EY Tax Alert Supreme Court validates the State Governments right to levy sales tax on processing and supplying of photographs

05 February 2015

2013mber 2012

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Executive summary

This Tax Alert gives an update on the recent decision by a three judges bench

of the Honble Supreme Court (SC) in State of Karnataka Etc v. M/s Pro Lab &

Others Etc.* SC has held that Entry 25 of Schedule VI of the Karnataka Sales

Tax Act, 1957 which makes part of processing and supplying of photographs,

photo prints and photo negatives, having the goods component exigible to

sales tax, is constitutionally valid.

SC further held that after insertion of clause 29-A in Article 366, the Works

Contract which was indivisible by legal fiction is permitted to be bifurcated into

"sale of goods" and "services" and making the goods component of the

contract exigible to sales tax. SC has also upheld the restrospective power of

State to impose sales tax in the instant case.

The ruling is a significant as it reverses Karnataka High Court (HC) ruling and

also sets aside two prior HC rulings, which favoured the taxpayer and had held

such levy as unconstitutional.

* 2015-TIOL-08-SC-CT-LB

Background and facts

Issue in the instant case arose in the context of Entry 25, Schedule VI of the Karnataka Sales Tax Act, 1957.

The said entry pertains to imposition of sales tax by the State Legislature on the sale of goods under a works contract for 'processing and supplying photographs, photo prints and photo negatives'.

Validity of the said entry was earlier challenged vide a writ petition filed in Keshoram1 case before the Karnataka HC, wherein the HC declared Entry 25 as unconstitutional.

Special leave petition (SLP) filed by

Karnataka State against this order was dismissed by SC placing reliance on its earlier Rainbow Colors Lab2 ruling.

It was observed in the Rainbow Colors

Lab decision that the reason for holding Entry 25 as unconstitutional was that the contract of processing and supplying of photographs, photo frames and photo negatives was predominantly a service contract with negligible component of goods/material and, therefore, it was beyond the competence of State Legislature, to impose sales tax on such a contract.

However, within one year of the Rainbow Colors Lab ruling, three judges bench of SC had rendered another decision in the case of ACC Ltd3, wherein it had expressed doubts about the correctness of the pronouncement in the Rainbow case.

After the SCs ruling in ACC Ltd, the

Commissioner of Commercial Taxes issued a circular4 instructing the

1 M/s Keshoram Surindranath Photo Bag (P) Ltd. and others v. Assistant Commissioner of Commercial Taxes (LR), City Division, Bangalore and Others; 121 (2001) STC 175 2 Rainbow Colour Lab and Another v. State of Madhya Pradesh and others 3 ACC Ltd. v. Commissioner of Customs; (2001) 4 SCC 593 4 Circular No. 17/2002-03 dated 27.9.2002

assessing authorities to proceed with assessments as per Entry 25.

The aforesaid circular was challenged

before the Karnataka HC by M/s Golden Colour Labs5. While holding the said entry again as unconstitutional, the HC observed that Entry 25, declared ultra vires the Constitution in Keshoram's case, cannot be revived automatically, unless the same is re-enacted by the State Legislature.

Given the above, the State Legislature

re-introduced Entry 25 in identical terms in form of Section 2(3) of the Karnataka Taxation Laws Act, 2004 with retrospective effect. This amendment was again challenged before the Karnataka High Court by the assessee alongwith others. The High Court once again held the provision as unconstitutional. Being aggrieved Karnataka State approached the SC.

Supreme Courts ruling

Placing reliance on the various rulings6, three

judges bench of SC set aside the HC

decisions, making the following key

observations:

After insertion of clause 29-A in Article 366, the Works Contract which was indivisible by legal fiction is permitted to be bifurcated into "sale of goods" and "services", thereby making goods component of the contract exigible to sales tax.

5 M/s Golden Colour Labs and Studio and Others v. The Commissioner of Commercial Taxes; ILR 2003 Kar 4883 6 Gannon Dunkerley and Co. and Others v. State of Rajasthan and Others; 2002-TIOL-493-SC-CT-LB. Builders Association of India and Others v. UOI and Others; 2002-TIOL-602-SC-CT. Larsen Toubro and Another v. State of Karnataka and Another; 2013-TIOL-46-SC-CT-LB. Kone Elevator India Pvt. Ltd. v. State of Tamil Nadu and Others; (2014) 7 SCC 1. Rainbow Colour Lab & Another v. State of M.P. and Others (supra). ACC Ltd. v. Commissioner of Customs (supra)

While going into the exercise of

divisibility, dominant intention behind such a contract, namely, whether it was for sale of goods or for services, is rendered otiose or immaterial.

It follows, as a sequitur that by virtue of clause 29-A of Article 366, the State Legislature is empowered to segregate the goods part of the Works Contract and impose sales tax thereupon.

Entry 54, List II of the Constitution of India empowers the State Legislature to enact a law taxing sale of goods. Sales tax, being a subject-matter into the State List, the State Legislature has the competency to legislate over the subject.

The dominant intention theory is no more valid in view of 46th Amendment to the Constitution.

While upholding the retrospective

amendment, SC placed reliance on various rulings7 and reiterated that power to legislate included power to legislate prospectively as well as retrospectively.

HC had not dealt with the various facets

of the issue in their correct perspective, in the light of subsequent judgments of this Court with specific rulings that Rainbow Colour Lab is no longer a good law.

State of Karnatakas appeal was therefore allowed.

7 National Agricultural Co-operative Marketing Federation of India Ltd. and Anr. v. Union of India; 2003-TIOL-96-SC-IT. Shri Prithvi Cotton Mills Ltd. and Anr. v. Broach Borough Municipality and Ors; 2002-TIOL-479-SC-MISC-LB. Indian Aluminium Co.etc. etc. v. State of Kerala and others; (1996) 2 SCR 23. Hiralal Rattanlal v. State of UP; (1973) 1 SCC 216. UOI and Anr. v. Raghubir Singh (Dead) by Lrs.; 2002-TIOL-810-SC-MISC.

Comments Efforts of the Karnataka High Court to invalidate the Entry 25 of Schedule VI on as many as three occasions have been finally throttled by the Supreme Court in the instant ruling.

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