Service Tax Implications of Composite contract
Composite contract could involve materials/goods and services. There could also be specie of contracts comprised of immoveable property+ goods and services. Works contracts [material plus labour contracts] or catering contracts namely ‘service wherein goods, being food or any other article of human consumption or any drink (whether or not intoxicating)is supplied in any manner as part of the service’] are composite transactions involving sale of goods and service. In this article the paper writer has examined composite contracts where construction service involved.
Under negative list based taxation, two entries of declared services are relevant. One is the services provided by way of construction of complexes intended for sale to the buyer where consideration is received prior to obtaining completion certificate. In the past wef 1.7.2010 an explanation was inserted to the taxable services category of construction services, levying service tax on construction and sale of complex by builder when sums received from buyer before completion certificate.
The next entry is the service portion involved in execution of works contract. Works contracts are defined to mean a contract which provides for the transfer of property in goods involved in execution of contract and such transfer is leviable to VAT. Even under earlier service tax law, wef 1.6.2007, works contract service was introduced as taxable service category liable to service tax.
As per charging section, service tax is chargeable on the value of service portion only. Section 66B sets out there shall be levied a tax (hereinafter referred to as the service tax) at the rate of 14% on the value of all services, other than those services specified in the negative list…… Section 67 – Subject to provisions of this chapter, service tax chargeable on any taxable service with reference to its value, then such value shall, – (i) in case where provision of service for a consideration in money, be the gross amount charged by the service provider for SUCH SERVICE provided or to be provided…….
In other words, in the service tax provisions there is no power to levy and collect the service tax on the value of goods or immoveable property.
Rule 2A of ST Determination of Value Rules sets out provision for determination of value of service portion in execution of works contract. Similarly in notification 26/12-ST it sets out that service tax to be paid on construction of complex, intended for a sale to a buyer, except where entire consideration is received after issuance of completion certificate by the competent authority on 30% of gross amount charged including land value.
There was a recent decision in Bansal in which it washeld that Service tax is not leviable on composite transaction involving immoveable property and construction[goods and service].
In this article the paper writer has examined validity of levy of service tax on such composite transactions in light of recent decision in Bansal.
Relevant Judicial decisions in past on composite contracts
K Raheja decision 2006 (3) STR 337 (SC) held the agreement entered into before the construction is complete, it would be a works contract. The L & T decision 2013-TIOL-46-SC-CT-LB, has affirmed Raheja at supra and held even an agreement to sell an immovable property would be treated as a ‘works contract’ as long as, amounts are received from the prospective buyer prior to the completion of the construction, as this transaction would also be a ‘works contract’ coupled with a transaction involving sale of immovable property.
In light of L&T decision, amounts received after entering into the contract with buyers before completion of construction would be treated as works contract in VAT and consequently service tax.
The decision also held if the transaction is treated as a composite contract comprising of both a works contract [goods and service] and a transfer of immovable property, levy of sales tax applies on the value of the material involved in execution of the works contract. It could be inferred the works contract involved in composite contract could be leviable to VAT on goods portion and service tax on service portion.
In light of L&T decision of 2013, question arises in composite transaction involving immoveable property and goods+ service, on what value it is permitted to levy service tax on services involved in the execution of works contract.
The Supreme Court in L&T decision ( 2015-TIOL-187-SC-ST )had concluded that prior the introduction of works contract service [earlier to 1.6.2007] a composite contract was not taxable. This was because in absence of Rule 2A of the ST Valuation Rules there was no machinery for excluding the non-service element from such composite works contracts involving an element of services and transfer of property in goods.
Latest decision and its impact
In Suresh Kumar Bansal vs UOI &Ors (2016-TIOL-1077-HC-DEL-ST)petitioners are individuals who have entered into separate agreements with a builder. There was challenge as follows:
i. The agreements entered into by them with the builder are for purchase of immovable property and the Parliament does not have the legislative competence to levy service tax on such transaction.
ii. The FA and the rules made there under do not provide any machinery for computation of value of services, if any, involved in construction of a complex and, therefore, no such tax can be imposed.
The issue involved in these petition relates to the question whether the consideration paid by flat buyers to a builder/promoter/developer for acquiring a flat in a complex, which under construction/development, could be subjected to levy of service tax.
Court observed the arrangement between the buyer and the builder is a composite one which involves not only the element of services but also goods and immovable property. The legislative competence of the Parliament to tax the element of service involved cannot be disputed but the levy itself would fail.
It has relied heavily on L&T decision of 2015 at supra, held there is no machinery provision for ascertaining the service element involved in the composite contract. Though there are abatement Notifications, in absence of any Rules to identify service element in composite contracts, no ST can be levied. Levy would fail, as the measure of Tax absent.
Paper writer’s comments
The decision has not examined whether services involved in construction of complexes is exigible to service tax as services in relation to execution of a works contract falling within the scope of Section 65(105)(zzzza) of the Act or under Section 65B(44) after the amendments brought about in the Act by virtue of Finance Act, 2012
The possible infirmity is that this decision has not examined and concluded whether such composite contracts having element of material and labour, could be treated as works contract and levied to service tax by adopting mechanism given in Rule 2A post 1.6.2007.
Further a tax on a particular activity in connection with land (in the present case it is Construction) cannot be said to be a tax directly on land to fall within the ambit of Entry 49[Taxes on lands and buildings] of List II of the Seventh Schedule of the Constitution.
It is quite certain this decision could be appealed against and final decision by Supreme Court citing L&T decision of 2013 supra could go in favour of revenue. This finality could come in next 5 years. In such a scenario, in future there is a strong possibility that SCN’s could be issued for extended period of 5 years. At which stage, the assessee may not be able to collect service tax from end buyers and needs to pay out of pocket along with interest and penalty.
In Karnataka this decision may not have widespread implications. This is because in Karnataka most developers opt for two agreement model, ie agreement to sell land and agreement of construction. In such case it is clear, ST is payable on labour portion of the construction contract.
Further in state of Karnataka CREDAI decision (2013 (6) TMI 588 – Karnataka High Court)Character of the levy being service tax on Construction, the grossvalue of construction clearly will have nexus with the element of service involved in theconstruction. Held that service tax could be paid on 25%
The decision in Bansal has merely persuasive value in Karnataka.By citing this decision of Delhi High Court developers of Karnataka executing composite contracts involving land+ goods+ construction service could take a call to stop paying service tax under intimation to department. This could be objected as there is contra view in a Karnataka HC decision.
Assesees who decide not to pay service tax by following said Delhi HC decision could do well to intimate department by RPAD letter setting out with reasons their bona fide understanding why they are not liable to service tax and seek confirmation of understanding.
This would ensure even if there was unfavourable decision by Apex Court after few years, there could be no sustainable demands of service tax for extended periods.