Interplay of GST and Indian Contract Act

Table of Contents

1. Relevance to GST
2. Capacity to Contract
3. Formation of Contract

Check out Taxmann's GST & Allied Laws which provides a comprehensive commentary into the realm of GST and its correlation with the foundational laws in India, such as the Indian Contract Act 1872, the Transfer of Property Act 1882, and the Limitation Act 1963, among others. It emphasizes the importance of consistency in assertions made by taxpayers across all regulations, highlighting the need for harmonious treatment of laws.

1. Relevance to GST

Every ‘form’ of supply addressed in GST is one or other kind of contract that is entered into. And for this reason, a transaction that fails to satisfy the ingredients of a valid contract can never come within the treatment applicable in GST.

Indian Contract Act was promulgated 145 years before GST and to ignore the wealth of authorities available in respect of Contract law would only leave this deliberation poorer that anything else. Vinculum juris refers to the bond of legal obligations that contracting Parties willingly enter into and it is not for anyone, not even a Court, to deny Parties their bargain and its assistance in default. And transactions involving supply flow out of commercial arrangements that are contractual all the way with some exceptions created by law. No student of GST law can graduate in their study of this law without a deep understanding of Contract law.

Including works of at least five different authors on Indian Contract Act would provide the understanding necessary to open up topics that pervade entire scope of supply in GST law. Publications based on English Contract law may also be included, especially, Anson’s and Chitty’s works on this subject.

2. Capacity to Contract

2.1 Validity of Contract

Precious little will have been achieved if Parties come together to engage in trade relations with each other are defeated when their contract is held to invalid in bringing binding relations inter se. Various elements affect validity of these relations and Parties take great pains and tread cautiously so as not to allow their efforts go in vain. The law is clear as to what impairs validity of a contract.

To test the validity of a contract requires deep insight into each validating ingredient listed in this Act. And as a corollary, where contract is purported to be enforceable, presumption runs in favour of its validity unless some incurable or inseverable invalidity is discovered in the contract, such as, minority or mistake or something else. Parties’ intended to bring about binding legal obligations cannot be seen denying their contract. And flow of consideration implies validity of the contract or the terms that constitute a binding contract.

Contact must not be understood as the ‘form’ of the document but the ‘consensus’ about the object and expectation as to its enforceability in the event of breach or threatened breach.

2.2 Ostensible competence

Very seldom is this question considered relevant in GST because without having crossed this hurdle, one would not have reached the place where a ‘tax treatment’ is up for discussion. But the concept of ‘distinct person’ demands some attention be paid to this cardinal rule of ‘capacity to contract’ before venturing any further into this deliberation on Contract law.

Minors must be protected against themselves. Courts cannot allow relief to minors, because for a Court to put its might behind the terms agreed with minors would impute capacity (to contract) to such minors. This cannot be, not even in the guise of preventing injustice in matters of Contract law which is a private matters’ legislation, such purposive construction is barred. However, while denying enforceability (to contracts with minors), Courts mould tortious relief outside the law of Contract basing the relief on equitable principles but this relief will be as the Court sees fit and not as the terms of that arrangement which are void ab initio due to incapacity of the minor.

Reference to instances of transactions with minors is to illustrate and bring to attention the need for sound understanding about ‘capacity to contract’. This is because, ‘distinct persons’ are imputed with capacity to contract in GST law and ‘contractual relations’ are imposed in certain instances like (i) section 9(5) or (ii) paragraph 3 to Schedule I, by overriding the express terms of contract between these Parties.

2.3 Lawful Authority

Capacity to contract takes within itself the aspect of lawful authority to contract. Unless legitimate authority exists, no person can assert to be contracting for that object. Authority is not limited to that of the Contractor but also that of the Contractee. With the precision and deliberate definition of ‘Recipient’ in section 2(93) of Central GST Act, Beneficiary of a contract is often used interchangeably with Recipient-Contractee.

Asserting any claim to a certain factual position demands that person hold the necessary legal authority to support that assertion. Whether as a clinical establishment or a charitable trust or an educational institution or any other fact which is a fact-in-issue for purposes of the extending the treatment demanded, without lawful authority nothing further remains to be examined as to the outcome of exact nature of those activities performed. Person with lawful authority providing poor quality care would be admitted in the definition but one who may provide high quality care but lacks lawful authority. To be admitted into doing something presupposes the existence of lawful authority so to do.

2.4 Economic Substance

Legislative fiction is not the treatment of law to be applied, but the alteration of facts by such fiction, so that the treatment otherwise applicable in this law can follow based on those altered facts. And where there is an express legislative override, not even the absence of capacity to contract or existent of express terms of contract, can come in the way of demanding compliance with the tax treatment to ensue. No questions can be raised as to the lack of capacity to contract when legislative fiction operates, but not beyond.

