Introduction
Infrastructure is the backbone of the Indian economy. The projected investment in infrastructure over the next 5 years – 2021 to 2026 is projected at US$ 1.4 trillion covering highways, energy, airports, smart cities, industrial corridors, metro projects, healthcare, logistics, etc. The Goods and Services Tax (GST) regime has had an impact on the infrastructure sector. Not only has GST consolidated several fragmented laws, but it has also changed the compliance landscape for several infrastructure companies. Although it has been 4 years since inception of GST, the law is still evolving. Especially with respect to road contracts, there have been numerous advance rulings, clarifications, circulars, rate change notifications etc. It is very important therefore that companies are cognizant of these changes and align their business strategies accordingly. What is interesting is that companies in road construction adopt several different models like Build- Operate- Transfer (BOT), Build- Own- Operate- Transfer (BOOT), Operation & Maintenance (O&M), Hybrid Annuity Model (HAM) and others.
In this article, we discuss the GST implications on the Hybrid Annuity Model which is popular now with most road construction companies. Recent changes in GST had created ambiguity regarding the taxability of HAM contracts. We also discuss and touch upon these changes in the article. We would like to emphasise that HAM may apply to a variety of infrastructure like roadways, canals, dams etc. but for the sake of this article, we are restricting ourselves only to road construction activities.
What is Hybrid Annuity Model (HAM)?
HAM is one of the newest models of Public Private Partnership in highway construction. In HAM model, the Government, typically pays 40% of the project cost during construction phase in the form of annual payments (hence the term annuity) and the remaining 60% is arranged by the developer and is recovered as a variable annuity amounts after project completion, as a percentage of the toll collections.
Under this model, the contractor agrees to deliver the project for a guaranteed price from SPV which will be received partly during construction phase (from Government) and partly during operation and maintenance phase (from NHAI or the SPV). The SPV bears the risk and rewards of revenue in the form of toll collection.
HAM’s success can be seen by the fact that it has become the preferred contract for NHAI, with 50 per cent contracts in FY18 in highway construction awarded under this model. Banks are also benefitting by limiting their exposure to 35 per cent (in HAM projects) compared with 70 per cent in the traditional BOT projects. Based on success of HAM in highway sector, many other entities like National Mission for Clean Ganga (NMCG) are taking up hybrid-annuity based PPP model for sewage treatment plants etc.
Taxability of HAM Contracts under the GST regime
In this section, we look at the taxability of HAM Contracts. The first question we look to address is whether HAM Contracts are a supply of goods or supply of services.
HAM Contracts – Nature of Supply
Typically, to construct a road, especially a highway, requires material as well as labour. Materials like cement, steel, gypsum etc. are essential for the construction itself and thus, any supply of such materials would be a supply of goods under the GST regime. However, without labour, it is difficult to construct highways or roads. Civil engineers, Site supervisors and EPC contractors are required to construct roads. The labour aspect would constitute a supply of services. Thus, HAM Contracts have an element that involves supply of goods as well as an element that involves supply of services. Thus, HAM contracts can be considered a composite supply.
Works Contracts has been defined in Section 2(119) of the CGST Act, 2017 as “works contract means a contract for building, construction, fabrication, completion, erection, installation, fitting out, improvement, modification, repair, maintenance, renovation, alteration or commissioning of any immovable property wherein transfer of property in goods (whether as goods or in some other form) is involved in the execution of such contract.”
Further, as per Para 6 (a) of Schedule II to the CGST Act, 2017, works contracts as defined in section 2(119) of the CGST Act, 2017 shall be treated as a supply of services. Thus, there is a clear demarcation of a works contract as a supply of service under GST laws.
Works contract in GST are specific to immovable property and highways and roads, would fall squarely in the definition of immovable property. Thus, construction of highways, under HAM model, would be a works contract and would therefore be construed as supply of services under the GST laws.
Taxability during Construction Phase
In the construction phase, the Government, or the NHAI, being a government entity contributes annuity payments to the contractor. This typically covers 40% of the project costs. In this case, the contractor is providing construction services or works contract services to the government or to NHAI. NHAI falls within the definition of “Government Entity” under the GST law. It must be emphasised that where the consideration is received from NHAI, the GST implications may differ. In any case, the annuity received during construction phase would be a works contract service.
As per Notification No. 11/2017 – CT (Rate) as amended up to 14th June 2021, the “Composite supply of works contract as defined in clause (119) of section 2 of the Central Goods and Services Tax Act, 2017, {other than that covered by items (i), (ia),(ib), (ic), (id), (ie) and (if) above} supplied by way of construction, erection, commissioning, installation, completion, fitting out, repair, maintenance, renovation, or alteration of a road, bridge, tunnel, or terminal for road transportation for use by general public” would be taxable at the rate of 12% (6% CGST + 6% SGST).
