Taxation on Sub-Contractor Payments: Supreme Court’s Ruling in Larsen & Toubro Case

The Supreme Court of India recently delivered a landmark judgment in the case of Larsen & Toubro Ltd. vs. Additional Deputy Commissioner of Commercial Taxes, addressing the taxation of payments made to sub-contractors under the Karnataka Sales Tax Act, 1957. This case clarified whether such payments should be included in the total turnover of the main contractor for calculating turnover tax.

Background of the Case

Larsen & Toubro Ltd. (L&T), a prominent engineering and construction company, engages in projects involving works contracts. These contracts are often partially executed by sub-contractors, who are registered dealers and independently pay taxes under the Karnataka Sales Tax Act.

The dispute arose when the Karnataka Sales Tax Department included the value of work executed by sub-contractors in L&T’s total turnover for calculating turnover tax under Section 6-B of the Karnataka Act. L&T argued that since sub-contractors had already paid taxes on their work, including these amounts in L&T’s turnover would result in double taxation.

The High Court had issued conflicting judgments for different assessment years. For 1997-98 and 2002-03, the court ruled against L&T, while for 1999-2000, it ruled in their favor. This inconsistency led to appeals in the Supreme Court.

Arguments of the Petitioner (Larsen & Toubro Ltd.)

L&T contended:

• The Karnataka Sales Tax Act taxes the transfer of property in goods involved in works contracts. In cases where sub-contractors execute a portion of the work, the transfer of property occurs between the sub-contractors and the ultimate client, not the main contractor.
• Including payments made to sub-contractors in the main contractor’s turnover would result in double taxation, as sub-contractors independently pay taxes on their turnover.
• The principle of transfer of property by accretion applies, meaning that the main contractor is not the transferor of property when the work is executed by sub-contractors.
• The issue was resolved in L&T’s favor in a similar case under the Andhra Pradesh Value Added Tax Act, 2005, and the same reasoning should apply here.

Arguments of the Respondent (Karnataka Sales Tax Department)

The Tax Department argued:

• Section 6-B of the Karnataka Act defines “total turnover” to include all payments received by a dealer, regardless of whether sub-contractors are involved.
• Turnover tax under Section 6-B is distinct from sales tax under Section 5-B and is designed to be a multi-point tax, applicable to both main contractors and sub-contractors.
• The High Court’s ruling against L&T for 1997-98 and 2002-03 correctly interpreted the provisions of the Karnataka Act.

Supreme Court’s Analysis and Judgment

The Supreme Court sided with L&T, ruling that payments made to sub-contractors should not be included in the main contractor’s total turnover for calculating turnover tax under Section 6-B. The Court emphasized the principle of accretion, wherein property transfers directly from sub-contractors to the client, bypassing the main contractor.

Key Observations by the Court

• Section 6-B imposes turnover tax on the “total turnover,” but this must be understood as payments representing the transfer of property in goods. Payments to sub-contractors do not involve such transfers by the main contractor.
• Including sub-contractor payments in the main contractor’s turnover would lead to double taxation, which is contrary to constitutional principles.
• The Andhra Pradesh judgment, which resolved a similar issue under the Andhra Pradesh Value Added Tax Act, was applicable here due to the identical nature of the issue.

Key Excerpts from the Judgment

The Court noted:

“Transfer of property in goods becomes a necessary event, and unless there is such a transfer, the amount paid is not to be included in the total turnover. The amount paid to the sub-contractor is not for transfer of property in goods.”

On double taxation, the Court stated:

“If the argument of the Department is to be accepted, it would result in plurality of deemed sales, contrary to Article 366(29-A)(b) of the Constitution, and may make the Act vulnerable to challenge under Articles 14, 19(1)(g), and 265 of the Constitution.”

Impact of the Judgment

This judgment provides clarity on the taxation of works contracts, ensuring that main contractors are not unfairly taxed for work executed by sub-contractors. It upholds the principle of taxing only the transferor of property in goods and prevents double taxation.

The ruling has significant implications for contractors and the construction industry, reinforcing the need for clear distinctions in tax liability between main contractors and sub-contractors.

Conclusion

The Supreme Court’s decision in Larsen & Toubro Ltd. vs. Additional Deputy Commissioner of Commercial Taxes sets an important precedent for works contract taxation. By aligning the Karnataka Sales Tax Act with constitutional principles and the broader legal framework, the ruling ensures fair taxation practices and provides much-needed clarity for businesses operating under works contracts.

Don’t miss out on the full details! Download the complete judgment in PDF format below and gain valuable insights instantly!

Download Judgment: Larsen & Toubro Limi vs Additional Deputy Co Supreme Court of India Judgment Dated 05-09-2016-1741883678807.pdf

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