The subject matter of works contract has always been complex. During last five decades the law relating to works contract is driven by judicial pronouncements rather than legislative action. The concept of works contracts is developed and has undergone change by various judicial decisions. Interpretations done by various courts in similar and little different situations and also special provisions made in the act for taxation of works contracts has made the subject complex and very difficult to understand. GST is an opportunity for the legislature to end uncertainty. However if one looks at the Model Draft of GST, I wonder whether the subject has been given it’s due importance or not.
Also Read- Job Work under Goods and Service Tax (GST)
It will be worthwhile to understand the history of the subject in brief.
As per the constitution the States have power to levy tax on sale or purchase of goods. In the case of Gannon and Dunkerlay (9 STC 353) Supreme Court ruled that the power to tax does not extend to the contract for construction of building even if there is transfer of building material during construction. It mentioned that the contract is not for sale of goods but for work. The principle laid down by Supreme Court was followed in similar circumstances of indivisible works contracts. It opened flood gates for tax planning. And many businessmen instead of entering into contract for supply of goods started entering into some composite contracts because of which supply part of the contract also became tax free. In order to overcome the difficulty the Government amended the Constitution. After the 46th amendment to the constitution the states are empowered to levy tax on transfer of property in goods involved in execution of works contracts. Since then the contracts are broadly divided in to three types i.e. contract for sale of goods, works contracts (transfer of property in goods during execution) and pure labour contracts.
However even after 35 years of the enabling amendment, the topic of works contract invokes discussions, debates, contrasting opinions and views amongst courts and experts. There is total confusion and heartburn amongst the tax payers.
After the power to levy tax was given to the states, initially many States levied tax on the entire value of works contract. The Supreme Court pointed out that the works contract has two elements. Transfer of property in Goods is one. Labour and services is another. And the state can levy tax only on value of Goods transferred during the execution of works contract. Initially dominant intention was considered as necessary for deciding whether a contract is works contract or not. Gradually it lost it’s significance. The pendulum swung to other extreme and even incidental use of goods in service contract became liable to tax under VAT laws.
It is also observed that it is very difficult to determine the value of goods and therefore the state may provide for some standard method and mechanism to determine it. The contract which was subject of dispute before the Supreme Court was construction contract and hence the deductions suggested in the Judgment are limited to construction contracts. Most states have thereafter adopted the same deductions without considering the fact that the nature of works contract defer from predominantly supply of goods to predominantly service oriented.
There is no full proof formula to decide determination of sale price. Cost plus profit is logical and proper method to arrive at the sale price of goods which are transferred during the execution of works contract. However in order to increase the revenue, the Sales tax Department has doggedly denied it. The determination of sale price has been bone of contention and has lead to large scale litigation.
The Central Government which has power to levy tax on services, found an opportunity to levy tax on that part of the works contract which can not be taxed under sales tax laws. Central Government started levying service tax on works contracts from 01/04/2007. Initially it’s scope was restricted to construction, erection, installation of plant and machinery. The scope was widened on 01/07/2012 to almost similar to sales tax laws. Thereafter the problem became more complicated. Central as well as states have different rules to decide the taxable part of the works contract. The outcome of such anomaly is that works contractor has to pay tax on amount of sum which is more than the contract price. Ultimately the cost of works contracts goes up.
One thing common in VAT and service tax provisions is that for levy of tax as works contract there should be transfer of property in goods involved in the execution of it.
Meaning of Works Contract Under GST : the definition of works contract is different it is as follows :
(107) “works contract” means an agreement for carrying out for cash, deferred payment or other valuable consideration, building, construction, fabrication, erection, installation, fitting out, improvement, modification, repair, renovation or commissioning of any moveable or immovable property.
It may be noted that transfer of property in goods is not essential to decide whether it is works contracts or not. As per Schedule II clause 5(f) of model GST Law works contract including transfer of property in goods (whether as goods or in some other form) involved in the execution of a works contract are to be treated as service.
