental use of materials cannot be expanded to
constitute real or deemed sale under Article 366(29A) and be charged service tax. Contract
with a photographer is only a contract for service and the use of film, etc is incidental and
will not constitute sale of goods.

 BSNL v. Union of India [(2006) 3 SCC 1] - Determination of “goods” and how

Gannon Dunkerley (1958) survives
Providing telephone connection can be judged to be a contract for sale and service. The
discernible sale element of the transaction must be extrapolated. The supply of handset or any
other accessory will be a taxable sale. Goods may be incorporeal, tangible or intangible as
long as they have the attributes of utility, capability of being bought or sold and capability of
being transmitted, transferred, delivered, stored and possessed. Electromagnetic waves do not
fulfil these criteria.
The legal fiction created by Article 366(29-A) is only applicable to those composite contract
of sale and services that have been mentioned in the Article. It does not allow for the splitting
of services contract not elucidated in the Article i.e. doctors, lawyers, other professionals.
The dominant nature test applies in cases of composite contracts not covered by the
clauses of Article 366(29-A).
46th Amendment acts a recourse for those contracts which are deemed to be sale despite not
fulfilling all the required characteristics of a sale. By introducing the separate concept of
deemed sale, the amendment does not alter the definition of “goods” and the legal
connotations of the other characteristics of sale. The Court may alter the definitions with
the contemporary developments of the time but the amendment does not allow for
investigations into whether something will be goods or not.
 Larsen and Toubro v. State of Karnataka [(2014) 1 SCC 708] – Ambit of “works
contract”
The meaning of the term “works contract” cannot be limited to a contract for supplying
labour or services. The term encompasses a wide range of contracts entered into for the
purpose of undertaking or bringing into existence some “works”. If the contract in question
fulfils the definition of works contract under Article 366(29A) i.e. there is transfer of goods
in execution of the works contract, it will be subject to the Article. Any additional clauses
added to the contract will not change the nature of the contract.
The dominant intention test of analysing the substance of the contract and distinguishing
contracts as one of work or sale is a traditional test that has lost has efficacy on composite
contracts like works contract. Herein, no matter what the substance of the contract actually is,
if there has been transfer of goods for execution of the works contract, it will deemed to be a
sale and subsequently subject to sales tax. Even if the dominant intention of the contract is
for rendering of services or for the transfer of immoveable property, it will still be
subject to levy of sales tax if it fulfils the criteria of being a works contract. Rainbow
Labs overruled.
In contract between developer and flat purchaser for construction of flat that will be
transferred to the flat purchaser, there is a contract for the execution of some work i.e.
constructing the flat according to certain standards and dimensions. In case of construction
contracts, issues like the purchaser not having control over the type and standard over
the materials used for construction or not having any right to monitor or supervise the
construction activity or having no say over the layout or design of the building are not
of any significance and will not dilute the nature of the works contract.
In order to judge the goods deemed to be sold in a works contract which will be subject to
sales tax, three conditions must be fulfilled:
i. The contract must be works contract
ii. The goods must be involved in the execution of a works contract
iii. Property in those goods must be transferred to a third party either as goods or in
some other form.
There conditions are fully met in a construction contract and thus they are a species of works
contract.
The use of the term “in some other form” enlarges the ordinary understanding of
“goods” to include goods in the form of other goods. This would also include goods that
were moveables but have lost that character after its use and attachment to the earth or some
immoveable property. Therefore, States must levy their tax on the value of the goods at
the time of incorporation of the goods in the works and not on the transfer of
immoveable property. Even if the transfer of property takes place after the
incorporation of the goods in the works, its value will be taken from the point of
incorporation.
Via the 46th Amendment, the indivisible composite works contract has been brought on par
with a contract containing two separate agreements for sale and works and State may levy tax
on the value of the materials used in execution of the works contract. It serves to bring
transactions where the essential ingredients of sale defined in the SoGA are absent within the
ambit of sale or purchase for levy of sales tax.
 Kone Elevator India v. State of Tamil Nadu [(2014) 7 SCC 1]
Dominant intention test is no longer applicable and the SC judgements are constitutionally
superseded and no longer good law. Dissent by J. Kalifulia: if the dominant intention and
nature of the contract is for supply of goods only with incidental obligations to provide
services, it should not be held to be a works contract.
Contract for supply and installation of lift where labour and services will be provided. The
manufactured goods such as lift, car, motor, ropes, rails, etc are installed by the labour and
precise skill of the workmen to become permanent fixture of the building. The technical skill
involved is for rendering safe and satisfactory service and obligation to maintain lift in safe
and satisfactory working condition and is integral to the overall contract of supply and
installation of the lift. These two elements of sale and providing service are indivisible. The
supply and installation of the goods are not merely transferred as chattels to the other party or
made part of the chattel of the other party. These goods are being transferred in execution of a
works contract wherein labour and supply of services is also being provided along with sale
of goods. The dominant intention test will not apply to term the supply of services as merely
incidental.
Dissent by J Kalifulia: the terms of the contract are threadbare which show that the contract
was simply for supply and manufacture of lift and the supply of services was ancillary.
46th Amendment lead to the creation of four concepts:
i. Works contract being an indivisible contract which is split into two parts by legal
fiction; one for sale of goods and the other for supply of labour and services.
ii. Dominant nature test is not applicable.
iii. The term “works contract’ is wide sweeping and includes all genres of works
contracts. Not to be narrowly construed to include only one species of a contract
to provide labour and services alone.
iv. Additional obligations do not dilute the nature of the works contract.

3. Works Contract under GST

The Works Contracts has been defined in Section 2(119) of the CGST Act, 2017 as “works
contract” means a contract for building, construction, fabrication, completion, erection,
installation, fitting out, improvement, modification, repair, maintenance, renovation,
alteration or commissioning of any immovable property wherein transfer of property in
goods (whether as goods or in some other form) is involved in the execution of such
contract.”
Any such composite supply undertaken on goods say for example a fabrication or paint job
done in automotive body shop will not fall within the definition of term works contract per se
under GST. Such contracts would continue to remain composite supplies, but will not be
treated as a Works Contract for the purposes of GST. As per Para 6 (a) of Schedule II to the
CGST Act, 2017, works contracts as defined in section 2(119) of the CGST Act, 2017
shall be treated as a supply of services. Thus, there is a clear demarcation of a works
contract as a supply of service under GST.
Valuation of a works contract service is dependent upon whether the contract includes
transfer of property in land as a part of the works contract. In case of supply of service,
involving transfer of property in land or undivided share of land, as the case may be, the
value of supply of service and goods portion in such supply shall be equivalent to the total
amount charged for such supply less the value of land or undivided share of land, as the case
may be, and the value of land or undivided share of land, as the case may be, in such supply
shall be deemed to be one third of the total amount charged for such supply.