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Publish Date: 09 Oct, 2010
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Is Works Contract deemed under Tax net?

 

Is Works Contract deemed under Tax net?

-         CA. Pradeep Jain

CA. Preeti Parihar

CA. Ridhi Anchalia

INTRODUCTION:-

Reality sector is always watched like a hawk by the government for the purpose of amending the service tax related provisions. Looking to the present scenario, it is the area where litigations are built more easily than the buildings. Recent Budget 2010 came out with amendments in the field of ‘Construction of Complex’ and ‘Commercial or Industrial Construction service’. We have already written two articles ‘Deeming Construction Service: Caught in Tax Net’ and ‘No Room for Builders under Service Tax Net’ dealing with the same issue. The amendments in this sector bring a new issue for the Works Contract. Now, how this happened? One person is affected by the disease but the side effects of the disease can be seen on another person.

 

BACKGROUND:-

 

Prior to Budget, 2010, the builders were not paying the service tax on certain transactions. For example, in case the agreement to sell was entered with the prospective buyers for selling the flats on completion. In such cases, the ownership was not transferred till completion of flats/buildings, they remained the owners till completion. Since no one can provide services to himself, it was contended that the service tax is not payable by them. Further, there were cases where the payment was given in piecemeal, and the possession was given/ownership was transferred on the payment of last transaction. In such cases it was contended that it is transfer of immovable property and no service is involved therein. Such cases created ambiguity and litigations.

 

Further, controversy was also added by the decision of Raheja Development Corporation V. State Of Karnataka [2005 Ntc (Vol. 27)-243]. In this decision it was held that even if the payment is made in instalments, then also, the transaction would fall in the category of the works contract.

 

Even the Board has issued Circular No. 108/02/2009– ST dated 29.1.2009 wherein it was clarified that where the any service provided by the builders/promoters/developers in relation to construction of complex and the sale deed is executed on completion of construction and on receipt of full consideration; it will be self service and would not attract service tax. Both, decision & circular added the fuel to the fire of litigation.

 

Now, in budget, 2010; government has come up with amendment in the definition of the Commercial and Industrial Construction and Construction of complex services.

 

EXPLANATION ADDED BY BUDGET 2010:-

 

In the definition of ‘Construction of Complex’ service given under Section 65 (105) (zzzh) of the Finance Act, 1994, the following explanation has been added:

 

“Explanation.—For the purposes of this sub-clause, construction of a complex which is intended for sale, wholly or partly, by a builder or any person authorised by the builder before, during or after construction (except in cases for which no sum is received from or on behalf of the prospective buyer by the builder or a person authorised by the builder before the grant of completion certificate by the authority competent to issue such certificate under any law for the time being in force) shall be deemed to be service provided by the builder to the buyer;”;

 

Similar explanation has been added in the definition of ‘Commercial or Industrial Construction service’ given in Section 65 (105) (zzq) of the Finance Act, 1994, which reads as follows:

 

“Explanation .—For the purposes of this sub-clause, the construction of a new building which is intended for sale, wholly or partly, by a builder or any person authorised by the builder before, during or after construction (except in cases for which no sum is received from or on behalf of the prospective buyer by the builder or the person authorised by the builder before grant of completion certificate by the authority competent to issue such certificate under any law for the time being in force) shall be deemed to be service provided by the builder to the buyer;”

 

Thus, this budget has provided that even the deemed service provided by a builder to the prospective buyer will fall under the service tax net by virtue of these explanations. But no such amendment has been done in the third pillar of reality sector – the works contract. We have pointed out the same in our article published on prestigious website taxindiaonline.com and clearly said that it will not be applicable on works contract. But other learned scholars said that it is only mistake and it will be rectified soon.  But no such amendment came at that time.

 

NO AMENDMENT IN WORK’S CONTRACT: -

 

The above explanations were added in the definitions of the Construction of Complex and Commercial or Industrial Construction service. But no such explanation has been added to the Works Contract - the third pillar of reality sector. So the first thought that arrives in mind is that if the government had any intentions of bringing the same amendment for the works contract, the same explanations would have been added there also. So it can be said that the deeming provisions of bringing the builders to the service tax net is not applicable on the works contract because the above explanation has not been added to the Works contract. Is that so? The situations that are prevailing in Works Contract say something else.

 

WORKS CONTRACT – PREVAILING PANORAMA:-

 

Basic Concept:

 

Works Contract is a composition of both material and labour. It is said to be a taxable service only if leviable to VAT in the respective state. In other words, if the sales tax is payable on execution of works contract, then only the service tax on the same would be levied. But works contract, though chargeable to sales tax, is not the ‘normal sale’ as understood in general. This is a sort of deemed sale as the goods involved are different prior and after the execution of sale. In other words, where the goods are ascertainable and definite at the time of contract of sale and remain the same even after execution of sale, it is a normal sale. But if the nature and form of goods changes after the execution sale, it is a works contract. For instance, the combination of cement, steel pipes, stones, labour, etc. gives rise to building. At the time of contract, these goods are separate but what is sold is a building. Since the identification of goods has changed into building, it is not the normal sale, it is a works contract. In the nutshell, the concept of Works Contract in itself a deeming provision of sale. Going ahead with the basic concept, there are judicial pronouncements regarding the Works Contract service which says the same thing. This has been held in the case of Hindustan Aeronautics Ltd. 55-STC 314-SC as follows:-

 

“In a contract of sale, the main object is the transfer of Property and delivery of the possession of Chattel as a Chattel to the buyer, where it is not so, it is a contract of Works & Labour”

 

As such, the concept of Works Contract says that in most of the cases, the goods at the time of agreement for sale are different and on execution of Works Contract thereupon, becomes different at the time of sale. Thus, the entire foundation of works contract is based upon the deeming concept of sale.

