SC Reiterates the Legal Fiction Created by Art.366 (29-A) of Constitution, Grants the Contractor Reimbursement

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Brief Facts of the Case

Respondent No. 1 (“Contractor”) was awarded a works contract based on a tender floated by the Government. The said contract contained a clause for reimbursement of sales tax (Central or State). Clause 45.2 entitled the contractor to the same in the said contract. Later, the Government of Orissa issued a circular which made work contracts after 07.04.1984 liable for reimbursement. 

Through another circular, the Government stated that no reimbursement is due to a contractor for completed item of works. Thus, the contractor filed a writ petition to declare the circulars invalid in the eyes of law. The High Court allowed the writ petition. However, the Government appealed against the said judgement. 

Arguments by the Appellant

The appellant contended that the 46th Amendment to the Constitution created a legal fiction by inserting Clause 29-A to Art. 366. According to this clause, works contracts were treated as a deemed sale on which sales tax was leviable. Further, the phrase “completed item of work” meant the completion of the works contract. Therefore, the contractor is bound to pay sales tax on the “taxable turnover”. The appellant further contended that there is no sales tax on the “completed item of work” which is an immovable property. Hence, there could be no question of reimbursement. 

In addition to this, the appellant contended that the High Court failed to examine the effects of Clauses 13.3 and 45.2. Clause 13.3 stipulates that the bid price includes all duties, taxes and other levies payable by the contractor. The circulars issued on 07.11.2001 and 19.06.2002 were clarificatory in nature and stated the correct position of Clause 45.2. 

Thus, the appellant contended that Clause 45.2 applied only for “completed item of work”. It added that the tax levied as per Sec.5(2)(AA) of Orissa Sales Tax Act, 1947 (“Act of 1947”) was not reimbursable. 

Arguments by the Respondent

On the other hand, the Contractor submitted that the deduction of sales tax on turnover basis presupposes the existence of sale. Thus, this entitled the contractor to reimbursement. Moreover, the party placed reliance on Gannon Dunkerley and Co. & Ors. V. State of Rajasthan & Ors. (1993) 1 SCC 364 (“Gannon Dunkerley”).

Court’s View

The Court referred to its decision in Builders’ Association of India & Ors.v. Union of India & Ors., (1989) 2 SCC 645. Therein, the Court had explained the legal fiction created by Clause (29-A) (b) of Art.366 of the Constitution. The 46th Amendment allows states to levy sales tax on the price of goods and materials used in works contracts as if there was a sale of the same.  

Referring to Gannon Dunkerley, the Court observed that even in an indivisible works contract, there is a deemed sale of goods. By deducting the charges towards the labour and services from the value of the entire works contract, this value is calculated. Through relevant amendments, the Orissa State Government amended Secs. 2(g), 2(jj) & 5(2)(AA) to levy sales tax on works contracts. 

Thus, when sales tax on the goods forms part of the contract price, the government had rightly denied the claim for reimbursement. 

Court’s Decision

Through the first circular, the Appellant provided a provision for the reimbursement of sales tax. However, with the later circular, the Appellant denied the reimbursement of the sales tax. The Court found that circulars cannot determine contractual obligations. Thus, the Court ignored the circulars.

Previously, the Government allowed the reimbursements based on Clause 45.2. The Court further observed that it deducted sales tax in a routine manner. It then deposited this tax with the Sales Tax Department. The appellant did not dispute this matter. Contrary to the Appellant’s assertion, the levy of sales tax was on the “completed item of work” in the contract. This would only after the completion of an item of work, reimbursement is permissible. The Court stated that if this expression was read to mean that sales tax was leviable on the completed item of work, it would be contrary to its real intent.

The Court entitled the contractor to reimbursement as per Clause 45.2 of the Contract. Additionally, it upheld the impugned order of the High Court. It held that the circulars were illegal and invalid.    


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