Introduction – The Issue with Composite Contracts
After the 18th Amendment[1] to the Constitution[2], goods are taxed by the federal legislature, and the services by the provinces[3]. There is no concurrency in tax. For a particular transaction, the tax is either levied by the federal legislature, or by the provinces. Under the current framework, the supply of goods is taxed by the center under the Sales Tax Act, 1990. The provinces, after the 18th Amendment, have promulgated provincial legislations to bring the taxation on services within their provincial domain.
This arrangement works well when the goods are supplied separately; and the services are provided separately. But the arrangement comes under strain when the goods are supplied alongside services, or the services are provided alongside goods, in a manner, that the two, under the contractual arrangements, are not necessarily separable. Who, then, gets to tax and collect taxes levied on such activities? The central government or the provinces?
The question arises particularly in the context of construction works. In Association of Builders and Developers of Pakistan v. Province of Sindh and others, 2018 PTD 1487 (Sindh) (“ABAD”)[4], the Petitioners before the Sindh High Court, for instance, were primarily, those entities that (1) purchased the land, developed it by laying down infrastructure, such as roads and sewage lines, and then parceled the land into plots, selling them onwards, and (2) constructed buildings, with shops, apartments and other such units, and sold them onwards, allowing payments, against those units, in installments. The question before the court was whether the amounts received by these property developers and promotors, was against the supply of goods, or provision of services. If the latter then the provincial sales tax on services legislation applied, and the tax could be collected by the provinces. The Sindh High Court referred to the test that would determine this question – the “dominant intention” test – but failed to apply it, itself. The Court, instead, decided the cases before it on other grounds, kicking the can down the road, for determining the vital, fundamental question that whether taxpayers before the Court were engaged in the supply of goods or provision of services.
The question of composite contracts has also arisen in the context of contractors performing works, such as constructing and building roads, for the National Highway Authority (the “NHA”). Two High Courts have looked into these contracts. The Islamabad High Court in Sardar Muhammad Ashraf D. Baloch v. National Highway Authority and another[5], and the Peshawar High Court in M/s Matracon Pakistan (Private) Limited v. Appellate Tribunal for Sales Tax on Services, Khyber Pakhtunkhwa[6]. Both have reached different conclusions. The Islamabad High Court held that what had been supplied were not “services”, but “goods”; the Peshawar High Court held that what had been provided to NHA were not “goods”, but “services”.
Whether “Property Developers and Promoters” Provide Services, as Opposed to Goods?
In ABAD, the Sindh High Court had the opportunity to address the question whether the activity that the “property developers and promoters” engaged in, were to be characterized as supply of “goods” or as provision of “services”. The Court, however, ducked.
It, instead, decided the question before it on a completely different basis. The activity of the “property developers and promoters” was the “creation of the immoveable property”[7], that is, the creation or preparation of the plots in a housing scheme, or the units in a building. The Court invoked section 54 of the Transfer of Property Act, 1882, to state that at the stage of the challenges to the show cause notices issued by the Sindh Revenue Board (SRB) before it, there were only agreements to sell, and nothing more. Without a registered sale deed, at the stage of agreement to sell, the buyers had no interest in the property. Therefore, this was not “economic activity” as defined under the Sindh Sales Tax on Services Act, 2011 (the “2011 Sindh Act”). Because this was not an “economic activity” primarily since there was no exchange of rights in property, the show-cause notices could not have been issued.
For the Sindh High Court, therefore, it became a matter of timing. It did not address the question of “services” versus “goods” because the taxpayers before it, were only at the stage of “agreement to sell”, and no property rights, in essence, had changed hands. In other words, there was no possible recipient of service, or a consumer of goods. And this sufficed for the Court.
