Works Contract tax has elaborately been discussed hereunder:
What is works contract - Some contracts are for contracts for labour, work or service and not for sale of goods, though goods are used in executing the contract for labour, work or service e.g. when a contractor constructs a building, the buyer pays for cost of building which includes cost of building material, labour and other services offered by the Contractor. Property in building is passed on to buyer and there is no contract for supply of building material as such.
An air conditioner manufacturer may undertake a ‘works contract’ for designing, fitting and commissioning of air conditioning equipment. This is contract for sale of labour and material and not contract of sale. Property in air conditioning equipment passes as an incidental to the works contract. Here, there is no sale of ‘goods’. It is a ‘works contract’ and not liable to CST. – State of Madras v. Voltas Ltd. (1963) 14 STC 446 and 861 (Mad HC) – also indirectly approved in Batliboi v. STO (2000) 119 STC 583 (Guj HC DB).
Laying of pipe line is yet another example of works contract, where passing of property in the pipe is incidental to works contract.
It is difficult to establish whether a particular contract is ‘contract for work’ or ‘contract of sale’ and rigid and inflexible fast tests cannot be laid down. It depends on main object of the parties, circumstances and custom of trade. Generally, a contract of sale is a contract whose main object is the transfer of the property in, and delivery and possession of, a chattel as a chattel to the buyer. Where the main object of work undertaken by the payee of the price is not the transfer of a chattel qua chattel, the contract is one for labour and work. The aspects like ownership of material, value of skill and labour compared to value of material can be considered, but these are not conclusive. - Halsbury’s Laws of England - quoted with approval in State of Gujarat v. Variety Body Builders - AIR 1976 SC 2108 = (1976) 38 STC 176 (SC). – same view in State of Himachal Pradesh v. Associated Hotels - (1972) 29 STC 474 (SC) = AIR 1972 SC 1131 = 1972(2) SCR 937 = (1972) 1 SCC 472
In Vanguard Rolling Shutters v. CST - (1977) 39 STC 372 (SC) = AIR 1977 SC 1505, it was observed that it is difficult to lay down any rule of universal application to decide whether a contract is a works contract or contract for sale of goods. If the contract is primarily for supply of materials at prices agreed and the work or service is incidental to the execution of contract, it will be contract for sale. On the other hand, where contract is primarily a contract of work and labour and materials are supplied in execution of such contract, it is a works contract.
In Hindustan Aeronautics Ltd. v. State of Orissa (1984) 55 STC 327 (SC) = (1984) 1 SCC 706 = 1983(2) SCALE 1090 = AIR 1984 SC 744 (SC 3 members), HAL imported materials and components on behalf of Government of India and manufactured aircrafts on behalf of Government of India. The goods belonged to Government of India but were entrusted to HAL for manufacture of aircraft to be delivered to Air Force. It was held that it is a works contract. It was observed that in contract for work, person producing has no 'property' in the thing produced as a whole, even if part or even whole of material used by him may have been his property. In contract of sale, the thing produced as a whole has individual existence as sole property of the party who produces it some time before delivery and the property therein passes only under the contract relating thereto to the other party for a price. In State of Gujarat v. Kailash Engineering Co. (1967) 19 STC 13 (SC) = AIR 1976 SC 2108, it was held that if unfinished goods are held as property of buyer, it is a works contract.
In UOI v. Central India Machinery Mfg Co. Ltd. (CIMMCO) AIR 1977 SC 1537 = (1977) 40 STC 246 (SC), it was held that if property in final article passes only after it is completed, the contract will be of sale, even if raw material is purchased on behalf of buyer.
In State of Tamilnadu v. Anandam Viswanathan – (1989) 1 SCC 613 = (1989) 73 STC 1 (SC), it was observed that nature of contract can be found out only when intentions of parties are found out. The fact that in the execution of works contract some materials are used, and the property in the goods so used, passes to other party, the contractor undertaking the work will not necessarily be deemed, on that account, to sell the materials. - - Primary difference between a contract of work or service and a contract for sale is that in the former, there is in the person performing or rendering service, no property in the thing produced as a whole, notwithstanding that a part or even the whole of the material used by him may have been his property. Where the finished product supplied to a particular customer is not a commercial commodity in the sense that it cannot be sold in the market to any other person, the transaction is only a works contract.
