M/S. Damodar Valley Corporation vs The State Of Bihar

Rewritten Version Notice: This is a rewritten version of the original judgment.

Court: Supreme Court of India

Case Number: Civil Appeal No. 285 of 1959

Decision Date: 21 November 1960

Coram: Bhuvneshwar P. Sinha, Syed Jaffer Imam, A.K. Sarkar, J.C. Shah

In the matter of M/S Damodar Valley Corporation versus The State of Bihar, a judgment was delivered on 21 November 1960 by the Supreme Court of India. The opinion was authored by Justice Bhuvneshwar P. Sinha, with Justices Syed Jaffer Imam, A.K. Sarkar and J.C. Shah forming the bench. The case is reported as 1961 AIR 440 and 1961 SCR (2) 522, and it concerns the application of the Bihar Sales Tax Act, 1947 (Act 19 of 1947), specifically sections 2(g), 13(5) and 25. The appellant, M/S Damodar Valley Corporation, had been assessed sales tax under section 13(5) on the price of machinery and equipment supplied to two contractor firms for the construction of a dam; the assessed amount was approximately Rs 42,63,305. Under the agreement entered into with the contractors, the price of the machinery and equipment was to be paid by the contractors, and until such payment was made, the property remained vested in the corporation. The agreement further provided that the corporation would take back the equipment after the completion of the work at a residual value to be calculated in accordance with the terms of the agreement, provided that the equipment had been properly maintained during its use. The contractors were also authorised, at an earlier date, to take possession of the equipment if it was declared surplus and certified as such by the consulting engineer. Payment for the equipment was to be made in eighteen equal instalments, with two‑thirds of the amount realisable in any event, after which the corporation would determine the dates of taking back the equipment based on an assessment of depreciation in order to arrive at the residual value. The corporation was not obliged to take back the equipment if its residual life fell below one‑third of the standard life as fixed by the parties, and the contractors were required to replenish the stock of spare parts supplied to them at their own cost. The corporation contended that the transaction did not constitute a sale within the meaning of the Act. The sales‑tax authorities disagreed, and the sole issue that the Board of Revenue referred to the High Court under section 25 was whether ownership of the equipment passed to the contractors and whether the transaction amounted to a sale. The High Court answered affirmatively, holding that the transaction was a sale within the meaning of section 2(g) of the Act, and it refused to issue the requisite certificate. The corporation then appealed by special leave to the Supreme Court. The Supreme Court held that the appeal must be confined to the question that had been debated before the High Court. It observed that, while acting in its advisory capacity under a taxing statute, the High Court cannot exceed the question that was referred to it, and that the grant of special leave does not permit an expansion of the scope of the controversy beyond what could be legally raised before the High Court. The Court outlined a two‑fold test for distinguishing a mere hiring contract from a purchase contract on deferred payment: (1) whether the hirer is under an obligation to purchase the goods, and (2) whether the hirer has the right to return the goods at any time during the contract’s subsistence. It stressed that the substance of the agreement, not the terminology used, must be examined, referring to the authority Helby v. Matthews and others (1895) A.C. 471. Applying this test, the Court concluded that there was no doubt that, on the terms of the agreement between the parties, the transaction was clearly a sale on deferred payment with an option to repurchase, rather than a mere contract of hiring.

The Court explained that when a matter is referred to the High Court under a statutory provision, the High Court must confine its consideration to the precise question that was referred to it or that it itself raised. The fact that the present appeal was granted by special leave did not permit the Court to broaden the issues beyond those that could lawfully be presented before the High Court. The Court then set out a two‑part test for deciding whether an agreement represents a simple hire‑purchase arrangement or a genuine contract of sale on deferred payment. The first element of the test requires examining whether the person who hires the goods is contractually obliged to purchase them. The second element asks whether the hirer retains the right to return the goods at any time while the contract remains in force. The Court emphasized that the true nature of the transaction must be discerned from the substance of the agreement rather than from the terminology used by the parties. In support of this approach, the Court referred to the authority Helby v. Matthews and others, (1895) A.C. 471. Applying the test to the facts before it, the Court found no doubt that the arrangement between the parties constituted a sale on deferred payment with an option to repurchase, and not merely a contract of hiring.

