[This article appeared in “Taxmann’s Service Tax Today” Vol. 10 dt. 12-10-2007]
Determining Value of Service under Works Contract: A Labyrinth
By CA. Pradip R Shah
e-mail: pradip_shah@vsnl.com
Introduction
1.1 With the introduction of Service Tax (ST) on service element of Works Contract (WC), a new dimension has been added to an already complex issue of taxation of services and WC. Circular no. B1/16/2007/TRU while explaining the provisions of S. 65(105)(zzzza) relating to the taxing of service element of WC, refers to Article 366(29A)(b) of the Constitution of India, vivisecting of the contract, identifying service element, determining its value via identifying value of goods and methodology to be adopted for charging tax thereon. A comprehensive reading of S. 65(105)(zzzza), Notification No. 29/2007, Rule 2A of Service Tax (Determination of Value) Rules and Circular No. B1/16/2007/TRU, reminds one of the early days of life while playing with kaleidoscope showing enchanting colours and designs. Combination of these four items will certainly provide different designs and colours as in kaleidoscope to the same taxpayer at different point of times - sans joy derived from it.
1.2 Although the Finance Act was already levying ST under various heads of services in relation to construction activities, a strategic move seems to have been made by the Government to rope in or expand the base by charging tax on service element of WC. Perhaps, the time is not far away when large number of services other than related to construction etc. will also be covered. The thinking appears to be if the state Government can levy VAT on value of property passing in the goods in respect of varities of cases, there is no reason why service element in respect of all the types of WC should not be covered under ST net.
1.3 In view of ST being already applicable to the WC covered u/s 65(105)(zzh), 65(105)(zzq) and 65(105)(zzd), the question of classification is bound to arise. In view of clear wordings of S. 65(105((zzzza) there is less ambiguity (See “Works Contract under Service Tax- How to make it work?” “Service Tax Today” Vol. No. 8 Part 8). However, valuation aspect is going to be more difficult one. An attempt has been made herein below to vivisect all the four items as mentioned above individually and holistically. Of the four items each one has its size, shape and colour. However, when all of them put together provides new design, shape, size and colour. At the end, one should not be surprised to find oneself like what happened to Abhimanyu in Mahabharata, who could not get out of labyrinth he has entered into.
Nature of WC
2.1 Primarily WC consists of two elements viz. goods and services. There is no defined proportion of element of goods and services to be present in WC. It varies from case to case. Apart from that it should also be appreciated that WC can be with respect to both the types of properties i.e. immovable and movable. In the case of immovable it is relating to construction, repairs etc. In the case of movable properties, it relates to vehicles, plant and machineries, textile fabrics etc. The basic principles of charging tax in respect of both the types remain the same under VAT laws. However, element of goods and services differ substantially. As far as ST is concerned, as of today, it is levied only in respect of WC related to immovable properties.
2.2 WCs are tailor-made contracts. There is no standard format. The contractor and the contractee determine its nature based on specific requirements. For example, the contract may not refer to the goods and service element at all. It may contain the type of work to be executed and some method by which its quantification can be made. In such a case methodology for charging can be lump sum or with reference to quantification of work done. In another scenario, the contract may provide for certain type of goods to be used and rate thereof. In such a case the rate of charging for goods will be based on consumption of material and ad hoc amount in respect of services. In the case of contract where service element is predominant, there will be reference to various services to be performed. In view of element of goods being low, services to be performed will be laid down in detail and charged accordingly.
2.3 As can be seen, it may or may not be possible to arrive at the value of goods and services from the contract or any document. The problem becomes more complex when element of profit has to be allocated between the two components viz. goods and services.
Connectivity between ST and VAT laws
3.1 Both ST and VAT are levied by the Central and State Governments respy. in terms of the powers conferred under different articles of the Constitution of India. Statutes enacted under the said articles are independent of each one. However, in the case of WC, the same transaction happens to be taxable under two different statutes, the connectivity is required to be established. If not done so, taxable value may turn out to be more than value of the transaction. Since this cannot be permitted, either of the statute has to take the other statute as a starting point for determining value. As WCs are already taxable under VAT laws, method for determining value of element of goods involved therein has already been developed. It is for these reasons that one finds reference to VAT laws extensively under ST. Some of the important references of VAT under the statue, rule, notifications and circulars are as follow.
Finance Act:
S. 65(105) “taxable service” means any service provided or to be provided,—
(zzzza) to any person, by any other person in relation to the execution of a works contract, excluding….
Explanation.—For the purposes of this sub-clause, “works contract” means a contract wherein,—
(i) transfer of property in goods involved in the execution of such contract is leviable to tax as sale of goods
Service Tax (Determination of Value) Rules, 2006
Rule 2A (1)(ii)
(ii) Where Value Added Tax or sales tax, as the case may be, has been paid on the actual value of transfer of property in goods involved in the execution of the works contract, then such value adopted for the purposes of payment of Value Added Tax or sales tax, as the case may be, 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 clause (i).
Circular No. F. No. B1/16/2007-TRU
9.3 Wherever VAT/ sales tax on transfer of property in goods involved in the execution of works contract is paid on actual value, the same value is also taken for the purpose of determining the value of works contract service.
9.10 Contracts which are treated as works contract for the purpose of levy of VAT / sales tax shall also be treated as works contract for the purpose of levy of service tax. This is clear from the definition under section 65(105) (zzzza).
