TAXATION OF WORKS CONTRACT CA Madhukar N. Hiregange CA Monalisa Khuntia Introduction: The new service tax regime based on Negative list has come into effect from 1st of July 2012. Though there are number of aspects and issues under the same, one of the main issues and concerns is about the works contract. This article discusses the valuation methodology for works contract w.e.f. 01.07.2012. What is Works Contract as per the new definition? There was lot of discussion and debate as to whether works contract is subject matter of service tax. It is now specifically set out in the definition of services to include declared service. In the declared services definition, service portion in a works contract is specifically included. Works contract for the purpose of service tax is specifically defined in Section 65B(54) of the Finance Act, 1994 to mean the contracts for the specified purposes which involves transfer of property in goods in the execution of such contract and such transfer of property in goods is leviable to tax as sale of goods. The specified purposes are for - carrying out o construction, o erection, o commissioning, o installation, o completion, o fitting out, o repair, o maintenance, o renovation, o alteration of any moveable or immovable property 1 August 2015
- for carrying out o any other similar activity or o a part thereof in relation to any moveable or immovable property It is important to note that the scope and coverage of the definition of works contract is now very vide and covers many other services which was earlier covered under different categories like, management maintenance or repair services, Business Auxiliary Services, Authorized Service Station, etc., Valuation for works Contract The valuation of taxable service in relation to services involved in the execution of works contact has been separately dealt with in Rule 2A of the Valuation Rules. In terms of the said Rule, the value of service portion in the execution of a Works Contract would be equivalent to - The gross amount charged for the works contract - less the value of transfer of property in goods involved in the execution of the said works contract. - Less the VAT or Sales Tax paid or payable, if any, on transfer of property in goods involved in the execution of the said works contract. The question would arise how to determine the value of goods said to have been transferred in the execution of works contract. For this it should be done in the following manner: - Where VAT /sales tax has been paid on the actual value of transfer of property in goods involved in the execution of the works contract, i.e. based on records maintained the actual value of goods transferred is identified and VAT/Sales Tax is paid accordingly, then the same value be taken as deduction for computing taxable value for payment of service tax. - If it is not so, then the value may have to be determined in any manner which can be substantiated with on sufficient documentary evidence (irrespective of the method adopted for VAT/Sales Tax). 2 August 2015
- In case the valuation has not been or cannot be determined by the above methods, then taxable service has to be compulsorily determined and tax to be paid by the person liable to pay tax as per the manner mentioned below: If the works contract is for original works, the service tax should be payable on 40% of the total amount charged for the works contract. If the works contract is not covered above including works contract entered into for a) maintenance or repair or reconditioning or restoration or servicing of any goods or b) maintenance, repair, completion and finishing services such as glazing, plastering, floor and wall tailing,, installation of electrical fittings of an immovable property, service tax would be payable on 70% of the total works contract value. [Please note that prior to 1.10.2014 service tax was payable on 60%] For the purpose of the above computations, there are few things which are relevant. Firstly, the term Total amount which is relevant for computation of taxable value based on fixed percentage as discussed above has to be understood. In this regard, the said term is defined to consider the total sum of the following: - Gross amount charged for the works contract - Fair market value of all goods and services supplied in or in relation to the execution of the works contract, whether or not supplied under the same contract or any other contract. Out of the said amount the following has to be deducted- - Any amount already charged for the said goods or services - VAT/Sales tax if any levied thereon. For determining the fair market value of goods and services so supplied, generally accepted accounting principles have to be followed. The determination of fair market value is going to be a very challenging task as it may be difficult to convince the revenue authorities about the methodology adopted. Though there was specific wording in the earlier provision as to goods and services supplied by the service recipient, the same is silent in the present rule. Obviously the same is implied. Secondly the term Original works has been defined to mean all new constructions; all types of additions and alterations to abandoned or damaged structures on land that are 3 August 2015
required to make them workable; and erection, commissioning or installation of plant, machinery or equipment or structures, whether pre-fabricated or otherwise. Thirdly, for the purpose of computing the value of services involved in the works contract, it is specifically said that the following shall be included. Labour charges for execution of the works; Amount paid to a sub-contractor for labour and services; Charges for planning, designing and architect s fees; Charges for obtaining on hire or otherwise, machinery and tools used for the execution of the works contract; Cost of consumables such as water, electricity, fuel, used in the execution of the works contract; Cost of establishment of the contractor relatable to supply of labour and services; Other similar expenses relatable to supply of labour and services; Profit earned by the service provider relatable to supply of labour and services; Eligibility of CENVAT Credit: As regards to CENVAT Credit, there is no bar on availment of credit of service tax paid on any inputs services in relation services involved in such works contract. However as far as duty paid on goods are concerned, it is specifically restricted for inputs used in or in relation to the said works contract. It would be interesting to note that benefit of CENVAT Credit of Capital Goods would to be available. Transition for existing schemes Many service providers, who are presently paying taxes under different schemes, are all required to fall into one umbrella as discussed above and there is no option for them to continue under their old scheme. This may create lot of difficulties in various running contracts, where the prices are fixed based on earlier tax structure and Work Orders are issued on particular basis. Further the computation of service tax to some extent depends upon the scheme under which the payments are being made under their respective state sales tax/vat laws. Therefore the impact of the same has to be examined. Further question would arise in cases where reverse charge as discussed below, how the past contracts to be given effect to. Reverse Charge In respect of services provided or agreed to be provided by way of works contract, by - any individual, 4 August 2015
