L&T v. State of Karnataka: pre-completion apartment sales as works contracts

The facts in brief

The 26 appeals before the three-judge bench consolidated 14 Karnataka disputes and 12 Maharashtra disputes raising the same structural question — whether the supply of materials by a builder-developer in the construction of an apartment for a flat-purchaser falls within Article 366(29A)(b) as a works contract, and so can be taxed by the State on the goods-element under State VAT.

The lead appellant, Larsen & Toubro Ltd, had entered into a development agreement on 19 October 1995 with Dinesh Ranka, the owner of land in Bangalore. The architecture was a familiar joint-development structure: the landowner contributed the land; L&T constructed an apartment complex at its cost; post-construction, 25% of the constructed space (plus a corresponding undivided land share) reverted to the landowner and 75% (with corresponding land share) was retained by L&T for sale to flat-purchasers. L&T entered into agreements of sale with flat-purchasers — typically during construction — stipulating that on completion the apartment would be conveyed along with an undivided share in the land.

The Karnataka VAT authorities sought to tax L&T under section 4(1)(c) of the Karnataka VAT Act 2003 on the value of goods — cement, steel, fixtures, plumbing, electricals — incorporated into the apartments post-agreement with each flat-purchaser, treating each agreement as a works contract for that flat-purchaser. The Maharashtra appeals raised the parallel question under the Maharashtra Value Added Tax Act 2002 in respect of Mumbai and Pune joint-development projects.

L&T's principal argument was that the substance of the transaction with the flat-purchaser was a sale of immovable property — the completed apartment — and not a works contract; and that K. Raheja Development Corporation v. State of Karnataka (2005) 5 SCC 162 — a 2-judge bench that had ruled otherwise — had been wrongly decided. The matter had been referred to the three-judge bench by a 2-judge bench of the Supreme Court that doubted K. Raheja's correctness. Several real-estate industry interveners argued that imposing VAT on apartment construction would distort the residential housing market and lead to double taxation in the form of VAT alongside stamp duty on the eventual conveyance.

The constitutional question

The central question was whether the agreement between a builder-developer and a flat-purchaser, where the apartment is under construction at the time of the agreement, constitutes a works contract within Article 366(29A)(b) such that the State can tax the goods-element. The subordinate questions were: whether K. Raheja Development Corporation (2005) was correctly decided; whether the "dominant intention" test of Rainbow Colour Lab v. State of M.P. (2000) 2 SCC 385 survived for Article 366(29A) deemed-sales; and how to identify the slice of materials that fell within the works-contract net.

L&T argued that the substance of the transaction was a sale of immovable property — the completed apartment plus an undivided land share — that fell outside Entry 54 of List II altogether; that K. Raheja was wrongly decided; and that Rainbow Colour Lab's dominant-intention test required the dominant intention of the contract to be transfer of goods for a works-contract characterisation, which was not satisfied where the dominant intention was acquisition of an apartment.

The State argued that Article 366(29A)(b)'s deeming fiction operated wherever there was a transfer of property in goods involved in the execution of a works contract — and that a builder constructing an apartment for a flat-purchaser under an agreement of sale was, functionally, executing a works contract for that flat-purchaser, with the goods passing by accretion to the rising building.

What the Court held

The three-judge bench, in a unanimous judgment authored by R.M. Lodha J., affirmed K. Raheja Development Corporation (2005) and held that pre-completion apartment sales by builders and developers are works contracts within Article 366(29A)(b). The reasoning proceeded in five steps.

Once the characteristics of works contract are met with in a contract entered into between the builder/developer and the flat-purchaser, any activity of construction has all the trappings of works contract.

First, "in some other form" is constitutionally significant. The constitutional text of Article 366(29A)(b) is wide: a tax on the transfer of property in goods (whether as goods or in some other form) involved in the execution of a works contract. The phrase "in some other form" captures goods that, by incorporation, lose their character as movable goods and become part of immovable property. The drafters of the 46th Amendment knew that bricks, cement, and steel would not remain "goods" in the building once the building was up — the deeming fiction was crafted to bridge that change of form. The accretion logic of Gannon Dunkerley I is constitutionally accommodated within Article 366(29A)(b) by the "in some other form" language.

