JULY 05, 2010

By Visali Kopparthy

THE Hon'ble Andhra Pradesh High Court, on 7.6.2010 delivered a judgement in M/s Nagarjuna Construction Company Limited v. Union of India (W.P.No. 6558 of 2008) - 2010-TIOL-403-HC-AP-ST on the issue relating to payment of service tax under Works contract service, availing the composition scheme. The decision, coming after a period of exactly three years from the date of introduction of service tax on works contract service has sent anxious ripples across the construction industry. The High Court has held that a service provider who paid service tax prior to 1.6.2007 under the categories of ‘erection, commissioning or installation service/ construction services' is not entitled to avail the benefit of composition scheme provided under the Works Contract (Composition scheme for Payment of service tax) Rules, 2007 (hereinafter referred to as ‘Composition scheme'). With due respect to the Hon'ble High Court, the present article attempts to analyse the Hon'ble A.P High Court's decision in denying the composition scheme to Works contracts started prior to the introduction of Works Contract Service. (B) Position of Law:

Rule 3 of the Composition Scheme :

Rule 3(1) of the Composition scheme provides that a service provider liable to pay service tax under Works contract service has an option to pay tax at a reduced rate of 2% /4%, as the case may be on the gross amount charged for the works contract, instead of paying at the rate specified under Section 66 of the Act. Rule 3(3) further states that the service provider has to exercise such an option prior to payment of service tax in respect of the said works contract, which is applicable to the entire works contract and cannot be withdrawn until the completion of the said works contract.

Circular dated 22.5.2007:

While introducing service tax under Works Contract Service, the Tax Research Unit of Ministry of Finance issued a clarification vide F.No.B1/16/2007-TRU dated 22.5.2007. The circular, on the specific issue of classification of a contract under the newly introduced works contract service or under erection, commissioning or installation and commercial or residential construction services clarified in express terms that Contracts which are treated as works contract for the purpose of levy of VAT/Sales Tax shall also be treated as works contract for the purpose of levy of service tax.

Circular dated 4.1.2008:

The CBEC issued Circular No.98/1/2008-ST dated 4.1.2008 amending the Master circular dated 23.8.2007 to the effect that in respect of contracts entered into prior to 01.06.2007 for providing construction service, for which service tax has already been paid for part of the payment received under the said taxable service, the service provider cannot change the classification of the service for the purpose of payment of service tax on or after 01.06.2007 and hence is not entitled to avail the Composition Scheme. Such a view adopted by CBEC in the circular is a gross departure from what is contemplated under Rule 3(3) of the composition scheme. The clause ‘prior to payment of service tax' under the Rule has to be interpreted to mean that ‘prior to payment of service tax under Works contract Service' which is introduced from 1.6.2007 only. As Works contract service itself came to be introduced from June 2007, a works contract was not subject to service tax prior to such period, which is laid down in a number of decisions of the Hon'ble CESTAT 2008-TIOL-342-CESTAT-BANG, 2007-TIOL-2337-CESTAT-AHM. In such a case, when service tax itself was not leviable on a works contract prior to 1.6.2007, the question of paying service tax on such a contract does not arise, as being interpreted by the circular.In a situation where an assessee paid service tax on a Works contract even prior to 1.6.2007, classifying it under Construction services or erection, commissioning/ installation service such a payment is not in lieu of a levy and was collected by the Department without an authority of law. Therefore, such a kind of payment made by the assessee does not amount to payment of service tax at all. Consequently, it cannot be said that such service providers have paid service tax on the works contract, thereby restricting them from availing the benefit provided under the Composition scheme. When service tax on works contracts itself is introduced from 1.6.2007, how does the question of payment of service tax on such a works contract prior to the levy arise? (C) Construing Rule 3(3) of the composition scheme: The Hon'ble A.P. High Court has made the following observation while rendering its critical decision,

“On a true and fair construction of Rule 3(3) of the 2007 Rules, it is clear that where in respect of a works contract service tax has been paid, no option to pay service tax under the composition scheme could be exercised. There is no ambiguity in this provision. The entitlement to avail the benefits of the composition scheme is only after an option is exercised under Rule 3(3) of the 2007 Rules and this provision specifically enjoins a disqualification for exercise of such option where service tax has been paid in respect of a works contract. To put it succinctly, where service tax has been paid in respect of a works contract, the eligibility to exercise an option to avail the benefits of the composition scheme under the 2007 Rules is excluded .” (Para 23)

The High Court also states that in the case on hand the challenge is confined to the impugned circular (Circular dated 4.1.2008) and the provisions of Rule 3(3) of the 2007 Rules are not challenged. Now, arises the million dollar question. Did the Hon'ble High Court give a true and fair construction to Rule 3(3). Even if it is assumed for argument sake that the composition scheme is extended only to those contracts entered after 01.06.2007, it would create two kinds of chargeability of Service tax on the same kind of service creating an anomaly. The first part of Rule 3(3) has to be understood to mean that the option of payment of service tax under Works contract service is available prior to payment of service tax in respect of the said works contract (under the regular method at the rate prescribed under Section 66 of the Act) . The second part complements such an interpretation by providing that such an option of payment of service tax under composition scheme shall be applicable for the entire works Contract and shall not be withdrawn until the completion of the said works contract. Thus, a complete and literal reading of Rule 3(3) makes it clear that the Rule only aims at ensuring uniformity in the payment of service tax on a specific Works contract either under the regular method or composition scheme. In view of such possible interpretation of Rule 3(3) the correctness of the Hon'ble High court's observations come into question. Composition Scheme- An exemption under Service Tax The Composition scheme is enacted under Section 93 of the Act which gives Central Government, the power to issue notifications or special orders to exempt generally or subject to conditions, taxable service of any specified description from whole or part of the Service Tax leviable thereon. Therefore Rule 3(3) of the composition scheme is an exemption from payment of Service Tax under Works Contract Service. Accordingly, once the rule is set in extending an exemption it cannot be denied by applying certain conditions which were not intended originally. Such a principle was upheld by the Apex court in Bombay Chemical Pvt. Ltd. Vs Collector of Central Excise, Bombay wherein it was held that “One of the settled principles of construction of an exemption notification is that it should be construed strictly, but once a [good] is found to satisfy the test by which it falls in the exemption notification then it cannot be excluded from it by resorting to applying or construing such notification narrowly....”

In view of the above, the construction industry is not left with any option but to wait and watch for some good news in the days to come by.

(The views expressed are personal of the author)