Taxability of Works Contract Under VAT & Service Tax

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.

General Exemptions

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.

Specific Exemptions

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.