In Hindustan Shipyard Ltd. v. State of Andhra Pradesh 2000 AIR SCW 2582 =(2000) 6 SCC 579 = 119 STC 533 = 2000(5) SCALE 216, after reviewing entire case law, following principles were evolved - (1) It is difficult to lay down any inflexible rule (2) Transfer of property of goods for a price is the linchpin of definition of sale. Main object of parties has to be found out. Substance of the contract and not form is to be looked into. (3) If the thing to be delivered has individual existence before the delivery as sole property of the party who is to deliver it, it is a sale. (4) If bulk of material used belongs to the manufacturer who sells the end product, it is strong pointer that the contract is for sale of goods and not of work and labour. However, the test is not decisive. Relative importance of material qua work is important.
Supreme Court in a very old case - State of Madras v. Gannon Dunkerley & Co. - AIR 1958 SC 560 = 1959 SCR 379 = (1958) 9 STC 353 (SC), had held that no tax can be levied on works contract, as tax can be levied only on ‘sale of goods’ as defined in Sale of Goods Act. In an indivisible works contract, there is no sale of goods as there could be no agreement to sell materials as such and moreover, the property does not pass as movables. The material used therein becomes property of the other party on the theory of accretion and, as such, no sales tax can be levied on such material.
‘Works Contract’ was one of the ways of avoiding sales tax. Hence, Constitution was amended on 2nd February, 1983 (46th amendment). Clause 29A was added to Article 366 to cover ‘transfer of property in goods involved in execution of works contract’. Subsequently, most of States have amended their sales tax laws to cover ‘works contract’, but Central Sales Tax Act was not amended till May 2002. Thus, till 11-5-2002, CST was not leviable on indivisible works contracts.
In Builders' Association of India v. UOI - (1989) 2 SCR 320 = (1989) 1 CLA 332 (SC) = (1989) 73 STC 370 (SC) = (1989) 1 SCALE 770 = (1989) 2 SCC 645 = AIR 1989 SC 1371 (SC 5 member constitution bench), it has been observed : ‘After the 46th amendment, the works contract which was indivisible one, is by a legal fiction altered into one for sale of goods and the other for supply of labour and services. After 46th amendment, it has become possible for States to levy tax on value of goods involved in a works contract in the same way in which the sales tax was leviable on the price of goods and materials supplied in a building contract which had been entered into two distinct and separate parts.’
In Associated Cement Companies Ltd. v. CC 2001(1) SCALE 436 = (2001) 4 SCC 593 = 124 STC 59 = AIR 2001 SC 862 = 2001 AIR SCW 559 (SC 3 member bench), it was held that even if the dominant intention of the contract is rendering of service which will amount to a works contract, after forty-sixth amendment to Constitution, the State would now be empowered to levy sales tax on material used in such contract.
Contract of skill & labour - Some contracts are essentially contracts of skill & labour e.g. tailoring work, printing or cyclostyling etc. These jobs are not covered under 'works contract'. - - A contract to paint a portrait is a contract for skill and labour and not a contract for sale of goods, as substance of contract is for artist’s skill and it is only ancillary to that there would pass to the customer some materials like paint and canvas. – Robinson v. Graves (1935) 1 KB 579. However, in Lee v. Griffn (1861) 30 LJ QB 252, when a dentist agreed to make set of false teeth for a lady and to fit them into mouth, it was held a contract for sale of goods [There can be two views on the issue].
Mere supply of labour not covered – Taxable event is transfer of property in goods. In case of contract for supply of labour, there is no transfer of property in goods and hence there is no tax liability. – Ashok Kumar Garg v. UOI (2002) 128 STC 442 (P&H HC DB) * Rajiv Gumber v. S. (2002) 128 STC 494 (P&H HC DB).
