Hicure Pharmaceuticals Pvt. Ltd. vs The Deputy Commissioner of Commercial Taxes (Audit-3)

S. Sujatha, J.—These revision petitions are directed against the common judgment passed by the Karnataka Appellate Tribunal, Bangalore (Belgaum Camp) dated 18.12.2013 for the assessment years 2007-08 and 2008-09. The substantial questions of law that arise for consideration in these revision petitions are:

"i) Whether "Water for Injection (WFI)/De-mineralized water" used as an input in the execution of the works contract entered into by the assessee with the principals/customers attracts levy of tax under the KVAT Act/CST Act?

ii) Whether the contract executed by the assessee with its principals or customers is a contract for service or a composite divisible contract, attracting levy of tax on sale of goods under the provisions of KVAT Act/CST Act or otherwise, levy of tax on goods as well as on services is legally permissible in a single transaction?"

The facts in brief are:

"The assessee/petitioner is a registered dealer under the Provisions of Karnataka Value Added Tax Act, 2003 (hereinafter referred to as ''KVAT Act'' for short) as well as under the Central Sales Tax Act, 1956 (hereinafter referred to as ''CST Act'' for short). The petitioner is engaged in the manufacture and sale of Pharmaceutical preparations and also engaged in executing works contract which is asserted as job work by the petitioner with its customers M/s. Wallace Pharmaceuticals (P) Limited, Panaji-Goa; M/s. Bliss GVS Pharma Ltd., Mumbai and M/s. Indi Pharma (P) Ltd., Panjim-Goa. The Assessing Authority concluded the reassessment proceedings for the assessment years 2007-08 and 2008-09, and levied tax on ''Water for Injection'' (hereinafter referred to as "WFI/De-mineralized (DM) water" for short) treating the contract executed by the assessee with its principals as a composite works contract involving transfer of property in goods, i.e., Water for Injection (WFI)/De-mineralized (DM) water, which attracts levy of tax under Section 4(1)(b)(ii) of KVAT Act, read with Section 9(2) of CST Act. The Assessing Authority determined the tax liability on the value of goods deducting the labour and like charges at 25% of the total works contract receipts as provided in proviso to Section 2(h) of the CST Act, read with Serial No. 14 in the table appended to Rule 3(2)(m) of the KVAT Rules, 2005. On appeal preferred by the assessee, the appellate authority confirmed the levy of tax on the transactions of WFI/DM water involved in the execution of works contract. However, determined the value of WFI at 10% of the total works contracts received towards manufacture of water based injections. On further appeal carried on by the assessee, the Tribunal dismissed the appeals confirming the order passed by the first appellate authority. The said common judgment of the Appellate Tribunal for the assessment years 2007-08 and 2008-09 is impugned in these petitions."

Heard the petitioner (party-in-person) as well as the learned Government Advocate.

The arguments advanced by the assessee are two fold. Firstly, ''Water for Injection'' (WFI)/DM water is an exempted commodity as per Entry No. 54 of the First Schedule to the KVAT Act, not exigible to levy of tax. Secondly, the contract for manufacture of pharmaceutical preparational medicines entered into with its principals is a pure service contract not a composite contract. The assessee contended that the agreement of job work (service contract) was wrongly construed as a composite works contract involving sale of goods as well as services by the authorities. The pure job work undertaken by the assessee for manufacture of goods to another person is service contract, at any stretch of imagination it would not be characterized as works contract as contemplated under Section 2(37) of the KVAT, Act. It is further contended that, Entry No. 54 of First Schedule to the KVAT Act specifies that, water other than, aerated, mineral, distilled, medicinal, ionic, battery, demineralised water and water sold in sealed container is exempted. As per the said entry, water used in the manufacture of injection is non-taxable. The authorities and the Tribunal failed to consider the fact that there is no relationship of seller and buyer between assessee and its customers. The Tribunal failed to consider that Article 366(29-A) of the Constitution empowers the State to levy tax on transfer of property in goods whether as goods or in some other form involved in the execution of works contract. Thus, the transfer of property in goods involved in works contract is exigible to tax as deemed sale, not the services rendered by the assessee, the contract executed by the assessee being job work (service) contract. The assessee placing reliance on the judgment of the Apex Court in the case of BSNL v. Union of India and Others reported in 2006(60) KLJ 391 contends that, Article 366 (29-A) of the Constitution does not permit levy of tax on both goods and services in a single transaction.