There is a concept in direct taxation of ‘attribution of income’ to a permanent establishment located outside India. Assertion made to tax regulator in an overseas jurisdiction implies that to the extent of income so attributed cannot also be asserted as export of services by the distinct person in India.

Capacity to contract for purposes of entering into a contract is not the same as the imputation made by assertions of this capacity to regulators of overseas jurisdictions by admitting liability to local tax incidence in addition to and independent of incidence, if any, in India. And having asserted to the existence of an ‘establishment’ outside India, implications to ensue in GST cannot be denied on the basis that all contracts are with the Legal Entity and belong to the distinct person in India and not that of the establishment (asserted and) admitted to exist outside India.

Partnership firm is not a person but a collective noun for all Partners. Entering into a contract in the name of the firm, is in fact, formation of a contract between the Contractee and each Partner acting through the instrumentality of any one of them acting for all.

2.5 Legal fiction of distinct person

GST law introduces a sub-category of a Legal Entity and elevates it to the status of an independent Entity and refers to it as ‘distinct person’. Legal fiction is not a fictional treatment of law but (i) alteration of facts and (ii) subjecting altered facts to treatment otherwise applicable. As such, when there are multiple distinct persons (sharing a common PAN) transactions inter se are liable to tax treatment ‘as if’ the transacting ‘distinct persons’ were, in fact, two distinct Legal Entities.

Having admitted that each registered location is a Legal Entity on its own, it follows that all transactions inter se must be explained based on

(i) nature of transaction

(ii) object of supply implicit in this legal fiction and

(iii) imputed valuation of such transaction, by applying the same principles as would apply had independent Legal Entities engaged with each other and derived benefit or extended benefits from their respective capabilities and resources.

3. Formation of Contract

3.1 Existence by formation

Contracts are ‘formed’ when offer is accepted. To locate the ‘taxable supply’, it is important to locate the ‘offer’. Acceptance is merely of these terms. Acceptance cannot alter the terms offered. Non-payment of GST is very often attributed to non-existence of a contract on account of non-formation of any such contract. But formation of contract is not limited by conventional modes of acceptance of an express offer. Contract formation is more complex or less subtle than convention would indicate.

Formation of contract can be complex. Admitting that a contract is formed is where complexity lies. Acceptance of offer forms a contract, with all other essentials in section 10 for a valid contract being present. There is nothing in law to compel offer to comprise of the performance of a positive act. Performance of a negative act also bears all the indicia of a valid offer. This is referred to as ‘abstinence’ in section 2(d) while defining ‘consideration’.

A valid contract can be formed for ‘not doing’ the thing, as much as it can be validity formed for ‘doing’ that thing. So long as the ‘offer’ is for ‘not doing’ or ‘doing’ that thing, its acceptance will bring about a contract valid in every respect. After all, Parties are free to contract for a valid object. And if there is no ambiguity as to the ‘object’, there is nothing in law to come in the way, howsoever unusual it may seem to someone that the contract is for ‘not doing’ rather than ‘doing’ that thing. And when contracts can be implied, an implied contract for not doing something is no less, a valid contract as any other contract, for doing something else. Alarm, if any, is in the mind and not in law.

Every society has its own customs for formation of contracts of everyday activities. Unwritten contracts are no less enforceable than written contracts. Care must be taken not to imagine contracts contrary to societal customs or customs of trade. It is essential to examine tax treatment based on a careful study of the manner in which the contract giving rise to a tax consequence was formed. It is common to allow common-sense to guide this study and abandon some factors that indicate otherwise that may be evident in the facts apparent.

3.2 Counter-offer

Role of Offeree is to ‘accept’ the offer. Acceptance brings a contract into existence. Altering the offer is not acceptance but a counter-offer. When a counter-offer is made, the original Offeree becomes the Offeror and the original Offeror becomes the Offeree. Acceptance of counter-offer by original Offeror brings the new contract into existence.

Making of a counter-offer destroys the original offer. Consequently, there is no contract that is created whose object is the original offer when it already stands destroyed due to the counter. Offeree must do nothing more than accept. To do anything more or anything else, voids the offer.

Locating the contract demands locating the offer and acceptance. Offer can be made subject to conditions and timelines for its expiration. Acceptance can be express or implied. Acceptance cannot be assumed. Acceptance can be with or without knowledge of Offeror, if offer does not require communication of acceptance before entering into its performance. Acting upon an advertisement containing the offer is acceptance and when acceptance by one person does not exhaust the offer and available for others to also accept and act upon it, separate contracts are brought about between the Offeror and each Acceptor. In the celebrated decision of Carlill v. Carbolic Smoke Ball Co. (1893) 1 QB 256, general offer or advertisement was not a mere puff but the sincerity of Offer was established when prize-money was published to be placed with a bank which persons acting upon the general offer would find acceptable.

