SERVICE TAX ON WORK CONTRACTS

Rajkumar S. Adukia

 

 

What is ‘work contract’?

In India the tax on sale of gods are levied by the state as sales tax/ VAT whereas taxes on rendering of service as service tax. However, the problem arises when the contracts are such which involves both sale of goods and rendering of services. To address such contracts Finance Act 2007 introduced a new sub clause in the definition of taxable services.

Section 65(105) of the Finance Act, 1994 defines the taxable service in respect of various categories of services. The Finance Act 2007 introduced sub-clause (zzzza) to clause (105) of section 65, to define the taxable service as follows:

“to any person, by any other person in relation to the execution of a works contract, excluding works contract in respect of roads, airports, railways,   transport terminals, bridges, tunnels and dams.”

The Explanation under this sub-clause defines the term “works contract” for this purpose to mean a contract wherein:

(i) Transfer of property in goods involved in the execution of such contract is leviable to tax as sale of goods, and

(ii) Such contract is for the purposes of carrying out,—

(a) erection, commissioning or installation of plant, machinery, equipment or  structures, whether pre-fabricated or otherwise, installation of electrical and electronic devices, plumbing, drain laying or other installations for transport of fluids, heating, ventilation or air-conditioning including related pipe work, duct work and sheet metal work, thermal insulation, sound insulation, fire proofing or water proofing, lift and escalator, fire escape staircases or elevators; or

(b) Construction of a new building or a civil structure or a part thereof, or of a pipeline or conduit, primarily for the purposes of commerce or industry; or

(c) Construction of a new residential complex or a part thereof; or

(d) Completion and finishing services, repair, alteration, renovation or restoration of, or similar services, in relation to (b) and (c); or

(e) Turnkey projects including engineering, procurement and construction or commissioning (EPC) projects;”

Therefore, some of essential elements of any work contract are as follows:

a.       There should be  a transfer of property in goods;

b.      The goods must be liable to sales tax/VAT; and

c.       The contract must for one of the purpose specified in clause (a) to (e) of the above explanation

Therefore, all other works contracts are not subject to levy of service tax under this category. For example, printing contracts, dyeing contracts, maintenance contracts, electrical or structural contracts etc., which are not in the nature of services specified above, are not taxable under this category. It should also  be noted that though the contract for the repair/ alteration of new building, civil structure, pipelines,  new residential complex are work contracts for the purpose of service tax, the contract for repair of plant, machinery, equipment, etc. are not work contract.

 

Erection, commissioning, or installation

Section 65(39a) of the Finance Act 1994 defines erection, commission or installation as follows:

Erection, commissioning or installation” means any service provided by a commissioning and installation agency, in relation to,—

(i) Erection, commissioning or installation of plant, “machinery, equipment or structures, whether pre-fabricated or otherwise” or

(ii) Installation of—

(a) Electrical and electronic devices, including wirings or fittings therefor; or

(b) Plumbing, drain laying or other installations for transport of fluids; or

(c) heating, ventilation or air-conditioning including related pipe work, duct work and sheet metal work; or

(d) Thermal insulation, sound insulation, fire proofing or water proofing; or

(e) Lift and escalator, fire escape staircases or travelators; or

(f) Such other similar services;

Construction services

Construction services have been defined under Section 65(25b) for ‘commercial or industrial construction services’ and Section 65(30a) for ‘construction of complex services’ as follows: “Commercial or industrial construction service” means —

(a) Construction of a new building or a civil structure or a part thereof; or

(b) Construction of pipeline or conduit; or

(c) completion and finishing services such as glazing, plastering, painting, floor and wall tiling, wall covering and wall papering, wood and metal joinery and carpentry, fencing and railing, construction of swimming pools, acoustic applications or fittings and other similar services, in relation to building or civil structure; or

(d) Repair, alteration, renovation or restoration of, or similar services in relation to, building or civil structure, pipeline or conduit, which is —

(i) Used, or to be used, primarily for; or

(ii) Occupied, or to be occupied, primarily with; or

(iii) Engaged, or to be engaged, primarily in,

commerce or industry, or work intended for commerce or industry, but does not include such services provided in respect of roads, airports, railways, transport terminals, bridges, tunnels and dams;

