Gannon Dunkerley II: valuing the works contract after the 46th Amendment

On 17 November 1992, a five-judge Constitution Bench fixed the post-46th-Amendment ceiling on State works-contract VAT — value at the time of incorporation, with eight permissible deductions.

Valkya Editorial· Legal Intelligence·1 June 2026·12 min read

Court: Supreme Court of India
Citation: (1993) 1 SCC 364
Bench: M.H. Kania, C.J., J.S. Verma, J., S.C. Agrawal, J., Yogeshwar Dayal, J., Dr A.S. Anand, J.
Decided: 17 November 1992

Provisions discussed

Constitution of India art.366(29A)Constitution (Forty-sixth Amendment) Act 1982Central Sales Tax Act 1956Rajasthan Sales Tax Act 1954

The doctrinal centre-piece

The 46th Amendment's deeming fiction is real but finite. It converts a single indivisible works contract into a divisible contract for the limited purpose of taxing the goods-element — nothing more. The constitutionally permissible measure of the tax is the value of the goods at the time of incorporation in the works, not the contract price, not a fixed-percentage residue. Labour, sub-contractor charges, planning and architect's fees, plant and machinery hire, consumables, establishment costs and other similar expenses relatable to labour and services, and profit relatable to labour and services must all be deducted. The inter-State, outside-State, and import-export bars under Article 286 and the Central Sales Tax Act apply to deemed sales as they do to actual sales. The eight-deduction template governed two decades of State VAT on civil construction and travels into the GST architecture under the CGST Act 2017.

The facts in brief

The 1958 Constitution Bench decision in State of Madras v. Gannon Dunkerley & Co. (AIR 1958 SC 560) had struck down the Madras works-contract sales tax as ultra vires Entry 48 of List II. The wall held for twenty-four years. In 1982, Parliament passed the Constitution (Forty-sixth Amendment) Act, which inserted Article 366(29A). Sub-clause (b) deems the transfer of property in goods involved in the execution of a works contract to be a sale — directly undoing the structural holding of Gannon Dunkerley I. The amendment came into force on 2 February 1983.

State legislatures responded by introducing works-contract levies under the new constitutional umbrella. Rajasthan amended the Rajasthan Sales Tax Act 1954, inserting section 5(3) — a charging provision taxing the transfer of property in goods (whether as goods or in some other form) involved in the execution of works contracts at the rate applicable to the goods. The State also framed rule 29(2)(i) of the Rajasthan Sales Tax Rules 1955, which prescribed a statutory deduction from the gross value of the works contract: the assessee could either prove actual labour-and-service charges or, in default, claim a fixed percentage. The fixed-percentage default sat well below typical labour-and-service margins in civil construction.

Gannon Dunkerley & Co. — the very company that had won the 1958 case — and a clutch of other Rajasthan civil-engineering firms challenged the Rajasthan scheme. They were assessed on the difference between gross contract value and the fixed-percentage deduction, producing a tax base that swept up labour, plant-hire, overheads, and profit that were never goods at all. The Rajasthan High Court upheld the State scheme on 3 September 1991. Several Article 32 writ petitions were filed alongside the appeals from the High Court order. The matter was placed before a five-judge Constitution Bench given the constitutional architecture at stake.

The constitutional question

The central question was the constitutional outer limit of State competence to tax works contracts under Article 366(29A)(b) read with Entry 54 of List II. Did the deeming fiction authorise a State to tax the entire contract value as a sale of goods? Did it permit a fixed-percentage statutory deduction in lieu of actual labour and service value? Did the inter-State, outside-State, and import-export bars under Article 286 and the Central Sales Tax Act 1956 apply to deemed sales as they did to actual sales?

The State of Rajasthan argued that Article 366(29A)(b) created a self-contained deeming fiction that operated to convert the entire works-contract transaction into a sale of goods; that the fiction carried with it the State's authority to choose the measure of the tax; and that a fixed-percentage statutory deduction served the legitimate administrative purpose of avoiding contract-by-contract verification.

