Taxability of Back to Back Contracts in GST

Back-to-back contracts are not current phenomena but an old trend which was also in the picture and a matter of discussion from VAT & Service Tax Era where there was huge debate and subsequently resulted in various litigation before Entry No. 29 (h) of Mega Exemption Notification No. 25/2012 dated 20.06.2012 provided exemption to sub-contractor providing services by way of works contract to another contractor providing works contract services which are exempt at least in Service Tax.

Back-to-back contracts are usually used in the big contracts such as construction contracts either of roads, bridges or any other big-ticket work. A back to back contract involves employer (authority giving contract), main-contractor and sub-contractor. The employer always favours entering into only one contract or least contracts with a single party which helps them to monitor the project and take reports from a single party rather from an array of the contractors. However, in order to efficiently complete the allotted project in time, the main-contractor enters into various sub-contracts with the sub-contractors. This is generally done by way of back-to-back agreements or contracts.The question has been raised always on the taxability of sub-contractors in this overall chain of contracts, whether the tax rate/exemptions applicable to the main-contractor will be applicable to sub-contractors also?

GST though has subsumed VAT and Service Tax but many of inbuilt provision of previous acts have been tweaked to increase the revenue base. We will be discussing the law under GST Act, what is the fate of Back to Back Contracts taxability under the new scheme of Indirect Taxation.

GST law nowhere gives a clear-cut picture regarding taxability on this subject matter. So, let us examine some landmark judgements, Advance Rulings and other food for thought which is available for discussion under GST regime.

View 1: – Sub-contractor does not provide services to the employer directly (authority which gives contract) but they provide services to the Main-contractor, therefore taxability of sub-contractor should be different than of Main-contractor in the overall contract.

View 2: – Since Sub-contractor enters into an agreement with the Main-contractor with the same stipulation and condition as Main-contractor enters into with the employer, therefore sub-contractor is giving service to the employer in executing the contract on behalf of the Main-contractor. Therefore, taxability of sub-contractor should be same as of Main-contractor in the overall contract.

Let’s analyse above views taken in various scenario till date at Advance Ruling level.

Fact 1: –

A contractor entered into an agreement with the State Government for construction of flats under affordable housing scheme under PMAY (Pradhan Mantri Awas Yojana), now the main-contractor has sublet the work related to “pure labour” to another contractor under separate work contract pertaining to the main contract, now this sub-contractor again sublets the work to another contractor of a “pure labour” services under this sub-contract. Main contractor enjoys exemption by way of Entry 10, notification 12/2017.

Facts to be checked and verified with the provision of law: –

Whether above sub-letting of the work under back to back contracts, will be covered under Entry 10 of Notification no. 12/2017.

“Services provided by way of pure labour contracts of construction, erection, commissioning, installation, completion, fitting out, repair, maintenance, renovation, or alteration of a civil structure or any other original works pertaining to the beneficiary-led individual house construction or enhancement under the Housing for All (Urban) Mission or Pradhan Mantri Awas Yojana.”

Analysis of Provision

Basic element of the Entry 10 exemption notification suggests: –

1. Service by way of pure labour contract

2. Work related to contracts of construction, erection, commissioning, installation, completion, fitting out, repair, maintenance, renovation, or alteration of a civil structure or any other original works;

3. Pertaining to the beneficiary led individual house construction or enhancement under the Housing for All (Urban) Mission or Pradhan Mantri Awas Yojana;

“original works” means- all new constructions;

• all types of additions and alterations to abandoned or damaged structures on land that are required to make them workable;
• erection, commissioning or installation of plant, machinery or equipment or structures, whether pre-fabricated or otherwise;

Decision: –

As the scope of the above contract is not person-centric but project-centric; the entry 10 does not speak about contractor or any sub-contractor per se but the conditions are related to pure services by way of construction under special project “PMAY”. It is clearly mentioned that whosoever is supplying the pure labour contract services for the construction of a civil structure or any other original works under PMAY is exempted from GST.

Therefore, the sub-contract of pure labour will be covered under Entry 10 of Notification no. 12/2017 and the said contract will be eligible for exemption.

Fact 2: –

A railways construction contract was awarded to a main-contractor where it is sub-contracted to another contractor for original contract work pertaining to railways. Now a question arises that what tax rate to be charged by the sub-contractor to main-contractor on works contract service? Whether it would be same which main-contractor is required (12% as per Notification no. 20/2017) to collect or it should be 18% as normal works contract services.

Facts to be checked and verified with the provision of law: –

As per Notification 11/2017 amended with notification no. 20/2017 dated 22.08.2017

“(v) Composite supply of works contract as defined in clause (119) of section 2 of the Central Goods and Services Tax Act, 2017, supplied by way of construction, erection, commissioning, or installation of original works pertaining to, –

(a) railways, excluding monorail and metro; ….”

