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Works contracts — clearing the air on free supplies

Anjlika Chopra | Updated on October 14, 2012 Published on October 14, 2012

When the service recipient supplies for free certain materials/ capital goods to a works contractor, it is unclear whether the value of such material can be included in the contract value for computing service tax liability.

A works contract is an arrangement involving transfer of property as well as provision of services. Typical examples are construction, renovation, repair, alteration or maintenance contracts, for movable or immovable property.

In order to remove the ambiguities surrounding service tax valuation, the service portion in a works contract has been specifically included in the list of ‘declared services’, with effect from July 1, 2012.

The mechanism for determining the service portion is outlined in the corresponding Valuation Rules. An assessee can opt either for the composition scheme or pay service tax at the full rate, after reducing the value of ‘transfer of property in goods’. The total value of the contract has been defined to include not only the gross amount charged, but also the fair market value of all the goods and services that may have been supplied free, whether under the same contract or another. Gross amount includes consideration received in cash or kind before, during or after the services.

However, an impasse arises when the contractee (service recipient) supplies for free certain materials/ capital goods to the works contractor (service provider). It is unclear whether the value of such free material can be included in the total value of a contract, for discharging the works contract service tax liability. For instance, for repair services, if the service provider is given the machinery to be repaired, the goods supplied are those on which the contractor has been appointed to render services.

These goods cannot, by any stretch, be termed a consideration for the contractor’s services. Though, if the goods supplied are tools or equipment, without which the repair cannot be made, it would be right to include their value in the gross value of the contract.

In the gas and energy or infrastructure sectors, construction of facilities such as towers or industrial boilers is not uncommon. The service recipient supplies consumables and capital goods free of cost. Such consumables in the nature of towers or boilers should not form a part of the contract value, as the contractor services these.

The fact that neither the works contractor derives any benefit out of such free supply, nor do such goods involve transfer of title from the service recipient to the service provider, should not entail inclusion in the gross value of the contract. An interpretation, based on the principles of fairness, of the valuation rules does not call for the addition of such value.

However, there could be an ambiguity where the free supply involves capital goods, tools or equipment used in project execution and subsequently returned to the service recipient. In contrast to pipes, capital goods could be viewed as hiring of machinery, which could be termed as a benefit accruing to the contractor. Had the contractor procured the capital goods on its own account, the cost of the services from the service provider could have substantially increased. Even if, say, the value of goods supplied free is included in the gross value of the works contract, it would imply that a certain notional value representing the benefit accruing to the contractor is included and service tax is paid on such increased value.

Additionally, the value of goods supplied can be excluded if the VAT liability has been discharged. However, following a recent Supreme Court judgment in the case of Indure Ltd, it would be interesting to consider sales during imports, where no VAT is leviable on the sale between the Indian importer (service recipient) and Indian service provider. Nevertheless, such value should be excludible from the works contract service tax value.

The revenue authorities should adopt a view that is not only within legal boundaries but also fair to industry.

Anjlika Chopra is Director, Deloitte Touche Tohmatsu India Pvt Ltd

Published on October 14, 2012
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