STATE OF MADRAS V. M/S GANNON DUNKERLEY & CO., (MADRAS) LTD.1

FACTS:

The assessees, Messrs. Gannon Dunkerley and Co. (Madras) Ltd., are a private limited

company incorporated under the Indian Companies Act and they carry on business as

Engineers and Contractors. Their business consists mainly of execution of contracts for

construction of buildings, bridges, dams, roads and structural contracts of all kinds.

The controversy started because “works contracts” were included within the ambit of the

Madras General Sales Tax Act and the Company was made subject to the levy of sales-tax

within the limitations provided in the said Act. Thus the amounts with respect to the materials

transferred, used in the execution of the contract, between the Government (the contracting

party) and the Company (the builder) were included in the annual turnover of the company

and thus was taxed under the Act aforementioned.

The amending Act added an inclusive definition of sale in the Madras General Sales Tax Act

under sec 2(h): “Includes also a transfer of property in goods involved in the execution of a

work contract.”

ISSUE:

Whether a building contract, as in the present case, constitutes within itself a contract of sale

of goods and contain any element of the nature of the sale of goods to justify the imposition

of the tax upon them?

To answer this question, the Court looked into what constitutes a “sale of goods”, and

whether a building contract includes a “sale of goods” to come under the tax net.

COURT’S VIEW:

What is “sale of goods”?

The term “sale of goods” has been used in Entry 48 of the Government of India Act, 1935

(now in entry 54 in the Constitution of India, 1950). Hence the argument put forth was that

this term has to be interpreted in a wider sense and thus include transfer of materials in a

works contract. But the Court was of the view that “the draftsmen and the Parliament must

1 AIR 1958 SC 5601

have been well aware that the expression “sale of goods” had acquired a legal import by that

time, and it is legitimate therefore to presume that the expression was used in the sense in

which it was understood by English lawyers and also in India. The draftsmen must have

intended to define the power of the Legislature to tax only the transaction of sale of foods,

which was understood in law as meaning and as constituting those composite series of acts

beginning with an agreement of sale and ending with transfer of property for a price, which

constitute sale of goods.”

In order to constitute a sale as defined in the English Sale of Goods Act, followed in the

Indian Sale of Goods Act, two things are necessary: (1) An agreement to sell, i.e, an

agreement to transfer the property in goods to the buyer for a price and (2) An actual sale by

which the property in the goods passes from the seller to the buyer.

Sale of goods, therefore, means a contract whereby the property in the goods is actually

transferred by the seller to the buyer. It is not an executory contract but an executed contract,

and the transfer of the property in the goods is for a price, i.e., for money consideration. In

this regard, the Court relied on various authorities like Benjamin on Sale and Halsbury’s

Laws of England.

For sale of goods, the Court held that there cannot be an agreement to one kind of property or

work and a sale regards another. For the true interpretation of the term “sale of goods” there

must be an agreement for the sale of the very goods in which eventually property passes.

Thus even the appellant’s contention that an express agreement is not necessary with respect

to the goods is also nullified. In a contract to construct buildings according to specifications,

there is no contract to sell materials used in construction. Thus such a contract for sale of

materials cannot be inferred from a building contract.

Thus the Court observed that the expression “sale of goods” has a well-defined meaning

under law even before the Government of India Act, 1935 had come into force and thus the

meaning in the Constitutional Act also has to be the same as understood by lawyers and

Courts, viz., as defined under the Sale of Goods Act. Under the Sale of Goods Act, “goods”

means every kind of moveable property other than actionable claims and money; and

Includes stock and shares, growing crops, grass and things attached to or forming part of the

land, which are agreed to be severed before sale or under the contract of sale. According to

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the definition in the English Act “goods” include all chattels personal, other than things in

action and money.