Second, the builder-flat-purchaser relationship is functionally a works-contract relationship from the date of the agreement. The moment the agreement-of-sale is signed, the flat-purchaser acquires a contractual interest in the under-construction apartment. The relationship between builder and flat-purchaser is functionally that of person-doing-the-work-for and person-on-whose-behalf-the-work-is-done. The fact that the immovable property is conveyed only on completion does not negate the works-contract character of the construction activity from the date of the agreement.

The view taken by a two-Judge Bench of this Court in Rainbow Colour Lab that the division of the contract after Forty-sixth Amendment can be made only if the works contract involved a dominant intention to transfer the property in goods and not in contracts where the transfer of property takes place as an incident of contract of service is no longer good law.

Third, Rainbow Colour Lab's dominant-intention test is partially overruled. For Article 366(29A) deemed-sales, no dominant-intention enquiry is needed. The constitutional fiction directly authorises the goods-element to be taxed irrespective of whether the contract is dominantly for services. Rainbow Colour Lab had imported a dominant-intention requirement that the constitutional text did not impose; that addition is no longer good law for Article 366(29A)(b) cases.

Fourth, the stage-of-completion bifurcation applies. Only goods supplied before the agreement-of-sale escape the works-contract net — those goods were not incorporated for that flat-purchaser, and the works-contract nexus to the flat-purchaser had not yet arisen. Goods supplied after the agreement are within the deeming fiction. The State must trace each batch of materials to the moment of incorporation to determine the relevant flat-purchaser and the relevant taxable supply.

Fifth, double taxation concerns are constitutionally legitimate. VAT on construction alongside stamp duty on the eventual conveyance taxes different objects — the goods-incorporation on one side and the immovable-property transfer on the other. The State is not constitutionally precluded from levying both, because each levy operates on a distinct constitutional base.

K. Raheja Development Corporation's holding was reaffirmed and elaborated. L&T's appeals were dismissed.

The doctrinal architecture

L&T v. Karnataka simultaneously accomplishes three doctrinal moves.

First, it brings the builder-developer apartment-sale transaction within Article 366(29A)(b)'s deeming fiction. The architecture is functional: the builder is constructing the apartment for, and on behalf of, the future flat-purchaser; the flat-purchaser obtains a contractual interest in the under-construction unit; goods pass to the flat-purchaser by accretion as the building rises. The accretion-logic line of Gannon Dunkerley I is preserved and constitutionally accommodated through the "in some other form" language.

Second, it partially overrules the dominant-intention test of Rainbow Colour Lab. For Article 366(29A) deemed-sales — works contracts, leases, restaurant supply, and the other sub-clauses — no dominant-intention enquiry is needed. The constitutional fiction directly authorises the deemed-split irrespective of the dominant character of the contract. The dominant-intention test continues to apply outside Article 366(29A), as restated in BSNL v. Union of India (2006) 3 SCC 1, but it cannot be imported into the closed list of deemed-sales as an additional gating requirement.

Third, it establishes the stage-of-completion bifurcation as the rule for identifying the slice of materials within the works-contract net. The agreement-of-sale fixes the moment from which the builder's construction activity attaches to the flat-purchaser. Materials supplied before that moment are outside the works-contract; materials supplied after are inside. The bifurcation is administratively workable — builders and developers maintain stage-of-construction records — and it gives State assessing authorities a principled basis for apportionment.

The adjacent precedents the judgment had to navigate included Gannon Dunkerley v. State of Rajasthan (1993) 1 SCC 364 on the post-46th-Amendment works-contract framework; K. Raheja Development Corporation v. State of Karnataka (2005) 5 SCC 162, which the bench affirmed; and Kone Elevator India Pvt Ltd v. State of Tamil Nadu (2014) 7 SCC 1, a contemporaneous five-judge Constitution Bench decision on the works-contract distinction for elevator supply-and-installation contracts.

What the judgment did not decide

The Court did not address the service-tax counterpart for the Union — whether the Union could levy service tax on the labour-and-service component of builder-developer construction. That question was touched in CCE Kerala v. Larsen & Toubro Ltd (2016) 1 SCC 170 and finally resolved into GST architecture for construction services.

It did not address the mathematics of valuation at the flat-purchaser level — what proportion of total construction materials was incorporated post-agreement for each flat-purchaser. The bifurcation principle was laid down; the apportionment exercise was left to assessing authorities.

