30 November 2007
The Apex Court in State of Uttar Pradesh Versus The Union of India while deciding on a matter relating to sales tax on telephone rentals held “Merely because service tax is imposed by Parliament on telephone connection to a subscriber, it cannot mean that State Governments could not impose any tax on rentals collected from subscribers”. This decision of the Apex Court meant that the State Government could tax a transaction deeming it to be a sale even though the same transaction is taxed by the Central Government deeming it to be service. On appeal to the Larger Bench by the appellants Messrs. Bharat Sanchar Nigam Limited (2006 2 STR 161) the Apex Court while overruling the earlier decision propounded the “aspect doctrine” and said, “Same transaction may involve two or more taxable events in its different aspects, but overlapping does not detract from distinctiveness of aspects. However this does not allow State to entrench upon Union List and tax services by including cost of such service in value of goods”. Following the ratio of this judgement, the Bangalore Bench of the Customs, Excise and Service Tax Appellate Tribunal in Shipa Colour Lab Versus Commissioner of Central Excise, Calicut (2007 5 STR 423) held that “in the services relating to photography, if certain goods and materials are consumed, then the value of those goods and materials cannot be included in the value of services for levy of service tax”. As the law relating to taxing an activity as a service or sale was settling down in the light of the above decisions, the Finance Act, 2007 introduced a new head service, “works contract” which was notified as a taxable service with effect from June 1, 2007. The term ‘works contract’ was defined to mean, “a contract wherein transfer of property in goods involved in the execution of such contract is leviable to tax as sale of goods”. By virtue of this entry the Central Government entered the tax domain of the State, surprisingly the State Governments remained mute spectators. The following were identified for taxing under the said category:
(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;
This new head of taxable service empowers the Central Government to levy service tax on certain activities already taxed by the State under the category “works contract”. However, works contract in respect of roads, airports, railways, ports, transport terminals, bridges, tunnels and dams are excluded from the levy.
Value of Taxable Service
Section 67 of the Finance Act, 1994 contains the provisions for determining the value of taxable service. Rule 2A has been introduced in Service Tax (Determination of Value Rules, 2006) to determine the value of services involved in the execution of works contract. To determine “value” for the purpose of taxation Rule 2A shall be followed. The service provider shall determine the value of services involved in the execution of a works contract in the following manner:
a) Value of works contract shall 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.
“Value” for the purpose of charging service tax at the rate of 12% plus the educational cess shall be the ‘value’ of services alone. To arrive at this ‘value of service’ the value of transfer of property in goods shall be computed and the same shall be deducted from the total value. To determine the ‘value of transfer of property in goods’ the service provider may take into account the ‘value’ offered for tax under the relevant State VAT law. However, when the service provider is opting for the composition scheme under the relevant State VAT law ‘value of property in goods’ cannot be determined separately. In this situation treating the entire amount, as ‘value of transfer of property in goods’ will result in Nil ‘value of service’ which will defeat the purpose of the rule and which does not seem to be the intention of the legislature. In such a situation the service provider can, based on the documentary evidence, compute the value of the property in goods.
b) Gross amount charged for the works contract shall not include Value Added Tax or Sales Tax paid on transfer of property in goods involved in the execution of the said works contract.
The amount of value added tax or sales tax paid for the transfer of property in goods shall not form part of ‘value of taxable service’ and accordingly no tax shall be levied on such amount.
c) However, value of works contract shall include:
i) labour charges for execution of the works; ii) amount paid to a sub-contractor for labour and services; iii) charges for planning, designing and architect’s fees; iv) charges for obtaining on hire or otherwise, machinery and tools used for the execution of the works contract; v) cost of consumables such as water, electricity, fuel, used in the execution of works contract; vi) cost of establishment of the contractor relatable to supply of labour and services; vii) other similar expenses relatable to supply of labour and services; and viii) profit earned by the service provider relatable to supply of labour and services;
The value charged by the service provider for the works contract shall include the costs and charges enumerated above. Wherever the service provider is recovering the same separately from the service receiver it will be chargeable to tax, as the same shall be treated as value of works contract.
d) Where value added tax or sales tax has been paid on the actual value of transfer of property in goods, involved in the execution of the works contract, then the value adopted for the purpose of payment of VAT or sales tax shall be taken as the value of transfer of property in goods involved in the execution of the said works contract for determining the value of works contract service under (a) above.
The question of determining value of goods in the works contract is answered above. As per the rule the value of goods involved in execution of works contract shall be that value which has suffered tax under the relevant VAT or sales tax law.
