1 b s r & co © 2006 bsr & co., a firm of chartered accountants, duly registered under the...

1B S R & Co © 2006 BSR & Co., a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.

Works Contract

Vs.

Other Construction Services

-by

Sanjeev Saraf

26 June 2010


Content

Works Contract

“Works Contract” – What is it?

Evolution under Sales tax law

Evolution under Service tax law – relevant taxable categories

Key Issues



Works Contract

Goods

Labour &

Service

Contract involving transfer of property in goods

along with consumption of services

Transfer of Property in

goods Consumption



TYPES OF CONTRACTSTYPES OF CONTRACTS

SALE CONTRACT

DIVISIBLE INDIVISIBLE

WORKS CONTRACT SERVICE CONTRACT

• Purely for Sale of Goods

• Property in goods passes on delivery

• Normal sales Tax/VAT

• Purely for services

• Service tax

• Split Contract - Sale - Service

• Property in Goods passes on delivery

• Normal Sales Tax /VAT

• Service tax

• Composite Contract

• Supply & Service

• Property in Goods passes on accretion

• VAT on “deemed sale”

• Service tax!!!

• Daelim• BSBK • works contract category



A transaction may as works contract, if :-

Property passes as and when the work is undertaken

Work is performed on the property belonging to another

Transfer of property is by the theory of accretion or accession

Contract is for one type of work and the property passes in another

Primary object is carrying out work with the use of labour and services, and material are used in the

course of execution of such work


“Works Contract” – wings spread…

Works Contract

Buildin

g

Constru

ctio

n

Turnkey

projects

Infrastructure

projectsCivil Jobs Commissioning

of Plant

Maintenance

contracts


Content

Works Contract




Key Issues


“Works Contract” – Evolution under Sales tax law

Applicability of Sales tax on works

contract1953

SC Held: • “Sales-tax” leviable only on “Sale” of “Goods”;

• “sale” would happen only if there is a “transfer of Property in chattle as chattle”. Under the law, there can not be agreement relating to one kind of property and sale as regards to another

• Levying tax on materials used in construction of building is not within the competence of the Provincial Legislature

(State of Madras V/s Gannon Dunkerley & Co. (Madras) (1958) 9 STC 353)

198246th Constitutional

Amendment

• States sought amendment in the Constitution to enable them to levy tax on “Goods involved in execution of Works Contract”

• Birth to the 46th Constitutional Amendment in the year 1983

• States given power to tax transfer of property in goods involved in the execution of Works contract – “deemed sale”



46th Constitutional Amendment - a46th Constitutional Amendment - amendment to Article 366 by inserting mendment to Article 366 by inserting Clause 29A: Clause 29A:

““tax on sale or purchase of goods” includes –tax on sale or purchase of goods” includes –

.... .... ....

(b) A tax on transfer of property in goods (whether as goods or in some (b) A tax on transfer of property in goods (whether as goods or in some other form) involved in the execution of Works contract;other form) involved in the execution of Works contract;

.... .... ....

Consequent to the amendment. states amended their definition of Sale to include “Works Contract”



1989Validity of 46th

amendment challenged

SC Held:

After 46th Constitutional Amendment

• States amended definition of Sale to include deemed sale i.e. transfer of property in goods involved in case of works contract

• State can levy sales tax on goods involved in works contract

(Builders Associations V/s UOI (1989) 73 STC 370)

1993Sales tax on value of

goods involved in works contract?

SC Held:

Works contract being included in the purview of sales tax does not entitle states to levy sales tax on entire contract value (including services)

Value to be arrived by reducing value for labour and other services from the works contract value

(Gannon Dunkerley & Co. V/s State of Rajasthan [1993] 088 STC 0204)


Content

Works Contract




Key Issues


Works Contract – Evolution under Service tax law

• With 46th amendment, state governments started levying VAT on the goods element involved in works contract

• However, the service element under works contract remained untapped

• Gradually, Central Government started taxing the same by considering the service element in works contract as service

• Started levying Service tax on service element under Service tax law by:

• Introducing new service category or

• Expanding scope of existing services


Works Contract Service and Other Construction related service

Works Contract Service (1 June 2007) Other Construction related service:

a) Erection, Commissioning or Installation of plant, machinery, equipment or structures, electrical or electronic devices, etc.