The appeal concerned Civil Appeal No. 285 of 1959 and was filed by special leave against the judgment and decree dated 13 July 1956 of the Patna High Court in M. J. C. No. 404 of 1954. The appeal was argued before the Supreme Court on 21 November 1960, with senior counsel representing both sides. The judgment was delivered by Chief Justice Sinha. The appellant was the Damodar Valley Corporation, a body incorporated under the Damodar Valley Corporation Act (XIV of 1948). The Court noted that the corporation was a multipurpose entity whose objectives included constructing a series of dams in Bihar and Bengal for flood control and power generation. One of the dams, the Konar Dam, was located in Hazaribagh district, Bihar. To build this dam, the corporation entered into an agreement on 24 May 1950 with Hind Construction Ltd. and Patel Engineering Co. Ltd., appointing them as contractors. Because the dam’s design was later altered, the parties executed a supplementary agreement on 10 March 1951, replacing clause 8 of Part II of the original contract with a new clause 8. Under the amended clause 8 of the agreement, the

The Corporation undertook to supply the Contractors with all equipment that was necessary and suitable for the construction of the dam, and the Contractors were to be charged the actual price that the Corporation paid for each piece of equipment and machinery, the charge including any freight costs and customs duties, as well as the cost of transport, but expressly excluding any sales tax. The equipment provided by the Corporation was divided into two categories, identified as Group A and Group B, and the classification of each item was set out in Schedule No. 2 to the agreement. Under the terms of the agreement, the machinery that fell within Group A was to be taken back by the Corporation after the work was completed, and the Corporation was to acquire the equipment at its “residual value,” the method of calculating that residual value being prescribed in the agreement itself. In contrast, the machinery classified in Group B was to become the property of the Contractors once the Contractors had paid the full price for those items. There was no dispute concerning the items in Group B, as the Contractors had acknowledged that the Group B machinery had been sold to them. The only point of contention that remained between the parties concerned the machinery placed in Group A.

On 12 August 1952 the Superintendent of Sales Tax in Hazaribagh issued an assessment against the Corporation under section 13(5) of the Sales Tax Act for the period covering April 1950 to March 1952. The precise amount of the tax demand was not in dispute, and therefore it need not be detailed here. The essential question before the tax authorities and later before this Court was whether the transaction involving the Group A equipment constituted a “sale” within the meaning of the Act. The Superintendent rejected the Corporation’s argument that it was not liable to pay tax on the equipment supplied to the Contractors. The Corporation then appealed to the Deputy Commissioner of Sales Tax, who, by an order dated 5 May 1953, dismissed the Corporation’s contention of exemption under the Act, while also making certain amendments to the assessment that were not material to the issues under consideration. The Deputy Commissioner held, inter alia, that the supply of the Group A equipment was a sale rather than a hire, that the provision for the Corporation to “take over” the equipment on the stipulated conditions amounted essentially to a condition of repurchase, and that the Corporation qualified as a “dealer” within the meaning of the Act. The Corporation subsequently moved the Board of Revenue, Bihar, invoking its revisional jurisdiction under section 24 of the Act. By its resolution dated 1 October 1953, the Board upheld the assessment and rejected the Corporation’s revisional petition. Following that decision, the Corporation filed an application under section 25 of the Act on 22 December 1953, seeking a reference to the High Court at Patna on three specific questions: (a) the maintainability of the assessment under section 13(5); (b) whether, in the facts of the case, the ownership of the Group A goods passed to the Contractors, thereby constituting a sale; and (c) whether the terms of the agreement amounted to sale transactions with the Contractors and whether the Corporation’s “taking over” of the equipment was essentially a repurchase. When the application for reference was heard before the Board on 20 May 1954, counsel for the Corporation requested leave to withdraw questions (a) and (c). The Board granted that leave, leaving only question (b) to be referred to the High Court.

