High Court rules that in-transit sale in turnkey contracts not eligible for exemption under Section 6(2) of the Central Sales Tax Act

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1 23 September 2015 EY Tax Alert High Court rules that in-transit sale in turnkey contracts not eligible for exemption under Section 6(2) of the Central Sales Tax Act Executive summary Tax Alerts cover significant tax news, developments and changes in legislation that affect Indian businesses. They act as technical summaries to keep you on top of the latest tax issues. For more information, please contact your EY advisor. This Tax Alert gives an update on the decision 1 of the Andhra Pradesh & Telangana High Court with respect to in-transit sale in case of inter-state supply of goods under turnkey contracts. The High Court (HC) held that supply of goods under the contract cannot be considered as subsequent sales in terms of Section 6(2) of the Central Sales tax, 1956 (CST Act). It was further observed that the title to the goods was not transferred during its movement from one state to another, but only after the goods were incorporated in the works in the State of Andhra Pradesh. The HC laid down the following principles: A contract of sale entered into either before commencement of movement of goods or after completion of movement of goods cannot be a subsequent sale under Section 6(2). The existence of a cross-fall breach clause is indicative of the fact that the contract is one single indivisible contract. In turnkey contract, sale cannot be said to have arisen during the movement of goods from one state to another. In terms of the contractual clauses, the title of the goods is transferred from the contractor to the contractee only after the erection and commissioning of the plant and on the issuance of the take-over certificate by the contractee, and not prior thereto. The HC, however, upheld the petitioners contentions that the transaction is an inter-state sale falling within the ambit of Section 3(a) of the CST Act, and would not be subject to tax under the Andhra Pradesh Value Added Tax Act, 2005 (AP VAT Act). The HC further held that the sale of imported goods under the supply contract is a sale in the course of import falling within the ambit of Section 5(2) of the CST

2 Background A bunch of writ petitions were filed before the Andhra Pradesh and Telangana High Court. The petitioners were engaged in the execution of Engineering, Procurement and Construction (EPC) works contracts on a turnkey basis. The contracts, which were the subject matter of the writ petition, were in two parts for supply of material and for erection and installation of equipment. The goods were tailor made for being used exclusively in the turnkey projects. The contracts envisage the purchase of goods by the petitioners-contractor from the identified suppliers. The materials so purchased were to be inspected by the owner (contractee) prior to its transportation and thereafter, the goods were to be transported by the contractor to the work site of the contractee. The goods are sold in transit by the contractor to the owner by way of endorsement of the lorry receipts. The petitioners claimed exemption for the goods supplied by them, for being used in the turnkey projects, on the grounds that these were subsequent sales under Section 6(2) of the CST Act and import sales under Section 5(2) of the CST transfer of documents of title to the goods before the goods have crossed the customs frontiers of India. As per Section 3 of the CST Act, a sale or purchase of goods shall be deemed to take place in the course of inter-state trade or commerce if the sale or purchase (a) occasions the movement of goods from one State to another; or (b) is effected by a transfer of documents of title to the goods during their movement from one State to another. The issue before the HC was whether the petitioners were eligible to claim exemption under Section 6(2) and Section 5(2) of the CST Also, whether the transaction will be subject to tax under the AP VAT Petitioners contentions The contracts entered into with the customers are two independent contracts one for supply and the other for erection. The inter-state transactions are transit sales eligible for exemption under Section 6(2) of the CST The bailment / free issue clause shows that, after the goods are sold by the petitioner to the owner, the owner then issues the very same material as free issues to the petitioner for being used in the erection and installation of plant. Section 6(2) of the CST Act provides that where any sale of goods in the course of inter-state trade or commerce has either occasioned the movement of such goods from one State to another; or has been effected by a transfer of documents of title to such goods during their movement from one State to another, any subsequent sale during such movement effected by a transfer of documents of title to such goods shall be exempt from Central Sales tax. Section 5(2) of the CST Act provides that a sale or purchase of goods shall be deemed to take place in the course of import only if the sale or purchase either occasions such import; or is effected by The appropriation of the goods took place, even before the movement of goods, at the place of manufacturer itself and the goods belonged to the contractee only. Relying on various contractual clause such as transit insurance clause, liquidated damages clause and bailment/free issues clause, it was contended that the sale of the goods took place when the goods are in movement from one state to another. Alternatively, it was also contended these transactions were sales falling within the ambit of Section 3(a) of the CST

