Background of works contract

Levy of taxes in case of composite contracts is a complex phenomenon. Specifically, the chargeability of tax on service vis-à-vis goods has always been a matter of discussion before the courts in the present indirect tax regime. The courts have also taken different-different views and always the matter is being subject matter of confusion / litigations.

In the case of “State of Madras vs. Ganoon Dunkerley & Co. Ltd.” It was held that States cannot bifurcate the material and labour portion in an indivisible contract and levy sales tax on the material supplied.

The States were contending that as per entry 54 of List II of seventh schedule of constitution of India, they can levy sales tax on the material supplied in a building contract and it is a right given to them by the constitution but the Apex Court disagreed with the contention of States and clarified that the definition of sale and purchase of goods given in constitution of India must be read with the definition given in “Sales of goods Act, 1930”.

The Apex Court by the said judgment has laid a law for the States that before taxing any transaction as sales of goods it should hold goods as per Sales of Goods Act, 1930 and consequently the States were facing too many problems after said judgment.

After the landmark judgment by Apex court limiting the power of States, The Union Govt. was too anxious about this litigation prone transaction of sales of goods and material in a bundle and which is too indivisible. After all the events the law had to settle finally and a Law Commission was formed to examine the severe impact of judgment in Gannon Drunkenly case and the Commission suggested to amend the Constitution by inserting clause (29A) in article 366 and also article 286 to resolve the controversy.

By inserting clause (29A) the parliament has ensured to resolve the dispute arising out due to Gannon Drunkenly case and covered maximum transactions under deemed sales. Sub clause (b) of clause (29A) specifically deals with works contract tax and empowered States to make laws related to taxation of works contract in a State.

Tax treatment for works contract under current regime

Currently, while the Centre effectively levies a 6 per cent services tax on construction work contracts (after a 60 per cent abatement), states impose value-added tax (VAT). In Karnataka, effective VAT rate is 10.15% in case of regular dealer and 4% in case of dealer opting for payment of tax under composition scheme.

Effective tax rate for a works contract in Karnataka is as below:

I. Effective tax rate for a builder opting pay tax under works contract service:

Particulars Regular Dealer Composition dealer
VAT 10.15 4
Service tax-Works contract service 6 6
Effective tax rate 16.15 10
Conditions CENVAT credit of Input is not allowed CENVAT credit of Input is not allowed and VAT paid on input is not allowed
Land Deduction Allowed: While calculating gross value liable for tax land Value (UDS value) can be reduced from Gross consideration

II. Effective tax rate for a builder opting pay tax under construction of complex service where abatement of 70% claimed as per notification ST 26/2012.

Particulars Regular Dealer Composition dealer
VAT 10.15 4
Service tax-Construction service (after abatement) 4.5 4.5
Effective tax rate 14.65 8.5
Conditions CENVAT credit of Input is not allowed CENVAT credit of Input is not allowed and VAT paid on input is not allowed
Land Deduction Allowed only for VAT purpose. While calculating Gross value liable for service tax Land value (UDS value) should be included

Works contract under GST

Works contracts consists of three kinds of taxable activities as per the current law. It involves sale of Land and supply of goods as well as supply of services.

Currently, the supply of goods is taxable in the form of VAT and the service is taxable under service tax.

So, different aspects of one a single activity are taxed by different laws. This causes a lot of confusion regarding treatment and taxability which is why there are so many legal disputes in related to works contracts.

GST aims to put an end to the uncertainty for the legislature.

GST Schedule II clearly mentions that the following are supply of service–

  • Construction of a complex, building, civil structure or a part thereof, including a complex or building intended for sale to a buyer, wholly or partly,
  • Works contract including transfer of property in goods (whether as goods or in some other form) involved in the execution of a works contract

Thus GST with its “One Nation One Tax” has removed the confusion regarding the tax treatment.

This means works contract will be treated as service and tax would be charged accordingly (not as goods or part goods/part services).

This treatment of works contract as service and not as supply of goods will bring in much needed clarification to the works contracts. Under the current regime, different states have different schemes for VAT. There are different composition schemes with different VAT rates. Service tax too is complex with 60% abatement on new works and 30% abatement on repair contracts. GST will solve such with a much simpler straightforward calculation.

Taxation of works contract under GST

Taxation of works contract under GST

The government has fixed a GST rates for work contracts, giving the impression of a higher burden on the construction sector. However, a closer look suggests that the actual tax incidence under the GST regime would be lower than the existing one and further allows facility of input tax credit (ITC) on raw materials. Also, the new indirect tax regime will simplify the extant convoluted tax structure by treating work contracts as only services.

Snapshot of GST on construction service as below

GST Rate 12% 18%
Nature of Transaction Construction of a complex, building, civil structure or a part thereof, intended for sale to a buyer, wholly or partly. [The value of land is included in the amount charged from the service recipient]

(Similar to Current construction of residential complex service where abatement of 70% claimed)

Composite supply of Works contract as defined in clause 119 of section 2 of CGST Act

(Works contract service similar to current regime where developer is paying service tax at 6% on works contract service)

Land value to be included Yes No
Land Value deduction considered as Exempt supply No Yes
Mechanism to identify the Value of Land-Exempt supply Not Applicable. As Gross consideration includes land value, separation of land value not required. Value of Land is required to be quantify in order to reverse the GST credit.