The Corporation applied to the High Court at Patna for a reference on three specific points: first, whether the assessment made under section 13(5) of the Bihar Sales Tax Act could be sustained; second, whether, given the facts of the case, the ownership of the goods listed in Schedule A had transferred to the Contractors and the transaction therefore constituted a sale; and third, whether the provisions of the agreement with the Contractors amounted to sale transactions and whether the Corporation’s taking back of the equipment amounted to a repurchase. This application was filed on 22 December 1953. When the matter was scheduled for hearing before the Board of Revenue on 20 May 1954, the parties were heard and counsel for the Corporation requested permission from the Board to withdraw the first and third questions from the proposed reference. The Board granted the request, noting that only the second question would remain for reference to the High Court. Consequently, the High Court was asked to consider solely the issue of whether the transaction amounted to a sale under the circumstances.

The Division Bench of the High Court, comprising Chief Justice Ramaswami and Justice Raj Kishore Prasad, examined the reference and delivered its judgment on 13 July 1956. The Court held that the reference should be answered affirmatively, concluding that the transaction in question did indeed constitute a sale within the meaning of section 2(g) of the Bihar Sales Tax Act. Following this decision, the Corporation filed an application under article 132(1) of the Constitution, seeking leave to appeal to the Supreme Court of India and requesting the requisite certificate that the case was suitable for such an appeal.

In addition to contesting the findings addressed by the High Court in the reference, the Corporation apparently raised further arguments at the time of hearing its application. The High Court’s judgment and order dated 31 January 1957 recorded these additional submissions. The Court observed that the Corporation’s counsel conceded that the case did not satisfy the conditions of article 133(1) of the Constitution. The Corporation argued, however, that leave might be granted under article 132 because the case involved a substantial question of law concerning the interpretation of the Constitution. The Court rejected this submission, stating that no substantial constitutional question was presented. It held that the dispute concerned solely the interpretation of section 2(g) of the Bihar Sales Tax Act, a question already decided by the Court in favor of the State of Bihar and to the detriment of the Corporation.

In the present matter, the petitioner's counsel argued that the provisions of section 2(g) of the Bihar Sales Tax Act were beyond the constitutional authority, but the High Court had not considered or decided that question in the reference. Consequently, the Court observed that the case did not fulfil the conditions of Article 132(1) of the Constitution, and therefore the petitioner was not entitled to a certificate authorising an appeal to the Supreme Court under that article. The application for such a certificate was consequently dismissed. After being unable to obtain the required certificate from the High Court, the Corporation approached this Court and secured special leave to appeal under Article 136 of the Constitution, with the leave being granted on 31 March 1958. Although the High Court’s decision under section 25 of the Act was confined to the reference made to it, the Corporation subsequently raised several additional points of controversy that had not formed part of the High Court’s decision. Apart from the primary issue of whether the transaction in question constituted a sale within the meaning of the Act, the Corporation’s statement of case advanced three further grounds of attack: first, that the Corporation was not a dealer within the meaning of the Act; second, that the proviso to section 2(g) of the Act was ultra vires the Bihar Legislature; and third, that the Act itself was ultra vires the Bihar Legislature because the legislation exceeded the scope of entry 48 in List II of Schedule 7 of the Government of India Act, 1935. The respondent then raised a preliminary objection, contending that these additional grounds were not open to the Corporation before this Court. The Court therefore needed to determine whether the additional grounds could be considered at this stage. In the Court’s opinion, those additional grounds were not open for consideration. They had never been raised at any stage of the proceedings before the lower authorities or before the High Court. This Court was hearing an appeal against the High Court’s decision under section 25 of the Act, and the High Court, in reaching its conclusion, had acted solely in an advisory capacity. Established precedent dictates that a High Court acting in an advisory role under a taxing statute cannot go beyond the matters referred to it or beyond a reference it itself initiated. Accordingly, the scope of the appeal to this Court, even when granted by special leave, could not be expanded beyond the controversy that could have been legally raised before the High Court. It was evident that the High Court could not have expressed an opinion on any matter other than the specific question that had been before it as a result of the Board of Revenue’s reference. For these reasons, the preliminary objection was allowed, and the appeal was limited to the singular issue of whether the transaction at hand amounted to a sale within the meaning of the Act.

