Holding

The supply of spare parts, toners and developers under both FSMA and SSMA is a sale of goods and is liable to sales tax.

Summary

Xerox Modicorp Ltd entered into Full Service Maintenance Agreements (FSMA) and Spares and Service Maintenance Agreements (SSMA) with customers after selling Xerox machines. The dispute concerned whether the supply of spare parts, toners and developers under these agreements amounted to a sale liable to Karnataka sales tax. The Supreme Court held that the agreements contain a supply of goods for a price, with transfer of title in tangible movable goods occurring when the parts are provided or when consumables are placed in the machine, satisfying all elements of a sale. The term “consumables” in Explanation I to Rule 6(4) of the Karnataka Sales Tax Rules was interpreted to refer only to items consumed before any transfer of property, which was not the case here. Consequently, the supply of parts and consumables attracted sales tax. The appeal was dismissed, upholding the lower court’s decision.

Issues considered

Whether the supply of spare parts, toners and developers under FSMA and SSMA constitutes a sale under the Karnataka Sales Tax Act, 1957.
Whether such supplies fall within the definition of “consumables” under Explanation I to Rule 6(4) of the Karnataka Sales Tax Rules and are therefore exempt from tax.

Legislation cited

Karnataka Sales Tax Act, 1957s. 2(1), s. 2(v), s. 5B
Karnataka Sales Tax Rules, 1957s. Explanation I to Rule 6(4)
Sale of Goods Act, 1930

Subjects

sales taxKarnataka Sales Tax Actservice agreementmaintenance contractsale of goodsconsumablestransfer of propertytonersdevelopersFSMASSMA

Judgment

XEROX MODICORP LIMITED. A
v.
STATE OF KARNATAKA

AUGUST 24, 2005
B
[S.N. VARIAVA AND TARUN CHATTERJEE, JJ.]

Sales Tax:

Karnataka Sales Tax Act, 1957-Sections 2(1), 2(v) & 5B-Karnataka
Sales Tax Rules, 1957-Explanation I to Rule 6(4)--Company doing business c
in Xerox machines, parts and accessories-Service-cum-maintenance
agreen1ent entered into between con1pany and custon1er after sale of Xerox
machine-Supply of spare parts of components like toners/developers under
the agreement-Held: Supply was for a price-There was transfer ofproperty
in tangible goods before they got consumed-Hence had all elements ofsale.
D
Appellants are a Public Limited Company doing business in Xerox
machines, part and accessories. After the Xerox machine is sold to a
customer, if the customer so desires, the Appellants enter into a Full
Service Maintenance Agreement (FSMA) or a Spares and Service
Maintenance Agreement (SSMA). E
In FSMA the Appellants take on the responsibility offully maintaining
the machine, servicing if and if necessary replacing parts. The Appellants
also supply material, like toners and developers. They charge at a fixed
rate per copy produced by the machine. Under the SSMA, the Appellants
agree to maintain the machine including replacement of parts, if necessary, F
for a fixed lump sum amount per annum. However, the costs of toners,
developers etc. are to be borne by the customers.

The question that arose for consideration in the present appeal is
whether the supply of spare parts and components like toners and
developers under the aforementioned two types of agreements amounted
G
to sale.

Dismissing the appeal, the Court

" HELD: I.I. The Agreements are not just service contracts but also H
895
896 SUPREME COURT REPORTS [2005] SUPP. 2 S.C.R.

A maintenance contracts. Under the Agreements, apart from the service
element, for which no tax is sought to be levied, there is the element of
supply parts and components like toners/developers etc. Merely because
price is not being separately charged for this, does not detract from the
position that the supply is for a price. Such supply has all the elements
B of sale as understood in law. There is transfer of title in movables for a
price. [900-C-D-E]