Stamp duty value of land to be considered as Value of Exempt supply. (ITC rules)

Full Input tax credit is Allowed

Section 17 of CSGT Act

Yes No- GST input credit related to Exempt supply to be reversed For example if land value is 30% of total consideration 30% of total GST credit to be reversed

Illustration

We can understand the above applicable GST provisions with the below illustration. ABC developers engaged in developing of residential complex. Sale price of single unit is as below;

Particulars Amount in Rs. Ref Amount in Rs.
Land-Sq. Ft A 1,200
Stamp duty value per Sq. B 3,500
Land value-C C=A*B 4,200,000
Construction Value-D D 9,500,000
Total Base price of flat E= C+D 13,700,000
Percentage of Land Value to the total value F= C/E 31%
Assumption
GST Credit available G 1,282,500
Option 1 pay tax at 12%
GST @ 12% on H=E*12% 1,644,000
Gross GST Credit 1,282,500 G
Reversal of GST Credit-Not Applicable
Net GST credit 1,282,500
Net GST payable 361,500
Option 2 pay tax at 18%
GST @ 18% on D (only on Construction Value) G=D*18% 1,710,000
Gross GST Credit 1,282,500 G
Reversal of GST Credit-Credit related to Land Value (Total Credit*Land %) 393,175 G*F
Net GST credit 889,325
Net GST payable 820,675

It is relevant to analyse each project independently, rather than following to pay single rate of GST for all the projects.

While analyzing it is require to keep value of land in mind, it may be possible that where land value is significant compare to construction cost (like construction project in heart of the city areas) discharging a GST @ 18% may be an ideal scenario.

Relevant Provisions of GST law as below:

Section 2(119)-Works contract definition

Section 17- Conditions for availing GST credit

Explanation to Input tax credit draft rules

Tax rate as finalized by 14th GST council meeting.

Disclaimer

This article includes general information about legal issues and developments in GST Law. Such materials are for informational purposes only and may not reflect the most current legal developments.

These informational materials are not intended, and must not be taken, as legal advice on any particular set of facts or circumstances. I disclaim all liability in respect to actions taken or not taken based on any or all the contents of this article to the fullest extent permitted by law. Do not act or refrain from acting upon this information without seeking professional legal counsel.

 

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Location: Bengaluru, Karnataka, IN
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13 responses to “Key tax impact on Real Estate & works contract service under GST with Illustration”

  1. Prakhar Singhal says:

    Dear Manjunath. S,
    Sec 17(5) of CGST Act does not restricts us to avail credit regarding materials? Kindly explain a bit about it.

  2. GAUTAM says:

    can you mention the provisions where it is stated that builder can opt either 12% or 18% gst as per his choice

  3. Sarvesh Baldi says:

    As per section 16 of CGST act , no ITC of works contract service is available for providing construction of complex service . Now if a builder engages a works contractor and pays GST to him , he will not get credit on GST output liability on construction services

  4. gvkreddy says:

    currently construction of road for public(government works) is exempt from service tax, but this does not appear in the GST exemption list and could result in increase in construction cost of the project .is there any separate GST Rate will be announced for the works contractors in government works?

    • Manju3010 says:

      I don’t think they will issue separate tax rate for Govt contracts.
      In order to keep exemption list very minimal government has removed said exemption I think. or it may be a clerical omission in drafting exemption list.

  5. Siju Varghese says:

    ? No input is needed for sale of land in case of composite works contract. Then, why do we need to reverse the Input credit to the proportion of land value?

    • Manju3010 says:

      Please refer Section 17(2) of CGST Act where sale of land has been considered as Exempt supply and by virtue of section 17(2) taxable person (Builder) required to reverse the credit related to Exempt supply.
      As per explanation given to ITC rules- Value of land shall be Stamp duty value for the purpose of quantifying Exempt supply.

      • Sudhee says:

        Hi Manjunath.. regarding 17(2) of CGST Act, can we take a stand that input goods/services are being used only for providing taxable services (i.e. construction value) and hence full ITC can be taken? We anyway dont have have any input goods/services for sale of land. Thanks

  6. CA Chandravijay Shah says:

    Under – construction Project will be completed in, say, October ’17. In Maharashtra, MVAT on Sale of Immovable Property is leviable at the time of Registration of Agreement of Sale. Hence, MVAT is not paid on Advances already received by the Developer. How the Developer will calculate GST after taking ITC when he gets OC and gives possession to the Buyers after receiving balance Payment in October ’17? Please provide steps involved with illustrative figures.

  7. Satish Kumar Vattam says:

    Dear Manju, Would there be any requirement for reversal if the entire credit is from works contract or supplies of Raw material used for construction…?

    • Manju3010 says:

      Dear Satish
      Under GST, if Builder is opted to pay tax at the rate of 12% on gross consideration where land value also included then builder not required to reverse any credit.
      If he Opt to pay tax at 18% only on construction then he may require to reverse the credit to attributable to value of land (UDS value).

  8. Sanjiv says:

    What shall be the impact on under construction project where agreement to sale has entered with the buyer ? Whether sale price should be lowered considering input to be claimed by builders. Paying 12% GST on simply on price as per agreement shall be ahuge liabilities ??

    • Manju3010 says:

      Downward or Upward revision of Price depends upon state where project is running and also methodology adopted by builder to discharge VAT & Service tax.
      In My view, price should be reduced to the small extent considering seamless flow of credit.

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