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Service Tax - Works Contract
[Submitted by CA. Madhukar N. Hiregange,
FCA, DISA(ICAI),
Bangalore, Karnataka]
June 13, 2007
The non compliance with service tax by the construction industry in
general, added to the conflicting circulars and the decision in the case
of Daelim Industries of non applicability of service tax on indivisible
contracts has led to this simpler and more importantly lesser impact
alternative being proposed to encourage compliance.
This entry would be legally valid if the "deemed service" concept can be
legally valid. The clarity in this aspect however may take some time if
challenged.
The service tax on "works contract" would be w.e.f. 1.06.2007. This
category seeks to tax those services wherein transfer of property in goods
is involved during the execution of works contract. The tax would be on
services involved in the execution of a works contract. This category
however deals with only certain type of activities wherein the transfer of
property in goods is involved and not all type of services wherein the
goods are also transferred like Management, Maintenance and repair
Services , Business auxiliary etc.
Definition
"Works contract" means a contract wherein transfer of property in
goods involved in the execution of such contract is leviable to tax as
sale of goods and such contract is for the purpose of carrying out -
- 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 relating 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
- 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
- Construction of a new residential complex or a part thereof or
- Completion and finishing services, repair, alteration, renovation or
restoration of, or similar services, in relation to (2) or (3) above or
- Turnkey projects including engineering, procurement and construction
or commissioning (EPC) projects.
The services provided by any person, to any other person in relation to
execution of a works contract excluding works contract in respect of
roads, airports, railways, transport terminals, bridges, tunnels and dams
would be taxable under this head as per section 65(105)(zzzza).
The term "turnkey projects" has not been defined and one would have to
be understood in common parlance until clarified.
Who is liable? To whom applicable?
This entry would be applicable to the following existing service
providers:
- Industrial and Commercial Construction
- Construction of Complex
- Erection, installation and Commissioning
If there are works contracts which cover activities not coming under
the ones specified above, they would have to be taxed under other existing
heads and consequently, the composition benefit in such cases would not be
available. In such a scenario, the existing notifications such as 12/2003
ST and 1/2006 ST would have to be relied upon to get the any deductions.
For pure labour services where there is no material involved the
service would continue to be covered under the above categories as the
definition of works contract makes it clear as to the requirement of
transfer of property in goods for a contract to be liable under this
category.
Composition Scheme
Works contract (Composition Scheme for Payment of Service Tax) Rules
2007 has been notified vide notification 32/2007 ST dated 22.05.2007 by
the Central Government for the purpose of specifying the scheme for
composition. The person executing works contract has the option to pay tax
under the composition scheme at the rate of two percent on the gross
amount charged for the works contract. Gross amount shall not include the
VAT or sales tax paid on the goods transferred during the execution of
such works contract. The option is to be exercised prior to payment of
service tax in respect of the said works contract and once exercised,
shall be in force till the completion of the works contract.
Exemption
Services in relation to execution of works contract provided by any
person to any other person in relation to construction of ports or other
ports has been exempted from service tax. This exemption shall not extend
to services of completion, finishing, repair, alteration, renovation,
restoration, maintenance or repair. This maybe an unintended omission.
Valuation
A new Rule 2A has been inserted by notification 29/2007 ST dated
22.05.2007, which prescribes the valuation method in case of works
contract service. The value of works contract service shall be equivalent
to the gross amount charged for works contract less the value of goods
transferred during the course of execution of works contract. The gross
amount shall not include the VAT and sales tax paid on the goods
transferred. The service provider shall ensure that the value of works
contract service as aforesaid shall include the following -
- 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 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
and
- Profit earned by the service provider relatable to supply of labour
and services
The above has been cut pasted from the landmark decision of Gannon
Dunkerly under sales tax law but may not be legally valid, as some of the
components above do not appear to have the characteristics of a service at
all.
It remains to be seen whether the deduction for CST paid on transfer of
property would be allowed. At present, it appears to be deductible.
It is to be noted that the rules specifically allows for deduction of
the amount on which Sales Tax/VAT is paid if it is on actuals. On the
other hand if it is on notional basis or tax is paid under composition
scheme the rules is silent as to how the value of the goods has to be
determined.
In view of the paper writers, the value of the goods added with the
normal Gross Profit ratio would be proper methodology to arrive the value
of the goods transferred. The said value can be claimed as deduction while
arriving the value of service in the works contract as per the valuation
rules.
