DVAT for works contractors - Jargon simplified

Works Contract has always been a matter of dispute for judiciary as well as professionals. The Complexity of transactions can briefly be gauged from the fact that applicable provisions include levy of Sales Tax (As per State Acts), Service Tax (As per Central Government), TDS and WCT Deductible (as required in most of state act) all on one single running bill of a Larger Work Contract. The Fact that one Single Works Contract may run into years and thereby resulting in transactions like Mobilisation advance, running bills and advances adds to the jargon.

Introduction to Works Contract

A Works Contract in Simple terms is a contract for carrying out certain works on any immovable or movable property of others. Article 366(29A) of Constitution of India has been formulated to impose a tax on transfer of property in goods involved in execution of a works contract. It Covers only those contracts which are composite in nature and segregated by fiction of law so that tax can be on transfer of goods involved.

Normally when any goods is sold, what shall be the applicable tax. Of course VAT/CST. Similarly when services of any nature are provided to service provider to service recipient, the applicable statute shall be Service Tax. Things sound that simple. In Case where a contract has both aspect of material as well as service it shall be called as Composite contract.

As Presented above in the Chart, A Composite Contract can be of two natures viz. Divisible and Indivisible Contract. First let’s discuss the Treatment of Taxes in Case of Divisible Contracts. (To Establish Divisbility of Contract is purely on nature of transaction and Professional Judgement and Lot of times this itself has been the subject matter of appeals to Judiciary).

In Case Of Divisible Composite Contract, Lets say of `100 say `80 of Material and `20 of Service Component. Then `80 shall be taxed at the rate as specified tariff applicable to the item and `20 shall be considered for computation of service tax.

Definition

Works contract includes any agreement for carrying out for cash or for deferred payment or for valuable consideration, the building construction, manufacture, processing, fabrication, erection, installation, fitting out, improvement, repair or commissioning of any moveable or immovable property. (Refer Section 2(1) of DVAT Act, 2004)

“Agreement” though not defined in VAT Act, has been cleared by judiciary as to be construed as provided in Indian Contract Act, 1872. Therefore, in works contract, the contractor promises to carry out some obligations like the construction of building, fabrication of machinery etc in consideration of the employer promising to pay a certain amount in cash or in the form of some other valuable consideration. (Refer Larsen & Toubro Ltd. vs State of AP (2006) 148 STC 616 (AP)) 

Why Constitution Required Insertion – A Case Called Gannon Dunkerly

Without Going into the technicalities of the decision (as this is not the prerogative of this article) it can be said that the Case abovementioned considered only those sales in the ambit of constitutional leviability for sales tax which can be squarely covered in Sales of Goods Act, 1930. Works Contract of nature mentioned above shall not fall in the above nature and thus it was held that charging Sales tax on Works Contract shall be Unconstitutional.

Thus to constitutionally correct the leviability of Works Contract under respective state vat acts the Article 366(29A) was insertion that required deeming fiction to tax the value involved in the contract for transfer of Property.

Rate  

Under Delhi Value Added Tax Act, 2004 rates of tax are different for different commodities. Rates for different commodities are as under:

*shall be paid at the rate of 4% on declared goods, as defined in the Central Sales Tax Act, 1956, involved in the execution of works contract if such goods are transferred from the contractor to the contractee in the same form in which they were purchased by the contractor:

Valuation of works contract under DVAT   

Option 1*: When Bifurcation ascertainable from Books

Value at the time of transfer of property in goods (whether as goods or in some other form) involved in the execution of work contract and shall exclude –

a. the charges towards “labour, services and other like charges**”; and

b. the charges towards cost of land, if any, in civil works contracts

*subject to the dealers maintaining proper records such as invoice, voucher, challan or any other document evidencing payment of referred charges to the satisfaction of the Commissioner.

