Revenue Cannot Artificially Split Indivisible Turnkey Contracts Governed By Finance Act 1994 To Levy Service Tax: Supreme Court

The Court was hearing appeals filed by the Commissioner of Service Tax, Chennai, challenging the order of the Customs, Excise and Service Tax Appellate Tribunal, South Zonal Bench, Chennai, which had set aside service tax demands raised against M/s Diebold Systems (P) Ltd. on 33% of the gross consideration received from banks under turnkey ATM contracts.

A Bench of Justice Prashant Kumar Mishra and Justice Shree Chandrashekhar, while affirming the CESTAT’s view, observed:

“A contract whose dominant object is the provision of a taxable service may undoubtedly attract service tax even though certain goods or materials are consumed or incidentally supplied in the course of its performance. Equally, where the statute specifically provides for the taxation of composite contracts and prescribes an appropriate machinery for determining the service component, the levy may validly operate upon such transactions. However, where the contract is one entire and indivisible, embodying obligations relating to the transfer of property in goods together with labour and services for a single consolidated consideration, the Revenue cannot, in the absence of statutory authority, artificially split the transaction into separate taxable components merely because one part of the contractual obligations answers the description of an existing taxable service”.

The Bench, accordingly, held:

“…neither the charging provisions contained in Sections 65 and 66 nor the valuation provisions contained in Section 67 of the Finance Act, 1994 conferred any such authority during the relevant period. The assumption that an indivisible contract could first be vivisected and only thereafter subjected to service tax begs the very question which the statute required to be answered. In the absence of an express legislative mandate permitting such segregation under the Finance Act, 1994, the Revenue could not, by a process of administrative attribution or notional apportionment, create a taxable event where none existed under the charging provisions of the Act during the relevant period”.

Gurmeet Singh Makker, AOR, appeared for the appellant, while Advocate Charanya Lakshmikumaran appeared for the respondent.

Background

The respondent-assessee was engaged in supplying Automated Teller Machines to various banks. Under contracts awarded by different banks, it undertook the supply, installation and commissioning of ATMs at sites identified by the banks. The contracts were executed on a turnkey basis, under which the assessee was responsible not only for supplying ATMs but also for their installation and commissioning.

The Revenue sought to levy service tax on 33% of the gross consideration received by the assessee from banks for the period from July 2003 to April 2006, treating that portion as attributable to installation and commissioning under the taxable category of “commissioning or installation” under the Finance Act, 1994. Show cause notices were issued, and demands were confirmed by the Commissioner of Service Tax, Chennai.

The assessee argued that the contracts were indivisible turnkey contracts involving the supply of goods with incidental installation and commissioning, and that no part of the consideration could be segregated and taxed as a separate service. It also contended that it had discharged sales tax or VAT on the entire value of the contracts and that no separate consideration was stipulated or received towards installation and commissioning.

The CESTAT examined the contractual terms and held that the contracts were indivisible turnkey contracts in which the dominant object was the supply of ATMs, while installation and commissioning were incidental obligations. It held that, in the absence of an express charging mechanism permitting vivisection of such contracts, no part of the composite consideration could be artificially segregated and taxed under “commissioning or installation”.

Court’s Observations

The Court first noted that service tax, during the relevant period, was levied under Section 66 of the Finance Act, 1994, on taxable services enumerated in Section 65(105), while Section 67 prescribed valuation. It held that Section 67 could operate only after the taxable service was first brought within the charging provision.

The Court observed: “A plain reading of the statutory scheme thus discloses that the levy under Section 66 was attracted only where the activity in question answered the description of a taxable service under Section 65(105), whereafter Section 67 operated only to determine the measure of tax.”

Relying on Shiv Steels v. State of Assam and Others (2025), the Bench reiterated that machinery or valuation provisions cannot create or enlarge the charging provision. It held that the Finance Act, 1994, during the relevant period, did not contain any express provision authorising the dissection or vivisection of an indivisible composite turnkey contract to extract and tax one component in isolation.