This reflects importance of knowledge of VAT laws per se and its applicability to a particular transaction of WC.
Vivisecting the contract
4.1 Since WC consists of two elements viz. property in goods and services, it will have to be vivisected. Clause 9.1 of the Circular dt. 22-5-2007 refers to vivisecting the contract. This process is required to be carried out to determine:
- the value of passing of property in goods
- profit element in the value of passing of property in goods
- the value of services provided
- profit element in value of services provided
Determining quantum of passing of property in goods
5.1 Under the VAT laws, tax is levied on the property in goods passing to the contractee. The Supreme Court has in the case of Gannon Dunkerley (88 STC 204) laid down that it is not the cost of goods (or the cost of acquisition) the property of which is taxable. The tax is to be levied on the value of the goods at the time of incorporation in the works. Therefore, it involves two steps viz. determining the quantum of goods used for the works and its value at the time of incorporation in works. Essentially, it means profit element in respect of such goods also will have to be taken into account while arriving at the value.
Determining Value of Goods
6.1 The Supreme Court has, in the case of Gannon Dunkerley, laid down the methodology for arriving at the value of the goods as well. It is provided that value of goods can be arrived at by taking into account the value of the entire WC and deducting there from the charges towards labour and services viz. amount paid to sub-contractor, charges for planning, designing etc. Here, it should be noted that the method applied is indirect. It is not the summation of value of property in goods which is passing. This may be perhaps due to presumption that element of service may be low as compared to quantum and value of goods.
Determining quantum of service element
7.1 Since ST on WC is on service element of WC, same principles as laid by the Supreme Court in respect of goods should also prevail. It means that tax has to be paid on the quantum of service rendered in respect of WC and value thereof. Does it mean that value of services can be derived by deducting value of goods from the total value of contract? It is at this stage the question of connectivity between ST and VAT laws comes into picture.
Priorities in determination of value
8.1 Should one determine value of services first and pay VAT on the balance amount treating as value of goods for VAT purposes? Or should one determine value of goods under VAT and pay ST on the balance amount of the contract? ST is required to be paid before 5th of the next month / quarter and generally VAT is required to be paid in the third / fourth week of the next month / quarter. Therefore, operationally one may be tempted to go for determining value of services for ST. However, the provisions with respect to ST are deviating in this respect. Rule 2A (1)(i) requires the assessee to deduct the value of goods as determined under VAT laws from the total value of contract to arrive at the value of services. Thus, under the ST, the priority is required to be assigned to determining the value of goods and not services.
Gross amount Charged
9.1 Sub-clause (i) of Rule 2A(1) lays down following formula for arriving at the value of service.
Value of WC Service = gross amount charged for WC less value of transfer of property in goods involved in the said WC.
Rule 2 A does not contain any definition for the term “gross amount charged”. It may be noted that the above formula is to be applied only when the gross amount charged is inclusive of VAT or sales tax. See also para 9.4 of the Circular No. F. No. B1/16/2007-TRU
Value of transfer of property in goods involved in the execution of WC
10.1 Rule 2A(1)(i) requires the assessee to deduct value of transfer of property in goods in the execution of the WC. It should be noted that there is no reference to value of transfer of property in goods as per the provisions of VAT laws. It means the assessee can determine the value of goods independently. However, clause (ii) provides that if the assessee has paid VAT on the basis of actual value of transfer of property then such value has to be considered for the purposes of clause (i). Here, the Rule is silent about the scenario wherein the assessee has not paid VAT on actual basis. A glance at the provisions of VAT laws of any state Government will show that all of them provides for an alternative in the form of deduction in respect of service element on an ad hoc basis. This is for the reason that, in large number of cases, it is not possible to maintain detailed records for each contract independently. Therefore, VAT Act / Rules provide for ad hoc deduction for value of labour / services on the basis of nature of WC. VAT is required to be paid on the balance amount, as it is the amount of value of transfer of property in goods, which is being passed.
10.2 A question that may arise here is what will happen if the dealer has not paid VAT on actual value of transfer of property in goods involved. Does it mean that clause 2A(1)(i) will not be applicable? If so, how to determine the value in such cases? A close reading of clause (ii) will reveal that the assessee is required to use the value as per VAT only if tax under VAT has been paid on actual value of property passing. Both the clause i.e. (i) and (ii) are independent. Therefore, if clause (ii) cannot operate, clause (i) can operate on its own. It means that the assessee can determine the value of transfer of property in goods for ST purposes independently of VAT computation. Putting it differently, it means that it is only in the case of VAT being paid on actual basis, the value is required to be used for valuation under ST purposes. There do not appear to be anything in the rule which prohibits the assessee in determining the value of goods independently for ST purposes, if the VAT has not been paid on actual value of transfer of property.
10.3 While sub-clause (i) gives an option to compute value of goods there is no reference to the methodology adopted for the same. For example, value of goods should be inclusive of VAT paid thereon or not. How much profit element should be assigned to such value of goods?