Construction of complex” means —

(a)   construction of a new residential complex or part thereof; or

(b)   completion and finishing services in relation to residential complex such as glazing, plastering, painting, floor and wall tiling, wall covering and wall papering, wood and metal joinery and carpentry, fencing and railing, construction of swimming pools, acoustic applications or fittings and other similar services; or

(c)   repair, alteration, renovation or restoration of, or similar services in relation to, residential complex;

Validity of Service tax on work contract:

Entry 54 of List II of the Seventh Schedule (List II) to the Constitution enables the State to levy “taxes on the sale or purchase of goods other than newspapers subject to provision of Entry 92A of list I”. Article 366 of the Constitution is definitions clause for the purposes of the Constitution. The 46th amendment to Constitution has inserted a new clause (29A) which defines term “tax on the sale or purchase of goods” and it includes under (b) “a tax on the transfer of property in goods (whether as goods or in some other form) involved in the execution of works contract” and under (d) “a tax on the transfer of the right to use any goods for any purpose (whether or not for a specified period) for cash, deferred payment or other valuable consideration”. Therefore, having regard to entry 54 of List II of the Seventh Schedule, the transaction contemplated by sub-clause (b) and (d) of clause (29A) of article 366 is a transaction of sales of goods. The Supreme Court of India in paragraph 40 of its judgement in case of Builders’ Association of India V. Union of India [1989] 73 STC 370 (SC); (1989) 2 SCC 645, says: “As the Constitution exists today, the power of the States to levy taxes on sales and purchases of goods including the ‘deemed’ sales and purchases of goods under clause (29-A) of article 366 is to be found only in entry 54 and not outside it”.

Therefore, question arises, whether Service Tax can be imposed where contract is composite or indivisible (i.e. for sale/supply of goods and services) such as construction contracts, software development contracts, etc?

 

Entry 48 in List II of Sch. VII to the Government of India Act, 1935, included the item ‘taxes on the sale of goods’ but the definition of “sale” insection 2(h) of the Madras General Sales Tax Act was enlarged so as to include ‘a transfer of property in goods involved in the execution of works contract’. The issue arose in The State Of Madras V. Gannon Dunkerley & Co., (Madras) Ltd. (1958) 9 STC 353(SC), as to whether the provisions introduced by the Madras General sales tax Act are ultra vires the powers of the Provincial Legislature under Entry 48 in List II. The Apex Court 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 a tax thereon under Entry 48. The 46th amendment to the Constitution was made thereafter to provide for a definition of ‘tax on sale or purchase of goods’, which includes transfer of property in goods (whether as goods or in some other form) involved in the execution of a works contract.

Even after the amendment to the constitution, the definition of sale under the Central Sales Tax Act was not amended. The levy of sales tax on inter-state works contract by the States was challenged in Gannon Dunkerley’s case (1993) 88 STC 204 (SC) where the apex court held that State Governments were not competent to levy sales tax on inter-state works contract. The Finance Act, 2002 has also amended the definition of ‘sale’ under the Central Sales Tax Act, 2002 on the lines of the definition of deemed sale under the 46th amendment to the constitution. In the context of service tax, as already stated, it has been held that works contract cannot be vivisected for the purpose of levy of service tax. The landmark cases are:

·         Daelim Industrial Co. Ltd. Vs. CCE (155) ELT 457 (Tri-Del)

·         CCE, Vadodara vs. M/S. Daelim Industrial Co. Ltd. 2004 (170) ELT A181 (SC) – SLP filed by department dismissed

·         Larsen & Toubro Ltd. vs. CCE 2004 (174) E.L.T. 322 (Tri. - Del.) v Commissioner vs. Larsen & Toubro Ltd (182) ELT A149 (SC)- Supreme Court admitted the appeal filed by the Commissioner of Central Excise against the decision of the Tribunal

·         Emerson Process Management Power & Water Solution Inc. vs. CCE 2006 (3) STR 508 (Tri. - Del.)

·         CCE vs. Larsen & Toubro Ltd. 2005 (69) RLT 62 (CESTAT-Che.)

