Works Contracts, Composite Contracts and the Sale of Goods: The Indivisibility Rule, the Dominant Nature Test, and Deemed Sales under Article 366(29A) of the Constitution

Many modern contracts combine the supply of goods with work, skill or services: building a house, installing a lift, catering an event, printing a book, repairing a car with new parts. Under the Sale of Goods Act the question is simple to state and often hard to answer: is the transfer of goods the substance of the bargain, or incidental to something else? The question has been fought out almost entirely in tax cases, because until 1982 a State could tax only a sale of goods. The Constitution was then amended to create deemed sales for tax purposes, and the case law since has been about how far that amendment reaches. It is important to keep the two meanings of sale apart: the meaning under the 1930 Act, and the wider meaning for taxation.

1. The Starting Point: Indivisible Contracts Are Not Sales

In State of Madras v. Gannon Dunkerley & Co., AIR 1958 SC 560, the Supreme Court held that an indivisible building contract is not a sale of the materials used in it. The expression sale of goods bore its meaning under the Sale of Goods Act, which requires an agreement to transfer goods as goods for a price. In a building contract there is no agreement to sell bricks and cement as movables; they become the owner's property by accession when they are built into his land. The State could not split an indivisible contract into a sale of materials and a supply of labour in order to tax the first.

A contract for work and labour is one where skill is the essence and materials are incidental, as with a portrait, a repair or a tailor making clothes from the customer's cloth.
A contract of sale is one where the thing produced is the essence, and the work is merely a means of producing it, as with ready-made goods or goods manufactured to a standard pattern.
An indivisible works contract is one where goods and labour are so intertwined that the contract cannot be split, as with a building, a bridge or an installed plant.

2. The Forty-sixth Amendment and Article 366(29A)

Article 366(29A), Constitution of India, in substance

“Tax on the sale or purchase of goods” includes (a) a tax on the transfer, otherwise than in pursuance of a contract, of property in any goods; (b) a tax on the transfer of property in goods, whether as goods or in some other form, involved in the execution of a works contract; (c) a tax on the delivery of goods on hire-purchase or any system of payment by instalments; (d) a tax on the transfer of the right to use any goods for any purpose; (e) a tax on the supply of goods by an unincorporated association or body of persons to a member; and (f) a tax on the supply, by way of or as part of any service, of goods being food or any other article for human consumption or any drink; and such transfer, delivery or supply shall be deemed to be a sale of those goods by the person making it and a purchase by the person to whom it is made.

The amendment, made in 1982, responded directly to Gannon Dunkerley and to cases such as State of Himachal Pradesh v. Associated Hotels of India, AIR 1972 SC 1131, which had held that meals supplied in a hotel were not sales. It did not overrule those cases on the meaning of sale under the 1930 Act. It created a separate and wider concept for taxation, and allowed the States to split a works contract and tax the goods element. In Builders Association of India v. Union of India, (1989) 2 SCC 645, the Supreme Court upheld the power so created.

From Gannon Dunkerley to Kone Elevator, and the six deemed sales in Article 366(29A)

3. Other Composite Contracts: The Dominant Nature Test

For composite transactions not covered by the six categories in Article 366(29A), the Supreme Court in Bharat Sanchar Nigam Ltd. v. Union of India, (2006) 3 SCC 1 held that the court must ask what the dominant nature of the contract is. If the substance is the transfer of goods, it is a sale. If the substance is a service, and goods pass only incidentally, it is not. A mobile telephone connection was held to be a service. The Court also emphasised that the deemed sales in Article 366(29A) are confined to the categories listed, and that the tax fiction does not extend to other composite contracts.

4. Works Contracts After Kone Elevator

📖 Kone Elevator India (P) Ltd. v. State of Tamil Nadu, (2014) 7 SCC 1

Facts: A company manufactured, supplied and installed lifts in buildings. An earlier three-judge bench, in State of Andhra Pradesh v. Kone Elevators (2005), had held such a contract to be a sale, treating the installation as incidental to the supply of the lift. The question was referred to a Constitution Bench.

Held: The Constitution Bench held that a contract for the manufacture, supply and installation of lifts is a works contract and overruled the 2005 decision. The installation was not incidental but a substantial part of the contract: the components were assembled and fixed at site as a permanent part of the building, and goods, skill and labour were so connected that the contract was indivisible. There was no transfer of the lift as a chattel. Once a contract is a works contract within Article 366(29A)(b), the dominant nature test is not applied to recharacterise it as a sale.

Ratio: A contract whose performance requires goods, skill and labour intimately combined, resulting in a fixture, is a works contract. The labour and service element cannot be treated as incidental so as to make the whole a sale.

📖 Larsen & Toubro Ltd. v. State of Karnataka, (2014) 1 SCC 708

Facts: Developers entered into agreements with prospective buyers to construct and sell flats, the agreements being made while the building was still under construction. The question was whether these were contracts for sale of immovable property only, or works contracts on which tax could be levied on the goods involved.

Held: A three-judge bench held that where the developer agrees with the buyer to construct the flat, and the agreement is made before construction is complete, the contract is a works contract within Article 366(29A)(b), and the goods element may be taxed. The Court approved the earlier decision in K. Raheja Development Corporation v. State of Karnataka (2005).

Ratio: A builder's agreement to construct and sell a flat, made during construction, is a works contract for the purposes of Article 366(29A)(b).

5. The Position Under GST

Since the goods and services tax came into force in 2017, the old contest between sales tax and service tax has largely disappeared from practice. The Central Goods and Services Tax Act, 2017 treats a works contract as a supply of services, and composite and mixed supplies have their own statutory rules. The case law discussed here remains important for two reasons: it explains the concepts on which the current law is built, and it states the meaning of sale under the Sale of Goods Act, which GST did not change.

⚠ Two meanings of sale, kept apart

A deemed sale under Article 366(29A) is a sale for tax purposes only. A works contract, a hire-purchase agreement, a transfer of the right to use goods, or the supply of food with a service does not become a contract of sale under the Sale of Goods Act because of the Article. Questions about the passing of property, implied conditions, the unpaid seller or remedies in such a transaction are answered by the general law of contract and by the rules for works contracts, hire-purchase or bailment, not by the 1930 Act.

6. The Position Stated Shortly

Gannon Dunkerley: an indivisible works contract is not a sale of the materials used in it.
Work and labour, sale, and indivisible works contracts are distinguished by the substance of the bargain.
The Forty-sixth Amendment created six categories of deemed sale in Article 366(29A), for taxation only.
BSNL: other composite contracts are classified by their dominant nature.
Kone Elevator: supply and installation of lifts is a works contract, overruling the 2005 decision.
Larsen & Toubro: a builder's agreement to construct and sell a flat during construction is a works contract.
Under GST a works contract is a supply of services; the meaning of sale under the 1930 Act is unaffected.