Significance of clause (ii)
11.1 What is the significance of sub-clause (ii)? A plain reading will reveal that it takes care of a scenario wherein the value of transfer of property has already been determined. If the said happening has not taken place then the clause will become in-operative. In consequence thereof, clause (i) will operate independently without taking cognizance of clause (ii). There are two scenarios under VAT laws wherein it can happen i.e. value of property in goods is determined on an ad hoc basis or option is exercised for Composition Scheme (CS) under VAT. This may look too complex to follow. However, the following table will clarify the position:
|
|
Value of property transferred in Goods under VAT
|
Value of property transferred in Goods under ST
|
Applicable ST Rule
|
|
Option A
|
Actual basis
|
Actual as under VAT
|
Rule 2A(1)(i)
|
|
Rule 2A(1)(ii)
|
|||
|
Explanation (b)
|
|||
|
Option B
|
Ad hoc basis
|
Actual as under ST
|
Rule 2A(1)(i)
|
|
Explanation (b)
|
|||
|
Option C
|
Under CS
|
Actual as under ST
|
Rule 2A(1)(i)
|
|
|
|
|
Explanation (b)
|
All the above are valid propositions. Refer to first para of 9.3 of Circular B1/16/2007 TRU dt. 22-5-2007 which reads as follow:
“Wherever VAT / sales tax on transfer of property in goods involved in the execution of works contract is paid on actual value, the same value is also taken for the purpose of determining the value of works contract service. In other cases, value of works contract service shall be determined based on the actuals.
CS under VAT
12.1 An interesting issue will arise here. What will happen if the assessee has opted for CS under VAT and has paid VAT at lump sum rate? It should be noted that there is no necessity that the dealer opting for CS under VAT should also opt for CS under ST. It is entirely at the option of the assessee to follow the option as he may deem fit. Look at the options available to the assessee from the following table:
|
|
CS under VAT
|
CS under ST
|
|
|
Option A
|
Yes
|
Yes
|
Permitted
|
|
Option B
|
No
|
Yes
|
Permitted
|
|
Option C
|
No
|
No
|
Permitted
|
|
Option D
|
Yes
|
No
|
Permitted
|
12.2 As we know, under the CS, WC is not required to be vivisected and value of goods and services are not required to be determined independently. VAT under CS is being paid on an ad hoc basis on total value of WC. Since, in such cases, the assessee has not paid VAT on the basis of actual value, the question of deducting it from gross value charged, as laid down under Rule 2A(ii), does not arise. Can the assessee, for the purpose of ST, compute the value of goods and deduct it as laid down under rule 2A(1)(i)?
Should the value of goods and services remain the same under VAT and ST?
13.1 An interesting situation will arise here. Is it necessary that value of goods and services on which VAT and ST is being paid should remain the same both under VAT and ST? There is no provision under the VAT laws or the Rules for Determining Value of Services under ST to do so.
Pitfall of applying provisions of rule 2A(1)(i)
14.1 What will happen if the goods are used in the execution of WC but property therein does not get transferred to the contractee? In the case of WC, number of items of goods is being consumed but all of them do not necessarily remain in existence when the WC is completed. Property in such cases does not get transferred. It is a matter of detailed examination in each case as to proportion of such material. But, it is a fact that in majority of the WCs, there is existence of such goods. In the case of VAT, tax is not levied on such goods i.e. property wherein is not being passed. Various courts have accepted this principle and all the State Governments are following the same. Provisions of 2A(1)(i) refers to “less the value of transfer of property in goods involved in the execution of the said WC”. Thus, here also the principles to be followed will be as in the case of VAT. Therefore, if due care is not taken, this will lead to payment of ST on goods as well. This will be clear from the following example.
|
|
|
Case I
|
Case II
|
|
A
|
Gross amount charged for WC
|
10,000
|
10,000
|
|
|
Less:
|
|
|
|
B
|
Value of property in goods involved in execution of WC
|
(3,000)
|
(3,000)
|
|
C
|
Value of property not transferred in goods involved in execution of WC
|
---
|
(1,000)
|
|
D
|
Value of property transferred (B +C)
|
3,000
|
4,000
|
|
E
|
Value of services rendered
|
7,000
|
6,000
|
|
E
|
Value of Taxable services for ST purposes (A-B)
|
7,000
|
7,000
|
As can be seen from above, in Case-II since the value of property not transferred is not deducted, ST will be on higher side.
Applicability of provisions of Central Excise
15.1 ST is being paid on the value of services rendered. Therefore, value of goods should not be subject to verification of ST department. However, if the value of service is dependent on value of goods then value of goods will be subject to scrutiny of the ST Department. Therefore, if the value of transfer of property in goods involved is not as per VAT laws as provided under rule 2(1)(ii) then the value of goods can be subject to scrutiny of ST Department. To what extent the provisions of Central Excise Act will be applicable in such cases is a matter to be examined.
Explaining the “Explanation”
16.1 Apparently, the provisions of clause 2A(1)(i) should have served the purpose. However, Explanation (b) is the real villain, extending the scenario to its further height. The said clause innocently provides that total value WC service shall include various eight items mentioned therein. Although not said so specifically, is it not requiring the assessee to carry out valuation of service element involved independently? If that is so, one would have expected such clause as a part of the main clause (i) itself and laying down that the value of service shall be higher of either of the two. However, such a condition has been inserted through an “Explanation”. It is a fact that in many cases value of service to be determined as provided under clause (i) cannot match with that of the value as derived under clause (b) of Explanation. If so, the proper course would have been to do so in the clause (i) itself. Is it not the case of extending the enacting part through the Explanation?
16.2 The AP High Court has observed in the case of H V Jagdeesh (AIR 1966 AP 35) that proper function of an explanation is to make plain or elucidate what is enacted and not to add or subtract from it. An Explanation does not either restrict or extend the enacting part; it does not enlarge or narrow down the scope of the provision that it is supposed to explain.
