Supreme Court of India in Uttar Pradesh Power Transmission Corporation limited vs. CG Power and Industrial Solutions Limited1, handed down a decision regarding the Levy and Collection of cess charged under the Building and Other Construction Workers' Welfare Cess Act, 1996 (hereinafter "Cess Act") on supply contracts.

Background of the Cess Act

The Parliament enacted the Cess Act to regulate the employment and conditions of service of building and other construction workers and to provide for their safety, health and welfare measures and other incidental matters. In view of the same, the Cess Act is intended to provide for levy and collection of a cess on the cost of construction incurred by employers. This has been mandated in order to augment the resources of the Building and Other Construction Workers' Welfare Boards constituted under the Building and Other Construction Workers (Regulation of Employment and Conditions of Service) Act, 1996 (hereinafter "BOCW Act").

The Statement of Objects and Reasons of the BOCW Act is intended to generate funds for the Welfare Boards to enable them to undertake social security schemes and welfare measures for building and construction workers.

Section 3 of the Cess Act is the charging section which provides for the levy and collection of cess. Relevant portion of the said provision is being reproduced hereunder:

"3. Levy and collection of cess –

(1) There shall be levied and collected a cess for the purposes of the Building and Other Construction Workers (Regulation of Employment and Conditions of Service) Act, 1996, at such rate not exceeding two percent, but not less than one percent of the cost of construction incurred by an employer, as the Central Government may, by notification in the Official Gazette, from time to time specify." (Relevant portion only – Emphasis supplied)

In view of the above, it is clear that there shall be levied and collected a cess for the purpose of the BOCW Act, at such rate not exceeding two per cent and not less than one percent of the cost of construction incurred by an employer.

Notably, the term 'cost of construction' defined under Rule 3 of the Building and Other Construction Workers' Welfare Cess Rules, 1998 ("Cess Rules") provides as under:

"3. Levy of Cess –

For the purposes of levy of cess under sub-section (1) of the section (3) of the Act, cost of construction shall include all expenditures incurred by an employer in connection with the building or other construction work but shall not include –

- cost of land;

- any compensation paid or payable to a worker or his kin under the Workmen's Compensation Act, 1923." (Relevant portion only)

The aforesaid definition of 'cost of construction' has been a havily contested issue in several litigations regarding levy and chargeability of cess. The Apex Court's decision in the present case, strives to declutter the ambiguity with regard to levy and chargeability of cess on supply contracts vis-à-vis Engineering, Procurement & Construction (hereinafter "EPC") Contracts.

Brief Facts of the Case

CG Power and Industrial Solutions Limited (hereinafter "Contractor") had entered into a Framework Agreement with Uttar Pradesh Power Transmission Corporation Ltd. (hereinafter "UPPTCL") for construction of 765/400 KV Substations, at Unnao, Uttar Pradesh (hereinafter "Project"). As per the scope of work detailed in the Framework Agreement, the Contractor was required to construct and deliver the Project to UPPTCL on single source turn-key basis. Framework Agreement clearly provided that the scope of work was split under four separate contracts with a clear stipulation that the 'Nature of Contract' shall be as under:

a. First Contract – Supply and Delivery of Equipment & Material

b. Second Contract – Handling, Erection, Testing and Commissioning Works

c. Third Contract – Civil Works

d. Fourth Contract – Three years Operation & Maintenance (O&M)

Frame Work Agreement clearly stated that the first and second contract shall cover all works other than civil works required to be completed. The third contract would cover all civil works including required materials under its scope.

Subsequently, there was an audit inspection of the Project by the Audit Officer from the office of Comptroller & Auditor General of India (hereinafter "CAG"). The audit report pointed out a lapse on the part of UPPTCL, in not deducting labour cess from the bills of the Contractor in respect of the First Contract (which is a supply contract). It was observed that every employer was required to levy and collect cess on the 'cost of construction' incurred by an employer and to deposit the same with the Welfare Board. Pursuant thereto, UPPTCL informed the Contractor of the said audit objection and contended that cess was to be collected from the Contractor on the Project cost, which would include supply of equipment and materials as well as erection work, to which the Contractor objected. The Contractor also made representations to the UPPTCL for setting aside the demand for cess alleged to be outstanding, on the ground that the first contract was exempted from cess under the BOCW Act and the Cess Act.

In the meanwhile, UPPTCL instructed the concerned bank to retain an amount alleged to have been unpaid cess from the bank guarantee (hereinafter "BG") furnished by the Contractor. Further, the payment towards pending bills of the Contractor were sought to be withheld in order to recover the allegedly unpaid cess amount under the supply contract.