• Erection, Commissioning or Installation service (10 September 2004)

b) Construction of New building or civil structure or part thereof

• Commercial or Industrial Construction Service (10 September 2004)

c) Construction of New residential complex • Construction of Complex Service (16 June 2005)

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

• Management, Maintenance or Repair service (1 July 2003)

e) Turnkey projects including EPC projects

Others:

• Site Formation and Clearance, Excavation and Earth moving and demolition service (16 June 2005)


Relevant service categories – Definition

Commercial or Industrial construction services (10 September 2004) Section 65(105)(zzq) defines: Taxable service means ‘any service provided or to be provided to any other

person in relation to commercial or industrial construction’

Explanation (1 July 2010): For the purposes of this sub-clause, the construction of a new building which is intended for sale, wholly or partly, by a builder or any person, authorised by the builder before, during or after construction (except in cases for which no sum is received from or on behalf of the prospective buyer by the builder or the person authorised by the builder before grant of completion certificate by the authority competent to issue such certificate under any law for the time being in force) shall be deemed to be service provided by the builder to the buyer.

Section 65(25b) defines: ‘Commercial or Industrial construction’ means

construction of a new building or civil structure or a part thereof; or

construction of pipeline or conduit; or

completion and finishing services such as glazing, plastering, painting…

repair, alteration, renovation or restoration of, or similar services …,

which is used, or to be used, primarily for; or occupied, or to be occupied, primarily with; or 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 service (16 June 2005) …

Section 65(105)(zzzh) defines: Taxable service means ‘any service provided or to be provided to any person by any other person in relation to construction of complex’

Explanation (1 July 2010): For the purposes of this sub-clause, the construction of a complex which is intended for sale, wholly or partly, by a builder or any person, authorised by the builder before, during or after construction (except in cases for which no sum is received from or on behalf of the prospective buyer by the builder or the person authorised by the builder before grant of completion certificate by the authority competent to issue such certificate under any law for the time being in force) shall be deemed to be service provided by the builder to the buyer.

Section 65(30a) defines ‘construction complex’ means

construction of a new residential complex or part thereof; or

completion and finishing services …such as glazing, plastering, painting, …

repair, alteration, renovation or restoration of, or similar services in relation to residential complex



… Construction of complex service (16 June 2005)

Section 65(91a) defines ‘residential complex’ means any complex comprising of:

(i) a building or buildings, having more than twelve residential units;

(ii) a common area; and

(iii) any one or more of facilities or services such as park, lift, parking space, community hall, common water supply or effluent treatment system,

located within a premises and the layout of such premises is approved by an authority under any law for the time being in force, but does not include a complex which is constructed by a person directly engaging any other person for designing or planning of the layout, and the construction of such complex is intended for personal use as residence by such person.

Explanation - For the removal of doubts, it is hereby declared that for the purposes of this clause, -

(a) “personal use” includes permitting the complex for use as residence by another person on rent or without consideration;

(b) “residential unit” means a single house or a single apartment intended for use as a place of residence;



Erection, commissioning or installation service (10 September 2004)

Section 65(105)(zzd) defines: Taxable service means ‘any service provided or to be provided to any person by an commissioning and installation agency in relation to erection, commissioning or installation’

Section 65(39a) defines ‘erection, commissioning or installation’ means any service provided by a commissioning and installation agency in relation to,-

erection, commissioning or installation of plant, machinery, equipment or structures, whether pre-fabricated or otherwise or;

Installation of -

electrical and electronic devices, including wirings or fittings thereof; or

plumbing, drain laying or other installations for transport of fluids; or

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

thermal insulation, sound insulation, fire proofing or water proofing; or

lift and escalator, fire escape staircases or travelators; or

such other similar services.



Management, Maintenance or Repair service (1 July 2003)

Section 65(105)(zzg) defines: Taxable service means ‘any service provided or to be provided to any person by any person in relation to management, maintenance or repair’

Section 65(64) defines ‘management, maintenance or repair’ means any service provided by -

(i) any person under a contract or an agreement; or

(ii) a manufacturer or any person authorised by him,

in relation to, -

(a) management of properties, whether immovable or not;

(b) maintenance or repair of properties, whether immovable or not; or

(c) maintenance or repair including reconditioning or restoration, or servicing of any goods, excluding a motor vehicle.

Explanation — For the removal of doubts, it is hereby declared that for the purposes of this clause,

(a) ”goods” includes computer software;

(b) ”properties” includes information technology software.



Works Contract Services (1 June 2007)

• Section 65(105) (zzzza) defines: taxable service means ‘any service provided or to be provided to any person, by any other person in relation to the execution of works contract, excluding works contract in respect of roads, airports, railways, transport terminals, bridges, tunnels and dams.’