Components of services and its valuation
17.1 Explanation (b) of Rule 2A(1)(i) reads as follow:
(b) value of works contract service 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 the 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;
What is the significance of this clause? Is it an additional condition to be satisfied? Does it mean that the assessee should also carry out independent exercise and to ensure that value of services as determined as per the formula given in 2A(1)(i) is not less than sum of items as enumerated in (i) to (viii)? Provisions of clause (b) are perplexing for various reasons. Firstly, the entire provisions of Rule 2A nowhere it is stated that the assessee has two options for computing value of services i. e. 2A(1)(i) and as per Explanation (b). Secondly, it is also not laid down that value of services will be higher of value arrived at under 2A(1)(i) or under Explanation (b).
17.2 A glance at the structuring of the rule 2A may help in understanding the provision in a better way. There is only one formula to be applied for determining value of services i.e. as laid down under 2A(1)(i). Before applying the provision of 2A(1)(i) the assessee has to find out the value of material applied under VAT laws. If it is on actual basis then the said value has to be applied for deducting from gross amount charged for WC. Having arrived at the value of WC service, in terms of clause (b) it has to be ensured that such value is not less than summation of eight items mentioned therein.
17.3 Why should one also carry out another exercise? Things which appear simple at this stage are not so. It may so happen that the value of goods might have been arrived at a higher rate resulting into lower value of services. In that case, tax on service element will be lower. In order to safeguard against such contingencies “Explanation” can help checking in leakages. This has wide implications.
17.4 Firstly, it is a point to be examined whether the “Explanation” can redefine the main operative part under which it is appearing. While clause (i) defines the method by which value of service should be determined, “Explanation” prescribes the other method below which the value of service should not be. Although it is not specifically stated so, a reading of the wordings “value of works contract shall include” implies that value as derived under clause (i) cannot be less than summation of eight items mentioned under clause (i) to (viii) as appearing under sub-clause(b) of the “Explanation”.
17.5 Secondly, although not specifically stated under sub-clause (i), the assessee is required to make two separate calculations viz. one as per the method prescribed under rule 2A(1)(i) and, secondly, as mentioned under Explanation (b) to rule 2A(1)(i). In fact the assessee will have to make the computation as follow.
|
Rule 2A(1)(i)
|
|
Explanation (b) to rule 2A(1)(i)
|
|
|
|
1
|
2
|
3
|
4
|
5
|
|
|
Rs.
|
Rs.
|
|
Rs.
|
|
Gross amount charged for WC
|
xxx
|
|
(a) labour and service charges for the execution of the works
|
x
|
|
Less: Value Added Tax or Sales Tax paid
|
xx
|
|
(b) amounts paid to a sub-contractor for labour and services
|
x
|
|
Gross amount charged excluding VAT or Sales Tax
|
xxx
|
(c) charges for planning, designing and architect’s fees;
|
x
|
|
|
Less: Value of Transfer of property in goods involved in the execution of WC
|
xx
|
(d) charges for obtaining on hire or otherwise, machinery and tools for the execution of the works contract;
|
x
|
|
|
|
|
(e) cost of consumables such as water, electricity, fuel used in the execution of works contract
|
x
|
|
|
|
|
(f) cost of establishment of the contractor to the extent to which it is relatable to supply of the said labour and services;
|
x
|
|
|
|
|
(g) other similar expenses relatable to the said supply of labour and services
|
x
|
|
|
|
|
(h) profit earned by the service provider relatable to supply of labour and services:
|
x
|
|
|
Value of services
|
xxx
|
Total Value of services
|
xxx
|
|
17.6 Three scenarios will emerge from above.
a) In the first case, value of service as computed under col. 3 is equal to that of under column 5. No issues will arise as amount appearing under column 5 can be said to be included under column 3.
b) Under the second scenario, amount computed under column 3 is more than that of column 5. Here also there will not be any issue as the amount as appearing under column 5 is less than column 3, it can be said that value as appearing under column 3 are inclusive of the amount in column 5. (Here, a question may arise as to whether service tax is charged in respect of value of goods i.e. (3 -5). However, it is a different issue). See the example below.
|
Rule 2A(1)(i)
|
|
Explanation (b) to rule 2A(1)(i)
|
|
|
|
1
|
2
|
3
|
4
|
5
|
|
|
Rs.
|
Rs.
|
|
Rs.
|
|
Gross amount charged for WC
|
104
|
|
(a) labour and service charges for the execution of the works
|
3
|
|
Less: Value Added Tax or Sales Tax paid
|
4
|
|
(b) amounts paid to a sub-contractor for labour and services
|
3
|
|
Gross amount charged excluding VAT or Sales Tax
|
100
|
(c) charges for planning, designing and architect’s fees;
|
3
|
|
|
Less: Value of Transfer of property in goods involved in the execution of WC
|
70
|
(d) charges for obtaining on hire or otherwise, machinery and tools for the execution of the works contract;
|
4
|
|
|
|
|
(e) cost of consumables such as water, electricity, fuel used in the execution of works contract
|
3
|
|
|
|
|
(f) cost of establishment of the contractor to the extent to which it is relatable to supply of the said labour and services;
|
2
|
|
|
|
|
(g) other similar expenses relatable to the said supply of labour and services
|
2
|
|
|
|
|
(h) profit earned by the service provider relatable to supply of labour and services:
|
5
|
|
|
Value of services
|
30
|
Value of services
|
25
|
|
17.7 Here, since the amount under column 5 is less than column 3, it can be said that value of services as computed under rule 2A(1) are inclusive of various items as laid down under clause (b) to the Explanation.
