No Refund of unutilised ITC on Works Contract for Construction Services

It is observed that – under the GST regime, taxpayers and the revenue often find themselves at a crossroads in determining as to whether – ‘refund of unutilised ITC is allowed in case of supply of construction services by way of works contract’. The taxpayers have often claimed refund on unutilised ITC accumulated through their transactions of works contract for construction services. However, the question as to whether the same is allowed under GST regime requires detailed analysis due to the quantum of amounts involved in such claims; as major components of inputs like cement and formworks suffer from 28% rate of tax, whereas the output supply viz. construction service generally suffers much lesser rates (say, 12 / 18%). As such, the refund claims of unutilised ITC, accumulated through such inverted tax structure, invariably total up to significant amounts.

I. The Controversy

Before we begin to examine into this controversy, let us understand the root of this debate. The Central Government, vide Notification No. 15/2017 – Central Tax (Rate) dated 28.06.2017, notified that w.e.f. 01.07.2017 –

“… no refund of unutilised input tax credit shall be allowed under sub-section (3) of section 54 of the said Central Goods and Services Tax Act, in case of supply of services specified in sub-item (b) of item 5 of Schedule II of the Central Goods and Services Tax Act.”

The said sub-item (b) of item 5 of Schedule II of the CGST Act, 2017 (“the Act”) treats ‘construction of a complex, building, civil structure or a part thereof’ [hereinafter “the said construction services”] as a supply of service. As such, it appears, prima facie, that the said notification disallows the refund of unutilised ITC in case of supply of the said construction services. To clarify, the scope of the said construction services, for purpose of this article, is limited to that of complex, building, or a civil structure[1].

However, it has been observed that the taxpayers have oftentimes argued that they supply goods (say, materials including cement) as well as services (say, construction, transportation) for construction, and thus, their supplies are in nature of ‘works contract services’ – falling within the scope of item 6(a) of Schedule II of the Act, and not item 5(b). Consequently, their supplies fall outside the purview of the said notification. Based on this premise, the taxpayers have oftentimes claimed refund on the unutilised ITC accumulated through their transactions, which are in the nature of ‘works contract’.

II. Analysis: Works Contract under GST regime

Works contract has been defined under clause (119) of Section 2 of the Act as follows:

“(119) “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”

The above interpretation clause defines ‘works contract’ in a restrictive manner, by employing the word ‘means’, as a contract between two parties, execution of which would necessitate supply of certain services specified therein along with supply of goods. Further, such ‘supply in execution of works contract’ is treated as a ‘supply of services’ by sub-item (a) of item 6 of the Schedule II of the Act, as follows:

“6. Composite supply

The following composite supplies shall be treated as a supply of services, namely:-

(a) works contract as defined in clause (119) of section 2”

However, it must be noted that such treatment of works contract, which is naturally a composite supply (as it involves supply of material as well as labour), does not, ipso facto, make the activity / transaction of works contract as a service in itself, but it merely considers the ‘supply of works contract’ as a ‘supply of service’ for the purposes of the Act.

This distinction is of paramount significance as determination of any supply as ‘supply of services’ is not sufficient for levy of tax under the Act, and the same requires further identification as to the description of such service. There is no uniform rate of tax levied on ‘supply of services’ of all kinds, rather services of different descriptions are levied with different rate of taxes, as notified vide Notification No.11/2017 – Central Tax (Rate) dated 28.06.2017, as amended.

Therefore, sub-item (a) of item 6 of Schedule II of the Act does not treat ‘works contract’ as a service by itself, supply of which, would attract levy of tax regardless of what principal service is supplied by way of the said ‘works contract’. Conversely, an inquiry into the principal service is but necessary for determination of tax liability and refund thereof.

III. Levy of GST on Works Contract

It is useful to understand, at this juncture, that GST is levied on goods and services of specific description:

• Item 6(a) of Schedule II of the Act clarifies that works contract under GST are in the nature of composite supplies and the same shall be treated as supply of services. It further makes a reference to clause (119) of Section 2 of the Act. A perusal of the said clause (119) reveals that ‘works contract’ can be for various services, viz. building, construction, fabrication, and eleven other activities / services as mentioned therein.
• As such, item 6(a) of Schedule II of the Act directs a further inquiry into the principal service that the parties to the said ‘works contract’ agree upon and which is to be supplied in execution of the said contract.
• The tax rates on the various services provided under clause (119) of Section 2 of the Act are different, as notified, and taxpayers cannot claim that they are providing a ‘works contract service’ – as it would imply that there is a blanket tax rate on different services specified under clause (119) of Section 2 of the Act, which runs contrary to the scheme of classification of services under GST.

