Case clarifies VAT aspects vis-à-vis BOOT contracts

Governments across the globe enter into public-private partnerships for the development, financing, operation and maintenance of public infrastructure (both moveable and immoveable). Some such partnerships are in the nature of build, own, operate, transfer (BOOT) contracts.

In India these arrangements are typically awarded by the government (called the grantor) to a private sector player (operator) for building, operating and maintaining infrastructure meant for government/public use. The operator receives a service or user fee from the grantor or third parties at defined intervals for an agreed period of time. There are umpteen variants of the BOOT model and the taxability may vary accordingly.

Meghalaya High Court’s decision in Tata Consultancy Services Limited v The State of Meghalaya (2014) is one of the first high court decisions to consider the value-added tax (VAT) implications on contracts under the BOOT model.

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Facts of the case

The Meghalaya Information Technology Society (MITS), through the state government of Meghalaya, entered into a BOOT contract with Tata Consultancy Services Limited (TCSL) to set up a Meghalaya state-wide area network (MSWAN), aimed at modernizing e-communications to accelerate the state’s development through improved government interfaces. MSWAN was required to be implemented in five years for which the MITS/State of Meghalaya was to pay a minimum guaranteed amount (service fee) to TCSL on a quarterly basis.

At the end of five years, TCSL was to transfer all equipment to MITS/State of Meghalaya at a nominal value. Contractual terms relating to “title to the equipment”, “control and possession” and “transfer” provided that: TCSL would provide the services as prescribed in service level agreement and MITS/State of Meghalaya would release guaranteed payments against these services; TCSL would be deemed to be in control and possession of the equipment; MITS/State of Meghalaya would have no title to any of the equipment made available for delivery of services by TCSL during the period of the contract; and after five years, TCSL would transfer all equipment to MITS/State of Meghalaya at a nominal cost of ₹1.

Key issue and determination

The VAT Authority of Meghalaya considered that TCSL was building the MSWAN project for sale of its equipment under a “works contract”. Accordingly, the service fee was sought to be taxed and subjected to withholding of tax at source under the provisions of the Meghalaya Value Added Tax Act, 2003.

The high court observed that TCSL was not only in control and possession of the equipment, but was also the owner as there was no “sale”, “supply of equipment” or “transfer of right to use” any goods.

Relying on the Supreme Court’s decision in State of Andhra Pradesh v Rashtriya Ispat Nigam Ltd (2002), the high court declared that the expression “transfer of right to use” any goods for any purposes is inclusive in “tax on sale or purchase of goods” in terms of article 366(29A)(d) of India’s constitution. This article was not attracted as TCSL had not handed over control and possession of the equipment.

Noting the Supreme Court’s ruling in Builders Association of India v Union of India (1989), the high court further stated that article 366(29A) of the constitution does not say that “a tax on sale or purchase of goods” included “a tax on the amount paid for execution of a works contract”.

Citing the Supreme Court’s findings in Bharat Sanchar Nigam Ltd v Union of India (2006), the high court emphasized that in cases of composite transactions of service and sale, it is possible for states to tax the sale element, “provided there is a discernable sale and the ‘dominant intention’ test is satisfied”. In the given context, no equipment had yet been transferred to MITS/State of Meghalaya nor had they control and possession over any equipment.

The high court thus ruled that TCSL was a service provider that had not transferred the equipment to MITS/State of Meghalaya during the operation of the contract. Hence, the service fee payable to TCSL was not by reason of a “sale” (or works contract) and thus was not subject to VAT. Accordingly, any attempt to subject the service fee to withholding of tax was illegal.

This decision for the present appears to settle the position on applicability of VAT and deductibility of works contract tax/tax deducted at source during the operation stage of BOOT contracts. Though the decision does not explicitly deal with the applicability of VAT on the eventual transfer of ownership of the equipment to MITS/State of Meghalaya, since it holds that the consideration flowing to the operator during the operation of the contract is in the nature of a “service consideration”, the logical corollary appears to be that the eventual transfer of ownership (on the facts of this case) could be subject to VAT only on the transfer consideration of ₹1.

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Karthik Sundaram is an associate partner and Rajat Chhabra is a senior associate at Economic Laws Practice. This article is intended for informational purposes and does not constitute a legal opinion or advice.