·         CCE vs. Shapoorji Pollanji And Co. Ltd. 2005- TIOL-892-CESTAT-DEL

 

There is a deeming fiction in the constitution to treat the transfer of property in goods involved in the execution of works contract as liable to sales tax. However, there is no such deeming fiction to provide for a tax on the service component of works contract. Therefore, the imposition of tax on the service component in a works contract can still be challenged.

 

Valuation of service under work contract

Rule 2A of the Valuation Rules provides for valuation of services provided in relation to the execution of a works contract.

As per rule 2A(1) of valuation rules, the value of the works contract services shall be equivalent to the gross amount charged for works contract less the value of transfer of property in goods involved in the execution of works contract.

For this purpose,-

1. Gross amount shall not include VAT or Sales Tax paid on transfer of property in goods (Rule 2A(1) (i))

2. Value of works contract service shall include:

3. As per rule 2A(1)(ii) of Service tax valuation rules when VAT or sales tax is paid on the actual value of transfer of property in goods, then such value adopted for the purpose of payment of VAT or Sales Tax shall be taken as the value of transfer of property in goods for determining the value of works contract service under clause (i) of Rule 2A (1) (it can be deducted from the gross value to arrive at the service component in the works contract for the purpose of payment of service tax.)

Optional Composition Scheme for Works Contract:

As a trade facilitation measure and also for ease of administrative convenience, the Works Contract (Composition Scheme for Payment of Service Tax) Rules, 2007 has been notified vide notification No.32/2007-Service Tax dated 22.05.07, made effective from 1.06.2007, whereby the service provider has been given an option to pay service tax equivalent to 4% of the total value of the works contract instead of paying service tax at the rate specified in section 66.

The Government has revised the rate of service tax from 2 % to 4 % under composition scheme on Works Contract vide Service Tax Notification No.7/2008-ST dated 1st March 2008.

It has been clarified by CBEC that the service tax becomes chargeable on receipt of the payment and on the amount for receipt.  Therefore, the rate of 4 per cent is applicable for the work contract where the payment of service is receipt on or after 01.03.08

Works Contract (Composition Scheme for Payment of Service Tax) Amendment Rules, 2009 dated 07.07.2009

The ‘gross amount charged’ under the composition scheme has now been expanded with changes in Explanation to Rule 3 of Works Contract Composition Rules. The said Explanation now provides that for the purpose of composition scheme the ‘gross amount charged’ shall be the sum, -

a)  Including-

o        the value of all goods used in or in relation to the execution of the works contract, whether supplied under any other contract for a consideration or otherwise; and

o        the value of all the services that are required to be provided for the execution of the works contract;

b)  Excluding-

o        the value added tax or sales tax as the case may be paid on transfer of property in goods involved; and

o        the cost of machinery and tools used in the execution of the said works contract except for the charges for obtaining them on hire:

The Circular No D.O.F. No. 334/13/2009-TRU dated 6.7.2009 issued by Ministry of Finance expresses the following intention of the amendment —

a.       the gross value should also include the value of goods received free of cost from the client;

b.      Gross value should also include the goods or materials used in the works contract whether forming part of consideration of contract or not

This amendment would not be applicable to the following contracts—

a.       where the execution of the contract has already commenced on or before 7.7.2009

b.      the payment [except by way of debit or credit in any account] has been made in relation to the said contract on or before 7. 7. 2009

The sub-rule 3 of Rule 3 of the Works Contract Composition Rules provides that composition option is qua each contract and option must be exercised prior to payment of service tax on a works contract and the option once exercised shall apply for the entire works contract and cannot be withdrawn until the completion of the said works contract.

Vide the amendment Rules, 2009 sub-rule 4 has been inserted so as to provide that the above option shall be permissible only where the declared value of the works contract is not less than the gross amount charged for such works contract. Thus, the composition scheme would be applicable only if the composition rate [presently 4%] is applied on an amount which is atleast equal to or more than gross amount.

Service Tax exempted in relation to execution of a works contract in respect of canals

The Central Government vide Notification No. 41/2009 –ST., dt, 23/10/2009 exempts the taxable service referred to in sub-clause (zzzza) of clause (105) of section 65 of the said Act, in relation to execution of a works contract in respect of canals, other than those primarily used for the purposes of commerce or industry, from the whole of service tax leviable thereon under section 66 of the said Act.