- Hindu Undivided Family or - proprietary firm or - partnership firm, whether registered or not, - including association Provided or agreed to be provided to - any company formed or registered under the Companies Act, 1956 (1 of 1956) or - a business entity registered as body corporate (this also includes LLPs) The service tax only to the extent of 50% of service tax payable has to be paid by the service provider and balance 50% has to be paid by the service recipient. Please note under works contract services, where both service provider and service recipient is the persons liable to pay tax, the service recipient has the option of choosing the valuation method as per choice, independent of valuation method adopted by the provider of service. As a consequence of this, the specified service recipients who are not at all providing any taxable service would also be liable to register under service tax and pay service tax for the services received. This would add additional compliance to such companies/corporate bodies. Further question arises where the service provider is eligible to claim the benefit of small service provider exemption, whether the service recipient is liable to be registered for paying Service tax. As per our understanding, the service recipient has to get himself register irrespective of the SSP exemption applicable to service provider. However, other than the SSP exemption the service recipients can claim other exemptions which would be applicable to service providers. Importance points to be noted 1. Whether value of free issue material need to be included as per Rule 2A of ST valuation Rules? Where the explanation that the gross amount charged shall include the value of goods and material is computing the abetment given to construction services by various notifications at different points of time was under challenge. While dismissing write petitions, held if an assessee wants to take benefit of the notification, he must comply and adhere to the terms and conditions stipulated as per the notification. Held in the case of G.D Builders v UOI 2013-TIOL-908-HC-Del-ST 5 August 2015
The value of goods and material supplied free of cost by a service recipient to the provider of taxable construction service, being neither monetary or non-monetary consideration paid by or flowing from the service recipient, accruing to the benefits of service provider, would be outside the taxable value or the gross amount charged. The same is being appealed to Apex Court. Held in the case of Bhayana Builder Pvt Ltd 2013-TIOL-1331-CESTAT-DEL-LB Comments if the terms of contract set out that consideration for service includes value of the goods and service supplier by recipient as well, the same may be part of taxable value. 2. The aspect theory of two statues taxing the same transaction would not apply to enable the value of the services to be included in the sale of goods or the price of goods in the value of the service. (Bharath Sanchar Nigam Ltd. v UOI 2006 (002) STR 161 SC) Comments: This decision would ensure that once values are arrived at as per either the VAT law or the service tax law, only the balance value would be liable under the other law. 3. The requirement of the Valuation Rules of paying service tax on the value of reimbursement was held to be ultra virus of the section which postulates payment of service tax on the value of services [Intercontinental consultants 2013 (29) STR (9) Del]. However, the said judgement is countered by including reimbursements as a specified element of consideration by amending the definition of consideration in union budget 2015-16 for valuation of service tax liability. 4. The deduction of 70% towards material which is specified in VAT law as arriving at the value of material involved and paying service tax on 30% under Notification 12/2003 Is in order and deduction valid. [Wipro GE Medical Systems P Ltd 2012 (28) STR J44 (SC) Note: The notification 12/2003 has been withdrawn w.e.f. 01.07.2012 which is likely to cause immense difficulty in taking a deduction for material in the light of the varying VAT laws providing for a deduction. Advisable not to test this deduction now. 5. Service tax not leviable on goods on which sales tax was paid, two taxes being mutually exclusive. Kone Elevators India Pvt. Ltd. v Commissioner of Service Tax Chennai [2007 (8) STR 525 (Tri-Chennai) 6 August 2015
Comments: this is an important decision based on the Supreme Court s decision in BSNL s case. In related development, Supreme Court held it would not be legally correct to make a distinction in respect of lift, for the contract speaks of obligation to supply of goods and material and installation of the lift which convey performance of labour and service. The fundamental characteristics of works contract are satisfied. Earlier decision rendered in Kone Elevators 2005-TIOL-30-SC-CT-LB overruled- Kone Elevators India Pvt Ltd v. State of Tamil Nadu 2014-TIOL-57-SC-CT-CB. Conclusion: In some respects, the new scheme of taxation for works contract is going to ease the complexities as all types of works contract is brought into one umbrella. However practically there may be lot of challenges which the businessmen have to face to align the existing practices to the new scheme considering various business propositions. The lack of clarity in classification would also lead to more complex and irresolvable issues cropping up. Please reach us at madhukar@hiregange.com or monalisa@hiregange.com for any further clarifications/ suggestions / feedback. 7 August 2015