[This article appeared in “Taxmann’s Service Tax Today” Vol. 10 dt. 5-10-07]
Composition Scheme for Works Contract Service under Service Tax – A Boon for Works Contractor?
By CA. Pradip R Shah
e-mail: pradip_shah@vsnl.com
Nature of the provisions
1.0 Under the normal scheme of taxation, tax liability is determined with reference to taxable value of the base with the rate of tax. However, due to complexity of the transactions, at times, it is not possible to determine the value of the base, determination of tax liability poses the problem. Since, in such a situation, any solution is prone to litigation and hardship, a via media is found by levying the tax on an ad hoc basis with reference to something which is easily identifiable and can be quantified. Here, the process of determining value of the taxable base is given complete by-pass. Under the taxing statute this is called Composition Scheme (CS). CS is prevalent under the VAT laws of almost all the states. For the purpose of levying tax under Works Contract(WC) which involves both, supply of goods and rendering of services, an option is given to the dealer for payment of tax under CS. Under the CS under VAT the dealer is not required to vivisect the transaction and determine value of property transferred in goods. VAT is required to be paid at substantially lower rate than the scheduled rate.
1.1 Administratively this process under CS is very convenient. However, the tax payer always has the pinch that he is being required to pay the tax on something which is not taxable at all under the statute. In order to take care of such complains, the rate of tax levied is kept substantially lower than the scheduled rate. This dilutes, to some extent, the complain by the taxpayers. While the tax payer is relieved of the hassles of determining value, there is a cost to it. It is in the form of denial of certain tax credit in respect of input. Under VAT scheme of taxation, the dealer is denied input credit of taxes paid on the goods used for executing the WC. However, the dealer is having the additional advantage of not required to detailed scrutiny of the records. Since the tax base is fixed in such a way that there is no ambiguity at all, there is no necessity to go through the said process.
1.2 It should be appreciated that CS is not an alternative tax but it is an alternative method of computing tax liability. Provisions with respect to CS are not the independent charging section. The State will continue to collect the tax under the charging section as provided under the Statute. The only difference being the tax payable in normal way is substituted by the tax to be paid as computed under CS. Thus, it is a rough and ready method of computation of tax.
CS under Service Tax
2.0 It is for the first time that the provisions have been made under the service tax (ST) to pay tax under CS. Notification No. 32/2007 dt. 22-5-2007 lays down detailed rules for composition scheme. ST is being levied for various services wherein supply of goods is involved along with rendering of services. However, in all such cases, abatement in the form of reduction in value of gross amount charged has been preferred by the authorities. The principal difference between abatement and CS is in the process. While in the case of abatement, value of service is determined by deducting value of goods from the gross amount charged on an ad hoc basis and the tax is levied on the balancing amount. However, in the case of CS, no attempt is being made to determine the value of services rendered at all. Tax is computed with reference to gross amount charged. Moreover, the rate of tax is also not the scheduled rate, but the one specifically laid down for this purpose. In the case of abatement, rate of abatement differs from services to services. However, the rate of tax remains the same for all the types of services i.e. the scheduled rate fixed under the Finance Act.
At a first sight, provisions of CS for services involved under WC is surprising. This is for the reason that the scheme of abatement is already in existence under the ST since long. However, the CS is quite popular under VAT laws of almost all the state governments. Perhaps, in order to keep the scheme of taxation of services of WC in alignment with that of the VAT, CS has been proposed.
Redeeming features of CS under ST
3.0 There are six noteworthy features of the CS under ST.
3.1 Firstly, the first part of Rule 3(1) of Works Contract (Composition Scheme for Payment of services) Rules, 2007 overrides the provision of S. 67 of the Finance Act. It is specifically provided that the payment of tax under CS will be discharging the tax liability under section 67. Thus, by not following the provisions of S. 67, there will not be any violation of the Finance Act.
3.2 Secondly, Rule 3(1) overrides the provisions of rule 2A of the Service (Determination of Value) Rules, 2006. Thus, the assessee is freed from the hassles of determining the value of services.