In this case the Court examined whether the transaction at issue amounted to a sale within the meaning of the Act and observed that the controversy between the parties could be resolved only by referring to the terms of the contract itself. The Court focused on clause 8 of the amended agreement, describing it as a very complex clause. The clause provided that the Corporation could hire or make available any of its equipment that was suitable for construction for the use of the Contractor. It further stated that the Corporation would charge the Contractor the actual price it had paid for the equipment, and that such price would include freight, insurance and any customs duties, as well as the cost of transporting the equipment to the site, but would exclude any sales tax of any kind, whether local, municipal, State or Central. The equipment would remain the property of the Corporation until the full price had been realised from the Contractor. The clause also provided that any equipment lent to the Contractor would be charged on mutually agreed hiring terms, and that those terms would cover interest on the capital cost and depreciation of the equipment. Finally, the clause stipulated that the Corporation would supply to the Contractor the machinery listed in Schedule No 2, which comprised Group A and Group B items. The Court then reproduced the description of the machinery set out in the schedule. Group A contained fourteen items; for illustration the Court mentioned only the first and the fourteenth items. Item 1 consisted of four excavators with accessories, valued at approximately Rs 12,46,390, and item 14 consisted of two excavators of another model, valued at approximately Rs 3,35,000. The total approximate cost of all Group A machinery was estimated at Rs 42,63,305. The schedule also listed Group B machinery, whose approximate aggregate cost was Rs 21,84,148. The Court further recited the conditions attached to the equipment in Group A, which required that the Corporation would take back items 1 and 14 on completion of the work at a residual value calculated on the basis of the actual number of hours worked, assuming a total life of 30,000 hours and proper maintenance by the Contractor. The remaining Group A items would be taken over by the Corporation at a residual value taking into account the actual hours worked and the standard life of each machine, using Schedule F of the United States Bureau of Industrial Revenue as the basis, which reflected probable useful life and depreciation rates allowable for income‑tax purposes as cited in the Engineering News Record dated 17 March 1949. The clause further required that the residual value of the machinery be assessed jointly by representatives of the Corporation and the Contractor, and that any difference of opinion between them be settled through arbitration.

In this agreement the parties stipulated that if the Corporation and the Contractor could not agree on the assessment of residual value, the dispute would be resolved by arbitration conducted by a third party mutually selected by both the Corporation and the Contractor. The items classified in Group A were to be taken over by the Corporation either upon completion of the work or at an earlier date if the Contractor elected to do so. However, an earlier take‑over could occur only after the equipment had been declared surplus at Konar and such a declaration had been duly certified by the Consulting Engineer within fifteen days after the Corporation received the declaration. For machinery that had been delivered to the Contractor on or before 31 December 1950, the cost of the equipment was to be recovered from the Contractor in eighteen equal instalments commencing in January 1951. For the remaining items included in Group A, the cost was to be recovered in eighteen equal instalments beginning in July 1951, on the condition that those items had been delivered to the Contractor before the last specified date. The agreement further provided that the total actual price of these equipments, provisionally estimated at Rs 42,63,305, would be chargeable to the Contractor in accordance with the first paragraph of clause 1. After approximately two‑thirds of the total cost, or an amount of Rs 28,43,000, had been recovered from the Contractor, the Corporation would consider the dates on which it could take over the equipments still in use, assess the extent of depreciation already incurred, and determine the residual value of each item. The recovery or refund of any amount payable by or to the Contractor for these equipments would be decided only if the Corporation was fully satisfied that, at the time of final hand‑over, the residual life of each item would not fall below one‑third of its agreed standard life. The contract thereafter listed terms and conditions for Group B, which were noted as not relevant to the present purpose. Following that, a set of uniform conditions applicable to all equipments—whether in Group A, Group B, or any other category—was outlined. Under these conditions the Contractor was required to maintain continuous and separate machine cards for each piece of equipment, showing on a daily basis the actual hours worked, the dates, and any other relevant particulars. In addition, the Contractor was obligated to keep all such equipment in good running condition and to provide regular and efficient service to all plant and machinery as may be required by the Corporation.

