By CA Ramankutty KR
CONSTRUCTION activity was brought under service tax net by the Finance Act (No-2) 2004. Construction of new building or civil structure or part thereof or repair alteration or restoration or similar services in relation to building or civil structure ,which has been used for industrial purposes has been taxed under this category. Construction of new residential complex, completion and finishing work thereto repair alteration, renovation or similar services in relation to residential complex was subjected to service tax by Finance Act 2005 effective 16-06-2005. Whether construction work is a service or not or whether the levy of service tax on construction work is within the Constitutional mandate given to parliament to legislate a tax on service are some of issues precipitating now out of recent judicial pronouncements. Added to this is the rampant action of field formations to collect more revenue under this head, by interpreting the relevant notifications (15/2004ST dated 10.09.2004, 18/2005ST dated 07.06.2005 and 1/2006 dated 1.03.2006), holding that the abatement under the notification is not admissible unless the free issue of material supplied by the contractee is included in the "gross amount charged" even if the gross amount charged includes the cost of material supplied or provided or used by the contractor. In fact this attitude reminds me of the story of the golden goose. We cannot expect officers of Central Excise Dept to be experts in Income Tax matters or the officers of Income Tax Dept or Sate Sales Tax Dept to be Experts in Excise matters. The addition of the value of free supply of material to the "gross amount charged" as advocated by a section, if followed, what harassment the contractor might face from Income Tax and Sales Tax Dept is itself topic of another discussion. An effort has been made in the article to analyse whether the above interpretation - i.e. inclusion of the value of free issue of material in the "gross amount charged" is correct or not, whether other interpretations are possible, if the option under the notification is not exercised what is the value of taxable service on which service tax is to be charged, whether the value as per section 67 of the Finance Act 1994 as amended is correct and legal etc.
Explanation to Notification 15/2004ST dated 10.09.2004 and 18/2005 ST dated 7.06.2005 as amended
"Explanation --For the purpose of this notification gross amount charged shall include the value of goods and materials supplied or provided or used by the provider of the commercial or industrial construction service for providing such service ."
According one school of thought the value of taxable service = gross amount charged by the contractor which includes goods and material provided or supplied or used by the contractor + the value of free issue of material received from the contractee and used by the contractor . It appears that the meaning of the words ' used by the provider is (mis)interpreted to include the material supplied free of cost to the contractor. The words can also be interpreted as the material brought by the contractor himself but getting consumed or exhausted in the process of work, like welding electrodes, sand, electricity plastering material etc used during construction but may not be visible after construction but for which there is cost as material and not as service. The notification does not explicitly state that the value of free issue of material is to be included in the gross amount charged. 'In a taxing statute there is no room for any intendment but regard must be had to clear meaning of the words' . One can have enough support from Heamraj Gordhandas v HHDave 1978(2)ELT.J.350-SC, Cape Brandy Syndicate, IRC(1921)1.KB64P.71 etc ...to argue against the former interpretation. Arguments can also be advanced that when two interpretations are possible one that is favourable to the assessee has to be taken. But the issue gives rise to wider problems of different dimensions in the case of construction contracts which are mostly entire and indivisible.
If the former interpretation is taken , the value of taxable service would include a part of the value of the free supply of material and service tax would be paid on material cost also which is not the intention of Govt . The whole objective of abatement being elimination of the material cost to arrive at the value of taxable service the interpretation should not go against the very objective to give rise to absurd result. If value of free issue of material is not included in the value of gross amount charged the benefit of abatement is lost. In other words the gross amount charged would be subjected to tax. This would again lead to a situation where the value of material supplied or provided or used by the contractor in the execution of work is subjected to service tax. If a contractor is not opting for abatement what would be the value on which service tax is to be paid ? Section 67 ( prior to amendment vide Finance Act 2006 ) reads as the "gross value chargeable" for such service. In the case of construction contracts which mostly are entire and indivisible the value of material and labour not being separated, taxing the gross amount would lead to taxing material cost which is a subject of state sales tax. Under both the situations i.e. whether opting for abatement or not, the provision in the law for charging service tax on the value which includes a substantial portion of material is beyond the Constitutional mandate given to the parliament to legislate law for levy of service tax . The immediate reaction of a reader would be that cost of material can be deducted in terms of notification 12/2003. Whether Notification 12/2003 can be applied to all situations in construction contracts or the notification has only limited application? If Notification has only limited application then what would be the true value for charging service tax for the person not opting for abatement. These issues also need to be addressed to examine whether the above interpretation brings out the correct position of law.
All civil construction contracts are works contracts. Before proceeding to discuss the applicability of service tax on construction contacts, one need to know the concept of works contract, taxability of works contract introduced by the 46th amendment to the constitution etc. etc which is a subject of sales tax . To know how the area of sales tax and service tax are intermingled and how the territorial trespassing is done due to faulty drafting of service tax legislation a discussion on the subject is considered necessary.
Brief outline of the nature of works contract is given below.