3.3 Thirdly, although not specifically stated so, the clause 3(2) also overrides certain portion of CENVAT Credit Rules. Generally, under the CS of VAT, input credit is not permitted. However, under CS under ST, input credit in respect of goods only is not permitted. It means that all the provisions of CENVAT Credit Rules, particularly input credit in respect of input services and capital goods are applicable.
3.4 Fourthly, unit of assessment under CS is each WC and not the total amount of services rendered during the taxable period WC. It means for WC under CS, tax will have to be ascertained separately and added to the total tax liability for other WC. Total amount of services rendered under WC under CS will not be added to the chargeable value of services for a particular month / quarter, as there is no determination of the volume of services under CS.
3.5 Fifthly, there is no upper limit of the value of the WC in respect of which the option can be exercised. Thus, irrespective of the amount of the WC, the option can be exercised.
3.6 Sixthly, there is live connectivity between provisions of WC under VAT and ST in many respects. For example, the applicability of taxation of services under WC itself is based on the applicability of VAT laws. However, the scheme of CS under ST is silent about it. One would have expected it to be applicable in the case only if the assessee has opted for the same under VAT. However, it is not so. The very fact that there is no reference to option exercised by the dealer under VAT for CS, it is entirely at the option of the assessee, to choose the most beneficial method of taxation.
Optional Scheme
4.0 Rule 3(1) provides that the assessee shall have the option to discharge his service tax liability. Here, two things are worth noting.
4.1 Firstly, there is no compulsion on the assessee to opt for the scheme. Realisation under WC involves value of goods and services, adoption of contract value cannot be permissible mode of levy for ST. Since, the CS is departing from the process of determining tax as laid down under the Statute, assessee’s consent becomes essential. Having opted for the CS, the assessee cannot challenge its provision. It is for this reason the CS is always made optional. The assessee is permitted to follow the scheduled method of determining value of taxable base and pay the tax thereon. It is open for the assessee to work out cost benefit analysis of both the methods of taxation and follow the one wherein the tax liability is lower.
4.2 Secondly, tax paid under CS is considered as discharging the tax liability as laid down under the Finance Act. Thus, by making the payment of tax under CS, the assessee is in fact discharging his liability of ST as laid down under the Finance Act. Since the Rule specifically provides to this effect, it will not be open for the administrative authority requiring the assessee to determine the value of services under and pay tax under the scheduled method. Thus, by paying tax as computed under the CS the assessee will be complying the provisions of S. 67 of the Finance Act.
Determining the Taxable Base
5.0 In terms of provisions of S. 67 of the Finance Act, the tax is required to be paid in respect of service provided or to be provided. Thus, it covers both the contingencies i.e. amount received in respect of services rendered and advance received for the services to be rendered. Provisions as applicable in this respect under CS are also the same. The Rule 3(1) provides that tax will have to be paid on amount realised in respect of service provided or to be provided.
5.1 In the case of WC, at times, advance payment is being made by the contractee. In terms of provisions of S. 65(105), and Explanation 3 to section 67, ST is required to be paid thereon. Therefore, in such cases the assessee will have to take decision about the option at an early stage of execution of WC. If tax is paid on advance received then it will not be possible to exercise the option at a later stage and ST will have to be paid on the value determined as mentioned in Rule 2A of Determination of Value Rules.
5,2 The whole structuring of the CS is such that the assessee will have to make calculations in advance about the element of goods and services involved and carry out cost benefit analysis. Once the bill raised has been approved and dues have been realized, the liability to pay ST will arise. This may pose some problem when the payment is received at the fag end of the month/quarter as the liability to pay tax will arise by the 5th of the next month / quarter.
Rate of Tax
6.0 Generally the scheme of CS provides for by-passing the scheduled process of determining the value for computation of tax and the rate of tax provided in the statute. Accordingly Rule 3(1) provides that under the CS the assessee is permitted instead of paying service tax at the rate specified in section 66 of the Act to pay the tax at the rate as laid down under the scheme. Thus, by paying the tax under CS, the assessee is discharging his liability as laid down under section 67 of the Finance Act. A look at the following table will give idea about the whole process of payment of ST and how CS fit into it.