** Separately defined in Rule 3 of DVAT Rules, 2005 as:

a. labour charges for execution of works;

b. charges for planning and architects fees;

c. charges for obtaining on hire or otherwise machinery and tools used for the execution of the works contract; d. cost of consumables such as water, electricity, fuel, etc. used in the execution of the works contract the property in which is not transferred in the course of execution of a works contract;

e. cost of establishment of the contractor including cost of marketing, finance expenses and securities deposits to the extent it is relatable to supply of labour and services;

f. other similar expenses relatable to supply of labour and services;

g. profits earned by the contractor to the extent it is relatable to supply of labour and services subject to furnishing of a profit and loss account of the works sites:

Option – 2: When Bifurcation not ascertainable from Books

Value at the time of transfer of property in goods (whether as goods or in some other form) involved in the execution of work contract and shall exclude –

a. the charges towards “labour, services and other like charges^”; and

b. the charges towards cost of land, if any, in civil works contracts

^ the amount of such charges shall be calculated at the percentages specified in rule 3 of Dvat Rules, 2005.The general rate being 20% of the total contract value. 

How is VAT Applicable on the above Running Bills pursuant to legal provisions applicable?

As per Provisions of DVAT Rules, 2005 the turnover arises in a tax period as per below provisions:

Therefore, Applying provisions as detailed above at each above stage of billing where consideration becomes due to be received DVAT shall be Applicable.

(Refer Rule 4 of DVAT Rules….)

Who is Liable to Deduct Tax at Source (WCT)

Contractee: Every person, not being an individual or a Hindu undivided family, who is responsible for making payment to any contractor for discharge of any liability on account of valuable consideration payable for the transfer of property in goods (whether as goods or in some other form) in pursuance of a works contract.

Contractor:  Every contractor responsible for making any payment or discharge of any liability to any sub-contractor, in pursuance of a contract with the sub-contractor for the transfer of property in goods (whether as goods or in some other form) involved in the execution, whether wholly or in part, of the works contract.

When to Deduct TDS

Contractee: At the time of credit of such sum to the account of the contractor or at the time of payment thereof in cash or by any other mode, whichever is earlier, on account of valuable consideration payable for the transfer of property in goods (whether as goods or in some other form) in pursuance of a works contract.

Contractor:  At the time of such payment or discharge, in cash or by cheque or draft or any other mode, to the sub contractor for transfer of property in goods.

Rate of TDS

Tax shall be deducted at the rate of 2% on the sum paid/payable towards transfer of property in goods.

Basic Exemption

Contracts (including Sub Contracts) for a value upto Rs 20,000/- shall be held exempt.

Few Relevant Aspects:

1) Deduction of TDS under Delhi VAT Act is in addition to the obligation of the contractee or the contractor, as the case may be, to deduct tax u/s 194C of the Income Tax Act

2)  TDS is not deductible by contractee on advance payments made to a contractor pursuant to the contract.

3) TDS is not deductible on inter-state sale, sale in course of import or labour and service

4)  TDS certificate is to be issued in Form DVAT 43 within 15 days from end of the month in which tax has been deducted in three copies. The same shall be preserved for a period of minimum 7 years.

5)  Every deductor shall apply for Tax Deduction Account Number (TAN) within seven days from tax deduction liability in form DVAT – 44.

Computation of Taxable Turnover and Tax

Its a very Broad Aspect but we shall take up the cases with few illustrations to discuss those cases which are general to some soughts.

Case 1:

Total Contract Value – `10,00,000/-

VAT – Additional as Applicable

Labour & Services – Not Ascertainable – Specified Percentage – 30%

Then, Taxable Turnover shall be – 10,00,000*70% = `7,00,000

And VAT Shall be 12.5%  -  87,500/-

Case 2:

Total Contract Value – `10,00,000/-

VAT – Inclusive in Contract

Labour & Services – Not Ascertainable – Specified Percentage – 30%

Computation of Taxable Turnover shall be a Complex effort Now, Assume total contract value to be 100.

Lets Assume material to be x, thus VAT would be 12.5% of x and Labour would be 30% of (100 – 12.5x/100). This Shall Create a complex Linear Equation and need to be solved. On Solving you get the VAT of Rs 80,460/- and Material Value of Rs 6,43,678/-

Conclusion

In the End, I would end by Saying that as we are going towards several changes to simplication it is the need our the hour that the service tax and vat aspects of such a works shall be brought fully in congruence with each other such that assessee and professionals can ensure implementation of standard practices across the board of Works Contract Industry.

About the Author

CA Ankit Gulgulia

The Author is a Practicing Chartered Accountant based in New Delhi. He can be reached at Ankitgulgulia@gmail.com