Thus the Court held that the power of the legislature could not extend to anything other than a

transaction of sale as understood in law. It does not mean that the Legislature has no power to

enact provisions which are intended and are necessary for the enjoyment and exercise of

power, but the Legislature can tax only on what constitutes a “sale of goods”. Under the guise

of enacting a law in respect of a field open to the Legislature, it is not entitled to transgress

the limits and widen the field by enacting an inclusive definition of sale of goods, to include

what in law is not a transaction of sale. If really the Legislature has no power to levy a tax

upon transactions, which do not constitute in law sales of goods, it purports to do something,

which is forbidden.

Thus it has become clear that the Legislature has a power to determine taxable events, but has

no power to widen the field and change the definition of “sale of goods” as understood in

law.

Whether building contracts include “sale of goods”?

In this regard the Court observed that when the material is fixed to the corpus by the builder,

the property passes when the property in the larger corpus itself passes to the other party.

This rule, of course, is subject to any special stipulations in the contract to build. If the parties

intended that property in materials should pass at an earlier stage that of course governs the

rights between the parties. If the material is supplied by the other party to the contract, or if

on his account the builder purchases the materials, the contract in either event will be a mere

contract for labour and work and not for sale of the material.

The Court then relied on an English decision [1904 AC 223 (L)], wherein before the ship was

completed, the builders became bankrupt. At that time, there were iron and steel plates of a

large quantity lying in the railway station which were ordered by the ship-builders. Now, both

the builders and the ship owners claimed these materials. The House of Lords held that there

was no sale with respect to materials in this case and the contract of sale was with regards to

the purchase of the ship. The materials in question should not be regarded as appropriated to

the contract or sold under the Sale of Goods Act.

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The Court thus held that building contracts are always considered in law as entire and

indivisible contracts in the sense, that the complete fulfillment of the promise by one party is

a condition precedent to the right of the other to call for the fulfillment of any part of the

promise by the other.

Here, the Court used an analogy, taking cue from another English case. It observed that the

materials which were used by the builder into the property of the other contracting party

became part of that property. Bricks built into a wall become part of the house; thread stiched

into a coat which is under repair or planks and nails and pitch worked into a ship under repair

become part of the coat or the ship; and therefore, generally, and in the absence of something

to show a contrary intention, the bricklayer, or tailor, or shipwright, is to be paid for the work

and materials he has done and provided.

There is, therefore, no element of sale of the materials in such a contract, as the contract in

substance is not a contract to sell materials as goods for a price stipulated between the parties

as explained under the Sale of Goods Act. The contract therefore does not become a contract

relating to sale of goods but is only a contract to build. There is no element of sale of goods

either and the contract is one and indivisible. Unless the work is completed, the builder is not

entitled to the price fixed under the contract or ascertainable under the terms of the contract.

It does not imply or involve a contract of the sale of the materials for a price stipulated. The

property in the materials passes to the owner of the land because they are fixed in pursuance

of the contract to build, and along with the corpus, the materials also pass to the owner of the

land.

In the present case, cement and other materials were provided by the Government. It is only

the non-controlled materials (meaning labour and workforce etc.) that the company had to

find for the purpose of the work. The company does not purport to sell the materials under the

contract, and it is not a contract for the sale of the materials. On the face of the contract,

therefore, it is difficult to come to the conclusion, that the contract involves any element of

sale of goods to justify the imposition of a tax upon the assesses.

It therefore, follows that the building contracts, which the assessees entered into during the

assessment year, on which the turnover was calculated, do not involve any element of sale of

the materials and are not in any sense contracts for the sale of goods as understood in law.

Having regard to the terms of particular contracts, there may be an intention to pass the

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ownership in the materials for a price agreed upon between the parties, in which case such

contracts might contain an element of sale of goods, but that is not the case here. The Court

held that if the Legislature intends to bring under the tax net contracts such as these, then the

amendment is ultra vires of the legislature to that extent as they had no power to tax

transactions which are not “sale of goods”. Thus the levy of tax in this case is not justified in

law.