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|
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Under Determination of Value Rule
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Under CS
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1
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Execution of WC
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Yes
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Yes
|
|
2
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Raising of provisional bill for work done
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Yes
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Yes
|
|
3
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Approval of the work by architect etc.
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Yes
|
Yes
|
|
4
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Raising of final bill
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Yes
|
Yes
|
|
5
|
Determination of consumption of material for computation of VAT
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Yes
|
Yes
|
|
6
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Determination of VAT liability
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Yes
|
Yes
|
|
7
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Payment of VAT
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Yes
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Yes
|
|
8
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Receipt of money against the bill raised
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Yes
|
Yes
|
|
9
|
Determination of value of services rendered for ST purposes
|
Yes
|
No
|
|
10
|
Computation of Input services
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Yes
|
Yes
|
|
11
|
Computation of final ST / CS liability
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Yes
|
Yes
|
|
12
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Payment of ST
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Yes
|
Yes
|
6.1 One may get the feeling that under CS only one step is avoided. This is at the cost of paying ST on value of goods involved in WC. However, it should be appreciated that Step 9 is the most difficult and complex part of the whole process. It is at this stage that one may have to face various factual and legal issues. Therefore, one will have to weigh pros and cons at the early stage of WC.
6.2 Rule 3(1) provides for the rate of tax at the amount equivalent to two per cent of the gross amount charged. Under the normal circumstances ST, is required to be paid at the rate as fixed under the Finance Act on value of services rendered only. However, CS differs here. Firstly, the rate as fixed under the Finance Act is not applicable. Secondly, value of services rendered is not required to be determined. Thirdly, the rate of tax will be as mentioned in the Rules. And lastly, tax will be computed not with reference to value of services rendered but with reference to the gross amount charged.
6.3 The wordings “gross amount charged” may lead one to conclude that CS will be required to be paid on bill raised. However, looking to the scheme of ST, the ST is required to be paid only when value of service is realised. Reference to 2.00% of gross amount charged is for the purpose of determining total tax liability. Assessee’s liability to pay the tax arises only when money is realised against WC executed. Therefore, if for any reason, certain amount is not received against the bill raised, there is no liability to pay the tax thereon.
Exclusion of VAT liability
7.0 As provided under Explanation (a) of Rule 2A(1)(i) of Service Tax (Determination of Value) Rules, 2006, under the CS also, as per Rule 3(2), gross amount charged shall not include Value Added Tax (VAT) or sales tax. Base for computation of CS is gross amount charged in the bill. This amount may be including VAT as well. If so, the amount of VAT required to be paid thereon will have to be deducted. This will avoid payment of ST on VAT. In case, if the assessee has opted for CS under VAT then the amount of CS under VAT will have to be considered, otherwise actual amount of VAT liability computed will have to be deducted. In case, if the bill comprises value of work done and amount of VAT separately then the value of work executed as shown will be the basis for computation of CS.
Input Credit
8.0 The most interesting aspect of CS is the provision for permitting the assessee to avail the benefit of tax paid on input services. Generally, as per the CS under VAT the dealer is not permitted to take input credit for tax paid on goods consumed. This is for the reason that the rate of tax fixed under the CS is substantially lower. Moreover, in many cases the dealer is not required to maintain detailed records as well. However, the CS departs here substantially from CS under VAT. Read the provisions in this respect which runs as follow:
shall not take CENVAT credit of duties or cess paid on any inputs, used in or in relation to the said works contract.
8.1 At a first glance, one may get an impression that input credit for tax paid is not permitted. However, it is only with reference to duty paid in respect of goods. WC involves rendering of services and for the said purpose the assessee might have availed the services of other service providers. The assessee also might have bought capital goods and paid duty thereon. The Rule, as mentioned above, does not prohibit claiming so. Please note that the provisions of CENVAT Credit Rules have not been overridden. The assessee is permitted to take input credit in respect of both of these items. See the following extract from clarification No. 097.01/23-8-2007 of Circular No. 96/7/2007 dt. 23-8-2007.
