Service Tax on Works Contract and Renting of Immoveable property - An Analysis

1.      Works Contract Service

The insertion of the new category ‘Works contract Service’ has brought in the service component involved in the execution of works contract liable to service tax where the transfer of property in goods is liable to sales tax/ VAT.  In other words, only those works contract where sales tax/ VAT is leviable is liable to service tax. 

1.      The ‘taxable service’ is works contract in relation to construction of a new building or a civil structure for commercial or industrial purpose, construction of residential complexes, erection, commissioning or installation and turnkey projects, including Engineering, Procurement and Construction or Commissioning (EPC) projects.

since some of the services like erection, commissioning or installing, construction of residential complexes, commercial/industrial building/structure have specific category and also appear first among the sub-clauses of section 65 of the finance act, the specific category will prevail over the general category being works contract.  

2.      The law has introduced two schemes under the category of Works contract Service.  They are Regular Scheme and Composition Scheme.

Regular Scheme 

3.       As per the above scheme ‘value of works contract service’ is equivalent to the gross amount charged for the works contract less the value of transfer of property in goods as well as VAT/Sales Tax paid thereon. This option is available only when there is documentary evidence to prove the actual value of goods involved in works contract. The same is explained with an example as below

Eg:

*¹Gross Amount Charged = Material value + VAT+ Labour and other charges + Service Tax + Gross Profit

Value of works contract service shall include labour charges for execution of works, amount paid to sub-contractor*² for labour and services, charges for planning, designing and architect’s fees, charges for obtaining on hire or other wise, machinery and tools used for the execution of the works contract, cost of consumables, cost of establishment, other similar expenses and profit in relation to supply of labour and services.

*²In case the works contract service is sub-contracted, service tax charged by sub-contractor is allowed as CENVAT Credit against the service tax payable by main contractor.

Composition Scheme

4.      The service providers executing works contract find it difficult to keep a track of the material and labour expenses.  To provide relief to such works contract dealers a composition scheme has been introduced wherein the works contractor can pay 2% on Gross amount charged*² plus education and higher and secondary education cess on the same.  This option is exercisable only before commencement of works contract and no withdrawal from the scheme is permitted till the said project is completed. As per the rules specified duty paid on inputs and cess on the inputs is not allowed as service tax credit as per CENVAT Credit rules. It means the service tax credit can be availed for the duty paid on capital goods and tax paid on input services. The same is explained with an example as below

Eg:

The services providers getting registered under the Works Contract service are given the option to opt  either for regular scheme or the composition scheme. We analyze that, the composition scheme seems to be more beneficial as compared to the regular scheme.

If the service provider has multiple works contracts, he can opt for composition scheme for some of the works contracts provided such scheme will not be withdrawn before the completion of such contracts.

The emergence of the entry Works contract service can be traced back to the case of M/s Daelim Industrial Co Ltd vs. CCE, Vadodara [1994-2006] STT 438 where the Tribunal held that a works contract cannot be vivisected i.e., bifurcated into material and labour portion and part of it subjected to tax. The tribunal further held that there cannot be any service tax levied on a works contract. The petition filed by revenue against this decision was dismissed by the Supreme Court.

In this backdrop we can say that there is big chance of the entry works contract will be disputed in the court of law with the argument that liability to works contract is brought into the service tax net from 01.06.2007 and services provided earlier were not taxable.

2.      Renting of Immoveable property service – The most controversial category

 The service tax law defines the above service as ‘renting, leasing, letting, licensing or similar arrangements of immoveable property for use in the course of furtherance of business or commerce’ which is exigible to service tax. Specific exclusion is given to renting by or to a religious body and renting to an educational body other than a commercial training or coaching center or for the purpose of residence and holding of sports completion and entertainment programs.

For furtherance of business or commerce includes immoveable property used as factories, warehouses, office building, theatres, exhibition halls and multiple-use buildings.

In case a immoveable property is let out/ leased etc partly for commercial purpose and partly for residential purpose, then the property shall be treated as let out wholly for commercial purpose.

There is no deduction provision against such taxable service. Only vide notification 24/2007, deduction to the extent of property tax paid in relation to immovable property is allowed. For Example: If rent charged is Rs.50,000/- and property tax is Rs.1000/-. The service tax is payable on Rs.49,000/-. Self-adjustment is allowed within one year from the date of payment of property tax i.e, to say in case service tax paid before payment of property tax, the adjustment can be done within one year. 

It is a question as to how renting of a space is a taxable service. By referring the case of TAMIL NADU KALYAN MANDAPAM ASSOCIATION Vs UNION OF INDIA AND OTHERS (2006) 5 STT 231…, where it is held that the mere providing of premises on a temporary basis for organizing any official, social or business function is a taxable service and also the facilities provided thereto. It was further held that a mandap keeper apart from letting of space also provides the lighting arrangements, furniture and fixtures, floor coverings.  The government has also given an abatement of 60% of the gross amount charged by the mandap-keeper to the customer.  But no such relief is given to the person renting out a immoveable property for commercial/ business purpose.

Only the CENVAT credit in relation to this service can be availed on the expenses incurred by the owner of the immovable property in relation to the property like maintenance and repair expenses etc.

The constitutional validity of the levy of service tax on rent payable for renting of commercial immovable property is highly doubtful. This is because Entry 49 of List II of the Seventh Schedule refers to land and building.  List II being for state levy, only state government can levy tax on land and building eg. Property tax, stamp duties are state levies.  The Central Government cannot levy a Central tax on state subject.  We believe that it is not valid under the constitution and thus the levy of service tax on immoveable property is to be challenged in the court of law.