c) Under the third scenario, amount arrived under column 5 is more than the amount under column 1. It is in this case that clause (b) of the Explanation will operate. Here, to the extent of the difference between column 5 and 3, it can be said that value as arrived at under rule 2A(1) does not include certain amount of services. This can be clear from the following example.
|
Rule 2A(1)(i)
|
|
Explanation (b) to rule 2A(1)(i)
|
|
|
|
1
|
2
|
3
|
4
|
5
|
|
|
Rs.
|
Rs.
|
|
Rs.
|
|
Gross amount charged for WC
|
104
|
|
(a) labour and service charges for the execution of the works
|
5
|
|
Less: Value Added Tax or Sales Tax
|
4
|
|
(b) amounts paid to a sub-contractor for labour and services
|
5
|
|
Gross amount charged excluding VAT or Sales Tax
|
100
|
(c) charges for planning, designing and architect’s fees;
|
5
|
|
|
Less: Value of Transfer of property in goods involved in the execution of WC
|
70
|
(d) charges for obtaining on hire or otherwise, machinery and tools for the execution of the works contract;
|
4
|
|
|
|
|
(e) cost of consumables such as water, electricity, fuel used in the execution of works contract
|
3
|
|
|
|
|
(f) cost of establishment of the contractor to the extent to which it is relatable to supply of the said labour and services;
|
5
|
|
|
|
|
(g) other similar expenses relatable to the said supply of labour and services
|
2
|
|
|
|
|
(h) profit earned by the service provider relatable to supply of labour and services:
|
5
|
|
|
Value of services
|
30
|
Total Value of services
|
34
|
|
17.8 As can be seen from above, amount under column 5 is Rs. 34 and that of column 3 is Rs. 30.Therefore, to the extent of Rs. 4 (i.e. 34 – 30), the condition as laid down under clause (b) to the Explanation is not satisfied. Hence, service tax will have to be paid on Rs. 34 and not on Rs. 30 as arrived at under Rule 2A(1).
17.9 The objective of making such provision here appears to ensure that there is no leakage of revenue under service tax which may arise as a result of pegging the value of goods artificially under the VAT laws or actual value as determined by the assessee. In fact, the same thing could have been achieved by making specific provisions in this respect rather than going the round about way. In the ultimate analysis, a jungle has been created within a jungle itself.
Labyrinth within the labyrinth
18.1 If the first layer of labyrinth is the Rule 2A, clause 2A(1)(i) is the second one. The third one is Explanation (a) to Rule 2A(1)(i). The fourth layer of the labyrinth can be found in clause (b) of the Explanation. However, a glance at eight clauses thereof will make one feel the fourth layer as labyrinth itself. Each of the eight clauses is having its own layers. However, let us have a look at it in general.
18.2 In view of space constraint, it may not be possible to discuss each of the eight item in detail herein. All these eight items can be found referred to in the classic judgment of the Supreme Court in the case of Builders Association. If all the State Governments and the Central Government had followed it exactly in the manner as directed by the Supreme Court, there would not have been any problem. Not only have the State Governments deviated from it while implementing tax on WC under Sales Tax / VAT laws, the Central Government have deviated as well. Since computation of service element is made dependent on value as arrived under VAT, one would have expected some commonality between the two. To the extent different yardsticks are followed, picture arising will be incoherent. Let us have a look at the provisions of Rule 58(1) of Maharashtra VA Rules vis-à-vis clause (b) of the explanation.
|
Clause (b) of Explanation to Rule 2A(1)(i) of ST Rules
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Maharashtra VAT - Rule 58(1)
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(a) labour and service charges for the execution of the works
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(a) labour and service charges for the execution of the works where the labour and service done in relation to the goods is subsequent to the said transfer of property;
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(b) amounts paid to a sub-contractor for labour and services
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(b) amounts paid by way of price for sub-contract, if any, to subcontractors;
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(c) charges for planning, designing and architect’s fees;
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(c) charges for planning, designing and architect’s fees;
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(d) charges for obtaining on hire or otherwise, machinery and tools for the execution of the works contract;
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(d) charges for obtaining on hire or otherwise, machinery and tools for the execution of the works contract;
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(e) cost of consumables such as water, electricity, fuel used in the execution of works contract
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(e) cost of consumables such as water, electricity, fuel used in the execution of works contract, the property in which is not transferred in the course of execution of the works contract;
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(f) cost of establishment of the contractor to the extent to which it is relatable to supply of the said labour and services;
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(f) cost of establishment of the contractor to the extent to which it is relatable to supply of the said labour and services;
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(g) other similar expenses relatable to the said supply of labour and services
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(g) other similar expenses relatable to the said supply of labour and services, where the labour and services are subsequent to the said transfer of property;
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(h) profit earned by the service provider relatable to supply of labour and services:
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(h) profit earned by the contractor to the extent it is relatable to the supply of said labour and services:
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18.3 As can be seen from the words highlighted there are differences between both the provisions. All the State Governments have provided for more or less on the line as above as under Rule 58 of Maharashtra VAT Rules with variations. Thus, the provisions of VAT laws and that of ST are not at common level. If that is the case, how can it be said that by adopting the value of goods under VAT laws the assessee will get the correct value of services? What is the assurance that by adopting such methodology ST will not be paid on the value of property transferred in the goods?