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097.01 / 23.08.07
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Whether CENVAT credit of duty paid on capital goods and service tax paid on input services can be taken by a service provider who opts to pay an amount equivalent to two per cent. of the gross amount charged for the works contract instead of paying service tax at the rate specified in section 66, under the Works Contract (Composition Scheme for Payment of Service Tax) Rules, 2007, notified vide notification No.32/2007-Service Tax dated 22.05.07?
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Rule 3(2) of the Works Contract (Composition Scheme for Payment of Service Tax) Rules, 2007 provides that the provider of taxable service opting to pay service tax under the composition scheme is not entitled to take CENVAT credit of duty on inputs, used in or in relation to the said works contract, under the provisions of the CENVAT Credit Rules, 2004.
There is no restriction under notification No.32/2007-Service Tax dated 22.05.07 to take CENVAT credit of duty paid on capital goods and service tax paid on input services.
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8.2 It categorically states that the assessee can claim input credit for input services and capital goods. This is for the reason that the provisions of CENVAT Credit Rules are applicable to the full extent except to the extent of duty paid on input goods. This is certainly a beneficial provision for the assessee as he is not only paying the tax at a substantially lower rate but also permitted to take credit for tax paid on input services and capital goods. Isn’t it icing on the cake?
Input Credit at Global Level?
9.0 Sub-clause (2) does not permit credit in respect of duty paid on input goods. Thus, input credit on services and capital goods are permitted. A question that may arise is whether the said amount is permitted at global level i.e. whether excess input credit of a particular WC can be adjusted against tax liability arising under other WC under CS or even otherwise? This is for the reason that, in the initial phase of the execution of the contract, payment for input services will start while realization may be at a much later date. What will happen, if during the intervening period, the assessee is required to pay the tax and file ST Returns? There is no clarity about it. It should be appreciated that under the scheme of ST, it is not necessary to follow the principle of one-to-one matching of the services rendered and input services. Therefore, there should not be any problem in claiming input credit in the cases wherein realization of the service is zero or lower than input services.
Time Element of CS
10.0 The CS imposes certain conditions on the assessee with respect to exercising the option. The first condition is that the assessee will have to exercise such option in respect of a works contract prior to payment of service tax in respect of the said works contract. The assessee is required to exercise the option before the payment of ST. Once the payment of ST in respect of a particular WC is commenced, the option cannot be exercised. Does this mean that the option can be exercised even though due date of payment of tax has already lapsed? This is for the reason that the option is required to be exercised prior to “payment of service tax” and not the last date of payment of ST as provided under the Finance Act.
10.1 In the case of WC, real problem arises when advance is received prior to commencement of execution of the contract. Since the amount of advance received will attract payment of ST, option will be required to be exercised even before the WC has commenced. Does it mean that payment of tax on advance received can be postponed till the first payment under the normal course is received? Of course here the question of payment of interest for late payment of tax on advance received will arise.
Basic exemption of Rs. 8.00 lacs
11.0 Under CS, unit of assessment is each WC and not the total amount of services rendered. Therefore, a question may arise particularly in the case of a new business whether the basic exemption limit will be available or not. It should be noted that under CS there is no computation of value of taxable services rendered. Sub-rule 3(1) suppresses the provisions of s. 67 and Rule 2A and permit the assessee to discharge the tax liability on an ad hoc basis. Since there is no computation of value of services rendered, the question of applying its value for computation of the basic exemption limit will not arise. Does it mean that the assessee can keep taxable value of services under various contracts under Rs. 8.00 lacs and opt for CS for other contracts? There do not appear to be any provisions, which prohibit the assessee to have mixture of both the options and derive maximum benefits.
11.1 Consider the case of an assessee who has started the business in the year and opts for CS. What will be the amount of taxable services for the purpose of computing threshold limit? Whether the gross amount charged for WC under CS can be considered for the said purpose? No. Since the quantum of services rendered has not been determined at all, gross amount charged for WC under CS cannot be considered for this purpose.
