Tax deducted at source (TDS) has proved to be a controversial area of law for quite some time now. One issue that has most recently come to light is likely to have enormous commercial significance – under what circumstances is a company obliged to treat an ordinary transaction as a “works contract” and not a “sale of goods” with the consequent liability to deduct TDS?
The governing provision is s. 194C of the Income Tax Act, 1961. It provides that any person responsible for paying any sum to any resident for carrying out any work in pursuance of a specified contract shall be liable to provide for TDS on that payment. The crucial question, therefore, is the meaning of the expression “carrying out any work”. In 1972, the Supreme Court, in a landmark judgment (State of Punjab v. Associated Hotels, AIR 1972 SC 1131, answered this question as follows:
“…where the principal objective of work undertaken by the payee of the price is not the transfer of a chattel qua chattel the contract is of work and labour. The test is whether or not the work and labour bestowed end in anything that can properly become the subject of sale…neither the ownership of the materials nor the value of skill and labour as compared with the value of the materials is conclusive although such matters may be taken into consideration in determining in the circumstances of a particular case, whether the contract is, in substance, one of work and labour or one for the sale of a chattel. A building contract or a contract under which a movable is fixed to another chattel or on the land where the intention plainly is not to sell the article but to improve the land or the chattel and the consideration is not for the transfer of the chattel, but for the labour and work done and the material furnished, the contract will be one of work and labour…”
This was in contrast to the requirements under the traditional law of the sale of goods, particularly before the 46th Constitutional amendment, that the existence of “goods”, the intention to transfer title to those goods and actual transfer of title are necessary to consider the transaction a sale (State of Madras v. Gannon Dunkerley, AIR 1958 SC 560). However, disagreement still persisted, and in an attempt to resolve it, the CBDT issued a circular in 1994 stating expressly that s. 194C does not apply to a “sale of goods”. Following this, attempts to extend the reach of s. 194C to professional services, commission agents etc. were struck down by the Bombay and Delhi High Courts. In 2005, the Supreme Court once again affirmed the test laid down in Associated Hotels, and added that any determination of the nature of a transaction had to take commercial reality and the intention of the parties into account (State of Andhra Pradesh v. Kone Elevators, (2005) 3 SCC 389).
Applying these principles, a transaction where the customer supplied the plans and specifications and had the right to trial runs before delivery was still considered a sale. Similarly, a transaction where the Orissa Government agreed to supply a chassis to a contractor who was to build a bus was considered a contract for the sale of the bus to the Orissa Government. In both cases, the parties intended to buy the article in question. On the other hand, making photostat copies of a document and delivering it to the customer is not a contract for the “sale of paper” because the object of the transaction, in the minds of the parties, is the provision of photocopying services, and not the supply of paper. In other words, the passing of title must be “ancillary” to the contract for performance of work for it to constitute a contract for work (Hindustan Aeronautics v. State of Karnataka, AIR 1984 SC 744).
The reason this issue has become relevant now is that the Supreme Court has issued notice last week to Samsung India on its liability to provide for TDS. Samsung outsources the manufacture of certain goods to other manufacturers, and the IT Department has argued in its written submissions that the other manufacturers are not at liberty to dispose of the goods, to use a different process of manufacture etc., and that the contract in substance is one for works. This is a question of fact that is likely to be closely contested, for the transaction does appear, at first sight, to resemble a contract for works. The Delhi High Court had found in favour of Samsung. A Business Standard report is available here.
The Supreme Court’s verdict is likely to be of great interest to several companies, given the difference it makes to TDS liability. For example, if the Department prevails in the Supreme Court, Samsung faces a TDS bill of about Rs. 1.7 crore for one assessment year.