 

Judicial pronouncements:-

Ø     M/S. Raheja Development Corporation V. State Of Karnataka [2005 Ntc (Vol. 27)-243:

The facts of the case are that the appellant were carrying on the business of real estate development and have entered into development Agreements with owners of lands. They were constructing the residential/commercial complexes by entering into Agreements of Sale with intended purchasers. The Agreements provided that complex would be handed over to the purchasers on completion and they will get an undivided interest in the land also.

 

It was argued by the appellant that they were themselves developing the property and selling flats or commercial complexes in that property and in such type of activities no works contract was involved. It was also argued that in the Agreements with the intended purchasers, there was a clause which provides that if all payments are not made then amounts paid can be forfeited and the agreement rescinded. Whereas, no such right is available to the person carrying on works contract.

 

However, it was held that the definition of works contract as given in section 2(1) (v-i) of Karnataka Sales Tax Act is very wide. This section defines a "works contract" as follows: -

 

"2(1)(v-i) "works contract" includes any agreement for carrying out for cash, deferred payment or other valuable consideration, the building, construction, manufacture, processing, fabrication, erection, installation, fitting out, improvement, modification, repair or commissioning of any moveable or immovable property."

 

It does not distinguishes as to by whom the works contract is to be carried on. As such, even if the owner of property enters into an agreement to construct for cash, deferred payment or valuable consideration a building or flats on behalf of anybody else it would be a works contract. Therefore, the above landmark judgment itself brings the developers to the service tax net under the category of the works contract. The contention that they are the owners has been quashed by the hon’ble Supreme Court in this decision.

 

Ø     Larsen & Toubro Ltd. V. State Of Karnataka [(2008) 17 VST 460 SC]:

 

The question therein was whether the appellant, which was engaged in property development involving construction and building of flats and subsequent sale of complete flats, would be liable to pay tax under the KST Act, 1957. The facts were appellant had agreed to develop the plot owned by one person. There were two agreements the development agreement and the tripartite agreement. The tripartite agreement was between the owner of the plot, the developer i.e. appellant, and the prospective buyer of the flat. The respondent relied upon the decision of K.RAHEJA reported in 141 STC 298 SC; AIR 2005 SC 2350 and took the position that appellant had constructed the flats on behalf of the prospective buyers. According to them it was not the development agreement but the tripartite agreement that was the works contract. The Court observed distinction between two kind of contracts, sale and works contract, which rest on the principle that a contract of sale is one whose object is transfer of property in and delivery of possession of chattel to the buyer, while as the object of the works contract undertaken by the payee for price is not the transfer of chattel as chattel the contract is one of work and labour. The hon’ble Supreme Court, then referred the matter for reconsideration by larger bench for appropriate directions as in view of the above decision.

 

WORKS CONTRACT AFTER THESE TWO DECISIONS:

 

So, as of now, there is no final verdict available on the issue. However, the ratio laid down by the Raheja case has been referred to larger bench for deciding. Till the matter is decided, the decision of Raheja Development will be applicable. However, while deriving ratio from this decision, the definition of works contract is to be analyzed as the service tax on works contract is leviable only if the material in subject attracts Sales Tax/VAT. Every state has different Sales Tax Act wherein different definitions have been given for the term – works contract. But, more or less these definitions are the same. As such, if the concept of deferred payment is there in definition of “works contract” then the service tax will be applicable following the decision of Raheja Development case.

 

As such, amendment in Construction of Complex or in Commercial and Industrial Construction brought by the Budget, 2010 was already prevailing in the works contract by virtue of this decision. Thus, there was no need to enact a law already depicted by the Supreme Court – the court of last resort. Perhaps, by keeping in view this decision, no amendment has been done in the case of Works contract.

  

But another school of thought said that there is no amendment in works contract and hence this levy does not cover “works contract” in its ambit. Even scholars following this analogy said that since the circular issued by the Board has not been withdrawn and hence it is still applicable on works contract. They even went further and said that since most of the builders have opted for works contract and as such this levy has very limited effect and we should not discuss more on the same. 

 

With due respect to views of other scholars, the view of authors of this article is different. From the foregoing, it is clear that since the levy was already applicable on works contract as per Highest Court verdict, the explanation was not added to works contract. Secondly, it is settled position of law circulars which are contrary to legal position are not binding even on departmental officers.

 

WHILE PARTING:-

 

An ambiguity that took birth with the additions of explanations in the Commercial and industrial construction and Complex construction will end only when there will be some final verdicts available. The explanation not added in works contract cannot just be an error on the part of the government. Mistakes may be committed by the government, but the chances of blunders are very less. As already the situation of deeming provision prevails in the works contract, the government might have thought of that there was no requirement of any further clarifications. Only we can do is be a spectator and wait for the decisions and clarifications from the government.

 

*******

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