Whether Levy of Service Tax & VAT/Sales Tax Are Mutually Exclusive

The legislative competence of the Parliament to tax Services is traced to entry 97 of list I of the Seventh Schedule to the Constitution of India while the power of a State to levy Sales Tax or VAT is traced to entry 54 of List II of the Seventh Schedule to the Constitution of India.

Undisputedly, States have the power to levy sales tax/VAT but the same is subject to the transaction falling within the parameters of a ‘sale’.

Taxing a transaction of rendering service would fall outside the legislative competence of a State legislature and thus, even by a device of legal fiction, such transactions cannot be subjected to levy of Sales Tax or VAT.

See Also : Tim Delhi Airport Advertising Pvt. Ltd. Vs. Special Commissioner – II, Department of Trade & Taxes {Delhi High Court, 2 May 2016}

Supreme Court on Tax

In Gujarat Ambuja Cements Ltd. v. Union of India: (2005) 274 ITR 194 (SC), the Supreme Court had held that

  • This mutual exclusivity which has been reflected in Article 246(1) means that taxing entries must be construed so as to maintain exclusivity.
  • Although generally speaking a liberal interpretation must be given to taxing entries, this would not bring within its purview a tax on subject matter which a fair reading of the entry does not cover.
  • If in substance, the statute is not referable to a field given to the State, the court will not by any principle of interpretation allow a statute not covered by it to intrude upon this field.

Following the aforesaid decision, the Supreme Court in Bharat Sanchar Nigam Ltd. v. Union of India: 2006 (3) SCC 1, held that:

  • No one denies the legislative competence of the States to levy sales tax on sales provided that the necessary concomitants of a sale are present in the transaction and the sale is distinctly discernible in the transaction.
  • This does not however allow the State to entrench upon the Union List and tax services by including the cost of such service in the value of the goods.
  • Even in those composite contracts which are by legal fiction deemed to be divisible under Article 366(29-A), the value of the goods involved in the execution of the whole transaction cannot be assessed to sales Tax.

Insofar as the legislative competence of Parliament or State to make a particular legislation is concerned, the same has to be considered in the context of the subject of the legislation.

In Union of India v. Shri Harbhajan Singh Dhillon, (1971) 2 SCC 779, a Constitution Bench of the Supreme Court applied the doctrine of pith and substance in order to examine whether imposition of wealth tax on agricultural lands, by virtue of an amendment to the definition of ‘net wealth’ under the Wealth Tax Act brought about by the Finance Act, 1969 fell within the legislative competence of the Parliament or the States.

The Supreme Court has also in several cases explained the difference between the incidence of tax and the measure of tax.

In several cases, it is seen that the subject and the pith and substance of two or more taxing statutes are different but the measure of such taxes is similar or overlapping.

In Governor General in Council v. Province of Madras, (1945) FCR 179 P.C., the Court explained the distinction between the subject of tax and measure of tax in the context of duties of excise and sales tax in the following words:

  • The two taxes, the one levied upon a manufacturer in respect of his goods, the other on a vendor in respect of his sales, may, as is there pointed out, in one sense overlap.
  • But in law there is no overlapping.
  • The taxes are separate and distinct imposts.
  • If in fact they overlap, that may be because the taxing authority, imposing a duty of excise, finds it convenient to impose that duty at the moment when the excisable article leaves the factory or workshop for the first time upon the occasion of its sale.

In Federation of Hotel & Restaurant Association of India v. Union of India, (1989) 3 SCC 634, the Supreme Court referred to the Aspect doctrine and explained that

  • “The law „with respect to‟ a subject might incidentally „affect‟ another subject in some way; but that is not the same thing as the law being on the latter subject.
  • There might be overlapping; but the overlapping must be in law.
  • The same transaction may involve two or more taxable events in its different aspect.

However, in Bharat Sanchar Nigam Limited (supra), the Supreme Court explained that the Aspect doctrine only dealt with the issue of legislative competence.

In a later decision in Imagic Creative Pvt. Ltd. v. Commissioner of Commercial Taxes &Ors., (2008) 2 SCC 614, the Supreme Court unequivocally held that the levy of service tax and VAT were mutually exclusive and even in cases of composite contracts, sales tax would not be payable on the value of the entire contract irrespective of the element of service provided.

In cases where the contracts are indivisible – other than those contracts which are by legal fiction deemed to be divisible under Article 366 (29-A) of the Constitution of India – the intention of the parties to the transaction would be material.

While, considering the issue whether providing SIM (Subscribers‟ Identification Module) Cards would be chargeable to sales tax, the Supreme Court, in Bharat Sanchar Nigam Limited (supra) held that:

  • If the SIM card is not sold by the assessee to the subscribers but is merely part of the services rendered by the service providers, then a SIM card cannot be charged separately to sales tax.
  • It would depend ultimately upon the intention of the parties.
  • If the parties intended that the SIM card would be a separate object of sale, it would be open to the Sales Tax Authorities to levy sales tax thereon.

In view of the above, if a transaction has been held to be one of providing services then the same would not be chargeable to VAT.

The dominant object of the transaction (other than those deemed to be divisible under Article 366 (29-A) of the Constitution of India) would be determinative of the nature of the transaction.