In the previous article(see previous article here) some aspects of works contract service were discussed. In this continuing article an attempt has been made to discuss the reverse charge mechanism in works contract service.
What is reverse charge: Before jumping to the reverse charge mechanism in works contract service, it is important to understand what is reverse charge. Normally service tax is payable by the service provider after charging/collecting the same from the service receiver.
Under reverse charge service receiver is made liable to pay service tax directly to the treasury instead of paying to the service provider, thus service provider gets exempted from the liability to collect service tax from service receiver and paying into the Government treasury.
Partial reverse charge: Under section 68(2) of Finance act, 1994 already certain services were notified [vide notification No. 36/2004-ST, dated 31-12-2004, where the recipient is liable to pay tax for the entire amount of service tax.
By the Finance act, 2012, section 68(2) has been further amended to empower the Central government to notify the services on which service tax shall be payable by a person other than service provider by specifying the extent of the service tax, which shall be payable by such person and remaining part shall be payable by the service provider.
50% reverse charge in works contract service: Thus section 68(2) empowers Central Government to impose partial reverse charge in any service. Under the works contract service partial reverse charge to the extent of 50% has been imposed subject to certain conditions.
In works contract service 50% of service tax will be payable by service receiver and 50% by the service provider if the following conditions are satisfied:
1. Provider of works contract service is an individual, HUF or partnership firm, whether registered or not, including Association of persons, located in the taxable territory and,
2. Such works contract service is provided to a business entity registered as body corporate, located in the taxable territory.
Thus both the above conditions must be satisfied before reverse charge mechanism is to be applicable in works contract service.
It is important to understand the word Business entity and body corporate for understanding of application of reverse charge.
Business entity means any person ordinarily carrying out activity relating to industry, commerce or any other business or profession. A charitable organization not carrying any business or profession, even if is a body corporate would not be liable under reverse charge mechanism as its not a business entity.
Body corporate means an organization incorporated under any law for the time being in force. Company registered under companies Act, 1956, LLP, cooperative society are body corporate. However trusts or society registered under Society registration Act, 1860, HUF, partnership firms are not body corporates.
If both the provider and receiver are body corporate then reverse charge is not applicable. Similarly if Body corporate provides works contract service to an individual, HUF then no question of reverse charge mechanism arises.
No SSI exemption to service receiver but available to service provider: Service receiver who is liable to pay the service tax cannot avail the exemption of 10 lakh as no SSI exemption is available under reverse charge.
However service provider has the SSI exemption of Rs. 10 lakh in reverse charge. Thus there may be cases in one and the same works contract, where the service provider may not be paying the service tax due to SSI exemption available to him but service receiver will be paying the service tax.
Independent valuation of the works contract service by service receiver: As per Explanation-II to Notification 30/2012-ST, dated 20.06.2012, in works contract services, where both service provider and service recipient are the persons liable to pay tax, the service recipient has the option of choosing the valuation method as per choice, independent of valuation method adopted by the provider of service.
Now in this regard it is notable that after negative list there are two methods of paying service tax under works contract, one is paying service tax on actual services involved in works contract and other is under alternate method wherein service tax is payable on 40%, 70% or 60% of the total amount charged for the works contract as the case may be depending on the nature of contract.
Practical difficulty: The receiver of works contract service i.e. contractee if wants to pay service tax on actual value of services and the service provider/contractor chooses to pay under alternate method then a practical difficulty will arise in the valuation of service by the service receiver.
In most of the cases contractee would be depending upon the contractor’s Running account bills or accounting maintained by contractor for determining the amount of material and service/labour element involved in the contract.
If the contractor is paying service tax under alternate method then he may not bother to find out the actual services/labour element in the works contract as he has to calculate service portion at a fixed percentage of total amount under alternate method. In such case contractee if wanting to pay service tax on actual value of services it would be very difficult for him to find out the actual value of labour/service element involved in works contract in the absence of proper accounting by contractor.
Similarly small contractors who are covered under SSI exemption i.e. having turnover less than 10 lakh may not be making regular books of accounts under any law i.e. under Income Tax (Due to being covered u/s 44AD) or VAT laws(due to opting composite scheme), in such case again it would be difficult for the service receiver to pay service tax under actual scheme, so the above explanation-II would become redundant.
Some important clarification by Government:
What does a service provider need to indicate on the invoice when he is liable to pay only a part of the liability under the partial reverse charge mechanism?
The service provider shall issue an invoice complying with Rule 4A of the Service Tax Rules 1994. Thus the invoice shall indicate the name, address and the registration number of the service provider; the name and address of the person receiving taxable service; the description and value of taxable service provided or agreed to be provided; and the service tax payable thereon. As per clause (iv) of sub-rule (1) of the said rule 4A “the service tax payable thereon’ has to be indicated. The service tax payable would include service tax payable by the service provider.
If the service provider is exempted being a SSI (turnover less than Rs. 10 lakhs), how will the reverse charge mechanism work?
The liability of the service provider and service recipient are different and independent of each other. Thus in case the service provider is availing exemption owing to turnover being less than Rs. 10 lakhs, he shall not be obliged to pay any tax. However, the service recipient shall have to pay service tax which he is required to pay under the partial reverse charge mechanism.
Will the credit of such tax paid be available to the service recipient?
Normally, the credit of the entire tax paid on the service received by the service receiver would be available to the service recipient subject to the provisions of the CENVAT Credit Rules 2004. The credit of tax paid by the service provider would be available on the basis of the invoice subject to the conditions specified in the CENVAT Credit Rules 2004. The credit of tax paid by the service recipient under partial reverse charge would be available on the basis on the tax payment challan, again subject to conditions specified in the said Rules.
What shall be the point of taxation for the service recipient? When will he need to pay the service tax in respect of his liability?
Both the service provider and service recipient are governed by the Point of Taxation Rules 2011 in respect of the service provided or received by him. Usually it is the invoice or date of receipt of payment which is the point of taxation for the service provider. However for the service recipient, in terms of rule 7 of the said rules, point of taxation is when he pays of the service. Thus in the case where the invoice is issued in say July 2012 and the service recipient pays for the same in August 2012 the point of taxation for the service provider will be the date of issue of invoice in July 2012. The point of taxation for the service recipient shall be the date of payment in August 2012. The service provider would be required to pay tax (to the extent liability is affixed on him) by 5th/6th August, 2012 or 5th/6th October 2012 depending upon the admissibility of benefit under the proviso to Rule 6 of the Service Tax Rules 1994. The service recipient would need to pay tax (to the extent liability is affixed on him) by 5th/6th September 2012.
How is the service recipient required to calculate his tax liability under partial reverse charge mechanism? How will the service recipient know which abatement or valuation option has been exercised by the service provider?
The service recipient would need to discharge liability only on the payments made by him. Thus the assessable value would be calculated on such payments done. (Free of Cost material supplied and out of pocket expenses reimbursed or incurred on behalf of the service provider need to be included in the assessable value in terms of Valuation Rules) The invoice raised by the service provider would normally indicate the abatement taken or method of valuation used for arriving at the taxable value. However since the liability of the service provider and service recipient are different and independent of each other, the service recipient can independently avail or forgo an abatement or choose a valuation option depending upon the ease, data available and economics.
Is the reverse charge applicable on services provided and complete before 1.7.2012 though payments were made after 1.7.2012?
For any service whose point of taxation has been determined and whole liability affixed before 1.7.2012 the new provisions will not apply. Merely because payments are being made after 1.7.2012 will not add any additional liability on the service receiver in respect of such services.