SERVICE TAX ON WORKS CONTRACT VALUATION REVERSE CHARGE

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In this post we are discussing provision related to Service Tax on works contract after 01.07.2012 mainly under following heads
  1. Meaning of works Contract.
  2. Valuation Method including abatement % / prescribed % valuation  of  works Contract.
  3. Provision of Reverse Charge applicable on Works contract 

With effect from 01-07-2012 works contract are covered under “Declared Services” under Section 66E of the Act:



Meaning of Works Contract w e f 01.07.2012

Works Contract has been defined under section 65B(54)
works contract" means 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 movable or immovable property or for carrying out any other similar activity or a part thereof in relation to such property;
The above definition is exhaustive as it starts with Works contract "means".But last line of definition extend the scope to many similar activities.Major change in service tax on Works contract from 01.07.2012 is that now movable property is also covered under works contracts.Main features of new definition is 
  • Transfer of property in goods involved in the execution of such contract :First  part of the definition is that there must be transfer of property in goods in the contract while executing the contract.If no transfer of property is involved then it is not covered under works contract. 
Contract with consumables are not works contract:service provider is providing consumables like oiling and lubricating the machinery then it is not covered in works contract as property of goods is not transferred but goods are consumed .

Pure Labor contract are not works contract.

  • Transfer of Property in good is leviable to tax as sale of goods : Second important part is that Transfer of property in goods is taxable under sales tax. If such transfer is not taxable under sales tax then contract is not covered under works contract.
  • such contract is for the purpose of carrying out 
    1. construction, 
    2. erection,
    3. commissioning, 
    4. installation, 
    5. completion, 
    6. fitting out, 
    7. repair, 
    8. maintenance. 
    9. renovation, 
    10. alteration 
  • of Any movable or immovable property : Now works  contract covers movable property also.Like repair of vehicle , Movable machinery is also covered under works contract if material property of goods gets transferred while executing repair contract.
  • any other similar activity or a part thereof in relation to such property : This part extend the nature of activity other than 10 activities given above and prone to litigation.
Will the goods portion in transactions like annual maintenance contracts or erection and commissioning or construction be includible in the value of services  ?

All the examples given in the question now comprise “works contracts” and only the service portion of such contracts comprise service. By the express provisions contained in the definition of service (which is mandated by constitutional provisions) it is not possible to tax the goods portion of works contracts. However the principles of segregation of the value of goods are provided in Rule 2A of the Valuation Rules. Thus there is no basis for the taxation of goods in such contracts even after the deletion of the stated notification.

Even for the sale of any equipment for which a separate contract for warranty or after sales services or maintenance is entered the discernible sales portion is not to be included in the discernible portion of the value of service. For all practical purposes these will be two separate contracts. However for artificial segregation of value between goods and services, to save either of the taxes on goods or services, the benefit was neither available earlier under the stated notification and the position continues to be the same under the new regime.

Would contracts for repair or maintenance of motor vehicles be treated as ‘works contracts’? If so, how would the value be determined for ascertaining the value portion of service involved in execution of such a works contract?

Yes. Contracts for repair or maintenance of moveable properties are also works contracts if property in goods is transferred in the course of execution of such a contract. Service tax has to be paid in the service portion of such a contract.

Would contracts for construction of a pipe line or conduit be covered under works contract?
Yes. As pipeline or conduits are structures on land contracts for construction of such structure
would be covered under works contract.


Would contracts for erection commissioning or installation of plant, machinery, equipment or structures, whether prefabricated or otherwise, be treated as a works

contract?

Such contracts would be treated as works contracts if transfer of property in goods is involved in such a contract.

Would contracts for painting of a building, repair of a building, renovation of a building, wall tiling, flooring be covered under ‘works contract’?

Yes, if such contracts involve provision of materials as well.

Exemption to sub contractor in work ccontract  if main contract service are exempted : sub-contractor providing services by way of works contract to the main contractor, providing exempt works contract services, has been exempted from service tax under the mega exemption if the main contractor is engaged in providing exempt services of works contracts. It may be noted that the exemption is available to sub-contractors engaged in works contracts and not to other outsourced services such as architect or consultants.



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Valuation of Services in works Contract wef 01.07.2012

As compared to the old schemes for valuation of works contract services (up to 30.06.2012) one under the rule 2A of the Valuation Rules and second under the Works Contract (Composition Scheme for Payment of Service Tax) Rules 2007 has been replaced with a unified scheme under the new rule 2A of Service Tax (Determination of Value) Rules, 2006.

Substituted Rule 2A(i) of Service Tax (Determination of Value) Rules, 2006, inter alia, provides the rules to value service portion in the execution of a works contract.Main two option are available under valuation.In our view both these scheme of valuation are option available to assesses.


1 Pay service tax on Value of services after deducting value of goods from the gross value.

2 Pay service tax at composite rate
  • In case of original work, pay service tax on 40% value, 
  • In case of maintenance or repair or reconditioning or restoration or servicing of any goods, pay service tax on 70% value, 
  • In case of all other works contract, pay service tax on 60% value. (70 % wef 01.10.2014)
Service provider is also eligible to avail CENVAT Credit of input services and capital goods.

 Pay service tax on Value of services after deducting value of goods from the gross value:

gross amount charged for the works contract less the value of property in goods transferred
  • In the cases where VAT has been paid on ACTUAL value of transfer of property in goods, then this value will considered while calculating the value of Works Contract.
  • If the VAT is not paid on the ACTUAL value, the assessee will calculate the same for the purpose for service tax and it will be deductible from the gross value.