On the contrary, learned Government Advocate appearing for the State justifies the order passed by the Tribunal. He contends that, clauses in the agreement stipulates that the assessee has entered into written agreement/contract with the principals/customers to manufacture and supply medicinal and pharmaceutical injections of different varieties, both water based and oil based, strictly in accordance with the formula supplied by the principals and the standards laid down under the Indian Drugs and Cosmetics Act, 1940. In terms of the said contracts/agreements, all the required raw materials, inputs, labels and packing material are required to be supplied by the aforesaid principals, free of cost, except the input WFI, which complies with the tests for purified water with additional requirements for bacterial endotoxins (not more than (nmt) 0.25 IU of endotoxin per ml) conductivity and total organic carbon, the WFI de-mineralized water is an essential input for manufacture of water based injections. WFI/DM water is taxable goods under the provisions of KVAT Act and there is a deemed sale of these WFI/DM water in the execution of the works contracts undertaken by the assessee, attracts levy of tax under the KVAT/CST Act; the commodity WFI/DM water supplied by the assessee is not a commodity specified in Entry No. 54 of the First Schedule to the KVAT Act, as contended by the assessee. Consequently, the sale of WFI/DM water is not exempted from tax payable under the KVAT Act/CST Act during the relevant tax periods. On the examination of the clauses in the agreement and the tenor of law as envisaged in the KVAT/CST Act, the Tribunal has rightly levied tax on the deemed sale of WFI, determining the value of goods at 10% of the total works contract receipts, which is sustainable, the well reasoned order passed by the Tribunal would not warrant any interference by this Court. Accordingly, he seeks to answer the substantial questions of law in favour of the revenue and against the assessee.

We have bestowed our anxious consideration to the arguments advanced by both the sides. We have noticed that the manufacture of WFI/DM water, generally used for preparation of medicinal products involves specialized process. The required quantity of WFI is manufactured by the assessee company in its own water distilling plant and the same is consumed in the manufacture of injections for the execution of the works contract. The WFI/DM water is manufactured by the assessee by using various chemicals for removing inert, microbes and minerals etc., from the borewell water, which is known as de-mineralized sterile water. The process of getting pure sterile water from borewell water is a stipulated process, which is governed by the Drugs and Cosmetics Act and Rules. The WFI/DM water emerged out of this stipulated process, is a distinct different commercial commodity, other than the raw bore water.

Section 5(1) of the KVAT Act, contemplates that the goods specified in the First Schedule shall be exempted from levy of tax. Entry No. 54 of First Schedule to the KVAT Act, reads thus:

"Water other than.--

(i) aerated, mineral, distilled, medicinal, ionic, battery and demineralised water; and

(ii) water sold in sealed container."

Thus, it is clear that the goods exempted under this provision is water, other than, aerated, mineral, distilled, medicinal, ionic, battery and demineralised water. Goods to come within the ambit of this entry, must satisfy two conditions.

"i) Goods must be water.

ii) Such water must not fall in the excluded clauses (i) & (ii)"

If the goods - water falls in any one of the excluded clauses (i) & (ii), it is ousted from the Entry 54. Apparently, WFI/DM water is de-mineralized water used for medicinal preparation falling under clauses (i), as such, WFI/DM water is excluded from Entry 54. From the language employed in the aforesaid entry, it is evident that, WFI being water for medicinal preparation besides demineralized water is not an exempted commodity, but the same is exigible to levy of tax under the provisions of KVAT Act.

After analyzing the agreements/contracts executed by the assessee with its principals to manufacture and supply of medicinal pharmaceuticals injections of different varieties, the Tribunal has held that the assessee has executed the works contract to manufacture and supply medicinal pharmaceuticals injections of different varieties, both water based and oil based, strictly in accordance with the formula supplied by the principals and the standards laid down under the Indian Drugs and Cosmetics Act, 1940. In terms of the said contracts/agreements, all the required raw materials inputs, labels and packing materials are required to be supplied by the aforesaid principals, free of cost, except the input WFI, which complies with the tests for purified water with additional requirements for bacterial endotoxins (not more than (nmt) 0.25 IU of endotoxin per ml) conductivity and total organic carbon. The WFI is an essential input for manufacture of water based injections, which is required to be supplied by the assessee company.

