The article is a discussion to understand the significance of structuring of contracts for tax purposes. Structuring of contracts are predominantly undertaken by splitting one contract into multiple contacts, reasons being, no tax position, separate taxes on supply of goods and services, maximising the benefits of exemptions, etc.,
The ‘cross fall breach clause’ provides that a breach in one contract will automatically be classified as a breach of the other contract.
Understanding the cross fall breach clause by taking up reference to advance ruling in case of EMC Limited (West Bengal)
The Applicant is a supplier of materials and allied services for erection of towers, testing and commissioning of transmission lines and setting up sub-stations collectively called the Tower Package.
Issue for consideration
The applicant’s question related to contracts obtained mainly from M/s Power Grid Corporation of India (‘Contractee’).
Supply of Tower Packages were split up into two separate sets of contracts – one for supply of materials at ex-factory price (‘First Contract’), and the other for supply of allied services like survey and erection of towers, testing and commissioning of transmission lines etc (‘Second Contract’), which also includes inland/local transportation, in-transit insurance, loading/unloading for delivery of materials and storage of them at the contractee’s site.
The Applicant applied for an Advance Ruling under Section 97 (2) (a) & (e) of the CGST / WBGST Act, 2017 ( ‘GST Act’) on whether he was liable to pay tax on such freight and other ancillary services like in transit insurance, loading/unloading of goods, etc., which forms part of the works contract service
Argument of the applicant
The applicant is not a Goods Transport Agency (‘GTA’) or engaged in insurance business. He usually arranges such services and pay the GST as applicable on the consideration paid to the suppliers of such services. The applicant argued that his service to the contractee for inland/local transportation was exempt under the GST Act – Notification No. 9/2017 – IT (Rate) dated 28/06/2017 which, grants exemption on transportation service provided by an entity other than GTA. Serial no. 18 of Notification No. 12/2017-Central Tax (Rate) dated 28/06/2017 (1136-FT dated 28/06/2017 under State tax) exempts services by way of transportation of goods by road, except the services of a GTA. Similarly, the applicant does not provide insurance service, but buy such services from an insurance service provider.
Facts of the case
The First Contract included ex-works supply of all equipment and materials. The scope of the work included testing and supply of transmission line towers, spares and accessories thereof, and all other materials required for successful commissioning of the transmission line.
The Second Contract included all other activities required to be performed for complete execution of the tower package. The scope of the work included transportation, in-transit insurance, loading/unloading and delivery of the goods to the contractee’s site; detailed survey including route alignment, profiling etc; classification of foundations for the towers and casing of foundations based on the drawing supplied by the contractee; erection of the towers; dismantling of the existing 400kv transmission line; stringing of power line crossing section under live line condition; painting of the towers; testing and commissioning of the transmission lines etc.
Cross fall breach
Black’s Law Dictionary defines that ‘a severable contract, also termed as divisible contract, is a contract that includes two or more promises each of which can be enforced separately, so that failure to perform one of the promises does not necessarily put the promises in breach of the entire contract’. From the above facts it was apparent that the First Contract could not be executed independent of the Second Contract. There could not be any ‘supply of goods’ without a place of supply as the goods to be supplied under the First Contract involve movement and/or installation at the site, the place of supply shall be the location of the goods at the time when movement of the goods terminates for delivery to the recipient, or moved to the site for assembly or installation (Section 10(1) (a) & (d) of the IGST Act, 2017). The First Contract, did not include the provision and cost of such transportation and delivery and therefore, did not amount to a contract for ‘supply of goods’ unless tied up with the Second Contract.
In other words, the First Contract was no contract unless tied up with the Second Contract. Although awarded under two separate contract agreements, it was clear that notwithstanding the break-up of the contract price, the contract shall, at all times, be construed as a single source responsibility contract and the applicant shall remain responsible to ensure execution of both the contracts to achieve successful completion and taking over of the facilities and any breach in any part of the First Contract shall be treated as a breach of the Second Contract, and vice-versa. The two contracts were, therefore, linked by a cross fall breach clause that specifies that breach of one contract will be deemed to be a breach of the other contract, and thereby turn them into a single source responsibility contract.
In terms of above supply of goods, their transportation to the contrctee’s site, delivery and installation, erection of towers and testing and commissioning transmission lines and related services were not separate contracts, but form only parts of an indivisible composite works contract supply, as defined under Section 2(119) of the GST Act, with single source responsibility. To simplify, the First Contract cannot be performed satisfactorily unless the goods have been transported and delivered to the contractees site, applied for erection of towers, the transmission lines laid, tested and commissioned in terms of the Second Contract and that supply of the goods and the allied services are not separately enforceable.
The applicant supplies works contract service, of which freight and transportation is merely a component and not a separate and independent identity, and GST is to be paid at 18% in terms of Serial no. 3 (ii) of Notification No. 11/2017 – Central Tax (Rate) dated 28/06/2017 (1135 – FT dated 28/06/2017 under the State Tax) on the entire value of the composite supply, including supply of materials, freight and transportation, erection, commissioning etc. The price components of both the First and the Second Contracts, including that for transportation, in-transit insurance etc are to be clubbed together to arrive at the value of the composite supply of works contract service as discussed above.
It is extremely critical that the contractual clauses are clearly defined in the contract and the contracts are well structured, to avoid litigations.
As per the trending structures many real estate companies are segregating material contracts and labour contracts to avail the benefits of taxation, the cross fall breach clause shall be carefully analysed and structured to avert lawsuits.
|State||Applicant name||Order no. and Date|
|Maharashtra||Siemens Limited||MAH/AAAR/SS-RJ/4/2019-20 dated 23.08.2019|
|Maharashtra||Cable Corporation of India Limited||GST-ARA- 63/2018-19/B- 134 Mumbai dated 03.11.2018|
|Maharashtra||Dinesh Kumar Agarwal||GST-ARA-36/2017-18/B-43 Mumbai dated 04.06.2008|
|West Bengal||IAC Electricals Pvt Ltd||05/WBAAR/2018-19 dated 28.05.2018|
|West Bengal||EMC Ltd.||04/WBAAR/2018-19 dated 11/05/2018|
Relevant Court Judgments
|Supreme Court||State of Madras v. Gannon Dunkerley and Company (Madras) Ltd||2015 (330) ELT 0011 SC|
|Supreme Court||Indure Limited and Another v. CTO||Civil Appeal No. 1123 of 2003, September 20,2010|
|Supreme Court||Dongfang Electric Co v. Deputy Director||I.T.A No.833.Kol/2011, 2012|
|Supreme Court||Ishikawajma-Harima Heavy Industries Limited v. Director of Income Tax Mumbai||2007 (6) STR 3 (SC)|
|High Court||Larsen And Toubro Ltd v. State of Andhra Pradesh||2015|