Profit earned by the service provider:
19.1 In view of the tangible nature of goods it may be possible to identify them and assign the cost associated with it. However, the problem is how to determine its value? As we know the contract includes the element of profit as well. Since there are two components of the WC, there will be two elements of profit i.e. profit on goods and on services. A question arises as to how to bifurcate the profit element of the contract between the two i.e. goods and services?
As per the practice followed under VAT, adhoc rate of gross profit is applied to the value of goods to arrive at the value of goods transferred. However, the Institute of CA of India has in its publication “State – Level VAT in India –A Study”, page no. 130 has recommended the following method.
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Rs.
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1
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Total Contract Value
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2
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less: Eligible deductions of charges towards labour and services & Consumables
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3
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Taxable Turnover of Sales [1- 2]
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4
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Cost of Goods Consumed (as arrived at on actual basis)
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5
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Value Addition (%) i.e. (3)/(4)
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4
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Cost of Goods (as in 4 above)
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5
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add: Value Addition @ as in 5 above
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6
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Selling Price liable for VAT [ 4 + 5]
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7
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VAT @ 4.00% / 12.50% on (6) above
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Here, Value Addition is based in the proportion of total cost of goods and sales price. This is in sharp contrast to the practice followed under VAT.
Charging for works contract
20.1 There is a wide difference between the invoicing process of WC, on one hand, and sale of goods and other services. In the case of WC for construction services, bills submitted are subject to certification by architect / engineers and other agencies. Deductions are made there from for various reasons. Clients make the payment thereafter and that too, in installments. Moreover, as per the terms of the contract, certain percentage of the amount billed is held as security deposit as performance guarantee. Secondly, in the case of VAT, liability is computed on mercantile basis i.e. the amount billed. However, in the case of ST, liability for payment of tax arises on receipt of contract money only. As can be seen, there is a wide gap between methodology to be adopted for computation of tax liability under VAT and ST.
20.2 Since Explanation (a) to sub-clause (i) provides for the computation under VAT as the base for computation under ST, it can function only if the basic foundation in both the cases is the same. To the extent of divergence between the two, conflicts are bound to arise. To that extent operation of clause (a) to Explanation will raise number of issues.
Advance received
21.1 In the case of WC, at times, advance payment is being made by the contractee. This may not raise any issue under the VAT. However, in terms of provisions of S. 65(105), and Explanation 3 to section 67, ST is required to be paid thereon. At the time of receipt of advance, there is no certainty as to in which month billing for the work done will take place. Apart from that, in the case of large contracts, billing takes place periodically, resulting into more than one bill depending upon progress of the work done. In such cases, the assessee will have no option but to keep track of ST paid in advance and make adjustments of it against the liability arising in future. This will be a complex process and there are bound to be mistakes. Apart from that problems will arise at the time of filing of half-yearly returns i.e. ST-3.
Consider the sequence of events of a routine type of contract.
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Date
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Description of event
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1
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1-7-2007
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Signing of the Contract for Rs. 1.00 cr.
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2
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5-7-2007
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Advance payment received of Rs. 30.00 lacs
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3
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31-7-2007
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Bill raised for work done to the extent of Rs. 10.00 lacs.
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4
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4-8-2007
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Bill approved for Rs. 9.00 lacs
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5
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7-8-2007
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Contractee released the payment of Rs. 7.86 lacs as follow:
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Rs. (lacs)
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Amount of the bill as approved
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9.00
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Less Retention money as per the contract @ 10.00%
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.90
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Balance amount to be paid
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8.10
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Less: adjustment @ 30.00% against advance as per the contract
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2.43
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6
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16-8-2007
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Cheque received for work done during July 2007
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5.67
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21.2 Events listed above are of quite routine nature for such type of business. No complex issues have been involved. However, let us apply the provisions of ST Rules and see the issues arising there from.
1) The contractor has been paid advance of Rs. 30.00 lacs as on 5-7-2007. This will be consisting of payment towards goods and services. In terms of provisions of S. 65 and 67 as referred to above ST is required to be paid on advance amount received. Since a part of the advance received will be towards goods the question of ST being paid thereon does not arise. There is no clarity in this respect. Since the WC has not been executed in any respect, the question of applying rules for determination of value does not arise. Therefore, one will have to make apportionment on estimated basis between component of goods and services and pay ST on service component on an adhoc basis. Let us say, in this case, component of service is Rs. 40.00 lacs. Therefore, the contractor will have to pay ST on 5th August, 2007 on Rs. 12.00 lacs (40.00% of Rs. 30.00 lacs).
2) Bill submitted for work done in July, 2007 has been approved on 4th Aug. 2007. Therefore, taxable service can be said to have been provided on the said date. Final value of work done will be Rs. 9.00 lacs as approved. Assuming that service component thereof is 40.00%, ST liability will arise on Rs. 3.60 lacs. Therefore, liability for ST can rise when payment against bill for Rs. 3.60 lacs is received. Here, two issues will arise. Firstly, whether the Contractor can adjust this liability against ST paid in advance on 5-7-2007? Secondly, if so, to what extent? As far as the adjustment is concerned there can be no doubt that since tax has already been paid in advance, ST paid on advance received can be adjusted. However, to what extent? Can it be to the full extent of ST liability i.e. Rs. 28,032 (i.e. 12.36% of Rs. 2,26,800 lacs [40.00% of Rs. 5.67 lacs]) or Rs. 8,410 (i.e. 30.00% of Rs. 28,032 tax liability)?