In the background of these factual aspects, now we have to analyze whether the agreements executed by the assessee is a contract for pure labour or a works contract involving transfer of goods as well as the service, i.e., a composite works contract. Section 2(37) of the KVAT Act defines works contract, which reads thus:

"Section 2(37) Works contract includes any agreement for carrying out for cash, deferred payment or other valuable considerations, the building, construction, manufacture, processing, fabrication, erection, installation, fitting out, improvement, modification, repair or commissioning of any movable or immovable property."

In the present case, the contract is for manufacture of medicinal preparation. In the course of contract, the assessee is manufacturing WFI i.e., demineralized water in the plant set up in its factory premises. In the plant, the water drawn from borewell undergoes different stages of removing inert material, different microbes and the minerals and becomes a demineralized water. This demineralized water is used by the assessee in the manufacture of injections, which comes under the realm of Section 2(37) of the Act.

Now, the question would be whether contract is a work for pure labour or composite works contract. If all the materials are supplied by the principals or customers with the formula to manufacture the injections as per their requirements and the assessee is engaged in the manufacture of such formulized products, without supplying any goods using only goods supplied by its principals/customers, it would be a contract for labour. On the other hand, if any goods is required to be supplied by the assessee in the course of manufacture of formulized products, i.e., injection, there is a deemed sale of such goods, attracting levy of tax. Supply of WFI/DM water in the execution of works contract with labour, necessarily to be construed as a composite contract.

Subsequent to 46th Constitutional amendment by insertion of Clause 29-A to Article 366 of the Constitution, the States are empowered to levy tax on the transfer of property in goods, whether as goods or in some other form involved in a works contract. Now by virtue of the said 46th Constitutional amendment, the term works contract takes within its fold all types works contract. The difference between a contract for service and a contract for sale of goods has been dealt by the Apex Court in series of cases. A Larger Bench of the Apex Court in the case of Larsen and Toubro Limited and Another Vs. State of Karnataka and Another, considering all the judgments holding the field on this issue, has held thus:

"It seems to us (and that is the view taken in some of the decisions) that a contract may involve both a contract of work and labour and a contract of sale of goods. In our opinion, the distinction between contract for sale of goods and contract for work (or service) has almost diminished in the matters of composite contract involving both (a contract of work/labour and a contract for sale for the purposes of Article 366 (29-A)(b) . Now by legal fiction under Article 366(29-A)(b) , it is permissible to make such contract divisible by separating the transfer of property in goods as goods or in some other form from the contract of work and labour. A transfer of property in goods under clause 29(A)(b) of Article 366 is deemed to be a sale of goods involved in the execution of a works contract by the person making the transfer and the purchase of those goods by the person to whom such transfer is made. For this reason, the traditional decisions which hold that the substance of the contract must be seen have lost their significance. What was viewed traditionally has to be now understood in light of the philosophy of Article 366(29-A) ."

Much emphasis is placed by the assessee on the judgment of the Apex Court in the BSNL''s Case (supra) to put forth his arguments that, in a single transaction, where admittedly, the services are involved, which is part of the contract, State has no power to levy tax on sale or purchase of goods. It is the case of the assessee that dominant nature test must be applied to find out the true nature of transaction as to whether there is a contract for sale of goods or the contract of service in a composite transaction covered by the clauses of Article 366 (29-A) . These arguments are squarely considered by the larger Bench of the Apex Court in the case of M/s. Larsen & Toubro Limited & Another (supra), which has held thus:

"It then clarified that Gannon Dunkerley-I3 survived the Fortysixth Constitutional Amendment in two respects. First, with regard to the definition of "sale" for the purposes of the Constitution in general and for the purposes of Entry 54 of List II in particular except to the extent that the clauses in Article 366 (29-A) operate and second, the dominant nature test would be confined to a composite transaction not covered by Article 366 (29-A) . In other words, in Bharat Sanchar, this Court reiterated what was stated by this Court in Associated Cement that dominant nature test has no application to a composite transaction covered by the clauses of Article 366 (29-A) . Leaving no ambiguity, it said that after the Forty-sixth Amendment, the sale element of those contracts which are covered by six subclauses of clause 29-A of Article 366 are separable and may be subjected to sales tax by the States under Entry 54 of List II and there is no question of the dominant nature test applying.

In view of the statement of law in Associated Cement and Bharat Sanchar, the argument advanced on behalf of the appellants that dominant nature test must be applied to find out the true nature of transaction as to whether there is a contract for sale of goods or the contract of service in a composite transaction covered by the clauses of Article 366 (29-A) has no merit and the same is rejected."