What the Sindh High Court glossed over was that at least some of show-cause notices, which had been challenged before it, were issued by the SRB under section 24 of the 2011 Act. This is the provision that requires registration of the taxpayers with the SRB. In setting these notices aside, there ought to have been a determination that the taxpayers before it – the property developers and promoters – were (or were not) required to register under section 24 of the 2011 Act, on the basis that they did (or did not) provide any services. In other words, the High Court ought to have reached the conclusion, one way or the other, that what was provided by the Petitioner taxpayers were “services”, or not. In not deciding the question of whether the activity of the “property developers and promoters” was service or not, the Court kicked the can down the road. This was probably a cop-out, although a creative one.
The show-cause notices under challenge before the High Court also had sought to tax “construction services”. The Court appreciated that the activities associated with a construction contract may be “multidimensional”[8], since they may involve, both, provision of services, and supply of goods, both of them intertwined. For such multi-dimensionality, the Court incorporated the “dominant intention” test, borrowed from the Indian Supreme Court’s Larsen and Toubro Limited and another v. State Karnatka and another (2014) 1 SCC 708. The Sindh High Court also referred to the decisions from the United States: (1) Bunebrake v. Cox 499 F.2d 951 (1974), from the Court of Appeals for the 8th Circuit, and (2) Propulsion Technologies Inc. v. Aitwood Corporation 369 F.3d 896 (2004), from the Court of Appeals for the 5th Circuit.
Borrowed from the US and the Indian courts, the “dominant intention” test is now rooted in our jurisprudence, for the purposes of determining whether the activity under question involves, predominantly, the provision of services or supply of goods.
The Agreed-Upon Test: “Dominant Intention”
The articulation of this test was also borrowed. In Propulsion Technologies, as cited by ABAD, the test is “whether the dominant factor or essence of the transaction is the sale of materials or of services”. Similarly, from Bunebrake, ABAD picked up the language, that the question is “whether their predominant factor, their thrust, their purpose, reasonably stated, is the rendition of service, with goods incidentally involved … or is a transaction of sale, with labor incidentally involved …”
Stated at this level of generality, even when the test offers a framework, its utility depends on how it is to be applied. The “dominant intention” test would seemingly create a need for a fact-specific analysis. The Court in ABAD appreciated this by articulating that the test’s “application may not be a simple and straightforward as the bare language of the entry [tariff heading No. 9824.0000 – Construction Services] may suggest at first sight”. But ABAD, again, goes no further. It sets aside the show-cause notices holding that “[n]o attempt appears to have been made to discover the specific facts applicable to each petitioner, and to the extent that the facts are set out at all, the same have not been fully appreciated, or explored”[9]. It, itself, also makes no attempt of applying the test to the facts before it.
In the decisions that have come since then, the courts have referred to the “dominant intention” test, even as they have differed diametrically in applying it. The Islamabad High Court in Sardar Ashraf Baloch, invoked the “dominant intention” test, which it said, had received “a lucid expression” in ABAD, and which “provide[d] the answer” to the question before it[10]. Similarly, in Matracon, the Peshawar High Court held that “in complex contract where the provisions of goods as well as services are involved, the dominant intention test is to be applied”[11].
While the Courts have reached an agreement that the “dominant intention” provides a useful tool to decide the cases of composite contracts, with the activity under question intertwines the supply of goods and the provision of services, the application of the test on a similar set of facts has been different. And much turns on how the “dominant intention” test is actually applied. When and how does one know, for instance, that the supply of goods or the provision of services predominate in a given contract? On what basis is this determination to be made? Is it on the basis of value of each, to be quantified and compared? Or, is it the case, that a judge before whom this question is raised, would know which one predominates, on the basis of “I’ll-know-when-I-see-it” test?
Construction Works are “Goods”
Before the Islamabad High Court, in Sardar Ashraf Baloch, was a contractor, who under the contract with NHA was to construct a “substantial section of the Hakla to DI Khan Motorway including an interchange”[12]. The contract incorporated “1992 FIDIC Conditions of Contract for Works of Civil Engineering Construction”, and was on basis of “unit pricing method”, which as the Court explained, was “the price for each finished sub-item of the overall works … inclusive of the supply of goods, materials and any incidental services for the construction works”[13]. The construction activities ranged from “earth excavation to concrete pouring and supply of all goods and materials including cement, bitumen, aggregate, steel, etc. required to deliver a finished motorway section ready for use by the motorists”[14]. This was a composite contract, with the supply of goods, and the provision of services, intertwined.