As per the contract, the contractee has deducted advance to the extent of 30.00%. The Contractor has paid ST on the said amount. Should adjustment in ST also be restricted to the terms of the contract or can it be made to the full extent of ST liability arising i.e. Rs. 28,032? A glance at the provisions of S. 65, 67 and Rule 6 will make clear that there is nothing therein requiring the assessee to make adjustment in ST as per the terms of the contract.
3) Retention Money:
What treatment should be given to Rs 90,000 which has been kept as security deposit? It should be noted that the same is part of taxable services but payment in respect of the same has been withheld as per the terms of the contract. Since liability to pay ST arises only when amount towards taxable services are realised, there will not be liability to pay ST on Rs. 90,000 in September, 2007.
4) Rule 4A requires the assessee to issue a bill / invoice / challan etc. from the date of completion of service or receipt of any payment toward the value of taxable service, whichever is earlier. As long as the assessee is providing services only there may not be any problem in issuing such bills / invoice etc. However, when it involves supply of goods, VAT laws all the State Governments provide for strict rules and regulations for timing, format etc. Chances of such provisions being in conflict cannot be ruled out.
Security deposit not realized
22.1 A typical character of WC for construction services is keeping certain amount of the contract as retention money. It is received after certain period of time as laid down under the contract or even may not be received at all. It may be noted that the amount in this respect has already been charged in the bill for VAT purposes and tax thereon has already been paid. However, since ST is required to be paid on receipt basis, liability for the payment of ST will arise only if the said amount is received. This will pose the problem while computing taxable value of services under Explanation (a) to clause 2A(1)(i) as the amount charged will be consisting of something which may not be realized at all.
Deduction of VAT paid
23.1 Explanation (a) to the sub-clause (i) provides that the gross amount charged shall not include VAT or ST paid. Therefore, if VAT is not shown separately in the bill then the quantum of VAT will have to be deducted from it. For example as per the terms of the agreement between the contractor and the contractee, the contractor might have agreed to borne the VAT. The contractee, therefore, might not have charged it in his bill separately. Secondly, in the above case, the dealer might have reduced the amount of value of contract by value of VAT. Thus, total amount charged from the contractee remains as agreed upon. Thirdly, the contractee might have opted for composition scheme under VAT laws and VAT laws may not be permitting to charge the tax separately in the invoice raised.
What will happen in above scenarios?
24.1 It should be noted that in the first and third case though VAT is not charged in the invoice raised, tax liability in respect thereof is being discharged by the dealer. Theoretically, ST cannot be charged on VAT element of the WC. If, therefore, VAT not charged but paid, is not deducted the question of ST being paid on VAT will arise. This will be clear from the following example.
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Case A
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Case B
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Rs.
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Rs.
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Value of WC
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100
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Value of WC
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104
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VAT Charged
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4
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VAT charged
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--
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Gross amount charged
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104
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Gross Amount charged
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104
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Computation of Value of Service under ST Rules
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1
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2
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3
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1
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2
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3
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Rs.
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Rs.
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Rs.
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Rs.
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Gross amount charged for WC
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104
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Gross amount charged for WC
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104
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Less: Value Added Tax or Sales Tax paid
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4
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Less: Value Added Tax or Sales Tax paid
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--
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Gross amount charged excluding VAT or Sales Tax
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100
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Gross amount charged excluding VAT or Sales Tax
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104
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Less: Value of Transfer of property in goods involved in the execution of WC
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80
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Less: Value of Transfer of property in goods involved in the execution of WC
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80
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Value of services
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20
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Value of services
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24
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As can be seen from above in Case A, value of service works out to Rs. 20 as against Rs. 24 in Case B. The difference of Rs. 4 is due to VAT paid of Rs. 4. It means that ST will have to be paid on Rs. 24 and not Rs. 20. Thus, if VAT paid is not deducted there will be additional payment of ST to the extent of VAT element involved.
VAT Input Credit
25.1 The Rule provides for deduction of the amount of VAT paid. As we know, under the VAT laws the dealer is permitted input credit from the gross amount of tax liability. Therefore, the actual amount of VAT paid will be less than the gross amount. Which amount should be considered – the gross amount of VAT liability or the actual amount of VAT paid? If, in such a case, the actual amount of VAT paid is considered then there will be ST liability on input credit availed under VAT laws. This can be seen from the following example.
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Case A
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Case B
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Rs.
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Rs.
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Value of WC
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100
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Value of WC
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104
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VAT Charged
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4
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VAT charged
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--
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Gross amount charged
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104
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Gross amount charged
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104
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Computation of Value of Service under ST Rules
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1
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2
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3
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1
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2
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3
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Rs.
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Rs.
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Rs.
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Rs.
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Rs.
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Rs.
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Gross amount charged for WC
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104
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Gross amount charged for WC
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104
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Less: Value Added Tax or Sales Tax paid
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4
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Less: Value Added Tax or Sales Tax paid
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4
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Less: Input Credit under VAT
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1
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Less: Input Credit under VAT
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1
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Net amount of VAT payable
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3
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Net amount of VAT payable
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3
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Gross amount charged excluding VAT or Sales Tax (104 – 4)
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100
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Gross amount charged excluding VAT or Sales Tax
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101
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Less: Value of Transfer of property in goods involved in the execution of WC
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80
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Less: Value of Transfer of property in goods involved in the execution of WC
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80
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Value of services
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20
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Value of services
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21
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As can be seen in the Case A value of ST works out to Rs. 20 as against Rs. 21 in Case B. This is due to VAT Input Credit of Rs. 1. Thus, in Case B, ST liability will be more as compared to Case A.