1.2. The mere fact that it is not known in the beginning whether or
not a part will have to be replaced is irrelevant. Even in the absence of
any such Agreements, if a part was required to be replaced and was ,..
C replaced there would be a sale of that part. The same position remains
even under the Agreements. As and when a part is required to be and is
replaced, a sale takes place at that instance. The tax is on sale. So if there
is no replacement of a part then there is no sale of a part. There is sale
of parts, both in FSMA and SSMA. [900-E-F-G; 903-E]
D
1.3. So far as toners and developers are concerned it is known from
the beginning that they will require regular replenishment. Under SSMA
the customer buys them. Under FSMA they are replenished by the
Appellants. There is sale of toners and developers even in the case of
FSMA. (900-G-H; 903-E-F]
E
The State ofMadras v. Gannon Dunkerly & Co., (Madras) Ltd., [1959]
SCR 379 and State of U.P. v. Union of India, [2003) 3 SCC 239, referred
to.

p 2.1. Though the Appellants submitted that the part or component
replaced can be considered to be material which is consumed in the execution
of the maintenance contract and, therefore, not exigible to tax by virtue of
Explanation I ~o Rule 6(4) of the Karnataka Sales Tax Rules, but the term
'consumables' used in the said Explanation has to be read in the context of
the words preceding and following. [900-H; 901-A, C-D)
G
2.2. The words 'consumables' in Explanation I to Rule 6(4) refers to
such items which get consumed before the property in the goods can pass.
Toners and developers are liquids which are put in the Xerox machine.
They perform the same function as ink in printers. "£!nder the Sale of
H Goods Act, 1930 if specified goods in a deliverable state are delivered the
.. XEROX MODICORP LIMITED v. STATE

property in the goods passes. Undisputably, the toners and developers are
delivered in bottles/containers. [902-E-F]
897

A

Pest Control India Ltd v. Union of India & Ors., (1989) 75 SIC 188;
The Deputy Commissioner of Sales Tax (Law), Board of Revenue (Taxes),
Ernaku/am v, MK. Velu, (1993) 89 SIC 40 and Dynamic Industrial &
Cleaning Services (P) Ltd v. State of Kara/a & Anr., (1995) 97 STC 564,
B
referred to.

3.1. In the FSMA, supplies are left with the customer. For the extra
stock of supplies there is a provision which provides that it is left in trust
with the customers. However once the toner and developer are put into C
the machine they are no longer in trust. This is because the property in
the toner and developer passed the moment they are put into the Xerox
machine. Now they belonged to the customer. At this stage they are
tangible movables in which property can pass. This is clear from the
provisions that Appellants will charge for unaccounted stock at prevaili~g
prices. (902-F-G; 903-B-CJ D

3.2. That they are goods in which property can pass is also clear from
the fact that in the SSMA the customer has to buy the toner and developer.
If as now claimed they are consumables in which property cannot be
-, transferred how could the Appellants charge for toners and developers. E
The sale i.e. transfer of property takes place before the goods are consumed.
The transfer takes place in respect of tangible goods. Just like petrol is
consumed after sale or ink is consumed after sale in this case also the
toners and developers get consumed after sale. The property passes the
moment they are put in the machine. At that stage they are not consumed
but are tangible good in which property can pass. [903-C-D-E] F

CIVIL APPELLATE JURISDICTION: Civil Appeal No. 3339 of2000.

From the Judgment and Order dated 18.2.99 of the Kamataka High
Court in S.T.R.P. No. 31 of 1996.
G
S. Ganesh, Mrs. Rohina Nath, Kavin Gulati and Umesh Kumar Khaitan
for the Appellant.

T.L.V. Iyer, Sanjay R. Hegde, Anil K. Mishra and A. Rohan Singh for
the Respondent. H
898 SUPREME COURT REPORTS [2005] SUPP. 2 S.C.R.

A The Judgment of the Court was delivered by

S.N. VARIAVA, J. : This Appeal is against the Judgment dated 18th
February 1999 passed by the Karnataka High Court.

