Works contract Under GST in India

What is a work Contract

A works contract is an agreement which is a mixture of service or labour and transfer of goods. Under a works contract the contractor agrees to do certain job in execution whereof, certain goods are transferred to the contractee. Thus, an agreement of building construction, manufacture, processing, fabrication, erection, installation, repair or commissioning of any movable or immovable property, is a works contract.

In a general sense, a contract of works, may relate to both movable and immovable property. E.g. if a sub-contractor, undertakes a sub-contract for the building work, it would be a works contract in relation to immovable property. Similarly, if a composite supply in relation to movable property such as fabrication/painting/annual maintenance contracts etc. is undertaken, the same would come within the ambit of the broad definition of a works contract.

Works contract as per VAT and Service tax

A works contract has elements of both provision of services and sale of goods, and was therefore taxable under both laws.

VAT

In the case of Gannon Dunkerly, the Hon’ble Apex Court had held that in case of a works contract, the dominant intention of the contract is the execution of works, which is a service and there is no element of sale of goods (as per Sale of Goods Act). The contract being one indivisible contract, it cannot be broken up to levy VAT on sale of goods involved in the execution of works contract.

However as it involved substantial portion of goods also which was getting transferred/sold during the execution of works State also needed their portion of revenue by imposing tax on the goods portion.

This decision led the Government to amend the Constitution of India and insert Article 366(29A) which enabled the State Governments to levy tax (VAT) on transfer of property in goods (whether as goods or in some other form) involved in the execution of a works contract.

Service tax

Works contract has been defined in section 65B of the Finance Act, 1994 as a contract wherein transfer of property in goods involved in the execution of such contract is leviable to tax as sale of goods and such contract is for the purpose of carrying out construction, erection, commissioning, installation, completion, fitting out, repair, maintenance, renovation, alteration of any moveable or immovable property or for carrying out any other similar activity or a part thereof in relation to such property. By virtue of Section 66E of Finance Act, 1994, the service portion involved in the execution of works contract was a declared service. Hence Service Tax could be levied only on the service element of the works contract. The principles of segregation of the value of goods were provided in Rule 2A .

So goods portion of works contract were taxed by respective states by various formulas and methods given in the State Act to determine the goods portion in the works contract and services portion was taxed by Central govt by the means of service tax .However, there was plethora of confusion and disputes with regard to valuation, classification, rates wrt to works contract prior to GST regime.

Check out How GST works in India.

Works contract under GST

 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.”

The most significant change with regard to Work Contract in GST is the meaning of “Work contract” has been restricted to any work undertaken for an “Immovable Property” unlike the existing VAT and Service Tax provisions where works contracts for movable properties were also considered.

Immovable Property Meaning

The term “immovable property” is not defined under GST. … According to section 3(26) of the General Clauses Act 1897, “immovable property shall include land, benefits to arise out of land and things attached to the earth, or permanently fastened to anything attached to the earth

As per Section 3 of the Transfer of Property ACT 1882 “Immovable property does not includes standing timber, growing crops or grass”

Some court judgements with regard movable and immovable property

♦ Sirpur Paper Mills Ltd v. Collector of Central Excise, Hyderabad (1998) 1 SCC 400

Excise duty on paper making machine – Attached to earth for operational efficiency – If the appellant wanted to sell the paper-making machine it could always remove it from its base and sell it – Held as movable.

♦ G. Industries Ltd. V. CCE, Raipur (2004) 167 ELT 501 (SC)

Machinery was erected at the site on a specially made concrete platform at a level of 25 ft. height – Considering the weight and volume of the machine and the processes involved in its erection and installation – held as immovable property which could not be shifted without dismantling the same.

Following defining factors emerge from the case laws and these can be used for deciding the all important question of whether something is immovable or movable:

• Degree of permanency of the attachment to the earth
• Intent of the Use of the goods / property is essentially of Immovable nature
• Cannot be detached from earth without causing substantial damage to it
• Identity of the goods as such post removal is lost

So in GST if there is a supply by the supplier to recipient which consist of element of  both goods and services then the first test for the purpose of identifying that whether the same is work contract is to identify that where a contract is for 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 ,if the answer is affirmative then 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 it 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.

If the answer is negative, then the same will be classifiable as composite supply or mixed supply   depending on the facts and cirumstance as per Section 2(30)&2(74)of CGST Act 2017  respectively.

Input tax credit for work contract under GST

As per 16. (1) of CGST Act , Every registered person shall, subject to such conditions and restrictions as may be prescribed and in the manner specified in section 49, be entitled to take credit of input tax charged on any supply of goods or services or both to him which are used or intended to be used in the course or furtherance of his business and the said amount shall be credited to the electronic credit ledger of such person.