CONCLUSIONS:

“Sale of Goods” in Entry 48 of the Government of India Act, 1935 (now in Entry 54

of the Constitution of India, 1950) is a nomen juris (or a legal term or expression) and

is to be understood in the context of the law prevailing.

Essential ingredients of sale are agreement to sell movables for a price and property

passing between the two competent parties therein pursuant to that agreement.

A building contract is one and indivisible. There is no sale of goods and thus no tax

can be imposed as it amounts to treating a building contract as including sale of

goods.

It is possible for parties to enter into two agreements, one for transfer of materials for

money consideration and other for payment of consideration for services and work

done. But here there are two separate agreements.

In the other case, there might also arise a situation wherein the parties agree to

transfer materials for a particular price in the building contract, but here also, there is

an express agreement.

But a works contract, without any of the express clauses or agreements, is only one

agreement and that is for the works and execution of contract and there is no

agreement for sale of goods. Thus it is one and indivisible.

View of the Court in BSNL v. Union of India2 (2006):

The Court in this case held that the Gannon Dunkerley case followed the classical thought

which says that there were three essentials of sale, namely, (i) an agreement to transfer title of

goods (ii) supported by consideration, and (iii) an actual transfer of title in the goods. In the 2 AIR2006SC1383

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absence of any of these elements, there is no sale. Therefore a contract with a builder to set

up a building or dam etc does not include a contract of sale of goods.

But the BSNL case held that the 46th Constitutional Amendment in Article 366 inserting a

definition of “tax on the sale or purchase of goods” in clause 29A(b) overcomes the Gannon

Dunkerley case. Clause (b) covers cases relating to works contracts. The effect in law of a

transfer of property in goods involved in the execution of the works contract was by this

amendment deemed to be a sale. To that extent the decision in Gannon Dunkerley was

directly overcome.

This case held that Gannon Dunkerley case survived the 46th Amendment in two respects:

First with regard to the definition of “sale” for the purposes of the Constitution in general and

for the purposes of Entry 54 of List II in particular except to the extent that the clauses in

Article 366(29A) operate. By introducing separate categories of “deemed sales”, the meaning

of the word “goods” was not altered.

The second respect in which it survived was with respect to, what the Court in BSNL case

termed as “dominant nature test” to be applied to a composite transaction. Article 366(29A)

covered only three types of composite transactions, viz., works contract, hire purchase

contract, and catering contract. Apart from these, where splitting of contract into service and

sale of goods is not possible, as in the case of hospital services or lawyer services, then in that

case the Court will check what the parties intended to do. If there was no intention of the

parties for sale of goods and materials, there is no sale, even if the contract could be

disintegrated. The test for deciding whether a contract falls into one category or the other is to

as what is the substance of the contract. This test for determining whether a composite

contract will be taxable or not was termed as dominant nature test.

Thus even in the case of State of Andhra Pradesh v. Kone Elevators3 (2005), the agreement

was clear in that the customer was asked to make all the arrangements for the lift

manufacturer to come and place the elevator. Hence, the Court held that the “works” part was

given to the customer and the “supply” part was given to the manufacturer which includes

installation after taking help of the “work” done by the customer. Thus it was a contract of

sale of lift than a service provided by the manufacturer.

3 (2005)3SCC3896

Finally, even in the case of Oriental Bank of Commerce v. State of U.P4 (2008), the Court

held that the Gannon Dunkerley case was holding field with respect to works contracts, and

in general composite contracts, before the 46th Amendment. But after the amendment, as

stated in the BSNL case, this aspect has been overcome and only the case survived in only

two respects as laid down in the judgment.

Thus with respect to works contracts, hire purchase contracts, and catering contracts and all

such transfers as specified in Article 366(29A), the transfer of materials will be considered as

sale. But as given by the BSNL case, the definition of sale and other things such as delivery,

intention of parties, goods etc shall stand as long as it includes the changes in the amendment.

Also the dominant nature test shall also stand, whose logic originated in the Gannon

Dunkerley case.

4 MANU/UP/0291/20087