B Briefly stated the facts are as follows:

The Appellants are a Public Limited Company doing business in Xerox
machines, parts and accessories, as part of its business. After the Xerox
machine is sold to a customer, ifthe customer so desires, the Appellants enter
into one of tffe two types of Agreements, namely, either a Full Service
c Maintenance Agreement (FSMA) or a Spares and Service Maintenance
Agreement (SSMA). In FSMA the Appellants take on the responsibility of
fully maintaining the machine, servicing it and if necessary replacing parts.
The Appellants also supply material, like toners and developers. They charge
at the rate of 0.27 paise per copy produced by the machine. Under the SSMA,
D the Appellants agree to maintain the machine including replacement of parts,
if necessary, for a lump sum of Rs. 7,000 per annum. However, the costs of
toners, developers etc are to be borne by the customer.

It appears that in the Returns filed by the Appellants, for Sales Tax
purposes, they declared total taxable turnovers at Rs. 4,23,58,510 and Rs.
E 1,63,58,556. The Assessing Authority, on verification of the books of
accounts, determined the total and taxable turnovers at Rs. 10,34,70,495 and
Rs. 4,70,23,693. The Assessing Authority held that amounts received for sale
of parts, toners and developers, under the aforementioned two types of
Agreements, were includible for the purposes of sales tax.
F
The Appellants filed an Appeal before the Joint Commissioner of
Commercial Taxes (Appeals), Bangalore. In that Appeal, the matter was
remanded back for purposes of considering certain reductions. An Appeal was
filed before the Karnataka Appellate Tribunal which was dismissed. In the
meantime, after remand the Assessing Authority again passed an Order
G holding that the spare parts and goods supplied under the Service Agreements
amounted to sale. The Appellants then filed a Revision Petition which was
dismissed by the impugned Judgment.

Mr. Ganesh, learned senior counsel for. the Appellants, submitted that
H the essence of a sale of goods is that the parties must enter into a contract
XEROX MODICORP LIMITED v. STATE [VARIAVA, J.] 899

for the transfer of property in movables for a price. He submitted that such A
a contract may be a separate and distinct contract or it may be an inseparable
part of a larger contract, such as a contract for the construction of a house
with materials to be supplied by the contractor. He further submitted that prior
to the 46th Amendment to the Constitution of India, it had been held by this
Court in the Gannon Dunkerly's case (1959 SCR 379] that no sales tax could B
be levied on the transfer of property in goods in the case of such an
inseverable contract. He further submitted that Article 366(29A)(b), inserted
by the 46th Amendment, only enables an inseverable contract to be split up,
so as to enable sales tax to be levied on that part of it which consists of a
contract to transfer property in movables for a price. He submitted that Article
366(29A)(b) does not have the effect or consequence of converting what in C
law is not a sale of goods into a taxable sale of goods. He submitted that

... Article 366(29A)(b) does not make any departure from the basic concept of
the parties having to enter into a contract for the transfer of property in
movables for a price. He submitted that the statutory definitions of "Sale"
(Sec. 2(t), "Taxable Turnover" (Sec. 2(u-l) and "Turnover" (Sec. 2(v), read D
with the charging Section 58, in the Karnataka Sales Tax Act, also indicate
that there must be an agreement for transfer of property in certain goods for
an identifiable price. He submitted that in a maintenance contract, the only
obligation cast on the service provider is to keep the equipment in question
in operating condition and to repair it if necessary and to replace a part only
if found necessary. He submitted that a maintenance contract is thus not a E
contract which is entered into for a transfer of the property in any specific
part or component for any identifiable price. He submitted that a maintenance
contract, \vhen entered into, is not an agreement for the sale of goods. He
submitted that a maintenance contract does not get transformed into an
agreement for the sale of goods merely by reason of the subsequent F
development of some parts or components being replaced by the service
provider, as an integral part of the contractual obligation of keeping the
equipment in good operating condition. He submitted that in a maintenance
contract, the sharge is paid for the service and not as a price for the
replacement of any particular part or component. He submitted that when the
contract is entered into, it is not even known whether any part or component G
will require replacement or not. He submitted that there is thus no nexus or
correlation between the price paid for the contract and the value of any part
or component which subsequently gets replaced, if at all, during the contract
period. He further submitted that the basic and essential requisites of a
contract of sale of goods are thus entirely missing in a maintenance contract, H
900 SUPREME COURT REPORTS [2005] SUPP. 2 S.C.R.