However as per Section 17(5)(c) of CGST Act 2017 input tax credit in respect of work contract services has been restricted to the recipient when supplied for the construction of an immovable property (other than plant and machinery)except where it is a input service for further supply of work 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. For example a building developer may engage services of a subcontractor for certain portion of the whole work. The subcontractor will charge GST in the tax invoice raised on the main contractor. The main contractor will be entitled to take ITC on the tax invoice raised by his sub-contractor as his output is works contract service. However if the main contractor provides works contract service (other than for plant and machinery) to a company say in the IT business, the ITC of GST paid on the invoice raised by the works contractor will not be available to the IT Company.

However in the following two circumstances recipient will be eligible to take input tax credit on work contract services even if its final output is not work contract services:

a) Work contract services used for construction  not resulting in capitalization to the said immovable property

As per Explanation given in Section 17(5)(c)expression “construction” includes re-construction, renovation, additions or alterations or repairs, to the extent of capitalisation, to the said immovable property

If any work contract services has been used by recipient which has not been capitalized by the recipient for the said immovable property credit of the same may be availed by the recipient subject to other conditions.

For example if Mr Ramesh is a Chartered Accountant and  has given a contract to repair his already constructed building to some contractor and supply by contractor is in the nature of work contract services  and repair expenses are not capitalized by Mr Ramesh in its books of account and instead has been debited to profit and loss account credit of the work contract services may be availed by Mr Ramesh.

Nature of the expense – ‘Capital’ or ‘Revenue’.

Classification of an expense between Capital and Revenue runs on a very thin line of interpretation and final decision rests on exact facts of a transaction.An expenditure is normally booked as capital or revenue in the books of accounts as per relevant accounting standards or as per Income tax provision ,however the same is very subjective and may vary from one organization to other .

GST Law does not define the terms capital expenditure and revenue expenditure; hence one  have to depend on their natural meaning as well as decided cases

Question is whether GST officer can challenge the accounting treatment given in the audited books of accounts .We submit that the same may not be challenged due to the following reasons:-

Explanation provided u/s 17(5) of the CGST Act, 2017 only provides that repairs to the extent of capitalization shall be treated as “construction” for applying clause (c) & (d) of the said provision. Hence the treatment given in the books shall be a base for deciding the admissibility of ITC and officer cannot question the books duly audited and accepted by the shareholders in the AGM as well as ROC .

 If legislator had intended that GST officer can challenge such accounting treatment, then it would have provided in the Explanation that “capitalization as accepted by the proper officer” can be regarded as “construction”. In absence of such words, GST officer is not allowed to challenge the accounting treatment.

b) Work Contract services relating to construction of plant and machinery

For the purposes of this Chapter and Chapter VI, the expression “plant and machinery” means apparatus, equipment, and machinery fixed to earth by foundation or structural support that are used for making outward supply of goods or services or both and includes such foundation and structural supports but excludes—

(i) land, building or any other civil structures;

(ii) telecommunication towers; and

(iii) pipelines laid outside the factory premises.

Plant and Machinery in certain cases when affixed permanently to the earth would constitute immovable property. When work contract services is  utilized for the construction of plant and machinery, the ITC of the tax paid to the works contractor would be available to the recipient, whatever is the business of the recipient. This is because works contract in respect of plant and machinery comes within the exclusion clause of the negative list and ITC would be available when used in the course or furtherance of business.

As per section 17(5)(d)of CGST Act 2017  input tax credit shall not be available in case of 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 includingwhen such goods or services or both are used in the course or furtherance of business.

Credit admissibility under section 17(5)(c&d) can be tabulated as below:-

 However a recent judgement by Orrisa High Court in the matter of M/s Safari Retreats Private Limited has came with a twist in the tale which is summarized as below

Facts: M/s Safari Retreats Private Limited (“the Petitioner”) is engaged in carrying on business activity of constructing shopping malls for the purpose of letting out of the same to numerous tenant and lessees. The Petitioner purchased cement, steel, sand, aluminium, wires, etc., in bulk. Additionally, it also availed services like consultancy service, architectural services, legal and professional service etc. As these supplies were taxable, the Petitioner had accumulated input tax credit in respect of purchases of inputs and input services. It applied for availing credit, however, by applying section 17 (5) (d) of the CGST Act, the Revenue took a view that input tax credit shall not be available in respect of goods and services or both received by a taxable person for construction of an immovable property (other than plant and machinery) on his own account including when such goods or services or both are used in the course of furtherance of business. The benefit of input tax credit was denied to the Petitioner

Issues Involved: The key issue raised before the Court was

Where inputs are consumed in the construction of an immovable property which is meant and intended to be for the provision of taxable output services, whether input tax credit was available to the assessee?

