Taxability of FOC Supplies made by recipient of service to service provider

On issue of Service Tax applicability on free of cost (FOC) supplies by the service recipient of construction service to the service provider (assessee), we are sharing with you a landmark judgement of the Hon’ble Supreme Court, decided in favour of the assessee, in the case of Commissioner of Service Tax Vs. M/s Bhayana Builders (P) Ltd.

Issue:

The main question before the Apex Court was:

• Whether the value of goods or material supplied by the recipient of service, FOC to the service provider, which is used by service provider for providing the taxable service of construction, is to be included in the gross consideration, for the valuation purpose under Section 67 of the Finance Act, 1994 (the Finance Act) for the chargeability of Service Tax?

Facts & Background:

The Respondents in the case are engaged in the business of construction services, known as ‘Commercial or Industrial Construction Services’.

It is a matter of common knowledge that for undertaking construction projects, the assessee not only renders services, lot of materials/ goods are also used in the construction of building or civil structure etc.  For valuation of taxable services, the material/ goods element has to be excluded. In order to make the things easier for the assessee as well as the Assessing Officers (AOs), the Government issued the Notification No. 15/2004-ST dated September 10, 2004 (“NN. 15/2004”) as per which Service Tax is to be calculated on the value which is equivalent to 33% of the gross amount charged from any person by such commercial concern for providing the taxable service.  This notification was amended vide another Notification No. 4/2005-ST dated March 01, 2005 whereby an explanation was added to the original notification. This explanation mentions that the ‘gross amount charged’ shall include the value of goods and material supplied and provided or used by the provider of construction services for providing such service.  It is made optional for the assessee to take advantage of the aforesaid notification and get the value calculated as per the aforesaid formula provided therein.  The assessee under Civil Appeal Nos. 1335-1358 of 2015 availed the benefit and paid the Service Tax @ 33% of the gross amount, which they have charged from the persons for whom construction was carried out, i.e., the service recipients.  It so happened that in all these cases where the construction projects were undertaken by the assessee, some of the goods/ materials (particularly, steel and cement) were supplied or provided by the service recipients.  As these materials were to be utilised in the projects meant for service recipients themselves, obviously, no costs thereof were charged from the assessee.  The Department wanted that value of such goods/materials evenwhen supplied or provided free should be included, while calculating the “gross value” and 33% thereof be treated as value for the purpose of levying Service Tax.

Observations of the Hon’ble Supreme Court:

The bench comprising of Justice AK Sikri and Ashok Bhushan observed as under:

• A plain meaning of the expression ‘the gross amount charged by the service provider for such service provided or to be provided by him’ would lead to the obvious conclusion that the value of goods/ material that is provided by the service recipient free of charge is not to be included while arriving at the ‘gross amount’ simply, because of the reason that no price is charged by the assessee/ service provider from the service recipient in respect of such goods/ materials. This further gets strengthened from the words ‘for such service provided or to be provided’ by the service provider/ assessee. Again, obviously, in respect of the goods/ materials supplied by the service recipient, no service is provided by the assessee/ service provider.
• Explanation 3 to sub-section (1) of Section 67 of the Finance Act removes any doubt by clarifying that the gross amount charged for the taxable service shall include the amount received towards the taxable service before, during orafter provision of such service, implying thereby that where no amount is charged that has not to be included in respect of such materials/ goods which are supplied by the service recipient, naturally, no amount is received by the service provider/ assessee. Though, sub-section (4) of Section 67 states that the value shall be determined in such manner as may be prescribed, however, it is subject to the provisions of sub-sections (1), (2) and (3).  Moreover, no such manner is prescribed which includes the value of free goods/ material supplied by the service recipient for determination of the gross value.
• At this stage, it is important to note that Explanation (c) to sub-section (4) of Section 67 was relied upon by the learned counsel for the Revenue to buttress the stand taken by them and we again reproduce the said Explanation herein below in order to understand the contention:

(c) “gross amount charges” includes payment by cheque, credit card, deduction from account and any form of payment by issue of credit notes or debit notes and [book adjustment, and any amount credited or debited, as the case may be, to any account, whether called ‘suspense account’ or by any other name, in the books of account of a person liable to pay Service Tax, where the transaction of taxable service is with any associated enterprise.]”

On that basis, it was sought to argue that the value of goods/materials supplied free is a form of payment and, therefore, should be added.

• The definition of “gross amount charged” given in Explanation (c) to Section 67 only provides for the modes of the payment or book adjustments by which the consideration can be discharged by the service recipient to the service provider. It does not expand the meaning of the term “gross amount charged” to enable the Department to ignore the contract value or the amount actually charged by the service provider to the service recipient for the service rendered.

Hence, it was held by the Hon’ble Apex Court that “the Service Tax is to be levied in respect of ‘taxable services’ and for the purpose of arriving at 33% of the gross amount charged, unless the value of some goods/ materials is specifically included by the Legislature, that cannot be added”. 

Our Comments:

The recent decision of the Hon’ble Supreme Court will act as precedent for deciding pending litigations on same matter.

Importantly, this issue need to be tested again in the GST regime wherein the service recipient is not contractually liable to supply goods/ materials to the service provider but decides to supply certain goods FOC to the provider of service for the provision of taxable services in the light of following Section 15(2) of the CGST Act, 2017:

“15 (2) The value of supply shall include:

(b) any amount that the supplier is liable to pay in relation to such supply, but which has been incurred by the recipient of the supply and not included in the price actually paid or payable for the goods or services or both;

(c) incidental expenses, including commission and packing, charged by the supplier to the recipient of a supply and any amount charged for anything done by the supplier in respect of the supply of goods or services or both at the time of, or before delivery of goods or supply of services;”

There are some situations where the service recipient is liable to provide the goods/ material or services to the service provider, the contract price would not include the value of such supply. In such a situation the supplier is not contractually liable to provide certain goods, but the recipient is obligated to provide such goods to the service provider. An example of such situation would be tailor (Service provider) and the customer (Service Recipient). On the basis of Section 15(2)(b) under GST, supply made by the recipient free of cost may not be included in the transaction value of the supplier and hence supplier may not be liable to GST.

There are also some situations where the supplier is liable to procure all the materials, however, certain goods are supplied by the recipient, regardless of the obligations stipulated in the contract and the contract price is reduced to that extent. As per our view the cost of such supplies may be added to the transaction value of the supplier and the supplier may be liable to deposit GST on the same.

(Author can be reached at Email: bimaljain@hotmail.com)