M J Antony: Convergence of sales and services

OUT OF COURT

Supreme Court evolves "dominant purpose test" in taxing statutes.

The question whether a transaction is a sale or a service or both has strained legal brains for some decades. Constitution benches and the Law Commission have considered it and despite a Constitution amendment, the Supreme Court and the high courts have gone wrong. Last week, a 100-page decision of the Supreme Court in BSNL vs Union of India tried to set at rest the doubts with regard to mobile phone connections.

If the telecommunication facilities provided by the service providers amount to a sale, the states are competent to levy sales tax on the transaction under Entry 54 of List II of the Seventh Schedule to the Constitution. If it is a service, the Central government alone can impose service tax under Entry 97 of List I. If it is both sale and service, the question would be whether both of them could charge their separate taxes together or only one of them. Since the issue involved all governments and telecommunication industry, all of them were arrayed before the court. The Central government was on the side of the industry and the states were on other side.

Only two years ago, the Supreme Court had ruled in State of UP vs Union of India that telecommunication and accessories that gave access to the telephone exchange were "goods" and the Department of Telecommunications was a dealer according to the UP Trade Tax Act. Transferring the right to use the telephone instrument and the whole system fell within the meaning of "sale". In the new judgement, the larger bench of the court ruled that the earlier judgement was wrong.

The interpretation of the term goods has dogged the courts since 1959, when the Supreme Court delivered the judgement in the Gannon Dunkerley case. The court, in that case, emphasised the classical concept of sale in the Sale of Goods Act. There must be a transfer of title for a consideration. However, with the advancement of trade and industry, composite contracts came into vogue.

According to the old concept, an agreement under which a contractor decided to construct a building would not be a contract for sale, though there was sale of material used in the building. In State of Punjab vs Associated Hotels (1972), the question was whether the meals served in hotels to the guests were subject to sales tax. The Supreme Court ruled that the government could not split up the contract into service and sale and charge the transfer of goods (food). In another case, a person leased out the negative print of a picture for 49 years. The sale tax authorities considered it as a sale and imposed the levy. The Supreme Court set aside the demand as it was not a sale in the strict sense of the term.

Because of these unsatisfactory verdicts, the Law Commission studied the scope of levy of sales tax by state governments in respect of work contracts, hire purchase agreements and such other transactions that are becoming more common. It recommended expansion of the term "sale" by amending Article 366 of the Constitution. It was done in 1982, through the 46th Constitution Amendment.

According to the BSNL judgement, even that amendment would not enable the states to impose tax on mobile phone services. The amendment was made in the context of judgements dealing with works contracts, hire purchase and catering contracts. Though the courts must move with the times, the judgement emphasised they should not "assume that a transaction is a sale and then look around for what could be the goods". The ingredients of sale remain the same. Otherwise, a doctor who gives a pill to a patient in the hospital would be covered by the sales tax law. Also, a lawyer who drafts a document and delivers it to his client.

The solution the court suggests is to look into the substance of the composite contracts and find out their dominant purpose. Thus, what the goods in a sales transaction are, would depend upon the intention of the parties. The judgement called it the "dominant purpose test". Further, it relied upon its earlier judgement in the Tata Consultancy Services case to stress that goods must be capable of being bought and sold. It must be capable of being transferred, delivered, stored and possessed.

In the BSNL case, the "goods" element in telecommunications was electromagnetic waves. They are not delivered, stored or possessed. They are not consumed, nor are they marketable. They are merely a medium of communication. Phone subscribers do not have any right to use the waves or radio frequencies. Therefore, the earlier conclusion of the Supreme Court was wrong. The debate on mobile services is closed, with heavy losses to the states and big gain for the cellphone industry. However, with technological advances, the debate is likely to arise in other fields.