Composition Scheme For Payment of Tax
The various options available to calculate tax for works contract, whether under VAT or Sales Tax law, has always posed a challenge for the assessee as well as for the department. Service Tax joins this list of elite group. Works Contract (Composition Scheme for Payment of Service Tax) Rules, here in after the Rules, were notified with effect from June 1, 2007.
The rate of service tax under section 66 is 12% and including education and secondary and higher education cess the total tax works out to 12.36%. Sub-Rule 1 of Rule 3 of the Rules provides for an optional rate of 2%, which including the cess will work out to 2.06%. Instead of paying tax at 12.36% the person liable to pay tax, the works contractor, can pay tax at the rate of 2% computed on the gross amount charged for the works contract. Here again, the gross amount shall exclude the VAT or sales tax paid on transfer of property in goods involved in execution of works contract. If the service provider chooses the optional rate then as per Sub-Rule 2 of Rule 3 credit of excise duty and cess paid on inputs like steel, cement etc., will not be available. However, since the word ‘input’ alone is used in the sub-rule, the service provider will be eligible to avail the credit of service tax and cess paid on ‘input service’ used in the execution of works contract. Sub-Rule 3 makes it compulsory for the service provider to exercise the option of adopting the 2% rate prior to the payment of service tax in respect of a works contract. The option once availed cannot be to be withdrawn till the completion of the said works contract.
Advantage – Composition Rate
All services identified under ‘works contract’ are already taxable under section 65(105) of the Finance Act, 1994. Services like construction, erection, commissioning etc., are eligible to pay tax on abated value at the normal rate. Whether 2% rate is competitive over the 12.36% on the abated value? A hypothetical situation is examined: Messrs. A Limited is engaged in construction of commercial complex. He is liable to pay service tax and pays the same after claiming abatement of 33% on the value. On a sum of Rs.100000/- the tax payable on Rs.33000/- at the rate of 12.36% will be Rs.4079/- Under works contract the tax on the same value will be Rs.2060/- (100000 * 2.06%). As explained in the preceding paragraphs cenvat credit of service tax and cess will also be available to the taxpayer. Hence, the composition rate seems to be the best option available. The taxpayer may also be assessed under the respective State VAT law where the tax rate has to be applied on a ‘value’. The value adopted for calculating tax under the State VAT/sales tax law may be different from the one adopted to calculate service tax. Under service tax the taxpayer may choose the compounding rate whereas under the VAT or Sales tax law it may be a different value which may be subjected to tax and both being fundamentally different legislations, value for the purpose service tax need not be the same for the purpose of calculating VAT or sales tax.
Issues
The ‘works contract’ service has added to the plethora of issues already pending:
The Rules make it compulsory to exercise the option prior to the payment of tax. The mechanism to exercise the option is not provided. Should the service provider write to the jurisdictional Superintendent or mere charging the rate of 2% on the invoice or bill will suffice?
The issue becomes more complex in the case of construction of complex service.
Situation No.1 Messrs. Sewa Karo Limited is a builder. He is registered under the category ‘construction of complex’ with the service tax department. In April 2007 he commences construction of an apartment complex comprising of 250 flats. Till May 2007 he enters into works contract agreement with 10 different individuals. Balance agreements are signed after June 1, 2007. The company wants to opt for 2% rate 240 flats on the premise that agreements have been entered after June 1, 2007. Can the Company proceed?
Situation No.2 The Construction has commenced in April 2007 but agreements are executed only after June 1, 2007. Can the Company opt for 2% rate for entire 250 flats?
Situation No.3 10 individuals have paid advance in April and May 2007 and Sewa Karo Limited has appropriated the advance towards land cost. The amount towards construction is received after June 1, 2007. Can the Company pay tax at 2% ?
Situation No.4 10 individuals have paid advance in April and May 2007 and the Company has appropriated the same towards land and construction. The Company pays the tax on the construction advance after availing the abatement of 33%. Can the Company opt to pay tax at the rate of 2% on the balance 240 flats?
Situation No.5 The Company submits that since ‘works contract’ is notified as a taxable service only from June 1, 2007 all contracts entered before the said date will not be taxable. The Company further submits that ‘works contract’ for which service tax was paid under the head ‘construction of complex’ is erroneous and hence wants to apply for a refund.
The above issues are only illustrative and not exhaustive. Many more such situations will arise, the law being in the nascent stage, it is sun shine days for consultants and department, alas the assessee.
Conclusion In conclusion, when opting for the composition scheme, a transaction covered under the works contract category will be taxed by both Centre and State, the value for the purpose of the levy may or may not be the same but the rate of tax may differ
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