Rules of place of supply, value of supply, recipient etc It will mean that value of goods which are transferred in execution of works contract will be liable to tax as service and not as goods. This is a major change. In many contracts value of goods is much more than value of labour and services. In such contracts predominant object is to supply goods, however under GST the supply of goods involved in execution of works contract will be service. Consequently GST rates, place of supply rules, valuation rules as applicable on services will apply to works contracts. While deciding whether a supply is interstate or intra state the place of supply of service will be applicable to works contract. The law of works contract is developed by numerous judgments of various courts. Some are apparently conflicting. Whether the ratio of those judgments will be relevant under GST? Cursory look at the proposed provisions are enough to apprehend that the subject matter of works contract will remain complicated.
Job works : In proposed draft job work is defined and has different treatment. It may be noted under GST the relation of job worker to manufacturing process is removed and therefore job work will have wider meaning than under excise rules. Then the question arises, what is difference between job worker and works contractor? It will be better that the provisions relating to job work be merged into works contracts.
If the goods are sent for some work not amounting to job work whether it will be treated as supply? There is special provision U/S 43A so as to exclude the goods sent for job work by registered taxable person. There is no similar provision for goods sent for works contract. It may be interpreted that Goods so sent are supply liable to tax. Consequently when the goods are sent back by works contractor he will have to pay tax again. It will increase complications, tax liability and litigation.
At present many experts may consider it as stretching the meaning too much. They think it is imaginary fear. However if the experience so far is any indication then the law should be very clear on this point. There should be no ambiguity. Till the judgment in the case of Ambica Steels under Central Sales Tax act, nobody imagined that goods sent for job work on principal to principal basis will be liable to tax in absence of F form. The Government has also not taken any legislative corrective action to redress the genuine grievances on this account.
Sub contracts : In most building contracts and other big contracts some part is assigned to sub contractors. Whether the theory that there is only single transfer of property form sub contractor to employer will be equally applicable to the new concept of supply? MVAT Act provides for deduction of turnover for that part of contract which is executed by subcontractor. Under GST Act there is no such provision. Therefore part of works contract executed by subcontractor will be supply of service to main contractor.
Denial of input tax credit
Sec 16 (9) (c) goods and/or services acquired by the principal in the execution of works contract when such contract results in construction of immovable property, other than plant and machinery;
(d) goods acquired by a principal, the property in which is not transferred (whether as goods or in some other form) to any other person, which are used in the construction of immovable property, other than plant and machinery;
Issue is about input tax credit where sub-contractor executes the work which results into immovable property. Sub clause (c) provides that goods and/or services acquired by the principal in the execution of works contract when such contract results in construction of immovable property, other than plant and machinery. As far as sub contractor is concerned the main contractor is principal to whom he has supplied goods or services. The apparent meaning is that goods and services acquired from sub contractor by main contractor in construction of immovable property will not be allowed as input tax credit. The intention seems to be to disallow input tax credit to the owner of the immovable property who is final consumer. Hence, to make legislative intent clear the provision has to be properly worded.
Many works contracts continue for a long period of time. Material and services for such contracts are procured from various sources, within state, interstate as well as imports. Whether input tax credit will be deferred till last supply?
Free Supplies : Another point is free supplies by the Awardee. Now suppose someone wants to construct bunglow for himself. He appoints a contractor on per square meter labour charges basis. Contractor is registered taxable person. The awardee buys construction material himself which is used by the contractor for construction of house. Whether contractor shall include the value of construction material while charging tax? Will it not be double taxation?
Whether the goods given for work will be treated as supply by principal to works contractor? Combined reading of Sec 43A, and provision of Schedule 1 (5) lead to the conclusion that it can be treated as supply without consideration. In GST supply by person is mentioned but it does not mention to other person.
Divisible works contracts : Machinery manufactured as per specification of customer to be installed or erected or commissioned in other state is moved to other state. If the price of the same is separately mentioned in the contract will it be treated as supply of goods or it will be supply of service? If there is difference in rate of tax on Goods and on services, then it will be point of dispute and litigation. Place of supply rules for Goods and services are different. Which rules will be applicable?
Conclusion : By treating works contract as service tax the taxation of it is likely to be simpler and less burdensome than at present. GST has provided an opportunity to provide complete solutions to contentious issues so far. It is necessary to give sufficient clarifications on various controversial issues so that under GST regime the works contractors can give sigh of relief.