Held: The Hon’ble Orissa High Court in Safari Retreats Private Limited Vs Chief Commissioner of Central Goods & Service tax in W.P. ( C) No. 20463 of 2018 vide order dated April 17 2019 read down section 17 (5) (d) of the CGST Act  for the purpose of interpretation in continuation to give benefit to the person who has paid GST and it has to be interpreted in continuity of the transaction since rent income is arising out of the malls which are constructed after paying GST on different items. If input tax credit is denied on building meant and intended to be let out, it would amount to treating the transaction as identical to a building meant and intended to be sold. Further, treatment of these two different types of transactions as one for the purpose of GST, is contrary to the basic principles regarding classification of subject matter of tax levy and, therefore, violative of Article 14 of the Constitution.

Hence, the interpretation adopted by the Revenue is frustrating the objective of the CGST and other respective state GST Acts inasmuch as the Petitioner in that case has to pay huge amount without any basis. Relying on (1999) 2 SCC 361, the very purpose of the credit is to give benefit to the assessee. Therefore, if the Petitioner is required to pay GST on the rental income arising out of the investment on which he had paid GST, it is required to have the input tax credit on the GST.

Delhi High Court issues notice to Revenue in similar matter

On the same lines, the Delhi High Court issued notice to Revenue while hearing Petitioner’s challenge to section 17 (5) (c) & (d) of the CGST Act pertaining to blocked credit for hotels. The Revenue in this case denied input tax credit on procurement of goods and services including works contract used for immovable property construction. This petition was filed seeking to declare section 17 (5) of the CGST Act, 2017 to be ultra-vires of Article 14 of the Constitution of India, as same is violating its fundamental right. The Petitioner has also requested for formation of High-Level Committee for addressing interpretational issues. The matter is listed on August 21, 2019.

Valuation of work contract services

Valuation of a works contract service is dependent upon whether the contract includes transfer of property in land as a part of the works contract.

As per explanation 2 of Notification no 11/2017 CGST (rate) In case of supply of service, involving transfer of property in land or undivided share of land, as the case may be, the value of supply of service and goods portion in such supply shall be equivalent to the total amount charged for such supply less the value of land or undivided share of land, as the case may be, and the value of land or undivided share of land, as the case may be, in such supply shall be deemed to be one third of the total amount charged for such supply.

Explanation. – For the above purpose, “total amount” means the sum total of,-

(a) consideration charged for aforesaid service; and

(b) amount charged for transfer of land or undivided

share of land, as the case may be 

For example if a builder is selling flats in which payment is collected in staggered manner the same is taxable as a work contract service. Selling of flats includes inherent cost of land also .So suppose payment received by builder as first installment is 12,00,000 GST will be leviable at applicable rate on 12,00,000*2/3 =8,00,000 and balance will be construed as cost of land on which no GST is leviable .

Place of Supply in respect of Works Contract

Works Contract under GST would necessarily involve immovable property. In view of the same the place of supply would be governed by Section 12(3) of the IGST Act, 2017, where both the supplier and recipient are located in India. The place of supply would be where the immovable property is located.

For example a contractor registered under GST  from Bhopal gets a contract for construction of hotel in Mumbai(including all material i.e cement ,steel etc) from M/s Richie which is registered in state of Telangana .Here the nature of services will be work contract services and  the location of supplier will be Madhya Pradesh assuming supplier do not have any permanent establishment in Maharashtra and place of supply will be Maharashtra where the immovable property is situated and not Telangana where the recipient is registered.

In case the immovable property is located outside India, and the supplier as well as recipient both are located in India, the place of supply would be the location of recipient as per proviso to Section 12(3) of the IGST Act, 2017.

E-way Bill in case of work contracts services

If the supplier registered in one state  gets contract in some other state and nature of the contract is work contract services and supplier  is not registered in the state in which it has got contract and has to transfer material ,equipment’s  etc to other state for the purpose of executing work  then the same shall be moved on the basis of delivery challan  and no tax shall be charged on the movement of goods  as the supply is of work contract services and  not of goods and same will be billed as per the contract  as a works contract services.

However if the supplier is registered in other state as well and the there has been a transfer of material,equipments to other state then in that case tax may have to  be charged on transfer of material ,equipment etc  if the services are provided from that place as  it will be construed  as a  supply of goods to distinct person .However credit of the same is available in the other state in which material,equipment has been transferred as it will be treated as services has been rendered from that State for which registration has been taken subject to other conditions.