Being aggrieved by the aforesaid acts of UPPTCL, the Contractor preferred a writ petition before the jurisdictional High Court. By an interim order, the High Court restrained UPPTCL from encashing the BG furnished by the Contractor. Finally, after hearing detailed arguments by the parties, the High Court set aside the demand order(s) issued by UPPTCL seeking to recover unpaid cess from the Contractor.

One of Contractor's arguments upheld by the High Court was that in absence of an order issued under the Cess Act and rules made thereunder, UPPTCL's demand from the Contractor is unsustainable under law. The High Court observed that if cess were leviable under the Cess Act, it would be necessary for the concerned authorities to undertake the exercise of assessment and levy of cess under the Cess Act, before itcould be realized from Contractor. The High Court held that in the absence of any order for levy and assessment under the Cess Act, recovery could not be made merely on the basis of an audit objection from CAG.

Supreme Court's observations and ruling

The Apex Court undertook a detailed review of terms of the Framework Agreement including that of the four separate contracts. It observed that terms of the Special Conditions of the Contract merely provides that duties, taxes, fees, etc. that are legally applicable, shall be paid at actuals by the Contractor, and hence, the said term clearly does not enable UPPTCL from recovering cess by encashing the BG.

The Court also took note of the Apex Court's decision in Dewan Chand Builders and Contractors vs. Union of India2, to examine the object and intent of the BOCW Act to be welfare of workers engaged in 'building and construction work'.

Further, the Court examined the concept of 'contractor' as contained in the BOCW Act. Under Section 2(g) of the BOCW Act the term 'contractor' means a person who undertakes to produce a given result for any establishment, other than a mere supply of goods or articles of manufacture, by the employment of building workers or who supplies building workers for any work of the establishment and includes a sub-contractor. In view of the same, the Court held that the Contractor in the present case, does not qualify as a 'contractor', within the meaning of the said provision vis-a-vis the first, second and fourth contracts (not involving any element of construction).

Furthermore, the Contractor in the present case which concerns the supply contracts, was held to be not an 'employer' within the meaning of Section 2(1)(i) of the BOCW Act. Said provision defines 'employer' to include the contractor in relation to a building and other construction work carried on by or through a contractor or by employment of building workers supplied by a contractor.

Basis the above, for the first second and fourth contract, which do not involve any element of construction or employment of construction workers, the Contractor was held not to be liable for cess under the Cess Act.

Also, since no intimation or information was given or any return filed with the assessing officer under the Cess Act in respect of the First and Second Contracts, either by UPPTCL or by the Contractor, the levy and chargeability of cess on the Contractor clearly fails. Also, the demand of cess by UPPTCL is solely based on the audit report by the CAG, and hence, in the absence of any adjudication under the Cess Act, such demand of cess from the Contractor was held to be non-sustainable. The Court also referred to the CAG's report, wherein it was categorically recorded that the UPPTCL's initial view was that cess was not chargeable on the supply contracts, which later changed only due to the CAG's report.

Further, the Court appreciated the intent of the parties in entering into the Framework Agreement by observing that four contracts had been treated as a singular contract solely for the purposes of responsibility for timely execution. Hence, for all other intents and purposes, including levy of any tax or fees, the contract for supply was understood by the parties as a separate and distinct contract. Moreover, the terms of payment were separate for the supply and delivery of equipment and materials.

The Court also took note of the instructions issued by several public authorities and corporation such as Delhi Metro Rail Corporation, Karnataka Power Transmission Corporation Limited, among others, where it was clearly instructed that no cess under the Cess Act is leviable on a supply contract.

The Court concluded that the action of UPPTCL in forcibly extracting cess from the Contractor in respect of the first contract, solely on the basis of the CAG report, is against the prevailing law and terms of the contract.

Conclusion

The Apex Court in this judgment has appreciated the commercial wisdom and intent of the parties entering into complex commercial contracts such as single turn-key contracts. These contracts, whilst appearing to impose a single point of responsibility on the contractor to construct and deliver the projects, entail completely different scope of works and / or nature of such work. By doing so, the Court has restrained the authorities from imposing liability on contractors without clearly understanding the nature of works involved therein, and seeking to impose cesses, taxes, etc. on the full value of contract for the sake of convenience and ease.

Having said the above, it is imperative for the contractors entering into such contracts to clearly record the terms relating to payment of cess and the parties on whom such obligation rests. Since the Cess Act has been enacted as part of a welfare measure, various courts have interpreted the provisions therein in a liberal manner. Therefore, the parties to such contract should strive to record clear terms as to the liability and in case of failure by such party, adequate mechanisms for recovery should be built in.

Footnotes

1 Uttar Pradesh Power Transmission Corporation limited vs. CG Power and Industrial Solutions Limited , Special Leave Petition No. 8630 of 2020; decided on May 12, 2021

2 Dewan Chand Builders and Contractors vs. Union of India, (2012) 1 SCC 101

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