3.3 Manner of formation

Traditional or modern, may be the manner in which contracts are formed but their existence cannot be nebulous. Express contracts may be examined from the words used by the Parties to express their bargain and tested on the anvil of their conduct whether it is congruous with the words expressed. And since actions speak louder than words, express contract will have to be discarded as being a poor record of the conduct pursuant to that contract which must prevail over any incongruous words used to express their bargain. CIT v. Motor and General Stores AIR 1968 SC 200 bars any authority, even a Court, from substituting what it believes ought to have been the terms of the contract unless the express contract is shown to be fictitious or a sham, and then proceed to ascribe meaning to their conduct with the terms of the arrangement based on the nature and object of such a contract.

3.4 Implied contract

One of the most illuminating instances of contract formation is when a contract is implied to have come into existence. Authority for ‘implied contracts’ is traceable to Upton-on-Severn Rural District Council v. Powell (1942) 1 All. ER 220 but it simply conveys that when something is put up for sale and a price attached to it, and someone appropriates (and consumes) that thing, then it is implicit by so appropriating that a contract for sale was intended. To say otherwise, would excuse everyone who appropriates and denies existence of contract when payment is demanded. It is customary not to have express contracts when valuable articles are put up for sale and in those circumstances no one who is not intending to make a purchase must enter and not only that but also collect and appropriate the same, only to deny existence of contract. It was held back in 1610 in Lampleigh v. Braithwait (1842) 3 QB 234, that past consideration which will normally not form consideration in a present contract will still be admitted to be consideration if it was

(i) provided at the request of Promisor and

(ii) with the understanding that it will be reciprocated or and made good under legal relations in due course.

Law in India is well established that enforceability once admitted trumps any uncertainty of consideration.

For this reason, deep understanding of the relevant trade and its customs regarding formation of contracts is essential before admitting or denying existence of a binding contract. Bond of legal obligations is exactly this, that Parties enter into the obligation and be answerable to make good what they bargained for, expressly or impliedly.

‘Assumpsit’ is a term when action can be brought on an express or implied promise or a contract not executed as prescribed, when acted upon in a manner that satisfied the Parties that binding obligations prevailed. In the publication ‘Humber Ferryman’s case’ of 1348, a ferry-man was sued for death (by drowning) of horse accepted for transportation without a sealed document containing terms of covenant (or binding contract). Action was validity brought under tort for killing the horse and not under contract for deficiency of service (of transportation). If the remedy sought is sans contract, terms of contract cannot be pressed. And if remedy is sought as per terms of contract, payment made must either be consideration or liquidated damages. Assumpsit assures remedy even without a sealed document (of contract) since the Parties’ conduct indicates consent to be bound by verifiable obligations else plaintiff would be left without remedy after having performed in good faith. Defence of absence of contract has not succeeded for more than 650 years and cannot certainly be assumed to readily succeed now when contract writing has made much progress when conduct of Parties unmistakably exposes their consent and binding obligations.

3.5 Test of Enforceability

Enforceability is the heart of existence of any contract [see section 2(h)] and anything that affects its enforceability renders the contract non est. To test the existence and validity of a contract, a more efficient question would be “is the payment obligation enforceable?”.

It is well known that acceptance is not necessary to be communicated to Offeror, especially, when the offer is by way of advertisement or policy declaration. When the Payer (or Obligor) announces the Offer with full understanding and full expectation to be under an obligation to come good on the Offer, terms announced when acted upon bring a contract into existence and enforceable in every sense.

If payment is enforceable, performance of obligation contained in the Offer is a pre-requisite. Without enforceability, existence of contract is unimaginable. Search for enforceability is the surest test for the existence of a valid contract. Parties admitting enforceability of published terms cannot deny existence of contract and therefore the tax treatment applicable.

A reliable test for enforceability will be the consequence of non-fulfilment of promise informed in policy declaration or advertisement published. And if the Promisor obliged to perform obligations under existing terms of arrangement, then this policy declaration or advertisement published is not merely for publicity but a binding contract. When questioned whether the publication is for publicity, the position taken will reveal the existence of a valid and enforceable contract.

Publicity may be an explanation that could be offered privately but not one that will be admitted in public or amidst stakeholders or least of all in an Affidavit to be filed in Court, when the defence of publicity is challenged. If there ever were some terms published that were not intendent to be acted upon but bears all the indicia of a valid offer, notwithstanding this private intention (that it was not to be acted upon), it will nevertheless be a valid contract when acted upon (by those to whom it is addressed) as per terms published. Defence of publicity hangs on a thread due to incidents of misrepresentation. Rule of contra proferentem demands that ambiguous terms in a contract be interpreted against its author.

3.6 Form of its formation

Contracts may take the form on a Purchase Order, Work Order, Sub-contract, Letter of Award, Labour Contract and umpteen other names given to them. Form of the contract does not dictate the nature of the contract. Terms governing their relations are more important. Existence of Purchase Order does not mean it is supply of goods and existence of Sub-contract does not mean it is works contract.