Applicability to the Entire WC
12.0 The option exercised under the CS is applicable to the entire WC. A WC can be consisting of various small jobs clearly identifiable. As long as they remain part of the single WC, the option of CS will be applicable to the entire WC. Therefore, it will be in the interest of the contractor to work out the business plan accordingly particularly keeping in mind element of goods and service involved therein. This can help in minimizing the tax liability to a great extent.
Timeframe of WC
13.0 The option for CS once exercised is final and is not permitted to be withdrawn until the completion of the said WC. It may so happen that the assessee, during the course of execution of WC, may not find the option of CS cost efficient. However, having opted for it once, there is no choice. It is for these reasons to go slowly and take into consideration various aspects involved in execution of WC.
13.1 It should also be kept in mind that the option is available in respect of each WC and therefore, having opted for CS for a particular contract, the assessee need not follow the same for the remaining contracts or future contracts. Discretion for future WC is with the assessee.
Input Credit for CS paid under VAT and ST – a comparison
14.0 Under the CS of VAT of state laws since the dealer is permitted to pay tax at lower rate, the tax so paid is not permitted to be charged separately in the invoice raised. It means the dealer is required to bear the same. Secondly, the contractee dealer is not permitted to take input credit for the amount of tax paid by the contractor. This is for the reason that the contractor has paid the VAT at substantially lower rate and the VAT paid is not shown in the invoice separately. However, CS under ST differs from CS under VAT substantially. As we have already seen input credit is permitted in respect of tax paid for input services and capital goods.
Input Credit for Service Receiver
15.0 Apart from that under VAT the buyer is not permitted to take credit for VAT paid under CS. However, there are no such provisions under the ST. Therefore, service receiver can claim the amount of CS paid as input credit. If structured efficiently, this can help in keeping the ST liability at the lowest.
Records to be maintained
16.0 CS gives relief with reference to computation of value of services and payment of tax on an ad hoc rate. However, there is no reference to maintenance of records as required under Rule 5 of Service Tax Rules. Therefore, the assessee will have to maintain all the records as required under Rule 5.
Arithmetic of CS
17.0 What is the cut-off rate of element of services for determining cost benefit under CS? Following table will give some idea about it.
|
Element of Goods
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Element of Service
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ST Liability u/s 67
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ST liability under CS
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Difference
|
|
60
|
40
|
4.80
|
2.00
|
2.80
|
|
65
|
35
|
4.20
|
2.00
|
2.20
|
|
70
|
30
|
3.60
|
2.00
|
1.60
|
|
80
|
20
|
2.40
|
2.00
|
0.40
|
|
84
|
16
|
1.92
|
2.00
|
-0.08
|
|
85
|
15
|
1.80
|
2.00
|
-0.20
|
|
90
|
10
|
1.20
|
2.00
|
-0.80
|
17.1 As can be seen from the table, the cut-off rate will be between 15 to 20% of services involved in the WC. Roughly, one can say that if the element of service is more than 20.00% in WC, it will be cost beneficial to opt for CS. However, as explained above the assessee will have to take into account various factors involved.
17.2 For the purpose of detailed cost benefit analysis, the assessee should also consider input credit available under both the options and a comparative analysis be made. Since it varies from case to case it has not be included in the above table. But it will be an important factor to take not of.
CS under VAT and /or ST
18.0 As seen above the assessee is having the option of having CS under VAT and / or under ST. The table below will give an idea about the options available.
|
|
Options under VAT
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Options under ST
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||
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Actual value of goods
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CS
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Actual value of services
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CS
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|
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Option A
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XX
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Yes
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XX
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Yes
|
|
Option B
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XX
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Yes
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Yes
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XX
|
|
Option C
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Yes
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XX
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Yes
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XX
|
|
Option D
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Yes
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XX
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XX
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Yes
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Conclusion:
19.0 Taxation of WC has always posed problems for both, the taxpayers and the administration. CS is the best compromise to the vexed issues involved therein. The state governments have imposed various conditions for availing benefit under CS under VAT. As can be seen, the provisions of CS under ST are one step ahead. It provides various options to the assessee making it possible to keep the tax liability at the lowest level. Perhaps it may become a point of envy for service providers for various other services. If structured methodically, there is no reason why it cannot be a boon for the works contractor.
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