Works contract not involving transfer of property of goods are pure service contracts . Works contract involving transfer of property of goods falls under two category (i) Divisible works contract and (ii) indivisible works contract (or commonly known as composite contracts. With regard to levy of service tax, divisible works contract does not pose any problem like the entire and indivisible works contracts. Indivisible works contracts are contracts for executing work involving supply of goods and labour but the value for the supply portion and labour portion are inseparable .Eg. Construction of building. Rates are quoted for a completion of the entire work without material or labour part separately stated. Usually in a civil construction work rates are quoted for say, piling work, super structure, finishing work like tiling, plastering, electrical work, sanitary work etc. The rates are inclusive of supply of goods + profit thereon +charges for executing the work +profit on the execution part.
At this juncture it is deemed necessary to discuss the intention of 46 th amendment to the Constitution by inserting sub - clause (b) to clause 29A to article 366 effective 2nd February, 1983. The sub - clause (b) was inserted to expand the meaning of sale of goods to include the transfer of property in goods involved in the execution of works contract. Indivisible works contact became divisible by a legal fiction since then. But all indivisible contracts are not covered by the Constitutional amendment. Where the dominant intention is work and not transfer of property in goods such contracts are outside the Constitutional amendment.
In works contract the transfer of property in goods takes place on the principle of accretion accession or blending . "Unless there is a contract to the contrary in the case of works contract the property in goods used in the construction of a building passes to the owner of land on which building is constructed when the goods or materials are incorporated in the building " [Builders Association of India v UOI 1989(73)STC370 ]. In the case of entire and indivisible contracts this gives rise to three different situations.
(i) Transfer of property in goods taking place before execution of works contract
This will be an ordinary sale contract subject to sales tax laws of the state. Transaction is outside clause 29A(b).
(iii) Transfer of property in goods taking place in the execution of works contract
Where the transfer of property in goods takes place during the execution of contract the transaction is within clause 29A(b). Since the transfer of property in goods takes place in construction contract on the principle of accretion and not sale of goods per se notification 12/2003 is not applicable. [ In indivisible works contract no "sale' à State of Madras v Gannon Dunkerly &Co (Madras) Ltd (supra), Builders Association of India v UOI (2002-TIOL-493-SC-CT-LB). By a deemed fiction the contract becomes divisible for the purpose of levy of sales tax/VAT on the transfer of property in goods taking place during the execution of works contract. [Builders Association of India (supra)]. In BSNL decision (2006-TIOL-15-SC-CT-LB) it has been held that the value on which sales tax has been charged has to be excluded from the value of taxable service for the purpose of charge of service tax.
State governments have fixed the percentage of material content in the deemed sale transaction for various of categories of contracts where the contractors are not in a position to ascertain the value of actual goods used in the execution of works contract. For the civil construction contract the percentage of material content fixed by most of the states are between 70 % - 85 % of the total contract value. The percentage fixed for abatement for service tax purpose being 67%, material cost used in the execution of work gets included in the value of taxable services.
In view of BSNL's decision there is no need to go into the controversy of inclusion of free supply of material in the value of taxable services for the purpose of abatement as the value of taxable service is linked with turnover for assessment of tax on works contract as per the State Legislation . The value of taxable service in the case of a composite contract for construction should be = Gross value of work done - taxable turnover for the purpose of works contract tax.
(iii) Transfer of property in goods taking place after execution of works contract
In the case of a building construction contract where the contractual arrangement is for transfer of property in goods after the execution of contract such contracts would be outside sub-clause (b) to clause 29A . This is because sub-clause (b) applies to transfer of property in 'goods' involved in the execution of works contract. Goods means movable property. Once the construction of building is completed the transfer of property is taking place in immovable property which will be subject to state laws relating to transfer of immovable property. Contract cannot be vivisected and therefore no service tax. The position is just like pre - Constitutional amendment where taxability of entire and indivisible works contract was challenged and apex court gave its verdict in State of Madras v Gannon Dunkerly &Co (Madras)Ltd 1958(9) STC 353.
1. Benefit of Notification 12/ 2003 will not be available to a building construction contract which is entire and indivisible where gross amount billed does not have bifurcation of value of material and labour.
2. If the free issue of material is to be included in the value of gross amount charged which already includes the value of material supplied or provided or used by the contractor the value of 33% which represents the value of taxable service would get hiked to the extent of free supply of material .This will amount to taxing material cost instead of service.
3. If free supply is of goods is not included in the gross amount charged then 100% of the gross value becomes the value of taxable service tax.
4. If option of claiming the rebate is not exercised the value as per section 67 has to be taken .
5. In all the cases listed above (2,3,4,) the value of material which is the subject matter of state sales tax is taxed again for service tax as the gross amount charged in construction contract is inclusive of material cost. This results in double taxation ;the value of taxable service should not contain the value on which sales tax / VAT was paid (BSNL's decision). Constitutional mandate given to parliament is only to tax service and not material.
6. What will happen to an indivisible works contract involving transfer of property in goods at a place where the State Governments have no jurisdiction to levy tax on works contract. An off shore construction contract in the Contiguous Zone of India? Service tax will not be exigible on the transaction till Constitution is amended to impose service tax on contracts which are entire and indivisible .