Contractor need not be owner if he sales flat before construction – The contractor need not be owner of property. He will be liable even if he never had absolute ownership of the flat. – Mittal Investment Corporation v. ACCT (2001) 121 STC 3 (Karn HC DB). The judgment was modified in Mittal Investment Corporation v. ACCT (2001) 121 STC 14 (Karn HC DB) to the extent that it was held that the contractor is not liable if he enters into agreement with buyer after construction of flat, but will be liable if he enters into contract before construction of flat. [Decision as per Karnataka Sales Tax Act, but principle may apply in other cases also.]
Value liable for Works Contract Tax – Some important case law is discussed here.
Builders Association of India v. UOI - This is a landmark judgment of Supreme Court on ‘works contract’. (1989) 2 SCR 320 = (1989) 1 CLA 332 (SC) = (1989) 73 STC 370 (SC) = 1989(1) SCALE 770 = (1989) 2 SCC 645 = AIR 1989 SC 1371 ( 5 member Constitution bench). The background of this case is that after amendment to Constitution in 1983, various State Governments imposed levy on works contract. The tax was levied by some State Governments on full value of contract which included the material cost and other costs like labour, supply of services etc. However, in the judgment, Hon. Supreme Court held that the power of States to levy tax on works contract is subject to limitation of Article 286 i.e. tax cannot be levied by State on (a) Outside the State (b) during import/export. (c) Restrictions placed on ‘declared goods’ are applicable even while levying tax on works contract. Further, tax cannot be imposed on full value of contract. The tax is on ‘transfer of property in goods involved in execution of works contract.’ Thus, tax on works contract can be levied only on ‘value of goods involved’ and not on whole value of works contract.
Gannon Dunkerley and Co. v. State of Rajasthan - This is also an important judgment on ‘Works Contract' (1993) 66 Taxman 229 = (1993) 10 CLA 56 (SC) = 1992 (3) SCALE 173 = 1993 AIR SCW 2621 = (1993) 1 SCC 364 = (1993) 88 STC 204 (SC - 5 member bench judgment)]. Here, it was held that taxable event is the transfer of property in the goods involved in the execution of a works contract. The said transfer of property takes place when goods are incorporated in the works. Hence, value of goods at the time of incorporation in the works can constitute measure for levy of tax. However, cost of incorporation of the goods in works contract cannot be made part of measure for the levy of tax. It was held that value of goods involved in works contract would have to be considered for taxation on works contract. Charges for labour and services have to be deducted from total value of works contract. Moreover, tax cannot be levied on goods which are not taxable under sections 3, 4 and 5 of CST and goods covered under sections 14 and 15 of CST. If contractor is not able to give detailed break up, legislature can prescribe scales for deductions permissible on account of cost of labour and services for various types of works contract. It is permissible to have a uniform rate for works contract. This rate may be different from the rates applicable to individual goods.
The judgment in this case was subsequently followed in Builders’ Association of India v. State of Karnataka - (1993) 88 STC 248 = AIR 1993 SC 991 = (1993) 1 SCC 409 = 1993 AIR SCW 152 (SC - 5 member bench).
In Daelim Industrial Co. v. State of Assam (2003) 130) STC 53 (Gau HC), it was held that in case of works contract, tax is payable only of value of goods and not on cost of design and engineering.
State of Kerala v. Builders Association - In State of Kerala v. Builders Association of India - 1996 (8) SCALE 730 = (1997) 104 STC 134 = (1997) 2 SCC 183 = AIR 1997 SC 3640 = 1997 AIR SCW 977 (SC), the position was that a convenient, hassle-free and simple method, which was 'rough and ready method' was evolved by State Government for collection of sales tax on Works Contract. This was optional to assessee. It was held that legislature can evolve such alternate, simplified and hassle-free methods of assessment, making it optional to assessee. - . - In the field of taxation, legislation must be allowed greater 'play in joints'. Allowance must be made for 'trial and error' by the legislature. - - In Mycon Construction v. State of Karnataka 2002 AIR SCW 2156 = 127 STC 105 (SC), it was held that a simplified composition scheme instead of regular assessment, can be evolved, if it is on optional basis. Validity of such provision has been upheld.
STUDY ON TAXABILITY OF WORKS CONTRACT UNDER VAT & SERVICE TAX
In order to constitute a works contract, two basic cumulative conditions need to be satisfied,
i) there must be a transfer of property goods involved in the execution of specified works contract,
ii) Such transfer is leviable to tax as sale of goods under the relevant Sales Tax / Vat Laws.