Taxability during Operation Phase
Previously, a view was adopted in the industry that consideration received annually from the Government as far as the same is attributable to construction of roads by way of annuity payments would be an exempt supply not chargeable to GST. This was because GST Council in its 22nd meeting, had recommended an exemption from GST on payment of annuity for construction of roads. Hence, relying on the recommendations from the GST Council, industry participants had taken a view that the services provided by concessionaire by way of construction of roads on annuity basis as exempt and monies received from Government would not be exigible to GST.
However, inconsistency arose when the GST Council provided the exemption only for “Services by way of access to road or bridges on payment of annuity.” [Entry no 23A of Notification. 12/2017-Central Tax (Rate) through Notification no. 32/2017- Central Tax (Rate) dt. 13/10/2017]. The exemption did not appear at all, to consider the recommendations that the GST Council provided earlier. The exemption seems to suggest that only the annuity portion that pertains to toll would be considered as exempt and the exemption would not extend to any consideration for construction or EPC services.
However, the GST authorities have ended the inconsistency between the Council recommendations and the Notification above, by further issuing a Circular no 150/06/2021 dated 17th June 2021 by clarifying that GST is applicable on the activity of construction of road where consideration is received in the form of deferred payments (annuity). The Circular clarified that GST is exempt on services falling under SAC 9967 by way of access to a road or a bridge on payment of annuity. [Entry 23A of Notification. 12/2017-Central Tax (Rate) . Hence entry 23 and 23A together exempts access to road or bridge where the consideration is in the form of toll or annuity.
Services by way of construction of road, however, fall under SAC 9954. Therefore, based on plain reading of the Circular mentioned, the exemption cited above does not seem to extend to consideration received towards construction or EPC work not falling in heading 9967, even if consideration is received during operations phase.
In view of the Circular, we would recommend contractors/concessionaires to take proper advice regarding incidence and classification of services supplied by them and consider the incidence and potential exposure in pricing of their contracts. The contract structure, scope of work and the classification of services would also need to be carefully examined from indirect tax perspectives.
To sum up, it can be said that any annuity pertaining to construction service of roads would be taxable at 12% and any annuity attributable to toll falling within SAC 9967 would be exempted from the levy of GST.
Input Tax Credit Considerations in respect of HAM Contracts
As per Section 17(5)(d) of the CGST Act, 2017, input tax credit shall not be available for goods or services, or both received by a taxable person for construction of an immovable property (other than plant or machinery) on his own account.
In case of HAM contracts, typically, the concessionaire/contractor cannot be said to be procuring goods and services on its own account for construction of immovable property and hence, shall be eligible to claim ITC on goods and services procured for works contracts subject to condition that the concessionaire/contractor has taxable output services.
Further as per section 17(5) (c) of the CGST Act, 2017, input tax credit shall not be available in respect of the works contract services when supplied for construction of an immovable property (other than plant and machinery) except where it is an input service for further supply of works contract service. Thus, ITC for works contract can be availed only by one who is in the same line of business and is using such services received for further supply of works contract service. Hence, a sub-contractor providing works contract service to a contractor / concessioner shall be eligible to claim ITC on goods and service procured by him for providing works contract service.
As per Section 17(2) of the CGST Act, 2017 read with Rule 42 of the CGST Rules, 2017, where goods or services are used for effecting taxable as well as exempt supplies, Input Tax Credit shall be restricted so much of the Input Tax Credit attributable to taxable supplies only. In the respect of HAM Contracts, the annuity portion attributable to construction and EPC work is taxable. However, the consideration attributable to toll, is exempted from tax. Thus, there are both taxable and exempt supplies being effected.
The HAM contractor would need to carefully analyse their expenses and map the same to the supplies. It is pertinent to however note that where a concessionaire/ contractor has both taxable and exempt supplies, as per CGST Rules, he would need to reverse input tax credit attributable to exempted supplies and, also, the common input tax credits as far as they pertain to exempt supplies. The tax credits reversed would construe a cost for the concessionaire/ contractor. The calculation of such reversals is an important task to be carried out during monthly and annual compliances.
Conclusion
HAM is fast emerging as a popular model of road construction using the Public Private Partnerships. In a country like India, where infrastructure is a key to economic growth, understanding this model is important. GST being an ad valorem transaction-based tax, needs to be carefully understood, especially in the context of HAM contracts, which are of high value and have long gestation periods. Errors in interpretation of GST incidence could lead to incorrect estimation of project costs and make the client liable for statutory lapses. With careful indirect tax advise and analysis of regulations, such risks of adopting incorrect tax positions can be minimised.
*****
Authored by: Siddharth Surana, Advisor – RSM India
(The author is Director – GST at RSM India (part of RSM International) and the views expressed are strictly personal. RSM International does not necessarily subscribe to the same and is not responsible or liable for any loss or damage caused to anyone due to any interpretation, error, omission in the articles being hosted on this site)
what is the Time of Supply for differed annuity payments by NHAI(remaining 60% of total value). Is it date of completion of service or date of Invoice??