Introduction – The Issue with Composite Contracts

After the 18th Amendment[1] to the Constitution[2], goods are taxed by the federal legislature, and the services by the provinces[3]. There is no concurrency in tax. For a particular transaction, the tax is either levied by the federal legislature, or by the provinces. Under the current framework, the supply of goods is taxed by the center under the Sales Tax Act, 1990. The provinces, after the 18th Amendment, have promulgated provincial legislations to bring the taxation on services within their provincial domain.

This arrangement works well when the goods are supplied separately; and the services are provided separately. But the arrangement comes under strain when the goods are supplied alongside services, or the services are provided alongside goods, in a manner, that the two, under the contractual arrangements, are not necessarily separable. Who, then, gets to tax and collect taxes levied on such activities? The central government or the provinces?

The question arises particularly in the context of construction works. In Association of Builders and Developers of Pakistan v. Province of Sindh and others, 2018 PTD 1487 (Sindh) (“ABAD”)[4], the Petitioners before the Sindh High Court, for instance, were primarily, those entities that (1) purchased the land, developed it by laying down infrastructure, such as roads and sewage lines, and then parceled the land into plots, selling them onwards, and (2) constructed buildings, with shops, apartments and other such units, and sold them onwards, allowing payments, against those units, in installments. The question before the court was whether the amounts received by these property developers and promotors, was against the supply of goods, or provision of services. If the latter then the provincial sales tax on services legislation applied, and the tax could be collected by the provinces. The Sindh High Court referred to the test that would determine this question – the “dominant intention” test – but failed to apply it, itself. The Court, instead, decided the cases before it on other grounds, kicking the can down the road, for determining the vital, fundamental question that whether taxpayers before the Court were engaged in the supply of goods or provision of services.

The question of composite contracts has also arisen in the context of contractors performing works, such as constructing and building roads, for the National Highway Authority (the “NHA”). Two High Courts have looked into these contracts. The Islamabad High Court in Sardar Muhammad Ashraf D. Baloch v. National Highway Authority and another[5], and the Peshawar High Court in M/s Matracon Pakistan (Private) Limited v. Appellate Tribunal for Sales Tax on Services, Khyber Pakhtunkhwa[6]. Both have reached different conclusions. The Islamabad High Court held that what had been supplied were not “services”, but “goods”; the Peshawar High Court held that what had been provided to NHA were not “goods”, but “services”.

Whether “Property Developers and Promoters” Provide Services, as Opposed to Goods?

In ABAD, the Sindh High Court had the opportunity to address the question whether the activity that the “property developers and promoters” engaged in, were to be characterized as supply of “goods” or as provision of “services”. The Court, however, ducked.

It, instead, decided the question before it on a completely different basis. The activity of the “property developers and promoters” was the “creation of the immoveable property”[7], that is, the creation or preparation of the plots in a housing scheme, or the units in a building. The Court invoked section 54 of the Transfer of Property Act, 1882, to state that at the stage of the challenges to the show cause notices issued by the Sindh Revenue Board (SRB) before it, there were only agreements to sell, and nothing more. Without a registered sale deed, at the stage of agreement to sell, the buyers had no interest in the property. Therefore, this was not “economic activity” as defined under the Sindh Sales Tax on Services Act, 2011 (the “2011 Sindh Act”). Because this was not an “economic activity” primarily since there was no exchange of rights in property, the show-cause notices could not have been issued.

For the Sindh High Court, therefore, it became a matter of timing. It did not address the question of “services” versus “goods” because the taxpayers before it, were only at the stage of “agreement to sell”, and no property rights, in essence, had changed hands. In other words, there was no possible recipient of service, or a consumer of goods. And this sufficed for the Court.

What the Sindh High Court glossed over was that at least some of show-cause notices, which had been challenged before it, were issued by the SRB under section 24 of the 2011 Act. This is the provision that requires registration of the taxpayers with the SRB. In setting these notices aside, there ought to have been a determination that the taxpayers before it – the property developers and promoters – were (or were not) required to register under section 24 of the 2011 Act, on the basis that they did (or did not) provide any services. In other words, the High Court ought to have reached the conclusion, one way or the other, that what was provided by the Petitioner taxpayers were “services”, or not. In not deciding the question of whether the activity of the “property developers and promoters” was service or not, the Court kicked the can down the road. This was probably a cop-out, although a creative one.

The show-cause notices under challenge before the High Court also had sought to tax “construction services”. The Court appreciated that the activities associated with a construction contract may be “multidimensional”[8], since they may involve, both, provision of services, and supply of goods, both of them intertwined. For such multi-dimensionality, the Court incorporated the “dominant intention” test, borrowed from the Indian Supreme Court’s Larsen and Toubro Limited and another v. State Karnatka and another (2014) 1 SCC 708. The Sindh High Court also referred to the decisions from the United States: (1) Bunebrake v. Cox 499 F.2d 951 (1974), from the Court of Appeals for the 8th Circuit, and (2) Propulsion Technologies Inc. v. Aitwood Corporation 369 F.3d 896 (2004), from the Court of Appeals for the 5th Circuit.

Borrowed from the US and the Indian courts, the “dominant........

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