Works contract-sale vs service to continue in GST regime

There has been a long history of litigation on the issue of classification of works contract activities that whether it is to be considered a service or to be treated as sale of goods. The reason behind it was that the constitution of India classifies the work contract activity as sale of goods and so does the state VAT laws. But in 2007, the Central Government introduced works contract service in the service tax net too. The service tax on works contract is continued in the negative list tax regime also by way of deeming fiction under section 66E (h) under declared list of services. Consequently, the activities became taxable under both VAT and service tax laws.

The centre of the litigation was the valuation of such service. Both the laws provided independent valuation measures and that is why the situation of double taxation occurred. VAT and service tax was being paid on the same value. Various judicial pronouncements having immense significance were rendered from time to time like the decision given in the case of Bhayana Builders [2013 (32) S.T.R. 49 (Tri.-LB)] where it was concluded that free supply of material will not be added to the taxable value of service for calculating the service tax. Reference may also be made to the landmark larger bench decision rendered by the Supreme Court in the case of Larsen and Toubro [2015 (39) S.T.R. 913 (S.C.)] where it was held that vivisection of services prior to 2007 is not allowable. The decisions pronounced are evidence of the prolonged litigation on this service and this has increased with time. However, it appears that the ruling of Bhayana Builders [2013 (32) S.T.R. 49 (Tri.-LB)]is overruled in the proposed GST regime as section 15(2)(b) of the GST Act, 2016 pertaining to value of supply seeks to include amount that supplier is liable to pay in relation to supply but which has been incurred by the recipient.

It was obvious that this litigation will also continue in the new regime of GST as well because even though the VAT and Service tax has been merged, it will be important to classify the activities into sale and service for the purpose of taxation. It is pertinent to note that in the new regime, the works contract service has been specifically classified as service in the schedule II which refers to classification of certain activities as sales/services. Although, the intention of the government by declaring works contract as a service was to remove confusion as regards classification of composite contracts such as works contracts in the GST regime but this clarification may further add fuel to the fire of litigation. This is for the reason that as per Article 366(29A) of the Constitution pertaining to transactions to be treated as deemed sales for the purpose of levy of taxes by State Government, works contract finds specific mention. Therefore, as per Constitution, works contract is a deemed sale whereas for the purpose of GST, works contract is a deemed service. The question that remains unanswered is whether deeming fiction created by an Act can override the provisions of the Constitution of India. This loophole wherein contrary deeming fiction is sought to be created by the new GST regime provides a scope for challenging the vires of Schedule II and thereby challenging the levy of GST on works contract. Hence, it is hoped that the government may make suitable amendment in the proposed GST law so that unnecessary litigations are avoided.