• Where the terms “works contract’ means a contract wherein:

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

(ii) Such contract is for the purpose of carrying out, -

a) erection, commissioning or installation of plant, machinery, equipment or structures…

b) construction of a new building or a civil structure or a part thereof,…

c) construction of a new residential complex or a part thereof; …

d) completion and finishing services, repair, alteration, renovation or restoration …

e) turnkey projects …


Content

Works Contract




Key Issues


Constitutional validity…

Validity of levy of Service tax on works contract / composite contracts

Entry No 92C of List I of Seventh Schedule

Central Government has power to levy and collect taxes on services

Vivisection of Works Contract

Material and Goods Service and Labour

Designing Construction

Installation

2004 – DaelimVivisection of composite contract not permissible

- Commissioner vs. Daelim Industrial Co. Ltd. (2004 (170) E.L.T. A181 (S.C.))

2010 – BSBKVivisection of

contract permissible CCE, Raipur Vs M/s BSBK Pvt. Ltd (2010-TIOL-646-CESTAT-DEL-LB)


Introduction of Works Contract Service ( 1 June 2007)

Material and Goods Service and Labour

Designing Construction

Installation

Works Contract Service – vivisects the contract to tax all the elements of service

Whether levy of service tax on service portion of works contract is constitutionally valid



Two School of Thoughts

Entry 92C covers only pure service contracts and should not include service component of works contract In the context of materials, there is specific provision in the constitution to consider

transfer of materials involved in the works contract as “deemed sale” Constitution of India does not provide similar concept of “deemed service” Therefore, service portion involved in works contract cannot be taxed under

service tax law Article 366 (29A) splits works contract not only for goods but also for services

Observations in BSNL vs. Union of India (2006 (2) S.T.R. 161 (S.C.)

Of all the different kinds of composite transactions the drafters of the 46th Amendment chose three specific situations, a works contract, a hire purchase contract and a catering contract to bring within the fiction of a deemed sale. Of these three, the first and third involve a kind of service and sale at the same time. Apart from these two cases where splitting of the service and supply has been Constitutionally permitted in clauses (b) and (g) of Clause 29A of Art. 366, there is no other service which has been permitted to be so split.

Therefore, no separate splitting is required, and service element of works contract can be covered under the constitutional powers of Entry 92C



Overlap in classification

What would be the appropriate classification of construction related services

Certain construction related services may get classified either under Works Contract service or under other Construction related service

Which is the more appropriate classification – new category of works contract or old construction related service categories

Since works contract category is introduced from 1 June 2007, whether the construction related services were not taxable prior to 1 June 2007

Section 65A – principles of classification

Specific description shall be preferred over general description

Composite service, if it cannot be classified as above, shall be classified as if they consisted of a service which gives them their essential character

If a service cannot be classifiable as above, it shall be classified as a service which occurs first among services which equally merits consideration



Applying the above principles of classification

One view

Works contract is more specific category over other Construction related service as it is a more comprehensive levy involving all types of works contract/ turnkey contracts where transfer of property is involved in the execution of such contracts and involves levy of VAT

Alternate view

Works contract is a general category which covers various contracts (including construction contracts) and therefore the earlier categories, that were specific to the specific nature of works contract should be more specific category

There are contrary decisions on the validity of earlier categories


Whether construction related composite contracts have been brought under the ambit of service tax only with effect from 1 June 2007 and hence not taxable earlier

Taxable only after 1 June 2007 Taxable under earlier categories before 1 June 2007

• Cemex Engineers vs Commissioner of Service Tax (2010-17-STR-534-Tri-Bang)

• Sunil Hi-Tech Engineers Ltd vs Commissioner of C.Ex. Nagpur (2010-17-STR-121-Tri-Mumbai)

• Creative Engineers (2010-18-STR-130-Commr. Appl.)

• Firepro Systems Private Limited V/s Commr. Service Tax, Bangalore (AIT-2008-311-CESTAT)

• M/s L & T limited V/s CCE Vadodra – II (2007-TIOL-744-CESTAT-MUM)

• Advance Ruling of Harikrishna Developers (2008-TIOL-03-ARA-ST)

• M/s Diebold System Private Limited (2008-TIOL-489-CESTAT-MADRAS)

• Master Circular No 96/7/2007 – ST dated 23 August 2007 – clarified that where tax paid under earlier categories, reclassification not permissible and hence availment of composition scheme under new category not permissible

• M/s India Hume Pipe Company Limited V/s CCE, Trichy [2008(10) STR 174]

• Soma Enterprises (2009-15-STR-559-Tri)

The issue is not free from doubt and open for interpretation



Issues due to differential classification…

Specific exclusion provided to roads, railways, airports etc under Works Contract service – no such exclusion under certain earlier categories like “Erection, Commissioning and Installation”

Erection, commissioning and installation of structure for railways projects – whether excluded under works contract services or taxable under “Erection, Commissioning and Installation” services?