Were these “services” or “goods”? Or both? And in case they were both, which tier of government could levy a tax, the center or the provinces? The Court held that the answer was provided by the “dominant intention” test. It found that the construction contract in question was “for ‘works’ for the supply of the finished product – the road, the bridges and the interchange – rather than one for services alone”[15]. The Court reasoned that “[t]he construction contract was to procure a fully constructed and functional motorway segment rather than procurement of services that formed only a minute and incidental part of the total value and function of the asset”[16].
In other words, services were provided, but only as a component. Those services were incidental to the supply of a good, the final product – a road. The Court, in this regard, reasoned that “[i]t is commonplace for engineers and contractors to provide construction services in relation to the construction of roads and bridges on standalone basis, such as design services, soil testing services, quantity measurement services, product testing services, topographical survey services, and many others”[17]. But in the contract before the Court “such services [were] subsumed as an incidental aspect of the supply of a finished product qua ‘works’ comprising tangible assets”[18] (emphasis asset).
The inquiry, for the Court, turned on what is it that the buyer, the NHA, received. It was a completed road – a tangible “asset”, a “good”. In the words of the Petitioner’s counsel[19], as recorded and agreed by the Court, “the contract was primarily one for supplying a ‘finished product’ that was to become fastened to the earth making it an immovable property of NHA”[20].
The Islamabad High Court, in its analysis, mentioned that the provision of services was merely incidental part of the total value and function of the asset. Therefore, one way to gauge what is meant by the “dominant intention” test is to see what portion of the total value of the activity comprises of the supply of goods, as opposed to provision of services. Another could be to see what is the function of the activity. While there may be many services involved in constructing a road, the function was to provide a completed portion of the road. The completed road itself, the Islamabad Court reasoned, is a good. Therefore, what had been supplied was a good, and not services. As a consequence, the provisional legislatures could not tax the activity, as it did not entail the provision of services.
No, Construction Works are “Services”
Not everyone agrees that the construction of a road for NHA constitutes only supply of goods, as opposed to provision of services. The Peshawar High Court, in Matracon, reached a different conclusion, for instance, on a similar set of facts, as the ones before the Islamabad High Court, in Sardar Ashraf Baloch. In Matracon, however, the issue was that a set of contractors, providing both goods and services as a part of the composite contracts, for constructing and building roads, had challenged the provisions of the Finance Act, 2013, and the superseding, Khyber Pakhtunkhwa Sales Tax on Services Act, 2022 (the “2022 KPK Act”) – provincial legislations that imposed tax on the construction contracts.
The question before the Peshawar High Court was that “whether a works contract falls within the ambit of ‘sale of any goods’, thereby excluding it from the legislative domain of the Province to levy tax thereon”[21]. The Court held no.
In holding this, the Court heavily relied on a number of old cases from the UK, from the 20th and early 21st century[22]. In these cases, the courts looked into contracts (1) to build a hotel[23], (2) to provide and install an engine of 100 horse power[24], (3) supply engines, boilers and machinery for ship-building[25], or (4) a complete ship[26]. Under the usual set of facts, the contract could not be performed due to bankruptcy of the party supposed to provide or supply the promised article(s). As a result, the party to whom the hotel or engines or ships were to be supplied, but were not, in turn, laid a claim that it was entitled to receive “goods”, the components, that were to be supplied to them, irrespective of whether the “works” had been completed or not. The Courts in the UK did not allow for the claims to succeed.
From these cases, the Peshawar High Court concluded that “mere use or provision of materials in the course of a works contract does not, therefore, constitute a ‘sale’ of such materials, and consequently falls outside the ambit of Entry No. 49 of the Fourth Schedule of the Constitution”[27]. This conclusion was, in turn, reached on the basis that the title in the materials does not pass on to the buyer “unless and until they are affixed, consumed, or utilized in the completion of the works”[28].