3 As regards import sales, it was contended that they were covered under Section 5(2) of the CST Revenue contentions The contract is in effect, an indivisible contract. Although they are styled as two different contracts i.e. supply and erection contracts, they are, in fact, one composite indivisible contract. If it is a single indivisible contract, the property in the goods would pass to the owner on its incorporation in the works. The sale of goods would not take place during the course of its movement from one state to another, and the petitioners would thereby be disentitled from claiming exemption under Section 6(2) of the CST As the works is executed within the State of Andhra Pradesh, such a sale would be intra-state sale liable to tax under the AP VAT Since the appropriation of the future goods takes place in the state of Andhra Pradesh, the sale is deemed to take place within the state and hence, subject to tax under AP VAT The supply contracts are agreements to sell which will not be covered under Section 3(a) of the CST Consequently, any movement pursuant to the supply agreement cannot be considered as a sale occasioning movement. High Court ruling The contracts are works contracts as they involve both supply of material and rendering services in connection with the work of erection and installation of plant. It was observed that in these contracts, the petitioner contractors obligations ceased only after the turnkey project became operational, and after the final payment was made for supply of materials and for erection and installation of equipment. The existence of a cross-fall breach clause which enables the contractee to terminate the supply contract for breach of the erection contract and vice versa, would mean that while the contracts are ostensibly two separate contracts, they are in fact one single indivisible contract. As regards the issue of eligibility of exemption under Section 6(2) of the CST Act, the HC referred to the decision of the Supreme Court in the case of A&G Projects & Technologies 2, wherein the scope of Section 6(2) of the CST Act was considered by the Apex Court. The HC was bound by the obiter dicta of the Apex Court in the above case. In order to attract Section 6(2) of the CST Act, it is essential that the sale must be a subsequent inter-state sale and should be preceeded by a prior interstate sale. A contract of sale entered into either before commencement of movement of goods or after completion of movement of goods can neither be a Section 3(b) sale nor a subsequent sale under Section 6(2). HC observed that the contracts were entered into between the contractor and the contractee prior to placing of an order with identified suppliers by the contractor for the supply of goods. As the contracts provide for sale of future goods, it cannot be said to have arisen during the movement of goods from one state to another. It cannot, therefore, be a subsequent sale exempt from tax under Section 6(2) of the CST On conjoint reading of various clauses of the contract such as title clause, postdelivery inspection clause, taking over certificate clause etc it is clear that the parties intended that the title to the goods would be transferred from the contractor to the contractee only after erection and commissioning of the plant, and not prior thereto. It is evident, therefore, that the title to the goods was not transferred during its movement from one state to another, but only after 2 (2009) 2 SCC 326

4 the goods were incorporated in the works in the State of Andhra Pradesh. The HC also considered the scope of Section 3(a) of the CST It observed that there was a conceivable link between the movement of goods and its sale. The inter-state movement was integrally and inextricably connected to the contract and hence, it is inter-state sale of goods. The mere fact that the goods were incorporated in the works within the State of Andhra Pradesh does not make the deemed inter-state sale, an intrastate sale. Thus, this transaction is an inter-state sale falling within the ambit of Section 3(a) of the CST Act, and would not be subject to tax under the AP VAT Notwithstanding that the supply contracts are agreements to sell, the said contracts have occasioned the movement of goods from one state to another and thus, would fall within the ambit of Section 3(a). Further, it was held that the respondents lack jurisdiction to levy tax on the petitioners under Section 3(a) of the CST Act, as they are the authorities of the state where the goods have been delivered. Section 9(1) of the CST Act confers powers on the authorities of the state, from where the movement commences, to levy tax under Section 3(a) of the CST By placing reliance on the decision of the Supreme Court in the case of Indure Ltd. 3 the HC also held that the sale of imported goods by the petitionercontractor to the contractee would fall within the ambit of the first limb of Section 5(2) of the CST It was observed that there was an inextricable link between the import of goods by the petitioner and the sale of the imported goods to the contractee. Thus, the sale of imported goods cannot be subject to tax under AP VAT Thus, while the exemption under Section 6(2) of the CST Act was denied, the 3 (2010) 9 SCC 461 petitioners contention that the sales fall within the ambit of Section 3(a) and Section 5(2) was upheld. Accordingly, the HC set aside the assessment/revisional order to the limited extent that the turnover pertaining to inter-state sales and import sales have been subjected to tax under the AP VAT The assessing/ revisional authorities are required to pass fresh orders in light of the observations of the HC. Comments The HC ruling is the first one to address the issue elaborately, after the same had been touch-based by the Apex Court in the case of A&G Projects & Technologies, way back in This ruling will have far reaching implication in case of all turnkey jobs where CST exemption had been claimed in case of interstate supplies on the second limb of the transaction. Some states had issued Circulars to suggest that the said exemption had to be examined on case to case basis and that the same cannot be simply denied on the ground that a turnkey job or a works contract do not per se qualify for the same. In the light of the principles laid down by the HC, companies undertaking project business will have to revisit the terms of the turnkey contract (contract clauses) in order to avoid litigation on claiming such exemption. Emergence of a contract during the movement of goods, point of time of transfer of title in an indivisible works contract are few issues where further clarity is still required.

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