Position under Vat:
Ordinarily all types of indivisible works contracts for supply of material and application of labour are liable for wct vat under the MVAT Act, 2002. However, if the contract is divisible into material and labour, then it will be a contract of sale and supply of labour. It will not amount to be a works contract. Under the Mvat Act, 2002, three options are given to the assessee. The rate for specified construction contracts is 5%, other than construction contracts, the rate will be 8% or at the scheduled rate of goods of 5%, 8% or 12.5% as the case may be. The option of choosing the rate of tax is left on the dealer executing the works contract.
Section 42(3) of the MVAT Act, 2002 specifies the rate of tax for construction contracts @ 5% on the full value of the contract with the rider that only 1% set off will be available to the dealer. In case the dealer opts for 8% tax on the full value of the contract, then 64% set off will be available from the full set off and 36% will be the retention of set off.
Rule 58 of the MVAT Rules 2005 provides a deduction / reduction for all services / labour portion and tax will be needed to levy on the material portion as per the rates specified in Schedules C, & E of the Mvat Act, 2002. In short tax will have to be levied at the specified rates as mentioned in the Schedules and not flat rate of 12.5% as some people understand. If this method is followed by the dealer, then full set off on the materials involved in the execution of the works contract will be available to him.
Alternatively, if the dealer is unable to keep the record of the materials used in the execution of works contract (construction of building), then a flat deduction of 30% of the full contract value will be allowed and vat @ 12.5% needs to be paid on the 70% of the full contract value. In such a scenario, the dealer will be entitled for full set off on the materials used in the execution of works contract. In case of any other contract as specified under Rule 58, a flat reduction of 25% is given for labour service component and specified rates of tax is required to be paid on the material component. If specified rates are not possible, then full rate of 75% is required to be paid on the total contract value. The validity of a hassle free composition rate of tax has been upheld by the Supreme Court in the case of Mycoon Construction v/s the State of Karnataka (2002) 127 STC 105 (S C)
Principal Contractor & Sub Contractor / Sub Contractors
The Mvat Act allows the Principal Contract either to execute the contract fully or either subcontract the same to a subcontractor or subcontractors fully or partially. In such a situation, it shall be the liability of the principal contractor to pay the tax under the Mvat Act, 2002 to the Government. Alternatively, he can subcontract part of the contract or fully subcontract the whole contract, and if the subcontractor undertakes to pay the tax, then the principal contractor will be exempt from paying tax as it is a single contract. Vice versa if the principal contractor undertakes to pay the tax, then the subcontractor is exempt from paying tax.
To avail this benefit, the following conditions need to be fulfilled:
In case the principal contractor undertakes to pay the tax, then Form 406 and Form 409 is required to be issued by the principal contractor to the subcontractor for claiming exemption. Similarly in case the subcontractor undertakes to pay the tax, then Form 407 & Form 408 is required to be issued by the subcontractor to the principal contractor for claiming exemption. This is a statutory requirement of law and in case this is not complied with, there will be a tax liability both on the principal contractor and the subcontractor as the principle of joint and several liability comes into play as defined under Section 45 of the Mvat Act, 2002.
Position under Service Tax
The Works Contract Services were notified for the first time by the Finance Act 2007 to be effective from 1/6/2007.
Sub-clause (zzzza) of Section 65 (105) of the Finance Act, 1994 defines the taxable service in relation to the execution of a works contract, excluding works contract in respect of roads, airports, railways, transport terminals, bridges, tunnels and dams.
The Explanation under this sub clause defines the works contract for this purpose as follows:
For the purpose of this sub clause, works contract means a contract wherein
a) transfer of property in goods involved in the execution o such contracts is leviable as sale of goods (liable to tax under vat) and
b) such contract is for the purpose of carrying out
i) erection commissioning and installation of plant equipment or machinery
ii) construction of new building or civil structure or a part thereof for the purposes of commerce or industry
iii) construction of a new residential complex or part thereof
iv) completion of finishing services in relation to ii) & iii)
v) turnkey & EPC projects.
