Taxability of the Infrastructure sector under Negative List
JULY 11, 2012
By Nitesh Jain, CA
SINCE 2005 the service tax law was made applicable to the Construction sector its been smooth sailing for the infrastructure sector. Construction of roads, airports, ports, Dam, non commercial structures etc were exempted from the levy of Service tax on wholesome basis. Only certain service providers like Engineers, Consultants to these projects were made to pay the taxes. Departments' circular no. 147/16/2011-ST dated 21.10.2011 clarified this position very aptly. This article is an attempt to analyse the taxability scenario for these infrastructure projects under the ‘Comprehensive Approach' or ‘Negative List' based Service tax law. In my personal view there are some hidden demons which I will try to analyse and put the same in public domain so that an informed debate on the same can take place.
Trade Practice of this Sector
First step for analyzing the taxability of any transaction is to understand the substance of the same. There are basically 2 models on which this sector works.
a. Government gives a contract to a successful bidder (hereinafter referred to as ‘Contractor') who quotes the lowest Amount. In this model, the Contractor does the work and raise periodical invoices to a government appointed body which after due verifications releases the payments.
b. The contract is awarded to a concessionaire on BOT (Build Operate Transfer) basis.
Under this model the concessionaire has to construct the whole project as per the design and specifications of the Government but the government does not pay him anything, instead the concessionaire gets a right to use and grant access to others for which it can collect a government notified ‘User Fee' for a specified period ranging up to 30 years or more. This model is a preferred mode and is popularly known as PPP model (Public Private Partnership).
Main thrust of this article would be to analyze taxability of BOT based models more than the traditional contracts.
Taxability Analysis
To analyse the taxability of infrastructure projects I will take 2 live examples and operationally dissect them.
Example 1:
Government of Gujarat (GoG) wants to build 30 Border Check Posts (BCP) in Gujarat and issues a tender in that regards wherein the contractor has to build the BCP's on turnkey basis.
There are 2 formats announced
a. One is where GoG will pay the contract amount to the contractor on periodic basis looking at the construction done; and
b. Other is on BOT basis wherein the Concessionaire will be given a right to collect ‘User Fee' from all the vehicles who visit the BCP's for the next 20 years.
A company named ABC Pvt Ltd bids and wins the contract for constructing the project BCP's for Rs. 100 cr. It decides to do the work in following manner:
Works amounting to 50 Cr are being done by DEF on own basis. Please note that 10 Cr is the profit of DEF Ltd and sub contracting is worth 80 Cr.
TAXABILITY STUDY OF A CONTRACT UNDER TRADITIONAL SYSTEM
Transaction No. 1
GoG gives a Contract to ABC for 100 Crores.
Services provided by ABC to GoG are classifiable under Works Contract Services (WCS) because it has to construct the BCP's on turnkey basis. Having done the classification let us analyse whether the same is exempt from the levy of service tax under Mega Exemption notification 25/2012.
As per serial no. 12 (c) of the notification following conditions need to be satisfied for claiming exemption:
| Condition | Condition Satisfied (Yes / No) | |
| | For ABC | For DEF Ltd |
Services provided to the Government, a local authority or a governmental authority | Yes ABC is appointed by GoG hence it is constructing the BCP's for the Government | No DEF is appointed by ABC and hence is providing services to ABC and not GoG |
By way of construction , erection, of | Yes It is constructing the BCP's | Yes It is constructing the BCP's |
(c) a structure meant predominantly for use for non commercial purposes | Yes The structure being constructed is meant for non commercial purposes | Yes The structure being constructed is meant for non commercial purposes |
In case of ABC all 3 conditions are fulfilled hence the Contractual receipts in its hands will be exempt from Service Tax, but in case of DEF Ltd only 2 conditions get satisfied hence he cannot avail the exemption under serial no. 12.
Transaction 2
ABC sub contracts the entire contract to DEF Ltd. for 90 Cr. Is DEF taxable?
As seen in the discussion in foregoing paragraph DEF Ltd is not exempt under entry no. 12 of the said notification. The Board understood this issue and brought in entry no. 29 (h) which lays down exemption for sub contractors on fulfilment of certain conditions as under
Sr No. | Condition | Condition Satisfied (Yes / No) |
1 | Sub-contractor | Yes DEF is appointed by ABC and hence is a sub contractor of ABC |
2 | providing services by way of works Contract | Yes He has taken the entire contract on back to back basis hence his services to ABC are also classifiable under WCS |
3 | to another contractor | Yes ABC is also a contractor |
4 | providing works contract services | Yes ABC is providing WCS to GoG |
5 | which are exempt | Yes Services in the hands of ABC are exempt |
All Conditions of entry no. 29 (h) are getting satisfied in case of DEF Ltd hence the Contractual receipts of Rs. 90 Cr in its hands will be exempt from Service Tax.