CENVAT credit benefit available under Rule 6(5) of CENVAT Rules, 2004

Full credit is available for services procured under “Commercial or Industrial Construction Service” while services procured under “works contract services” are subject to Rule 6(3) restriction

Different schemes available for payment of service tax and different credit restrictions applies


Various Schemes available Under Works contract services

Under construction services

Rule 2A Composition 12/2003 Full value Abatement

Rate of Tax 10.3% 4.12% 10.3% 10.3% 10.3%

Value for Service tax purpose Service portion

Full Contract value

Service portion

Full Contract value

33% of contract

credits available: Inputs No No No Yes No

Capital goods Yes Yes Yes Yes No

Input services Yes Yes Yes Yes No

Issues due to differential classification…

Classification in the category would determine the choice of available scheme – can result into differential service tax

implication and differential credit entitlement


Schemes available – case study

Contract value of contract given to - INR 400

Costing of the contractor Inputs Input services C/ Goods Total

Base price 250.00 50.00 50.00 350.00

Add: Taxes – Excise Duty 25.00 5.00 30.00

- Service Tax 5.00 5.00

Total 275.00 55.00 55.00 385.00

Rates taken as 10% for simplicity

Optimum scheme may change based on change on mix of goods and services, tax rates on individual materials etc


Analysis of the options Under Works contract services Under construction services

Rule 2A Composition 12/2003 Full value Abatement

Total contract value 400.00 400.00 400.00 400.00 400.00

Materials portion/ abatement 250.00 NA 250.00 NA 268.00

Service Value for payment of service tax 150.00 400.00 150.00 400.00 132.00

Service tax rate 10.30% 4.12% 10.30% 10.30% 10.30%

Service tax amount 15.45 16.48 15.45 41.20 13.60

Less: credits available: Inputs

- - - 25.00 -

Capital goods 5.00 5.00 5.00 5.00 -

Input services 5.00 5.00 5.00 5.00 -

Net service tax liability 5.45 6.48 5.45 6.20 13.60

Credit lost 25.00 25.00 25.00 0.00 35.00

Total tax cost 30.45 31.48 30.45 6.20 48.60

Schemes available – case study


Composition scheme for continuing contracts

Whether contracts executed before 1 June 2007 on which service tax is paid under earlier categories can reclassify under “works contract services” and pay service tax under composition scheme

Rule 3 of the rules providing composition scheme:

“The provider of taxable service who opts to pay service tax under these rules shall exercise such option in respect of a works contract prior to payment of service tax in respect of the said works contract and the option so exercised shall be applicable for the entire works contract and shall not be withdrawn until the completion of the said works contract”

Master Circular No 96/7/2007 – ST dated 23 August 2007

A service provider who paid service tax prior to 1.6.2007 under earlier categories is not entitled to change classification and hence is not entitled to avail composition scheme

Nagarjuna Construction Company Ltd versus GOI (2010-TIOL-403-HC-AP-ST)

A service provider who paid service tax prior to 1.6.2007 under earlier categories is not entitled to avail composition scheme


Budget amendment on construction service

Definition of ‘Construction of Complex Services’ and ‘Commercial or Industrial Construction Service’

amended to levy service tax in cases where whole/ part consideration is received by builder from

prospective buyer before issuance of completion certificate

“Explanation – For the purposes of this sub-clause, construction of a complex/ new building which

is intended for sale, wholly or partly, by a builder or any person authorized by the builder before,

during or after construction (except in cases of which no sum is received from or on behalf of the

prospective buyer by the builder or the person authorized by the builder before the grant of

completion certificate by the authority competent to issue such certificate under any law for the time

being in force) shall be deemed to be service provided by the builder to the buyer; “

Proposed amendment seeks to levy service tax on sale of residential / commercial property (even in

case where construction is complete but completion certificate due)

The only exemption is where no sum is received before grant of completion certificate – even token

consideration received before grant of completion certificate would attract levy of Service tax



Determination of liability

- exclusion for value of land – whether increase in abatement from 67% to 75% (vide notification

dated 29/2010 dated 22 June 2010) sufficient to cover cost of land

- exclusion for common areas – since common areas not constructed for specific customer

Provision of completion certificates does not exist in many places. How would the linking of

service tax with completion certificates happen in such places?

Whether stamp duty still payable

How will the refund mechanism work in case of cancellation of bookings or termination



Amendment by way of addition of explanation – explanation being substantive in nature, whether

effective retrospectively or prospectively?

Event of taxation – construction activity or receipt of payment linked to completion certificate

Classification under service tax law – “works contract services” or “Construction of Complex

services” or “Commercial Construction services”


Thanks

1 b s r & co © 2006 bsr & co., a firm of chartered accountants, duly registered under the...

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