The Peshawar High Court did not merely rely on cases from the UK, but also on the cases from India. Conversely to Pakistan, in India, the supply of goods is taxed by the states (as opposed to the federal legislature in Pakistan), and services are taxed by the central legislature (as opposed to the provinces in Pakistan). In India, the question of who gets to tax the construction works has been settled by their Constitution, after the 46th Amendment[29], in favor of the states. Under Article 366(29A) of the Constitution of India, “tax on the sale or purchase of goods” has been defined to include under sub-clause (b), “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”.
Before this settlement by the Constitution of India, the courts in India, as referred by the Peshawar High Court, had concluded otherwise. That is, the courts in India had held that “works” including construction works could not be taxed by the states, because construction works were not “supply of goods”. The constitutional amendment was a consequence of these judicial determinations. In the context of construction contracts, for instance, the Indian Supreme Court, in State of Madras v. Gannon Dunkerley & Co., AIR 1958 SC 560, had previously held that “there is no sale as such of materials used in a building contract, and that the Provincial Legislatures had no competence to impose tax …”. This language is reproduced in Matracon, at paragraph 19. In the same vein, a series of Indian cases, referred in Matracon, further suggested that a contract for, assembling and installing machinery and plant[30]; construction of sleeper coaches for the railway[31]; the fabrication, supply, and erection of steelwork[32]; providing and fixing customized windows according to specific designs, drawings, and instructions[33]; manufacturing and installing rolling shutters[34]; and fabrication, supply, and erection of overhead travelling cranes[35], were all “not a sale of goods, but a works contract”. This meant that they could not be taxed by the states (prior to the 46th Amendment to the Constitution of India), but by the center, as the states in India are only granted the power to levy tax on sales of goods, and these “works” were not sale of goods.
The inference that the Peshawar High Court drew is that before the 46th Amendment to the Constitution of India, it had been held, repeatedly, that the works contract, was not to be considered as supply of goods. The Peshawar High Court, then, concluded that “despite divisibility of service and goods portion/component in the construction contract and in view of the legislative field of legislation (exception to entry No. 49), it is the provincial legislature to tax the construction works exclusively”[36] (emphasis added).
Unlike ABAD, Matracon settles the debate by holding that the construction works are necessarily services, and are to be taxed under the provincial legislatures. But Matracon gives a completely different answer than the one that the Islamabad High Court gave to the same question in Sardar Ashraf Baloch.
Conclusion
Policing the divisions between powers of two different tiers of governments is often not easy. The Constitution seeks to neatly bifurcate the taxing powers: the federal legislature can levy a tax on goods, and the provinces on services. But while dealing with the real-world scenarios, this neatness does not necessarily translate into readily available solutions. In composite contracts, where the pricing of the goods and services are not separable, there is an issue as to whether the tax is to be levied on the entirety of the contract, under the presumption that the activity constitutes a supply of goods, or, alternatively, whether such activity comprises of provision of services.
In ABAD, the Sindh High Court borrowed the test from other jurisdictions, to be applied on each set of facts, for determining whether construction works under a particular contract would fall within the taxing domain of the federal or the provincial legislatures. This is referred as the “dominant intention” test. But as with all such tests, articulated at such a high level of generality, the application of such a test, is the actual test. The Sindh High Court, therefore, concluded that each contract would have to be evaluated on these terms, before reaching a conclusion one way or the other. Meanwhile, in applying the “dominant intention” test, two High Courts in Pakistan, have reached completely different results, in adjudicating upon a similar set of facts.