The assessees' case was that the deeming fiction was finite — it operated only to convert a single indivisible works contract into a divisible contract for the limited purpose of taxing the goods-element; that the constitutionally permissible measure was the value of the goods at the time of incorporation in the works; that labour, sub-contractor charges, planning and architect's fees, plant and machinery hire, consumables, establishment and similar expenses relatable to labour and services, and profit relatable to labour and services must all be deducted; and that Article 286 and CST Act limits applied to deemed sales as to actual sales.

What the Court held

The Constitution Bench unanimously struck down both section 5(3) and rule 29(2)(i) of the Rajasthan scheme. The judgment, authored by S.C. Agrawal J., proceeded in five connected steps.

The value of the goods which can constitute the measure for the levy of the tax has to be the value of the goods at the time of incorporation of the goods in the works.

— Agrawal, J.

First, the deeming fiction is finite. Article 366(29A)(b) operates only to convert a single indivisible works contract into a divisible contract for the limited purpose of taxing the transfer of property in goods. It does not authorise a State to tax labour, services, overheads, or profit. The contractual indivisibility that Gannon Dunkerley I had identified as a constitutional fact survives the 46th Amendment; the amendment alters the consequence of indivisibility but not the fact.

Second, the constitutional measure is the value of the goods at the time of incorporation. The State cannot use the contract price, the contract price minus a fixed percentage, or a residue produced by any deeming formula. The measure must track the actual goods-value at the point of incorporation in the works — the moment at which the goods cease to be movable and become part of the immovable property.

Third, the eight categories of deductions are constitutionally mandated. The Court crystallised eight permissible deductions that every State VAT scheme on works contracts must allow:

Labour charges for the execution of the works.
Amounts paid to sub-contractors for labour and services.
Charges for planning, designing, and architect's fees.
Charges for hire of plant and machinery used in the execution of the works.
Cost of consumables — water, electricity, fuel — used in the execution that do not pass into the finished works.
Establishment cost relatable to the supply of labour and services.
Other similar expenses relatable to the supply of labour and services.
Profit earned by the contractor to the extent it is relatable to the supply of labour and services.

Each category represents value that is not goods. The State cannot include any of these elements in the taxable base without exceeding the constitutional limit of the deeming fiction.

Fourth, Article 286 and the CST Act apply to deemed sales. The inter-State, outside-State, and import-export bars under Article 286 read with the Central Sales Tax Act 1956 apply to deemed sales under Article 366(29A)(b) just as they apply to traditional sales. A State cannot tax a deemed sale that is in substance an inter-State sale, an outside-State sale, or a sale in the course of import or export. The State must build inter-State and import-export carve-outs into its works-contract VAT scheme.

Fifth, the Rajasthan fixed-percentage deduction failed. Rule 29(2)(i)'s fixed-percentage statutory deduction operated without reference to the actual goods-value-to-labour-value ratio of any particular works contract, sweeping into the tax base value that was not goods at all. The rule was arbitrary on Article 14 grounds and offensive to the substantive limits of the deeming fiction under Article 366(29A)(b).

The value of the goods involved in the execution of a works contract on which tax is leviable does not include the cost of incorporation of those goods in the works.

— Agrawal, J.

The Court issued five propositions as the governing template that all State works-contract VAT schemes must satisfy going forward. Section 5(3) and rule 29(2)(i) of the Rajasthan scheme were struck down.

The doctrinal architecture

Gannon Dunkerley II simultaneously accomplishes four doctrinal moves that govern works-contract taxation across the entire post-46th-Amendment landscape.

First, it establishes the finitude of the deeming fiction. The 46th Amendment did not give States plenary power to tax works contracts as sales of goods; it gave them power to tax the goods-element only. The structural logic of Gannon Dunkerley I — that labour and service value cannot be folded into a sales-tax base — survives the constitutional amendment. The amendment changes the consequence of indivisibility (the goods-element can now be extracted), but it does not change the constitutional discipline that only goods can be taxed under a goods-tax entry.

Second, it establishes the value-at-incorporation principle as the constitutional measure for works-contract VAT. This principle has two consequences. It rules out the contract-price-as-measure approach that some States had attempted. It also rules out the fixed-percentage-residue approach that Rajasthan and others had used as a default. The principle requires States to provide either contract-by-contract verification or a rebuttable presumption mechanism that tracks actual value at incorporation — not an irrebuttable percentage rule.