A and the same are not created or brought into existence by the 46th Amendment.
He submitted that the predominant and basic object of a maintenance contract
is the rendering of a service and not the sale of any goods.

In support of his submissions Mr. Ganesh relied on the case of State of
B u. P. v. Union of India, [2003] 3 sec 239 where it is held that if a contract
is basically a service contract, the incidental supply of goods under the
contract as an essential part of the service does not attract the levy of sale
of tax even after the insertion of Article 366(29A)(b). It has been held that
this provision does not obliterate the distinction between a service and a sale
of goods.
c
Even though at first blush the submissions of Mr. Ganesh may appear
attractive, on a proper consideration, we think that Mr. Iyer was right when
he submitted that the Agreements are not just service contracts but also
maintenance contracts. Mr. Iyer is right that the machines belong to the
D customer after they are sold to them. If after the sale some part was to be
replaced or some component supplied there would be sale as understood in
law. Under the Agreements, apart from the service element, for which no tax
is sought to be levied, there is the element of supplying parts and components
like toners/developers etc. Mr. Iyer is right in submitting that merely because
price is not being separately charged for this, does not detract from the
E position that the supply is for a price. Such supply has all the elements of
sale as understood in law. There is transfer of title in movables for a price.
The mere fact that it is not known in the beginning whether or not a part will
have to be replaced is irrelevant. If there were no such Agreements, it would
not be known whether or not a part would be required to be replaced. It could
F not be denied that, even in the absence of any such Agreements, if a part was
required to be replaced and was replaced there would be a sale of that part.
The same position remains even under the Agreements. As and when a part
is required to be and is replaced a sale takes place at that instance. To leave
no room for doubt it must be mentioned that the tax is on sale. So if there
is no replacement of a part then there is no sale of a part. So far as toners
G and developers are concerned it is known from the beginning that they will
require regular replenishment. Under SSMA the customer buys them. Under
FSMA they are replenished by the Appellants.

Faced with this situation Mr. Ganesh next submitted that in any event,
H from the point of view of the Appellants, the part or component replaced can
MIS. XEROX MODICORP LIMITED v. STATE [VARIAVA, J.] 901
•
• be considered to be material which is consumed in the execution of the A
maintenance contract and, therefore, not exigible to tax by virtue of Explanation
I to Rule 6(4) of the Kamataka Sales tax Rules. The said Explanation reads
as under :

"for the purposes of clauses (m) and (n) of sub-rule (4), 'labour and B
other like charges' include charges for obtaining on hire or otherwise
machinery and tools used for execution of Works Contract, charges
for planning, designing and architects' fees, cost of consumables
used in the execution of the works contract, cost of establishment
to the extent relatable to supply of labour and services and other
similar expenses relatable to supply of labour and services." c
On the other hand Mr. Iyer submitted, and in our view rightly, that the term
'consumables' used in this explanation has to be read in the context of the
words preceding and following. He submitted that read as such it is clear that
the term 'consumables' refers to such items as are used up in execution of D
the works contract, so that nothing tangible is left, in which property in the
goods can pass to the buyer. A part placed in the machine does not get
consumed. It remains in the machine. May be over a course of time there may
be wear and tear and/or deterioration but it does not get consumed.

Mr. Ganesh however strenuously submitted that in the toner or developer, E
supplied in the FSMA there is no transfer of property or sale. He submitted
that the toner and developer are consumed in the process of the execution of
the Agreement itself. He submitted that no sales tax is, therefore, leviable.

In support of this submission Mr. Ganesh relied upon the case of Pesi F
Control India Ltd v. Union of India & Ors. reported in (1989) 75 STC 188.
In this case there was a contract for eradication of pests, rodents, termites etc.
In carrying out this work chemicals were sprayed through machines. The
question was whether there was a sale of chemicals in execution of the works
contract. It was held once the chemicals were sprayed they got consumed and
nothing tangible remained in which property could be transferred. G

Mr. Ganesh also relied on the case of The Deputy Commissioner ofSales
Tax (Law), Board of Revenue (Taxes), Ernakulam v. M K. Velu reported in
(1993) 89 STC 40. In this case there was a contract for display of fireworks.
The question was whether there was a sale of fireworks. It was held that the H
902 SUPREME COURT REPORTS [2005) SUPP. 2 S.C.R.