Therefore, the GST regime does not recognise ‘works contract service’ as a service by itself, rather, it provides for its nature as a composite supply and treats ‘supply of works contract’ as a ‘supply of service’.

For the purpose of levy of tax and refund, the details of a service must be matched with the descriptions specified in the scheme of classification of services notified vide Notification No.11/2017 – Central Tax (Rate) dated 28.06.2017. This identification of service is further considered during application of refund of unutilised ITC, as evident from a plain reading of Section 54(3)(ii) of the Act. Therefore, the taxpayers, providing the said construction services by way of works contract – would invariably arrive at item 5(b) of Schedule II of the Act, even if they begin by identifying the nature of their supply under item 6(a) of Schedule II of the Act.

IV. Refund of unutilised ITC

CBIC has clarified vide Flyer No. 37 dated 01.01.2018 – that the supplies specified under item 5(b) of Schedule II of the Act are construction services only, refund in respect of which is sought to be disallowed by Notification No. 15/2017 – Central Tax (Rate) dated 28.06.2017. The said notification does not seek to disallow refund of unutilised ITC with respect to all of the principal services listed under Section 2(119) of the Act, rather, it expressly covers one of the services enlisted therein, that is – ‘construction’ of complex, building, civil structure or a part thereof, as specified in item 5(b) of Schedule II the Act.

The argument that taxpayers have oftentimes made, that item 5(b) of Schedule II of the Act does not cover the said ‘construction services’ because their transactions involved supply under a works contract – ignores the possibility that the ‘works contract’ under item 6(a) of Schedule II of the Act may also be made for ‘construction’.

The mischief of such an argument is further aggravated by the fact that the exclusion of the said notification would operate in the following two-fold way, if the said interpretation of taxpayers is to be accepted:

• Some ‘X’, if engaged in providing ‘the said construction services’ under works contract, would be entitled to refund of unutilized ITC under Section 54(3)(ii) of the Act; whereas,
• Some ‘Y’, if engaged in providing ‘the said construction services’ by way other than works contract, would be disallowed from refund by application of the said notification.

Such an interpretation effectively creates classification amongst two similarly placed persons – X and Y, who are both registered persons supplying the said construction services. Mode of supply of service (i.e. under works contract or otherwise) is not a rational intelligible differentia, and thus, treating X and Y differently would be violative of Article 14 of the Constitution.

Therefore, regardless of the way of providing ‘service of construction of a complex, building, civil structure or a part thereof’, mentioned under item 5(b) of Schedule II of the Act, i.e. under works contract or otherwise, the taxpayers are debarred from refund of unutilized ITC under Section 54(3)(ii) of the Act in respect of supply of such services under the present regime.

V. Concluding remarks

While the ITC accumulated from supply of service of construction of a complex, building, civil structure or a part thereof can be utilised in regular course of business towards payment of output tax liability, refund of the same has been disallowed by way of the said notification. It appears that this is a conscious policy decision of the Government, as clauses (c) and (d) of sub-section (5) of Section 17 block the ITC related to supplies of works contract for construction of an immovable property from the side of recipient of the said construction service as well. Therefore, a complete appreciation of the issue at hand reveals that the taxpayers’ claim of refund of such unutilised ITC is disallowed by the said notification and the interpretation involving a recourse to item 6(a) of Schedule II of the Act is not of much relief in that regard.

[1] Complex, building, or a civil structure generally refer to and includes civil engineering works (highways, railways, bridges, dams, etc.), residential apartments, commercial apartments (shops, offices, malls, hotels, godowns, petrol and service stations, airports, rail or road terminals, etc.), industrial buildings (workshops, storage buildings, etc.), other non-residential buildings (educational institutions, hospitals, religious establishments, courts, museums, etc.), etc. including additions, alterations, replacements or remodelling thereof.

Further, it is immaterial whether such complex or building is intended for sale to a buyer or is a work for government – as item 5(b) employs the term ‘including’, which is separated by a comma, and thus, not a qualifier to the preceding terms – ‘complex, building, civil structure or a part thereof’.

See also:

https://www.cbic.gov.in/resources//htdocs-cbec/gst/Work%20Contracts%20in%20GST.pdf

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* The author is a 3rd-year student pursuing B.A. L.L.B. (Hons) from Gujarat National Law University and can be reached at parthivjoshi01@gmail.com.