Third, it crystallises the eight-deduction template. Each of the eight deductions identifies a category of value that is not goods. The template is not exhaustive of every possible labour or service element, but it gives State legislatures and revenue authorities a workable architecture: anything that falls within one of the eight categories must come out of the taxable base. The template carried forward into Rule 2A of the Service Tax (Determination of Value) Rules 2006 on the Union side and into State VAT Composition Schemes on the State side.

Fourth, it carries the Article 286 and CST Act inter-State discipline into the deeming fiction. A deemed sale that is in substance an inter-State sale, an outside-State sale, or a sale in the course of import or export cannot be taxed by a State under Article 366(29A)(b). The deeming fiction operates within the constitutional architecture, not outside it.

What the judgment did not decide

The Constitution Bench did not decide several questions that travelled into later litigation.

It did not decide whether composite contracts that combine works-contract elements with other supplies — for example, a turnkey IT-infrastructure contract embedding both works and software-licence components — could be split under a Gannon Dunkerley template. That question went to BSNL v. Union of India (2006) 3 SCC 1 and to L&T v. State of Karnataka (2014) 1 SCC 708.

It did not decide whether the value-at-incorporation measure could be administered by a rebuttable presumption mechanism rather than contract-by-contract verification. That question was left for future State legislation and litigation.

It did not address the treatment of builders and developers selling pre-completion apartments. That question was resolved in K. Raheja Development Corporation v. State of Karnataka (2005) 5 SCC 162 and affirmed by L&T v. State of Karnataka (2014) 1 SCC 708.

It did not address the Union service-tax counterpart — whether the Union could levy service tax on the labour-and-service component of a works contract. That question was answered in CCE Kerala v. Larsen & Toubro Ltd (2016) 1 SCC 170, which held that no such levy was sustainable pre-1 June 2007 for want of charge and machinery provisions.

It did not address the GST-era treatment of works contracts, which the CGST Act 2017 Schedule II paragraph 6(a) classifies as a deemed supply of services — a parliamentary reversal of the VAT-era goods-classification, achieved by legislative choice under Article 246A rather than by constitutional amendment.

After the judgment

The eight-deduction template governed twenty-five years of State VAT on civil construction. Every State works-contract VAT scheme had to satisfy the Gannon Dunkerley II template; failures triggered constitutional challenge. The value-at-incorporation principle resurfaces in the CGST architecture as section 13 (time of supply) read with section 15 (value of supply).

L&T v. State of Karnataka (2014) 1 SCC 708 extended the works-contract framework to builders and developers selling pre-completion apartments, applying Article 366(29A)(b)'s "in some other form" language to materials that, by incorporation, become part of immovable property.

CCE Kerala v. Larsen & Toubro Ltd (2016) 1 SCC 170 addressed the Union service-tax counterpart and held that no service tax could be levied on indivisible works contracts pre-1 June 2007 for want of charge and machinery provisions. The 2007 amendment introducing section 65(105)(zzzza) of the Finance Act 1994 — the "Works Contract Service" head — together with the Works Contract (Composition Scheme) Rules 2007 supplied the missing charge and machinery.

The GST regime under the CGST Act 2017 carries the doctrinal architecture into a new statutory setting. Schedule II paragraph 6(a) classifies works contracts as a deemed supply of services. The value-at-incorporation principle of Gannon Dunkerley II operates through CGST section 15 as the measure of taxable value. The eight-deduction template is partly absorbed into the GST input-tax-credit mechanism, which allows credit for goods and services used in the supply.

In Munjaal Manishbhai Bhatt v. Union of India (Gujarat High Court 2022), the 1/3rd land-value deemed deduction for under-construction flat sales under GST was struck down — the Court invoking the Gannon Dunkerley II value-of-incorporation discipline to hold that an irrebuttable percentage deduction cannot stand where actual land value can be proved. The 1992 holding remains a live constitutional reference in GST-era construction-services jurisprudence.

Three Supreme Court 2023-26 GST disputes on construction services have cited Gannon Dunkerley II for the upstream legislative architecture even though the immediate statutory text is now CGST/SGST. The doctrinal grammar of the eight-deduction template survives the constitutional simplification effected by Article 246A.