Transaction 3
Designing, architect and engineering Services are sub contracted for Rs. 5 Cr and they are not classifiable under Works contract services hence they do not satisfy the second condition of entry no. 29 (h) as explained in above table, hence they will not be exempt under the new law. They were taxable in the old law as well. They will have to pay a tax @ 12.36% on 5 Cr which comes to Rs. 61.80 Lacs.
Transaction 4
DEF Sub contracts a work for construction of BCP (with material) to XYZ Pvt Ltd. for Rs. 15 Cr. Services provided by XYZ are classifiable under WCS and hence all conditions specified in entry no. 29 (h) get satisfied, hence entire contractual receipts of XYZ will be exempt from levy of Service tax.
Transaction 5
Site formation and excavation work is sub contracted for Rs. 10 Cr to PQR Pvt Ltd. and they too are not classifiable under Works contract services because site formation job does not involve any transfer of property in goods, hence they do not satisfy the second condition of entry no. 29 (h) as explained in above table, therefore they will not be exempt under the new law. They will have to pay a tax @ 12.36% on 10 Cr which comes to Rs. 1.236 Cr. They were taxable in the old law as well. Can we say Site formation is equivalent to Construction and hence exempt under main entry itself?
Considering the tax outflow in the entire contract it can be seen that total tax payable comes to Rs. 1.854 Cr
WHAT IF SAME CONTRACT IS EXECUTED ON BOT BASIS
Transaction No. 1
GoG gives a Contract to ABC wherein it will get a right to collect User fee from each vehicle visiting the BCP's for the next 20 years.
Under BOT contracts ABC is said to construct the BCP's for the government but the concessionaire keeps the right to grant access for a specified period and there is no transfer of property in goods involved from ABC to GoG. After the lapse of the predefined period the project gets transferred to the Government. As there is no transfer of property in goods from ABC to GoG, there is no liability of VAT on ABC hence the contract cannot be classified under Works Contract Services (WCS).
As per serial no. 12 (c) of 25/2012 following conditions need to be satisfied for claiming exemption:
| Condition | Condition Satisfied (Yes / No) |
| For ABC | For DEF Ltd |
Services provided to the Government, a local authority or a governmental authority | Yes ABC is appointed by GoG hence it is constructing the BCP's for the Government | No DEF is appointed by ABC and hence is providing services to ABC and not GoG |
By way of construction , erection, commissioning, installation, completion of | Yes It is constructing the entire BCP's | Yes It is constructing the entire BCP's |
(c) a structure meant predominantly for use as a non commercial establishment | Yes The structure being constructed is meant for Non commercial purposes | Yes The structure being constructed is meant for Non commercial purposes |
In case of ABC all 3 conditions are fulfilled, but there is no consideration flowing from GoG to ABC hence exemption will not have any meaning .
Of course ABC will collect User fee from the visitors but that will be for granting ‘Right to access' the BCP's which is not exempt under the new law. Section 66D (h) grants exemption to service by way of access to ROAD or BRIDGE.
66D . The negative list shall comprise of the following services, namely:––
(h) service by way of access to a road or a bridge on payment of toll charges;
Hence User fee (inclusive of tax) collected by ABC will be taxable @ 12.36%. Assuming the user fee so collected to be 100 Cr. over a period of 20 years, ABC will have to pay 11.00 Cr on reverse calculation.
In case of DEF Ltd only 2 conditions get satisfied as he is not providing services to the government, hence he cannot avail the exemption under serial no. 12.
Transaction 2
ABC sub contracts the entire contract to DEF Ltd. for 90 Cr. Is he taxable?
As seen in the foregoing paragraph DEF Ltd is not exempt under entry no. 12 of the said notification. Does he satisfy conditions of 29 (h) .
Sr No. | Condition | Condition Satisfied (Yes / No) |
1 | Sub-contractor | Yes DEF is appointed by ABC and hence is a sub contractor of ABC |
2 | providing services by way of works Contract | Yes He has taken the entire contract on back to back basis hence his services to ABC are also classifiable under WCS |
3 | to another contractor | No ABC is not a contractor, he is a concessionaire |
4 | providing works contract services | No ABC is not providing WCS |
5 | which are exempt | No Services in the hands of ABC are not exempt |
3 Conditions out of 5 (of entry no. 29 (h)) are NOT getting satisfied in case of DEF Ltd hence the Contractual receipts of Rs. 90 Cr in its hands will be fully taxable @ 4.944% resulting into a tax outflow of Rs. 4.45 Cr. These services were exempt in the old law.
Transaction 3
Designing, architect and engineering Services are sub contracted for Rs. 5 Cr and they are not classifiable under Works contract services hence they do not satisfy the second condition of entry no. 29 (h) as explained in above table, hence they will not be exempt under the new law. They were taxable in the old law as well. They will have to pay a tax @ 12.36% on 5 Cr which comes to Rs. 61.80 Lacs. Albeit DEF will get credit of these services hence net outflow will remain same.
