M/s. Larsen & Toubro Limited V. State of Karnataka ((2014) 1 SCC 708)

Facts of the Case

This landmark judgment by a three-judge bench of the Supreme Court clarified the scope of the term "works contract" under the Constitution (Forty-Sixth Amendment) Act, 1982, specifically concerning agreements between property developers and prospective flat purchasers.

• Development Agreement: Larsen & Toubro (L&T) entered into a development agreement with a landowner (Dinesh Ranka) for an apartment complex. The owner contributed the land, and L&T undertook the construction. The consideration was a share of the built-up area (25% to the owner, 75% to L&T).

• Agreements with Purchasers: L&T entered into agreements of sale with prospective purchasers for its 75% share of the flats. These agreements stipulated that the purchaser would get an undivided interest in the land upon completion and handover of the constructed flat. The final sale deed was executed jointly by L&T and the landowner.

• Tax Challenge: The Deputy Commissioner of Commercial Taxes initiated action to tax the materials used by L&T in the construction of the flats, relying on the "works contract" definition established post-Article 366(29A)(b) and an earlier controversial SC ruling (Raheja Development Corporation).

• L&T's Contention: L&T argued that the development agreement was not a works contract because the consideration was a share of the finished property, not monetary payment for construction service. It contended that the entire transaction was for the sale of immovable property and thus outside the purview of VAT.

Issue

1. Whether an agreement between a developer (L&T) and a prospective flat purchaser for the construction and eventual transfer of a flat constitutes a "works contract" under Article 366(29A)(b) of the Constitution.

2. Whether the State Government is competent to levy VAT (Sales Tax) on the value of materials used in the construction component of such an agreement.

Judgment

The Supreme Court upheld the State's power to levy VAT. It held that any agreement for constructing and eventually selling an immovable property, entered into before the completion of construction, falls within the purview of a "works contract."

Legal Analysis

The Court provided a comprehensive analysis of the scope of the 46th Amendment and the nature of construction contracts.

1. Rejection of Dominant Nature Test

• The Court reaffirmed the constitutional history originating from Gannon Dunkerley and the subsequent 46th Amendment. It stressed that the constitutional amendment introduced the concept of "deemed sale" specifically to overcome the dominant nature test.

• Building contracts are a species of works contracts. Under Article 366(29A)(b), the contract can be bifurcated into the transfer of goods (taxable) and the supply of labour/service (non-taxable), even if the contract is otherwise indivisible.

2. Construction Agreement is a Works Contract

• Deemed Goods: When a builder undertakes to construct a flat for a prospective buyer and transfers property in goods that are incorporated into the structure (which become immovable property), that transfer of property in goods is, by legal fiction, a "deemed sale" subject to VAT.

• Nature of Transfer: The goods (like cement, steel, etc.) cease to be chattels when incorporated, but Article 366(29A)(b) specifically covers the transfer of property in goods "in some other form" involved in the execution of a works contract, validating the taxation of materials that have become part of immovable property.

3. Timing and Liablity

• Works Contract Commencement: The activity of construction undertaken by the developer becomes a works contract only from the stage the developer enters into a contract with the flat purchaser. If the flat is constructed by the developer before any agreement with a buyer, the transfer of materials is to himself, and no works contract exists.

• Tripartite Agreement: The agreements entered into by L&T with the purchasers, which required L&T to construct and eventually transfer the flat, satisfied the conditions of a works contract.

4. Overruling of Raheja Case (in part)

The Court clarified and distinguished the earlier Raheja Development Corporation case. While Raheja was correct in applying the works contract definition to developer-purchaser agreements, its observation that a developer can be charged VAT even if the entire construction is done for self-use was held to be incorrect and inconsistent with the legal requirement of a transfer of property to another person.

Commentary: Settling the VAT on Construction Debate

This judgment is pivotal as it resolves the long-standing debate concerning the taxability of construction contracts involving developers and flat buyers. It clearly established that the construction activity performed by the developer for the prospective buyer, pursuant to an agreement entered into before completion, is subject to VAT (now GST) on the value of the materials transferred. The decision gave full effect to the intent of the 46th Amendment in the context of the real estate sector.