The Court then examined the character of the contracts entered into by the assessee with banks. It held that the contractual objective was delivery of fully functional ATMs at designated sites, and that procurement, supply, transportation, installation, testing and commissioning were integral parts of a single contractual obligation.

The Bench noted: “The contracts envisaged a single commercial objective, namely, the delivery of fully functional ATMs at the designated sites of the banks. The obligations undertaken by the respondent-assessee, including procurement, supply, transportation, installation, testing and commissioning, were all integral components of the execution of that singular contractual obligation.”

It further observed that the consideration was composite and payable for the turnkey project as a whole. There was no separate bargain for installation or commissioning independent of the supply of ATMs, nor any distinct consideration earmarked for those activities.

The Court traced the law on composite contracts from State of Madras v. Gannon Dunkerley & Co. (Madras) Ltd. (1958), and noted that Article 366(29A), introduced by the Constitution (Forty-sixth Amendment) Act, 1982, permitted segregation of the goods component for the limited purpose of imposing sales tax or VAT. However, it clarified that the Finance Act, 1994, during the relevant period, had no corresponding provision authorising service tax on the service element of indivisible composite contracts.

The Court relied on Commissioner, Central Excise and Customs, Kerala v. Larsen and Toubro Limited (2016), where it was held that the taxable entries existing before the introduction of “works contract service” from June 1, 2007, contemplated only service contracts simpliciter and not indivisible composite works contracts.

The Bench stated: “Unlike the constitutional amendment empowering the States to tax the deemed sale element in a composite works contract, the Finance Act, 1994, during the period relevant to the present appeal, contained no corresponding provision authorising the Revenue to segregate and tax the service element of an indivisible composite contract under the existing taxable entries.”

The Court held that the subsequent introduction of Section 65(105)(zzzza) for “works contract service”, along with valuation machinery, showed legislative recognition that earlier taxable entries were insufficient to cover indivisible composite works contracts.

The Court rejected the Revenue’s argument that 33% of the gross contractual consideration could be treated as the value of the installation and commissioning service. It held that the percentage did not emerge from the charging provisions and that no statutory machinery existed at the relevant time for isolating the service element of an indivisible turnkey contract by allocating a fixed percentage.

The Court observed: “The absence of a legislatively sanctioned mechanism for such segregation assumes particular significance in the field of taxation, where both the charge and the measure of tax must have clear statutory authority. A fiscal liability as held in Shiv Steels (supra) cannot rest upon a notional or assumed apportionment unsupported by the charging enactment.”

It further held that the mere fact that the assessee undertook installation and commissioning activities did not bring the contracts within the taxable category of “commissioning or installation”. The determinative question was whether those activities were rendered as an independent taxable service or were integral and inseparable obligations under an indivisible turnkey contract.

The Court emphasised: “Once it is found, as we have held, that the respondent's contracts were indivisible composite contracts executed for a single consolidated consideration, the Revenue cannot isolate one constituent obligation thereof and subject it to service tax in the absence of a charging provision authorising such vivisection.”

Conclusion

The Supreme Court held that the CESTAT committed no error in setting aside the demands confirmed by the Commissioner of Service Tax, Chennai. It found that the assessee had executed indivisible turnkey contracts involving supply, installation and commissioning of ATMs for composite consideration, and that the Finance Act, 1994 did not authorise vivisection of such contracts during the relevant period.

The Court affirmed the CESTAT order and dismissed the Revenue’s appeals. All pending interlocutory applications were closed.

Cause Title: Commissioner Of Service Tax, Chennai v. M/s Diebold Systems (P) Ltd. (Neutral Citation: 2026 INSC 808)

Appearances

Appellant: Gurmeet Singh Makker, AOR

Respondent: Advocates Charanya Lakshmikumaran, Nitum Jain, Neha Choudhary, Medha Sinha, Swastik Mishra, Yashovardhan Singh, Adithya Nair, L. Badri Narayanan, M.P. Devanath, AOR, and Ananya Gupta

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