In the terms that were quoted, the agreement required that the Chief Engineer, or any of his authorized representatives, had the right to inspect, either personally or through delegation, all plant and equipment as well as the machine cards that were kept for each item, and that such inspection could be carried out at mutually convenient hours. The agreement further stipulated that no piece of equipment that the Corporation had supplied on loan or hire could be taken away from the work site at any time until the Corporation had recovered the full cost of that equipment from the Contractor; thereafter, removal of such equipment could be permitted only if the Consulting Engineer was of the opinion that taking the item away would not likely hinder the satisfactory progress of the work. In a similar manner, any equipment or material that belonged to the Contractor but for which the Corporation had advanced money could not be removed from the site until the Corporation had recovered the advanced amount from the Contractor, and even after recovery, removal could occur only if the Consulting Engineer believed that the removal would not impede the satisfactory prosecution of the work. The agreement also provided that the Corporation would supply to the Contractor any spare parts that had been procured or ordered for the equipment already given or to be given by the Corporation under the agreement; thereafter, the responsibility for replenishing the stock of spares rested entirely with the Contractor, who was required to take timely steps to procure fresh spares in order to maintain an adequate reserve. The spare parts to be supplied by the Corporation were to be issued to the Contractor by the Executive Engineer, Konar, as and when the Contractor required them, against an indent accompanied by a certificate confirming that the previously issued spares had actually been used up on the machines for which they were intended. Whenever spares were issued to the Contractor under this provision, their actual prices, inclusive of freight, insurance and customs but exclusive of storage and handling charges, were to be debited against the Contractor and recovered from his next fortnightly bill. Finally, to enable the Contractor to plan the procurement of additional spares in advance, the Corporation undertook to furnish the Contractor promptly with a complete list of all the spares it had procured or ordered for the equipment to be supplied to the Contractor. The quoted portions thus contain the essential terms and conditions that governed the transaction for the purposes of this case. It was evident that the Corporation had made available to the Contractors various categories of machinery and equipment grouped under Group A, with an approximate aggregate value of Rs 42,63,000, for which the price paid by the Corporation, including freight, insurance and customs duty, was to be charged to the Contractors, although the machinery and equipment so provided remained the property of the Corporation until the full price had been realized from the Contractors.

The Corporation retained ownership of the machinery and equipment until the full price had been realised from the Contractors. The written agreement clearly distinguished the portion of the contract dealing with the supply of machinery and equipment from the portion dealing with equipment that was lent to the Contractors on a hire basis, for which the Contractors were required to pay hiring charges, interest on the capital cost and depreciation. Consequently, the parties’ arrangement comprised two separate categories of transaction: first, the direct supply of machinery and equipment by the Corporation to the Contractors, and second, a loan‑for‑hire of additional equipment on terms to be mutually agreed, relating to the machinery and equipment already supplied by the Corporation. The agreement further provided that the Corporation would take back from the Contractors items numbered 1 and 14, together with the remaining items listed in Group A, at their “residual value” calculated in accordance with the formula set out in the paragraph that follows the description of the machinery and equipment. However, this “taking over” was conditioned on the requirement that the machinery be properly looked after throughout its period of operation. An additional condition stipulated that the Corporation would take over the equipment only when the work for which the equipment was intended had been completed, or earlier if the Contractors so chose, provided that the equipment was declared surplus for the Konar Dam project and certified as such by the Consulting Engineer. Accordingly, the provision for taking back the machinery and equipment was not an unconditional right analogous to that applicable to the equipment classified in Group B.

The total approximate price of the supplied machinery and equipment was Rs 42,63,305, payable by the Contractors in eighteen equal instalments. Of this total amount, two‑thirds, roughly Rs 28,42,000, had to be recovered from the Contractors regardless of any other considerations. Once this two‑thirds portion had been realised on account of the supply of equipment, the Corporation was required to determine the appropriate date or dates for “taking over” the equipment, after assessing the extent of depreciation caused by its use on the project, in order to calculate the “residual value”. The refund of the remaining one‑third of the price, or any other amount determined to be the residual value, depended on a further condition that the Corporation be fully satisfied that the equipment’s “residual life” would not fall below one‑third of its standard life as agreed by the parties. Hence, the “taking over” of any equipment eligible for return was not an unconditional entitlement. The Corporation was bound to accept the equipment back only if it was convinced that the residual life of the equipment was at least one‑third of the standard life fixed by the parties. The terms and conditions therefore made clear that the Contractors possessed no unrestricted right to return the machinery and equipment at any time of their choosing.

