State of Karnataka and Ors. v. Pro Lab and Ors. ((AIR 2015 SC 1098))

Facts of the Case

This case represents the State of Karnataka's third legal battle to enforce sales tax on the activity of processing and supplying photographs, photo prints, and photo negatives, which it had sought to tax as a "works contract."

• The Impugned Provision: Entry 25 of Schedule VI of the Karnataka Sales Tax Act, 1957, which levied sales tax on the goods involved in the works contract for "processing and supplying photographs." This provision was initially inserted in 1989.

• The Judicial Setback (Rainbow Colour Lab): The earlier Supreme Court decision in Rainbow Colour Lab's case (2000) held that the activity of photography and processing was predominantly a service contract involving skill and labour, with the transfer of photographic paper being merely incidental. Relying on the pre-46th Amendment logic (dominant intention test), the SC had effectively upheld the invalidity of similar state laws, which led to the dismissal of the State's challenge to the Keshoram case (which first invalidated Entry 25).

• The Re-enactment: Following subsequent Supreme Court judgments that clarified the expansive scope of the 46th Amendment (like ACC Ltd. and Larsen & Toubro), the State Legislature re-enacted Entry 25 with retrospective effect from July 1, 1989.

• The Final Challenge: The respondents (Pro Lab and others) challenged this re-enactment before the Karnataka High Court, which once again declared the provision unconstitutional, forcing the State to appeal to the Supreme Court for the third time.

Issue

1. Whether the activity of processing and supplying photographs, photo prints, and photo negatives falls within the definition of a "works contract" as a "deemed sale" under Article 366(29A)(b) of the Constitution, post-46th Amendment.

2. Whether the State Legislature was constitutionally competent to re-enact Entry 25 with retrospective effect from 1989.

Judgment

The Supreme Court upheld the constitutional validity of Entry 25 of Schedule VI of the Act, confirming the State's power to levy sales tax on the goods component of photo processing contracts, including its retrospective application. The High Court's decision was overturned.

Legal Analysis

The Court's reasoning was based on affirming the legal fiction created by the 46th Constitutional Amendment.

1. The Works Contract and Deemed Sale

• Dominant Intention Test Overruled: The Court emphatically reiterated that after the insertion of Article 366(29A), the "dominant intention test" (which was the basis of the Rainbow Colour Lab decision) is rendered obsolete for contracts falling under the six sub-clauses of the Article, including works contracts.

• Bifurcation by Legal Fiction: The 46th Amendment introduced a legal fiction that permits a composite, indivisible works contract to be bifurcated into two parts:

  1. A "sale of goods" component (taxable by the State Legislature).

  2. A "service/labour" component (not taxable as sale).

• Applicability to Photo Processing: The Court held that the activity of processing and supplying photographs involves the transfer of property in the photographic paper and chemicals used. Even though the value of the paper might be negligible and the contract is predominantly one of skill and service, the transfer of property in these materials is involved in the execution of a "works contract" and is, therefore, a "deemed sale" subject to sales tax.

2. Validity of Retrospective Effect

• The Court held that the legislature was fully competent to re-enact the provision with retrospective effect. The retrospective amendment was a valid exercise of legislative power intended to remedy the error caused by the High Court's earlier judgments, which were based on the now-discarded Rainbow Colour Lab ruling.

• Since the tax was constitutionally permissible post-1982, the retrospective levy from 1989 was justified.

Commentary: Final Nail in the Dominant Intention Coffin

The Pro Lab case is significant because it finally laid to rest the persistent judicial confusion, stemming from the Rainbow Colour Lab decision, regarding the applicability of the dominant intention test to photographic processing after the 46th Amendment. It solidified the principle that any contract where the transfer of property in goods occurs during the execution of a designated type of contract (like a works contract) is a taxable deemed sale, regardless of how minimal the goods component is compared to the service component. This judgment affirmed the constitutional power of the State to levy sales tax on the goods portion of service-heavy, composite contracts.