A fireworks got consumed in the process of execution of the work. It was held
that there~fter no tangible property remained. It was held that there was no
transfer of goods.

Mr. Ganesh next relied on the case of Dynamic Industrial & Cleaning
B Services (P) Ltd v. State of Kera/a & Anr. reported in (1995) 97 STC 564.
In this case there was a contract to clean boilers in factories. Chemicals were
used to clean the boilers. It was held that the chemicals were used up and
thus there was no transfer of property and thus no sale.

Relying on these cases Mr. Ganesh submitted that toners and developers
c get consumed in the process of printing and thus there is tangible property
left in which there can be transfer of property.

On the other hand, Mr. Iyer submitted that there is transfer of property
in tangible goods i.e. toners and developers, before they get consumed. He
D submitted that this case is akin to sale of petrol or sale of ink. He submitted
that the authorities relied upon by Mr. Ganesh are all cases where the goods
get consumed in execution of the work and where there is no transfer of
property in the goods before the goods are consumed. He submitted that the
principles laid down in those cases have no relevance and cannot apply to
the facts of this case.
E
We have considered the rival submissions. As set out hereinabove the
word consumable in Explanation I to Rule 6(4) refers to such items which
get consumed before the property in the goods can pass. We are infonned
that toners and developers are liquids which are put in the Xerox machine.
F They perfonn, to put it simply, the same function as ink in printers. Under
the Sale of Goods Act if specified goods in a deliverable state are delivered
the property in the goods passes. It could not be disputed that the toner and
developer will be delivered in bottles/containers. In the FSMA supplies are
left with the customer. Thus clause 9 of the Section dealing with the customers
obligation provides as follows:
G
"THE CUSTOMER

H 9. shall be accountable to MX for xerographic supplies stock left in
XEROX MODICORPL!MITED v. STATE [VARJAVA, J.] 903

trust with the customer who shall ensure that such stock is used only A
in the Equipment under this Agreement. MX reserves the right to
charge the Customer for any stocks which are unaccounted for, to
MX's satisfaction, at the then prevailing MX prices."

Thus for the extra stock there is a provision which provides that it is left in B
trust. However once the toner and developer are put into the machine they
are no longer in trust This is because the property in the toner and developer
passed the moment they are put into the Xerox machine. Now they belonged
to the customer. At this stage they are tangible movables in which property
can pass. This is clear from the provision that Appeliants will charge for
unaccounted stock at prevailing prices. That they are goods in which property C
can pass is also clear from the fact that in the SSMA the customer has to buy
the toner and developer. If as now claimed they are consumables in which
property cannot be transferred how are the Appellants charging for toners and
developers. In our view, Mr. Iyer is right. The sale i.e. transfer of property
takes place before the goods are consumed. The transfer takes place in respect D
of tangible goods. Just like petrol is consumed after sale or ink is consumed
after sale in this case also the toners and developrs get consumed after sale.
The property passes the moment they are put in the machine. At that stage
they are not consumed but are tangible goods in which property can pass.

In view of the above it is held that there is sale of parts, both in FSMA ·E
and SSMA. There is also sale of toners and developers even in the case of
FSMA. Before us no contention is raised that sales tax is not being levied on
a correct basis. On the contrary Mr. Iyer pointed out to us the Order dt. 30th
August 1994 of the Joint Commissioner of Commercial Taxes wherein, whilst
remitting back for recalculation of tax, the principles on which it is to be done F
are laid down. To us they appear to be correct.

In this view we see no reason to interfere with the impugned Judgment.
The Appeal stands dismissed. There will be no order as to costs.

B.B.B. Appeal dismissed. G