In the case of Imagic Creative Pvt. Ltd. Vs. The Commissioner of Commercial Taxes and Others, , the Apex Court having considered payment of service tax as also VAT in a single transaction has held thus:

"29. If the submission of Mr. Hegde is accepted in its entirety, whereas on the one hand, the Central Government would be deprived of obtaining any tax whatsoever under the Finance Act, 1994, it is possible to arrive at a conclusion that no tax at all would be payable as the tax has been held to be an indivisible one. A distinction must be borne in mind between an indivisible contract and a composite contract. If in a contract, an element to provide service is contained, the purport and object for which the Constitution had to be amended and Clause (29-A) had to be inserted in Article 366 , must be kept in mind.

We have noticed hereinbefore that a legal fiction is created by reason of the said provision. Such a legal fiction, as is well known, should be applied only to the extent for which it was enacted. It, although must be given its full effect but the same would not mean that it should be applied beyond a point which was not contemplated by the legislature or which would lead to an anomaly or absurdity.

Payments of service tax as also VAT are mutually exclusive. Therefore, they should be held to be applicable having regard to the respective parameters of service tax and the sales tax as envisaged in a composite contract as contradistinguished from an indivisible contract. It may consist of different elements providing for attracting different nature of levy. It is, therefore, difficult to hold that in a case of this nature, sales tax would be payable on the value of the entire contract, irrespective of the element of service provided. The approach of the assessing authority, to us, thus, appears to be correct."

BSNL''s case (supra) has been elaborately considered by the larger Bench of the Apex Court in M/s. Larsen & Toubro''s case (supra) and has categorically held as under:

"The Forty-sixth Amendment leaves no manner of doubt that the States have power to bifurcate the contract and levy sales tax on the value of the material involved in the execution of the works contract. The States are now empowered to levy sales tax on the material used in such contract. In other words, clause 29-A of Article 366 empowers the States to levy tax on the deemed sale."

In the case of All India Federation of Tax Practitioners and Others Vs. Union of India (UOI) and Others, the Apex Court has held:

"As stated above, Entry 60, List II refers to taxes on professions, etc. It is the tax on the individual person/firm or company. It is the tax on the status. A chartered accountant or a cost accountant obtains a licence or a privilege from the competent body to practise. On that privilege as such the State is competent to levy a tax under Entry 60. However, as stated above, Entry 60 is not a general entry. It cannot be read to include every activity undertaken by a chartered accountant/cost accountant/architect for consideration. Service tax is a tax on each activity undertaken by a chartered accountant/cost accountant or an architect. The cost accountant/chartered accountant/architect charges his client for advice or for auditing of accounts. Similarly, a cost accountant charges his client for advice as well as doing the work of costing. For each transaction or contract, the chartered accountant/cost accountant renders profession based services. The activity undertaken by the chartered accountant or the cost accountant or an architect has two aspects. From the point of view of the chartered accountant/cost accountant it is an activity undertaken by him based on his performance and skill. But from the point of view of his client, the chartered accountant/cost accountant is his service provider. It is a tax on "services". The activity undertaken by the chartered accountant or cost accountant is similar to saleable or marketable commodities produced by the assessee and cleared by the assessee for home consumption under the Central Excise Act."

Thus, a single transaction may involve two or more taxable events in different aspects. In Imagic Creative case (supra), the Apex Court has held that while interpreting taxing statutes involving applicability of Article 246 of the Constitution of India read with Seventh Schedule thereof, Court should take various theories including ''aspect theory'' while interpreting such statutes. ''Sale'' and ''Service'', different aspects may be involved in the single transaction, under different legislative powers, levy of tax on both aspects is legally permissible, State is empowered to levy tax on the sale or purchase of goods bifurcating the contract.

For the foregoing reasons and in the light of the judgments discussed above, we are of the view that the contract executed by the assessee to supply WFI/DM water which is an input for the manufacture of injection, supplied by the assessee is a composite works contract involving transfer of property in goods as well as labour and service. The State is empowered to bifurcate the contract and levy sales tax on the value of the goods involved in the execution of the works contract. The authorities and the Tribunal having considered the scope of 46th Constitutional amendment and the principles of law enunciated by the Apex Court have rightly subjected the deemed sale of WFI/DM water to tax on the value of such goods transferred in the execution of works contract, which cannot be found fault with. Accordingly, we answer the substantial questions of law in favour of the revenue and against the assessee.

Consequently, the revision petitions are dismissed.