The judgment noted that the contractual provisions did not give the contractors an unrestricted right to return any machinery or equipment whenever they wished or found it convenient. The same set of conditions applied uniformly to every piece of equipment, whether classified in Group A or Group B, and these conditions were essential for characterising the nature of the transaction. Under the contract the contractors were obliged to keep continuously updated machine cards that recorded certain specified particulars. They were also required to keep the machinery in proper working order and to service it regularly and effectively. The contract expressly prohibited the contractors from removing any item of machinery or equipment under any circumstances until the full cost of that item had been recovered from them; even after such recovery, removal was permissible only if it was not likely to impede the satisfactory progress of the work. A further important condition required the contractors to replenish the stock of spare parts for the machinery that the Corporation had made available to them. Whenever the Corporation supplied spare parts to the contractors, the contractors were liable to pay the actual price of those parts, which included freight, insurance and customs duties. These stipulations together formed the substantive terms of the agreement between the parties.

The sole issue that the appeal sought to resolve was whether, concerning the machinery and equipment that the Corporation had admittedly supplied to the contractors, the arrangement constituted merely a contract of hiring, as the appellant Corporation maintained, or whether it amounted to a sale or a hire‑purchase transaction, as the respondent State alleged. The court acknowledged that the governing legal principles on this point were well settled, but it observed that difficulty arose in applying those principles to the specific facts and circumstances of the case, which required a proper construction of the document evidencing the transaction. It was reiterated that a pure hiring contract is a form of bailment that does not confer any title on the bailee, whereas the law of hire‑purchase has evolved considerably over the past half‑century, giving rise to several variations and categories. Normally, a hire‑purchase agreement does not transfer title to the hirer but merely creates an option to purchase upon fulfilment of certain conditions. Some hire‑purchase arrangements also provide for the purchase of the hired item by deferred payments, with the condition that title passes only after all instalments have been paid. Other variations may exist depending on the specific terms agreed by the parties. The court further noted that questions concerning rights created in third parties by the parties’ actions or by operation of law did not arise in the present case. The determination, therefore, hinged on interpreting the contractual terms to decide which category—simple hiring, hire‑purchase, or outright sale—the agreement fell within.

In determining the appropriate classification of a particular agreement, the Court explained that it must examine the actual substance of the arrangement rather than relying on the terminology employed by the parties. The Court identified two principal tests for distinguishing a mere hiring contract from a contract of purchase on a deferred‑payment basis. The first test asks whether the hirer is under a binding obligation to purchase the goods; the existence of such an obligation points toward a sale‑like contract. The second test inquires whether the hirer retains a right to return the goods at any time during the life of the contract; if that right exists, the arrangement is treated as a hire and not as a sale, as held in Helby v. Matthews and others (1). Applying these tests to the transaction under consideration, the Court observed that the facts demonstrated a sale of goods subject to a condition of repurchase. The condition required the Corporation to be satisfied that the “residual life” of the machinery or equipment was not less than one‑third of the standard life, according to the terms agreed between the parties. The Court noted that the contractors did not possess a right to return the goods at their convenience, and instead they were bound to pay two‑thirds of the approximate total price in equal instalments.

The Court further observed that the agreement did not obligate the Corporation to accept the machinery back unconditionally; rather, the provision concerning the “taking over” of the machinery upon payment of the “residual value” was inconsistent with a simple hiring arrangement and indicated that ownership of the goods had passed to the contractors, subject only to the fulfilment of all instalments. Moreover, the stipulation that the contractors were to supply spare parts as needed for replacement of worn‑out components supported the view that title had transferred to them, making them responsible for maintenance, depreciation, and replacement. In a pure hiring contract, the owner would retain liability for such replacements. Consequently, after applying the two tests to the terms of the agreement, the Court concluded that the transaction constituted a sale on deferred payments with an option to repurchase, and not a mere contract of hiring as argued by the appellant. Accordingly, the Court affirmed that the judgment of the High Court was entirely correct, dismissed the appeal with costs, and ordered the appeal to be dismissed. (1) (1895) A.C. 471.