(i) Value of service portion in the execution of a works contract shall be equivalent to the gross amount charged for the works contract less the value of property in goods transferred in the execution of the said works contract.

Explanation.- For the purposes of this clause,-

(a) gross amount charged for the works contract shall not include value added tax or sales tax, as the case may be, paid or payable, if any, on transfer of property in goods involved in the execution of the said works contract;

(b) value of works contract service shall include, -

(i) labour charges for execution of the works;
(ii) amount paid to a sub-contractor for labour and services;
(iii) charges for planning, designing and architect’s fees;
(iv) charges for obtaining on hire or otherwise, machinery and tools used for the execution of the works Contract;
(v) cost of consumables such as water, electricity, fuel used in the execution of the works contract;
(vi) cost of establishment of the contractor relatable to supply of labour and services;
(vii) other similar expenses relatable to supply of labour and services; and
(viii) profit earned by the service provider relatable to supply of labour and services;

(c) Where value added tax or sales tax has been paid or payable on the actual value of property in goods transferred in the execution of the works contract, then, such value adopted for the purposes of payment of value added tax or sales tax, shall be taken as the value of property in goods transferred in the execution of the said works contract for determination of the value of service portion in the execution of works contract under this clause.

2. Pay service tax at composite rate

In our view First and second (1) and (2) shown in this post is optional and to opt option B ,A part must not be ruled out first.In second option wording has been used as "Where the value has not been determined under clause (i)" instead of "Can not be determined "

(ii) Where the value has not been determined under clause (i), the person liable to pay tax on the service portion involved in the execution of the works contract shall determine the service tax payable in the following manner, namely:-



(A) in case of works contracts entered into for execution of original works, service tax shall be payable on forty per cent. of the total amount charged for the works contract;


Explanation 1.- For the purposes of this rule,-
(a) “original works” means-
(i) all new constructions;
(ii) all types of additions and alterations to abandoned or damaged structures on land that are required to make them workable;
(iii) erection, commissioning or installation of plant, machinery or equipment or structures, whether pre-fabricated or otherwise;


(B) in case of works contract entered into for maintenance or repair or reconditioning or restoration or servicing of any goods, service tax shall be payable on seventy percent. of the total amount charged for the works contract;


70% is applicable on Movable property 

Section 65B(25) "goods" means every kind of movable property other than actionable claim and money; and includes securities, growing crops, grass, and things attached to or forming part of the land which are agreed to be severed before sale or under the contract of sale;

(C) in case of other works contracts, not covered under sub-clauses (A) and (B), including maintenance, repair, completion and finishing services such as glazing, plastering, floor and wall tiling, installation of electrical fittings of an immovable property , service tax shall be payable on sixty per cent(70 % wef 01.10.2014) of the total amount charged for the works contract;


(d) “total amount” means the sum total of the gross amount charged for the works contract and the fair market value of all goods and services supplied in or in relation to the execution of the works contract, whether or not supplied under the same contract or any other contract, after deducting-

(i) the amount charged for such goods or services, if any; and
(ii) the value added tax or sales tax, if any, levied thereon:

Provided that the fair market value of goods and services so supplied may be determined in accordance with the generally accepted accounting principles.


Explanation 2.--For the removal of doubts, it is clarified that the provider of taxable service shall not take CENVAT credit of duties or cess paid on any inputs, used in or in relation to the said works contract, under the provisions of CENVAT Credit Rules, 2004.”.

Cenvat Credit :The Provider of taxable service could not take CENVAT credit of duties/cess paid on any inputs used in or in relation to the said works contract. However, credit in respect of taxes paid on capital goods and input services shall be available


Can the manner of determination of ‘total amount charged’ be explained by way of a suitable example?


The manner of arriving at the ‘total amount charged’ is explained with the help of the following example pertaining to works contract for execution of ‘original works’.

1 Gross amount received excluding taxes =95,00,000
2 Fair market value of goods supplied by the service receiver excluding taxes =10,00,000
3 Amount charged by service receiver for 2= 5,00,000
4 Total amount charged (1+2-3) =1,00,00,000
5 Value of service portion(40% of 4 in case of original works) 40,00,000

Note: When the service provider pays partially for the materials supplied by the service receiver, gross amount charged would inevitably go higher by that much amount.
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Reverse Charge applicable on Works contract wef 01.07.2012 

The reverse charge method is extended to the works contract services to the extent of 50%(partial reverse charge). Thus, 50% service tax is payable by the recipient and the remaining by the provider of works contract service.The condition under reverse charges are 
  1. Service receiver must be a body corporate and 
  2. Service provider must be 
    • Individual,
    • HUF,
    • Partnership firm (registered or unregistered ) ,
    • AOP. 
  3. Both service Provider and service receiver must be located  in taxable territory. 
If above Conditions are not fulfilled then reverse charge is not applicable.Means if service provider is other then four categories given above then reverse charge is not applicable. Further service receiver must be Body corporate.


Thus the nature of the service(works contract) and the status of both the service provider and service receiver are important to determine the applicability of partial reverse charge provisions.

Further as per explanation II given in notification 30/2012 dated 30.06.2012 in works contract services, where both service provider and service recipient is 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.

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 obliged 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 for 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 /6October 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 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. 

Can Tax liability under reverse charge Mechanism be settled with use of Cenvat Credit by service receiver ?

No, Cenvat credit can be used fro output services only. Service tax payable under reverse charge is related to input services.so Service receiver have to deposit this service tax by Cash/challan only. However such deposited amount is available for Cenvat credit to service receiver on the basis of challan.

Change in effective service Tax rate on works Contract wef 01.10.2014

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