The essential ingredients to constitute a works contract liable to tax as works contract services are as follows:
The service provided or to be provided in execution of works contract which satisfy the conditions as specified in the Explanation above will be liable to works contract services under the Finance Act, 1994.
Para 9.1 of MF(DR) Circular No B1/16/2007-TRU dated 22/05/2007 clarifies as follows:
Works contract is a composite contract for supply of goods and services, A composite contract is vivisected and vat / sales tax is leviable on the transfer of property involved in the execution of works contract vide Article 366 (29A) (b) of the Constitution of India and service tax will be leviable on services provided in relation to the execution of works contract.
Further Para 9.10 of the aforesaid Circular clarifies as under:
Contracts which are treated as works contract for the purposes of levy of vat / sales tax shall also be treated as works contract for the purposes of levy of service tax. This is clear from the definition under section 65 (105) (zzzza) of the Finance Act, 1994.
Service Tax under Composition Scheme.
The rate of service tax on works contract services is 4.12% (including cess) of the total contract value.
According to the Service Tax (Determination of Value) Rules, the service tax on works contract can also be paid on the value of the services component, after determining the value adopted for vat purposes for the levy of vat. Supposing the value of the total contract is Rs 100/- Under Rule 58 of the Mvat Rules, 2002, vat can be paid as per the scheduled rates of 5%, 8% or 12.5%. Once this value for vat is adopted, then the balance value of the contract becomes the assessable value and service tax @ 10.3% may be paid on the balance amount.
An assessee has the following four options to pay vat and service tax under a works contract.
1) Pat vat / sales tax under composition scheme @ 5% in case of specified construction contract and 8% in other contract and service tax @ 4.12% under composition scheme.
2) Pay vat / sales tax under composition scheme and service tax @ 10.3% on actual labour service component.
3) Pay vat / sales tax on actual scheduled rates of goods @ 5%, 8% or 12.5% and service tax @ 10.3% on actual labour service component.
4) Pay vat / sales tax on actual scheduled rates of goods @ 5%, 8% or 12.5% and service tax under composition rate @ 4.12%
Value of taxable services
The value of taxable service shall be the gross value excluding vat but including all items of material component as well as labour service component.
Cenvat Credit on Inputs, Input Services & Capital Goods
There is restriction in availing service tax credit on inputs in both the cases where the assessee pays service tax at actual or under composition scheme.
The assessee can avail service tax credit on input services directly related to the provision of works contract services. Common input services credit need to be avoided as now there is a restriction to avail such credit under the Cenvat Credit Rules, 2004.
Regarding capital goods, as per Rule 2 (a) of the Cenvat Credit Rules, capital goods really means the goods which are used for providing output service and not those used in or while providing taxable services.
Secondly if a subcontractor pays service tax on the total contract value after availing the input credit, then the principal contractor can avail credit only to the extent of 40% of such credit.
Full exemption of service tax has been granted to the following recipients provided by a service provider.
a) Services provided to United Nations or an International Organization declared by the Central Govt. b) Services provided to a developer of SEZ or to a SEZ unit subject to certain conditions. c) Value of materials or goods sold by the service provider to the recipient of the service provided that no Cenvat credit has been taken on such inputs, and if such cenvat credit has been taken, the same needs to be reversed before effecting the sale.
Following are the specific exemptions :
1) Construction and works contract services relating to ports exempt only upto 1.7.2010, but no exemption to finishing or repairing services 2) Works relating to roads, bridges, tunnels, dams, airport, etc. 3) Construction of canals for government agencies 4) Exemption to works contract services provided within airport 5) Exemption to works contract service provided within port or other port 6) Exemption to works contract services provided for specified construction services in relation to specified projects
Rate of Service Tax
The rate of service tax is 12.36% from 1/6/2007 to 23/02/2009.
The rate of service tax is 10.30% from 24/02/2009 till date.
The rate of composition is 2.04% from 1/06/2007 to 31/03/2008
The rate of composition is 4.12% from 1/04/2008 till date
Prepared By CA Pankaj Jaiswal Chartered Accountants firstname.lastname@example.org