It did not address the treatment of completed-flat sales post-occupancy-certificate. Such sales are clearly outside the works-contract net — there is no construction activity attaching to the flat-purchaser after the occupancy certificate — but the bench did not formally address the boundary.

It did not address the treatment of redevelopment and society-collaboration contracts in Mumbai and Pune, where the consideration runs to the existing society members rather than to fresh flat-purchasers. That structural variation raised separate constitutional questions that did not feature in the appeals.

It did not address the GST-era treatment of construction services. Schedule II paragraph 5(b) of the CGST Act 2017 now classifies pre-completion-certificate apartment sales as supply of services — definitively closing the goods-versus-services classification debate at the legislative level, by parliamentary choice under Article 246A rather than by constitutional amendment.

After the judgment

L&T v. Karnataka is the doctrinal bridge from the VAT-era works-contract treatment of construction to the GST-era classification of construction services. Schedule II paragraph 5(b) of the CGST Act 2017 expressly classifies "construction of a complex, building, civil structure or a part thereof, including a complex or building intended for sale to a buyer, wholly or partly" as a supply of services — subject to the pre-occupancy-certificate caveat. Parliament's decision to classify this as a service rather than goods is a deliberate response to the L&T v. Karnataka and K. Raheja line — converting the deemed-sale fiction into a positive service classification, which is administratively cleaner.

The 1/3rd land-value deemed deduction for under-construction flat sales under GST was struck down in Munjaal Manishbhai Bhatt v. Union of India (Gujarat HC, 2022), invoking Gannon Dunkerley II's value-of-incorporation discipline. The Supreme Court's Safari Retreats v. Union of India (2024) decision on input-tax credit for construction of immovable property cited L&T v. Karnataka for the architecture of the goods-versus-immovable-property distinction.

For the VAT-era refund window between 1 April 2006 (Karnataka VAT introduction) and 30 June 2017 (GST commencement), this judgment generated extensive assessment proceedings against builders and developers across Karnataka, Maharashtra, and other VAT-implementing States. The stage-of-completion bifurcation was the operative rule for those assessments.

The judgment continues to be cited in GST-era jurisprudence on construction services for the underlying constitutional architecture — even though the immediate statutory text is now CGST Schedule II — and for the discipline that materials lose their movable character on accretion to immovable property.

In Total Environment Building Systems Pvt Ltd v. Deputy Commissioner of Commercial Taxes (2023) — a Supreme Court reaffirmation of CCE Kerala v. L&T (2016) on the Union side — the Court reiterated the constitutional split that L&T v. Karnataka had carried forward: the State taxes the goods-element of construction under Article 366(29A)(b); the Union taxes the service-element with charge-plus-machinery from 1 June 2007.

The judgment remains a foundational reference for the application of Article 366(29A)(b) to any construction-with-materials contract, and the stage-of-completion bifurcation remains the operative principle for VAT-era assessments still working through the appellate system.

Related on Valkya

• Gannon Dunkerley I: the works-contract sales-tax wall
• Gannon Dunkerley II: valuing the works contract after the 46th Amendment
• BSNL v. Union of India: aspect doctrine and the composite-transaction problem
• Mohit Minerals v. Union of India: GST on ocean freight

Sources

1. LiveLaw — works-contract jurisprudence trajectory: https://www.livelaw.in/top-stories/supreme-court-service-tax-not-leviable-composite-work-contracts-finance-act-2007-205536
2. Bar and Bench — Arvind Datar column on the Gannon Dunkerley test: https://www.barandbench.com/columns/legal-notes-by-arvind-datar-the-gannon-dunkerley-test-incorrect-and-unnecessary-dilution
3. SCC OnLine Blog — works-contract trajectory: https://www.scconline.com/blog/post/2023/06/22/assessee-not-entitled-total-contract-value-remit-service-tax-as-works-contract-service-supreme-court/
4. SCC OnLine Blog — pre-2007 works-contract service tax: https://www.scconline.com/blog/post/2023/08/24/works-contracts-leviable-to-service-tax-legal-update/
5. Taxsutra — L&T v. Karnataka and the GST construction-services framework: https://www.taxsutra.com/