Works contracts and GST    

As the Government’s promised date for implementing a Goods and Services Tax (GST) in India draws near, expectations are building up amongst those impacted by indirect taxes. One such expectation relates to a possible simplification of taxation of works contracts.

Competing Taxes

Works contracts can straddle three taxable activities as per the current law. There is of course supply of goods. Then, due to the very nature of the contract, there is supply of services. Further, if in the process of completing the works contract a new commodity comes into existence, there is the taxable event of manufacture.

As of now, the supply of goods is taxable in the form of Value Added Tax (VAT), while the services element is taxable as service tax. If a new commodity comes into existence, in the process of executing a works contract, then, at least in theory, Central Excise duty may be levied. Hence, different aspects of the same activity have a potential to be taxed by different statutes.

Legislative, judicial background

In law, this is covered by the doctrine of aspects. However, there have been differing views of the Supreme Court and the High Courts on the applicability of this theory. The final word of the apex court on this, in the BSNL and Others vs Union of India (SC 2006) case, was that the aspects doctrine pertains to legislative competence and not the application of taxation on the same components of a transaction.

A constitutional amendment in 1983 enabled the States to tax, among others, transactions involving works contracts.

Present Status

At present, State VAT laws have specific provisions for taxing works contracts. To avoid taxing the services element, these laws and associated rules provide for either separation of labour and materials or percentage deductions in transaction value.

A third method is of prescription of a lower rate of tax in a composition/lumpsum scheme for works contracts. The Central statute of service tax has also provided for similar treatment to avoid taxation of sale of goods as part of a works contract.

As far as Central Excise is concerned, the law seeks to preclude the applicability of service tax wherever the activity amounts to manufacture. In case the works contract leads to an immoveable property coming into existence, the operation of Central Excise levy anyway is out of question, as it is only goods which can be taxed.

The actual picture on the ground is however not as clear. Disputes on taxability and taxable value for the three competing taxes still refuse to fade away.

Opportunity in GST

Taxes on works contracts assume significance for the real estate/construction industry and those engaged in erection, commissioning and installation of plant and machinery. In these activities, apart from taxability, the concepts of right to use, credit of capital goods, and usage of consumables also come into play giving rise to various tax consequences.

With the probable introduction of GST in India, it is expected that simplification and consolidation of taxes would lead to multitude of case laws and legislative history on works contracts becoming irrelevant.

The overarching concept in a GST is one of supply which subsumes the concepts of sale of goods, provision of services and manufacture. If States and the Central Government share the powers of taxing services and goods, the separation instituted between provision of services and sale of goods, for segregation of taxing powers, will become redundant.

The elaborate schema of deductions and credits for taxing works contracts may slide into history. This of course is based on the premise that GST will have a simple structure and goods as well as services will be taxed on a uniform rate. Multiplicity of rates in goods or services in GST may lead us to retread the path of componentising works contracts for the purpose of tax which, in turn, will lead to complexity of interpretation as well as implementation.

What lies in store for works contracts in the GST regime is hence awaited with interest.