Transaction 4
DEF Sub contracts a work for construction of BCP (with material) to XYZ Pvt Ltd. for Rs. 15 Cr. Services provided by XYZ are classifiable under WCS. It satisfies 4 conditions out of 5. Last condition is not satisfied whereby the services provided by DEF also must be exempt. Hence Services provided by XYZ will also be taxable. They were not taxable in the old law. They will have to pay a tax @ 4.944% on 65 Cr which comes to Rs. 0.74 Cr. Albeit DEF will get credit of these services hence net outflow will remain same.
Transaction 5
Site formation and excavation work is sub contracted for Rs. 10 Cr to PQR Pvt Ltd. and they too are not classifiable under Works contract services because site formation job does not involve any transfer of property in goods, hence they do not satisfy the second condition of entry no. 29 (h) as explained in above table, therefore they will not be exempt under the new law. They will have to pay a tax @ 12.36% on 10 Cr which comes to Rs. 1.236 Cr. They were taxable in the old law as well. Albeit DEF will get credit of these services hence net outflow will remain same.
Considering the tax outflow in BOT model it can be seen that total tax payable comes to Rs. 11.00 Cr in the hands of ABC, and Rs. 4.45 Cr in the hands of DEF Ltd. ABC will also not get credit of the tax paid by DEF because as per the definition of Input Services – Works contract services are excluded for persons providing services other than Works contract services. ABC is providing services by way of access to use the BCP's and works contract services. So total outflow would be 15.45 Cr.
Sum and summation of the above is explained in the following table:
Service Provider / Service | Traditional | BOT |
ABC Ltd (Main Contractor) | Exempt | Taxable Tax payable Rs.11 Cr. |
DEF Ltd (Main Sub Contractor) | Exempt | Taxable Tax payable Rs.4.45 Cr. |
Design + Architect | Exempt | Taxable Tax payable Rs.0.61 Cr. |
BCP WCS | Exempt | Taxable Tax payable Rs. 0.74 Cr. |
Excavation/Other labour contracts | Taxable Tax payable Rs.1.24 Cr. | Taxable Tax payable Rs.1.24 Cr. |
Total Net Tax Outflow | Rs.1.24 Cr. | Rs.15.45 Cr. |
What if the same was a Road project where BOT model is a preferred route?
Service Provider / Service | Traditional | BOT |
ABC Ltd (Main Contractor) | Exempt | Exempt |
DEF Ltd (Main Sub Contractor) | Exempt | Exempt |
Street Lights / other similar works | Exempt | Exempt |
Protection work | Exempt | Exempt |
Building | Exempt | Exempt |
Excavation / any other labour work (assumed to be Rs.30 Cr.) | Taxable Tax payable Rs.3.71 Cr. | Taxable Tax payable Rs.3.71 Cr. |
Total Net Tax Outflow | Rs.3.71Cr. | Rs.3.71Cr. |
It can be seen that in case of road there is not much of a difference in taxability between traditional and BOT based contracts. But the exemption which was there earlier for site formation and other labour jobs earlier seems to be withdrawn, hence its a back door way of taxing the infrastructure sector which will hit the razor thin margins of the companies operating in this sphere.
Conclusion
Better Infrastructure is and should be priority area for the Government and taxing the same on a back door basis would create unwanted confusion in the industry already ridden with many other operational and fiscal issues. Coupled with the fact that taxation under reverse charge mechanism will hit them hard as majority of the sub contractors who are the back bone of this sector are constituted under non corporate format.
Following issues need to be clarified by the department:
a. Clarification given in educational guide under point no. 6.2.5 saying that under BOT the ownership of the project lies with the concessionaire and hence the said projects will be taxable seems to be factually wrong and needs to be revisited. The Concessionaire is not the owner of the project by any means, he is just the constructor of it and as the government does not pay it upfront due to fiscal issues, it transfers its right of collection of toll to the concessionaire for a pre-determined period. It is rather a deferred method of making the payment more than anything else. This is demonstrated by the fact the user fee is notified by the concerned governments and the concessionaire has no right to collect a single paisa more than the amount being notified.
b. Entry no. 29 (h) is a bit harsh as demonstrated in above example on genuine service contracts which ideally are a necessity for execution of the infrastructure project. Site formation, Excavation, utility transfers, laying jobs, digging, boring etc cannot be classified as works contract as no material passes hands. Hence they will never satisfy the conditions inscribed in the entry. The entry must be made more benevolent and status quo with situation pre 1.07.2012 must be maintained.
c. Reverse charge must be mandatory for those companies only which are having a turnover above 10 Crores as many small and medium corporates are not having the requisite infrastructure to cope with the rigours of RCM. In my belief the field offices of the department are already overburdened and this will make compliances near impossible to attain.
Law should be structured in a way that compliance becomes hassle free and tax should not be felt as a burden. Infrastructure sector needs tax free status for some more time to come and back door taxation is not the solution. If need be tax it upfront and without confusions.
