EY Tax AlertConstitution (five-Judge) Bench of Supreme Court overrules the decision of its earlierthree-Judge Bench decision in case of Kone Elevator India Pvt Ltd. by holding that acontract for supply and installation of Lifts is a Works Contract and not a contract ofSale.

9 May 20142013mber 2012

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Executive summaryThis Tax Alert gives an update on the recent decision of the five-JudgeConstitution Bench of the Supreme Court in the case of Kone Elevator India Pvt.Ltd. vs. State of Tamil Nadu & Ors. which has reversed the earlier judgmentpassed by the three-Judge Bench on the characterization of transaction ofsupply and installation of lifts by elevator companies.

The three-Judge Bench had earlier held that the transaction of supply andinstallation of lifts constituted contract for sale of goods.

By way of a majority view, the Constitution Bench has overruled the saidjudgment now and held that composite contract for supply and installation oflifts has to be treated as a works contract and not as a sale of goods / chattelsimpliciter.

While deciding the subject issue, Constitution Bench also referred to severallandmark judgements such as Gannon Dunkerley, Larsen and Toubro and BharatSanchar Nigam Ltd. and others.

Background and facts The three-Judge Bench of the Supreme

Court in the case of State of AndhraPradesh vs. Kone Elevator India Pvt Ltd.2had held that the supply and installationof lifts constituted sale and not workscontract. While arriving at the saidconclusion, the Bench had observed asfollows :

Main object of the contract was tosell lifts, and the skill and labouremployed (towards assembly andinstallation) for converting the maincomponents into the end productwas merely incidental and ancillary.

Lift has been classified as acommodity under Entry 82 of theFirst schedule to the AP GeneralSales tax Act.

There is no standard formula todistinguish between sale and workscontract. It mainly depends on (i)predominant object or the essenceand terms of individual contract, (ii)intent of the parties and thecircumstances of the case and (iii)the custom of the trade, whichbecome guiding factors in decidingwhether a transaction is a sale or aworks contract.

In a contract of sale, main object istransfer of property and delivery ofpossession of goods. On the otherhand, main object in a contract forwork is not the transfer of propertybut it is one for the work and labour.

Customer took the onus ofpreparing and making ready the sitefor installation of lift. The contractwas divided into two parts workpart was assigned to the customerand supply portion was assigned toKone Elevator. Such supply includedinstallation.

Reliance was placed on the decisionof Supreme Court in case ofHindustan Shipyard Ltd. v. State of

2 [2005 (181) ELT156]

AP wherein following principle waslaid down :

If the major component of the endproduct is the material consumed inproducing the chattel to bedelivered and skill and labour areemployed for converting maincomponents into the end product,then skill and labour are onlyincidentally used, the delivery of theend product by the sellerconstitutes a sale. On the otherhand, if the main object of thecontract is to avail skill and labourof the seller, though some materialor components may be incidentallyused during the process of bringingend product into existence byinvesting skill and labour, it wouldbe a contract for work.

By an order dated 13 February 2008,three-Judge Bench of the SupremeCourt, while dealing with the writpetition preferred by Kone Elevator IndiaPvt. Ltd. vs. State of Tamil Nadu andothers 3 , along with several SpecialLeave Petitions, thought it appropriatethat the controversy should be resolvedby the Larger Bench.

Majority View of theConstitution Bench

Constitution Bench referred to thedecision given by the Bombay High Courtway back in 1969 in Otis Elevators case4,wherein it was held that the contract forthe manufacture, supply, installation andcommissioning of lifts was an indivisiblecontract for the erection andinstallation of lifts. Materials furnishedwere only in execution of the workscontract and there was no sale of goods.

With reference to the said decision,Bench made the following observations :

It makes it limpid, how many facetsare to be taken care of for thepurpose of installation of theelevator, regard being had to its

3 (2010) 14 SCC 7884 [(1969) 24 STC 525 (Bom)]

technical facet, safety device andactual operation.

It has taken note of the fact thatupon the installation of the lift in thebuilding, it becomes a permanentfixture in the premises and that theinvolvement of technical skill andexperience pertain to the precisionin execution for renderingsatisfactory service and theobligation to maintain which areintegral to the supply andinstallation.

Bench then proceeded to deal with thecorrectness of the legal position asstated by the three-Judge bench of theSupreme Court in Kone Elevator case,and made the following observationsbefore passing the final order:

"The dominant nature test" or"overwhelming component test" or"the degree of labour and servicetest", are really not applicable. Ifthe contract is a composite onewhich falls under the definition ofworks contracts as engrafted underclause (29A)(b) of Article 366 of theConstitution, the incidental part asregards labour and service palesinto total insignificance for thepurpose of determining the natureof the contract;

The principal logic of applying theincidental facet of labour andservice is not correct.

Once there is a composite contractfor supply and installation, it has tobe treated as a works contract as itis not a chattel sold as chattel.

The conclusion, as has beenreached in Kone Elevator (supra), isbased on the bedrock of incidentalservice for delivery. It would not belegally correct to make such adistinction in respect of lift, for thecontract itself profoundly speaks ofobligation to supply goods andmaterials as well as installation ofthe lift which obviously conveysperformance of labour and service.

Hence, fundamental characteristicsof works contract are satisfied.

Thus analysed, we conclude andhold that the decision rendered inKone Elevator (supra) does notcorrectly lay down the law and it is,accordingly, overruled.

Minority View Out of five-Judge constitution bench,

Justice F.M. Ibrahim Kalifulla passed adissenting order stating that themanufacture, supply and installation oflifts/elevators come under the definitionof sale and not works contract as theinstallation though mentioned in thecontract, has very insignificant relation tothe consideration agreed upon betweenthe parties.

It was further observed by him that it islike doing some incidental work for fixinga fan or an Air Conditioner.

Final Order of ConstitutionBench Keeping in view the conclusions of the

majority, the Bench held that thedecision rendered in State of AndhraPradesh vs. Kone Elevator, does notcorrectly lay down the law and it isaccordingly overruled.

CommentsWith the pronouncement of the orderby the Constitution Bench of theSupreme Court - that the contractfor supply and installation of lifts is aworks contract and not a salecontract the controversial issueseems to have been set at rest.

This judgement will provide somerelief to the elevator companies asthe net tax cost is likely to bereduced.

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