1% Cess Only On Construction Cost, Not Entire Contract Value: Kerala High Court

A Division Bench of the Kerala High Court on August 19, 2026, clarified that the 1% cess under the Building and Other Construction Workers Welfare Cess Act, 1996 can be levied only on the "cost of construction" and not on the entire value of a composite works contract where supply and construction components are separately identifiable.

The Bench, comprising Chief Justice Soumen Sen and Justice Syam Kumar V.M., disposed of 18 writ appeals filed by Class A contractors of the Kerala Water Authority (KWA), challenging deductions made from their bills at 1% on the entire contract amount.

The Dispute Over Deductions from Contractor Bills

The appellants were awarded item-rate Bill of Quantities (BoQ) contracts for the supply, erection, testing, and commissioning of clear water distribution systems, including laying of pipelines. The KWA deducted 1% of the total bill amount towards cess under the Cess Act, without segregating the value of materials, equipment, pipes, and other supplies from the actual construction activities.

The contractors argued that the BoQ contracts clearly distinguished between supply items (pipes, valves, machinery, laboratory equipment) and construction-related activities (civil works, laying, erection). They contended that cess could be levied only on the cost attributable to "building or other construction work" as defined under Section 2(1)(d) of the Building and Other Construction Workers (Regulation of Employment and Conditions of Service) Act, 1996 (the Regulation Act).

"Pure Supply Contracts Outside Cess Act's Reach" – Contractors Argue

Relying on the Supreme Court's ruling in Uttar Pradesh Power Transmission Corporation Ltd. v. CG Power and Industrial Solutions Ltd. , the appellants asserted that a pure supply contract falls outside the ambit of the Cess Act. They argued that the same principle applies even within a composite contract, provided the BoQ enables clear identification and segregation of the supply portion.

The learned counsel, N. Krishnaprasad, submitted that the statutory liability is confined to “cost of construction” and that the profit element of a contractor cannot be included in that cost. He further contended that the dominant intention test, once applied to works contracts, has been rendered irrelevant by the legal fiction under Article 366(29-A) of the Constitution, as held in Bharat Sanchar Nigam Ltd. v. Union of India and Larsen and Toubro Ltd. v. State of Karnataka .

"Composite Contract, No Segregation Allowed" – KWA Counters

The KWA, represented by its Standing Counsel, argued that the contracts were indivisible works contracts where supply and execution were integrated. It relied on Clause 8.15.2 and 8.16.12 of the Tender Conditions, which authorised deduction of 1% towards the Kerala Construction Workers Welfare Fund. The Authority contended that the rates quoted by the contractors included the cess component, and that only the value of departmental materials supplied by the employer could be excluded.

Court's Analysis: The Composite Contract Fallacy

The High Court accepted that the projects, being water works involving pipelines, fall within the statutory definition of "building or other construction work" . However, it firmly rejected the argument that the composite nature of the contract automatically justifies levy on the entire contract value.

“The contractual character of the agreement does not enlarge the charging provision contained in Section 3,” the Court observed. “A BoQ contract does not, by itself, render a works contract divisible… Whether a contract is divisible depends on the intention of the parties as reflected in the contractual terms and not merely on the existence of separately priced items.”

The Bench clarified that the levy under Section 3 of the Cess Act is on the "cost of construction", not on the "contract value". It held that the Rules under the Cess Act cannot be interpreted to enlarge the charging provision.

Key Observations from the Bench

"A plain reading of Section 2(1)(d) of the Regulation Act shows that 'water works' and 'pipelines' are specifically included within the ambit of 'building or other construction work'."

"Merely because a contract is structured as an item-rate BoQ Contract, it does not cease to be a composite works contract . Equally, the mere existence of a composite works contract does not automatically render every item comprised therein liable to cess."

"Cess under the Cess Act is payable in respect of 'civil works' and supply and delivery of equipment and material and handling, erection, testing and commissioning works do not come within the purview of the said Act as these contracts do not involve any construction."

The Court also noted that the BoQ in the present cases contained separate entries for civil construction and for items like laboratory equipment, spectrophotometers, computers, and refrigerators, which are pure supply items.

Final Directions: Provisional Deductions, Final Assessment, and Refund

The High Court declared that the respondents are entitled to levy and recover cess only on those components that constitute the "cost of construction" under Section 3 of the Cess Act. It directed the competent Assessing Authority to recompute the cess payable, after affording the contractors a hearing, by excluding separately identifiable supply components.

The Court emphasised that deductions made at source under Rule 4(3) of the Cess Rules are provisional and do not attain finality. Contractors may furnish returns under Section 4, and the Assessing Authority must conduct a final assessment under Section 5. Any excess recovery shall be refunded or adjusted at the contractor’s option.

The entire recomputation exercise must be completed within two months from the date of the judgment, with refunds to follow within one month.