Cenvat credit
Where the service provider opts for the composition scheme for the
purpose of payment of service tax, he shall not take cenvat credit of duty
and cess paid on inputs used in relation to such works contract. However
the credit on capital goods used for providing the service as well as the
input service credit ( sub contractors , insurance, telephone, manpower
supply, architect etc) would be available.
Where the service provider does not opt for composition scheme, he
should be entitled to cenvat credit on inputs, input services and capital
goods used in execution of such works contract.
Possible Issues
- Whether the works contractor can continue under the existing entries
for ongoing contracts?
Comments: Since there is a new entry it is presumed that service
providers may have to choose considering the principles of Section 65A
on classification. However if they do not transfer any materials they
would continue under construction or erection categories. Herein it is
important to note that the department letter F.No. B1/16/2007 TRU dated
22.05.2007 goes on to say that contracts which are treated as works
contract for levying VAT/sales tax shall also be treated as works
contract for levying service tax. However, this letter would have to be
seen in the light of the explanation to section 65(105)(zzzza), which
deals with the contracts which can be regarded as works contract under
this category. This has already been discussed under the head definition
given earlier. This leads us to the conclusion that under the specified
categories of activities, if the definition of works contract were
satisfied, the assessee would be liable under this head.
- Whether the works contracts involving materials in progress can also
opt for the new entry though earlier they were registered under the old
entries?
Comments: The intention of the legislature in bringing about this
entry and the definition itself allows ongoing construction and erection
contracts to be reclassified under the WC entry. Therefore such
contractors can opt for the entry by intimating the department for
inclusion of new category in the registration certificate.
- What is a turnkey contract?
Comments: The expression has not been defined and the common
understanding may have to be adopted. It may indicate contracts of
bigger size having a number of sub contracts or differing nature such as
erection of a plant or a town itself. These contracts earlier were
covered under erection head.
- Whether the option of availing the credit on all the inputs (cement,
steel, glazing, tiles etc) and paying the service tax on the gross
amount is still available?
Comments: The composition scheme is optional and the works
contractor can even pay service tax on a value arrived at as aforesaid
at the normal rate. The law as it stands today is silent regarding the
cenvat credit on inputs in such a scenario as the credit has been
expressly barred only in case of an assessee opting for composition
scheme. Where the amount subject to VAT/sales tax has been deducted from
the gross value to arrive at the taxable value, it is hard to imagine
that credit would be available on inputs when the material value is not
considered for paying service tax. This aspect might have to be
clarified in future. Service providers who claim this may face
litigation and possible retrospective amendment.
- Whether the option chosen under VAT law has any bearing for the
classification or valuation under this new entry?
Comments: The WC option provides for the option of deducting the
value of goods transferred.. The Rules provides that the value which is
adopted for Sales Tax/VAT would be accepted if it is actuals. However
for the purpose of sales tax/VAT ad hoc method of value of materials is
adopted or composition payment of tax is opted under Sales Tax/VAT, then
the deduction of value would be dependent upon the actual value of goods
transferred. This may have to be arrived based on the supporting
evidence/document.
- What is the value of service for the purpose of computing Rs. 8
lakhs exemption limit under the WC entry?
Comments: The value of service would be the Gross amount
determined in terms of Valuation Rules. In other words Gross value of
the works contract less value of the goods transferred less Sales
Tax/VAT. However the contracts executed upto 31.5.2007 would not be
reckoned.
- Whether the service providers under the specified categories were
not liable for works contracts earlier to this entry?
Comments: The entry read with the department circular indicates
that works contracts were not earlier covered. The purpose for which
this entry was bought in also is favorable to this interpretation.
Therefore it can be construed that there was no liability earlier. This
view is also confirmed in the case of Dr. Lath Path Labs P Ltd. { 2006
(3) STR (711(T- Bom). This could lead to a situation where the service
provider who has paid the service tax from their pockets ( not recovered
from the customers) could go for a refund especially if the same was
done in pursuance of an investigation.
- Whether the sub contractors would be exempt as the main contractor
is paying the service tax?
Comments: The sub contractors would also have to discharge the ST
under works contract or other categories and would be liable for the tax
unless they are below Rs. 8 Lakhs.
- Whether the option of 2% allows for cenvat credit on capital goods
and inputs?
Comments: The cenvat credit on inputs is barred. However there is
no bar on the credit on capital goods and input services though the
budget clarifications had included such a restriction.
These are some of the important issues, which have been covered in this
article. The important gleaning from this entry is that instead of
litigation this option maybe preferable from a practical viewpoint and it
is expected that most of the service providers in these three categories
would be opting for this scheme.
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