The Islamabad High Court has reasoned that the finished, final product, as a consequence of construction works, is a tangible object, say, a road or a building, and therefore, it is to be considered a supply of goods, as opposed to provision of services. The Peshawar High Court, however, has held the “works” primarily comprises of provision of services, with the supply of goods being only incidental to the provision of services. While the reasoning of the Islamabad High Court is logically sound, and presents a reasonable and acceptable resolution of the dispute, the formulation of the Peshawar High Court, is also not completely without merit. In Matracon, the Peshawar High Court underscored that a “works” contract has not been understood, historically, in common law jurisdictions, to be a contract for the supply of goods. In other words, in a “works” contract, the assumption is that the services component necessarily predominates.
From the vantage point of the taxpayers, the construction contractors, certainty and a final settlement of an issue probably have a high premium. This is not a question where the taxpayers can possibly escape taxation on their business activity: they would either be brought under taxation by the federal government or the provinces. And while there may be a difference in tax rates, or even a preference in dealing with a particular fiscal regulator, the primary interest for the contractors would be that they know exactly who is to tax them, and how much, so that they plan around these given aspects. In India, a constitutional amendment definitively resolved this question. In Pakistan, this question remains alive and kicking.
By: Adeel Wahid, Partner AJURIS.
[1] Constitution (Eighteenth Amendment) Act, 2010
[2] The Constitution of the Islamic Republic of Pakistan, 1973 (the “Constitution”)
[3] This is by virtue of the amendment in item 49 of the Fourth Schedule of the Constitution, after the 18th Amendment. Item 49 now reads: “Taxes on the sales and purchases of goods imported, exported, produced, manufactured or consumed, except sales tax on services”. Previously, tax on services was levied under the Excise Duty Act, 2005
[4] Authored by Justice Munib Akhtar
[5] Writ Petition No. 871 of 2018 (announced in open court on 07.10.2022) (authored by Justice Sardar Ejaz Ishaq Khan)
[6] Tax Reference No. 18/2013 with CM No. 23 & 24/2023 (judgment signed on 02.08.2025) (authored by Justice Syed Arshad Ali)
[7] ABAD, at paragraph 23
[8] ABAD, at paragraph 40.
[9] ABAD, at paragraph 42
[10] Sardar Ashraf Baloch, at paragraph 2.12
[11] Matracon, at paragraph 29
[12] Sardar Ashraf Baloch, at paragraph 1.1
[13] Id
[14] Id
[15] Sardar Ashraf Baloch, at paragraph 2.13
[16] Id
[17] Sardar Ashraf Baloch, at paragraph 2.11
[18] Id
[19] Mr. Babbar Ali Khan
[20] Sardar Ashraf Baloch, at paragraph 2.5
[21] Matracon, at paragraph 13
[22] The Peshawar High Court in Matracon, from the UK, referred to Tripp v. Armitage (1839) 4 M & W. 687 (Australian Jurisdiction); Clark v. Bulmer [1843] 11 M & W 243; Seath v. Moore [1886] 11 App. Cas. 350; Reid v. Macbeth & Gray [1904] A.C. 223
[23] Tripp v. Armitage (1839) 4 M & W. 687 (Australian Jurisdiction)
[24] Clark v. Bulmer [1843] 11 M & W 243
[25] Seath v. Moore [1886] 11 App. Cas. 350
[26] Reid v. Macbeth & Gray [1904] A.C. 223
[27] Matracon, at paragraph 16.
[28] Id
[29] Constitution (46th Amendment) Act, 1982
[30] Carl Still G.M.B.H. v. State of Bihar [(1961) 2 SCR 466]
[31] State of Gujarat v. M/s. Kailash Engineering Co. (Pvt.) Ltd., AIR 1967 SC 547
[32] State of Madras v. Richardson & Cruddas Ltd., (1968) 21 STC 245 (SC)
[33] State of Rajasthan v. Man Industrial Corporation Ltd., (1969) 1 SCC 567
[34] Vanguard Rolling Shutters and Steel Works v. Commissioner of Sales Tax, (1977) 2 SCC 250
[35] Ram Singh & Sons Engineering Works v. Commissioner of Sales Tax, U.P., (1979) 1 SCC 487
[36] Matracon, at paragraph 30