No separate tax paid for each contract
26.1 As in the case of ST, under the VAT also computation of taxable value of the transaction is made separately for each contract. Rate of tax is applied on the total value of the taxable transactions. Entitlement for input credit is deducted there from. Thus, net amount of tax paid will be a consolidated figure. Identification of payment for a particular contract is not possible. There is no requirement to do so for each contract nor, it is feasible as well. Therefore, to prove that VAT has been paid for each contract is going to be a tough condition. The only alternative to prove payment of VAT for a particular contract is to provide entire computation of VAT liability, input credit and payment of tax. Thus, VAT computation will come under the scrutiny of ST department. To what extent this is feasible, and legal, is a point to be seen.
Synchronisation of payment of VAT and Determination of value of services
27.1 Generally, VAT is required to be paid in the third week of next month or the quarter while payment of ST is required to be made by 5th of the next month / quarter. For the purpose of determining value of services the assessee is required to deduct amount paid as VAT. This can happen only if the assessee makes payment of VAT on or before 4th of the next month. Thus, relief given under VAT laws gets diluted through the provisions of ST. The only alternative left open for the assessee is to delay the determination the value of services till VAT computation is made. This will defer the payment of ST, of course with interest thereon.
27.2 At times, under the VAT laws small dealers are permitted to compute and make payment on quarterly basis. Visualise a case wherein VAT is required to be paid on quarterly basis and ST is required to be paid on monthly basis. In such a case, the dealer might not have even made computation for the first two months at all for VAT purposes. Therefore, there will not be any alternative for the assessee to pay ST with interest only.
27.3 The whole issue arises for the reason that there is no synchronization of various events involved. This may not be possible for the reason that VAT laws come under state jurisdiction and there is no uniformity therein. Ultimately, in the process, the life of tax payers becomes pathetic. Despite the fact of having ready to pay the tax, such provisions compel him to pay interest. Isn’t it another form of taxation in disguise?
Seventh Layer of Labyrinth
28.1 Abhimanyu got trapped in the seventh layer and found it impossible to get out of it. Having tried to appreciate the provisions of valuing services in WC so far, the reader must be having the same kind of feeling. How to determine value? Should one start from VAT laws and apply the provisions of ST? What will happen if VAT laws are not applicable fully? What will happen if the VAT laws are applicable partially? What will happen if the assessee is under CS under VAT laws? And there may be many more questions. An attempt has been made here under to guide step by step in determining the tax liability.
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Step
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A
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Computation of value under Rule 2A(i) and (ii)
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A1
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Ascertain whether VAT laws are applicable to WC. If yes, it will attract the provisions of S. 65(105)(zzzza).
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A2
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Determine rate of profit in WC and appropriate rate as applicable to element of goods and services involved therein.
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A3
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Determine the gross amount charged for WC. If it is inclusive of VAT paid then the same has to be deducted from gross amount charged. If gross amount charged is not inclusive of VAT then the value exclusive of VAT will be considered.
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Rule 2A(1)(i)
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Rule 2A(1)(ii)
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A4
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In case, if the value of material has not been determined under VAT then compute quantum of transfer of property in goods for ST purposes.
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A5
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Apply the rate of profit as determined under step No. A2 to A1.
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A6
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Add the quantum of profit to the cost of goods i.e. A4 + A5. This will give value of transfer of property in goods.
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If the value of goods has been determined under VAT, clause 2A(1)(ii) will operate. Value as determined under VAT will be considered for ST purposes.
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A7
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Taxable value of service will be the amount as arrived at in A3 less A6
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B
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Computation of Value of services under Explanation (b)
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B1
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Identify various services rendered under the WC. Explanation to Rule 2A(1)(i) lists seven different types of services.
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B2
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Determine the value of various services as identified above
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B3
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Determine total element of services involved in the WC.
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B4
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Apply the rate of profit as arrived at in A2 to value of services rendered.
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B5
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Total B3 and B4 to get total value of service.
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SUMMARY
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C1
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If the amount as arrived at in no. A7 and B5 are equal then the said value will be taxable value of services under WC.
If the value as arrived at in A7 is less than value under B5 then value as arrived at under No. B5 will be considered as taxable value of services under WC.
If the value as arrived at in No. A7 is more than value under B5, the Act, Rules, Circular and Notifications are silent about it. While the ST Department would like to ignore it, having undertaken the exercise of determining the value of services rendered as required under Explanation (b), there is no reason why tax be paid on higher amount.
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C2
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Apply the rate of tax on the amount as arrived at under Step no. C1
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C3
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Deduct value of Input Services from the amount as arrived at under Step No. C3. This will give the net amount of tax to be paid.
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An alternative
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D1
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If you find the above steps too cumbersome, opt for composition scheme and pay the ST @ 2.00% of the amount as arrived at in No. A7
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D2
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Deduct amount of tax paid on Input Services paid from the tax determined payable under D2. This will give the net amount of tax payable.
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Conclusion:
29.1 Certainly, the task of determining value of services, and paying tax thereon, is more daunting and exhausting than executing the works contract itself.
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