Analysis of Provision

Here again notification is silent about the person but very specific about the exemption criteria which includes

1. Composite supply of works contracts

2. Supplied by way of construction, erection, commissioning or installation of original works

3. Work should pertain to specified category which specifically mention “railways”

Department stand contrary: –

Department here advocates view 1 – where the department has taken stand that in Notification 20/2017 Central Tax (Rate) dated 22.08.2017 serial no. V – does not specifically include of works contract service (WCS) provided by the sub-contractor to the main-contractor, therefore lower tax rate of 12% will not be available to the sub-contractor and standard WCS rate of 18% would prevail.

Even amendment by Notification no 1/2018 dated 25.01.2018 in para (c ) it is substituted that in serial no. (ix) & (x) that for the composite supply of WCS provided by a subcontractor to the main contractor given to Government Entity is 12%, but construction service of railways is not specifically included therefore rate would be 18% only.

Decision: –

As the contractor is subcontracted by the main-contractor to supply WCS and in turn, the main-contractor is supplying WCS to railways. WCS provided by the sub-contractor is the same or a part of the main contract entered into between the main contractor and Railways. It also appears that the work involves civil work and the property in goods (materials used in WCS) would also get transferred to Railways directly.

In such as a case as per clause (v) of Notification no. 20/2017- Central Tax Rate the works contract services provided by the sub-contractor to the main-contractor would be a supply of WCS pertaining to Railways and therefore chargeable @ 12% (6% of CGST & SGST each).

Fact 3: –

NHPC has been awarded a contract of construction of road from MEA, NHPC & PWD of Uttarakhand will be executing the contract, while the fund will be provided to the NHPC directly as NHPC will “Implementing Agency” and PWD will be acting as sub-contractor. Question asked here by NHPC is whether they will be required to pay GST under Reverse Charge in terms of Notification no. 13/2017 while making payment to PWD.

Discussion: –

Point to discuss here is the decision made by AAR, AAR stated at their decision that GST rate for the above works is exempted or the rate of tax is 0%. They stated that

• “They are of the firm view that if the principal contractor is providing an exempt works contract service to the Government and in such if work contract is partially or wholly sub-contracted then the sub-contractor would also be exempt from payment of GST”.
• In support of our view, we place reliance upon the Government view on the issue in hand in the pre-GST regime and the same are reproduced referring to the Serial no. 29 sub-clause(h) of the mega exemption notification 25/2012 dated 20.06.2012 which provides that service provided by the following person in respective capacities are exempt from service tax;

(h) sub-contractor providing services by way of works contract to another contractor providing works contract services which are exempt 

• Reference to Circular No. 147/16/2011 – Service Tax dated 21.10.2011 is also made where exemption is available to the works contract service providers.

“Clarification has been requested as to whether the exemption available to the Works Contract Service providers in respect of projects involving construction of roads, airport, railways, transport terminals, bridges, tunnels, dams etc., is also available to the sub-contractors who provide Works contract Service to these main contractors in relation to those very projects.” 

“It has clarified that the main infrastructure project of execution of works contract in respect of roads, airport, railways, transport terminals, bridges, tunnels, dams is sub-divided into several sub-projects and each such sub-project is assigned by the main contractor to the various sub-contractors. In such cases if the sub-contractors are providing works contract service to the main contractor for completion of the main contract, then service tax is obviously not leviable on the works contract service provided by such sub-contractor.”

• In view of the above we observe that the said activity comes under the purview of exempted category as discussed supra, therefore, the question of payment of GST under reverse charge in terms of Notification no. 13/2o17-Central Tax (Rate) dated 28.06.2017 does not arise.

Crux of overall decision: –

• Supreme Court in one of the judgement has categorically mentioned that “It is now a well-established principle of law that whereas eligibility criteria laid down in an exemption notification are required to be construed strictly, once it is found that the applicant satisfies the same, the exemption notification should be construed liberally.” – G.P. Ceramics Private Limited v. Commissioner, Trade Tax, Uttar Pradesh, (2009) 2 SCC 90
• Exemption notification should be analysed word by word to understand whether it is project-centric or person-centric. Once it is project-centric then whole project exemption criteria must be matched with the terms of the contract; if it is person-centric then check whether the person in question is eligible for an exemption or not.
• Department in GST era clearly showing dis-interest in providing the same treatment to Main-contractor to sub-contractor stating the reason as there is no direct law providing so. It is imperative that every such case will go for litigation. This is a small effort to put forth the facts and cases till date in order to enable all to take decisions and present their respective cases in order to have maximum benefit for all.

Disclaimer: –

Above discussion cannot be considered as professional or legal advice. Readers shall consider legal provisions or take legal advice from experts before taking action on it.