Introduction
Since 2005 the service tax law was made applicable
to the Construction sector its been smooth sailing for the infrastructure
sector. Construction of roads, airports, ports, Dam, non commercial structures etc
were exempted from the levy of Service tax on wholesome basis. Only certain
service providers like Engineers, Consultants to these projects were made to
pay the taxes. Departments’ circular no. 147/16/2011-ST dated 21.10.2011 clarified
this position very aptly.
This article is an attempt to analyse the
taxability scenario for these infrastructure projects under the ‘Comprehensive
Approach’ or ‘Negative List’ based Service tax law. In my personal view there
are some hidden demons which I will try to analyse and put the same in public
domain so that an informed debate on the same can take place.
Trade Practice of this Sector
First
step for analyzing the taxability of any transaction is to understand the
substance of the same. There are basically 2 models on which this sector works.
- Government or Government appointed body gives a contract to a successful bidder (hereinafter referred to as ‘Contractor’) who quotes the lowest Amount.
- The contract is awarded to a concessionaire on BOT (Build Operate Transfer) basis. In this model the Contractor does the work and raised periodical invoices to a government appointed body which after due verifications releases the payments. Under this model the concessionaire has to construct the whole project as per the design and specifications of the Government but the government does not pay him anything, instead the concessionaire gets a right to use and grant access to others for which it can collect a government notified ‘User Fee’ for a specified period ranging up to 30 years or more. This model is a preferred mode and is popularly known as PPP model (Public Private Partnership). Paucity of funds with the government and need for quality infrastructure is reason why Central as well as State Governments are opting for this model.
Main thrust of
this article would be to analyze taxability of BOT based models more than the
traditional contracts.
Legal Abstracts
Before
going into the taxability I would like to reproduce some legal abstracts from
the Finance Act, 1994 and Mega Exemption Notification 25/2012 which are
relevant for the discussion:
66E (h) service portion in the execution
of a works contract;
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 moveable or immovable
property or for carrying out any other similar activity or a part thereof in
relation to such property
Mega Exemption Notification 25/2012
12.
Services provided to the Government, a local authority or a governmental
authority by way of construction, erection,
commissioning, installation, completion, fitting out, repair, maintenance,
renovation, or alteration of -
(a) a civil structure
or any other original works meant predominantly for use
other than for commerce, industry, or any other business or profession;
13. Services provided by way of construction, erection,
commissioning, installation, completion, fitting out, repair, maintenance,
renovation, or alteration of,-
(a) a road, bridge,
tunnel, or terminal for road transportation for use by general public;
29. Services by the following persons in respective capacities -
(h) Sub-contractor providing services by way of works
contract to another contractor providing works contract services which are
exempt;
Taxability Analysis
To analyse the taxability of infrastructure projects
I will take 2 live examples and operationally dissect them.
Example 1:
Construction of a Government Border Check Post under
traditional contract method vis-à-vis under BOT (Build Operate Transfer)
Government of Gujarat (GoG) wants to build 30 Border
Check Posts (BCP) in Gujarat and issues a tender in that regards wherein the
contractor has to build the BCP’s on turnkey basis.
There are 2 formats announced
- One is where GoG will pay the contract
amount to the contractor on periodic basis looking at the construction
done; and
- Other is on BOT basis wherein the
Concessionaire will be given a right to collect ‘User Fee’ from all the vehicles
who visit the BCP’s for the next 20 years.
A company named ABC Pvt Ltd bids and wins the
contract for constructing the project BCP’s for Rs. 100 crores.
It decides to do the work in following manner:
TAXABILITY STUDY OF A CONTRACT UNDER TRADITIONAL SYSTEM
Transaction No. 1
GoG gives a Contract to ABC for 100 Crores.
Services provided by ABC to GoG are classifiable
under Works Contract Services (WCS) because it has to construct the BCP’s on
turnkey basis. Having done the classification lets analyse whether the same is
exempt from the levy of service tax under Mega Exemption notification 25/2012.
As per serial no. 12 (c) of the notification following
conditions need to be satisfied for claiming exemption:
Condition
|
Condition Satisfied (Yes / No)
|
|
For ABC
|
For DEF Ltd
|
|
Services provided to the Government, a
local authority or a governmental authority
|
Yes
ABC is appointed by GoG hence it is constructing the BCP’s for the
Government
|
No
DEF is appointed by ABC
and hence is providing services to ABC and not GoG
|
By way of construction, erection,
of
|
Yes
It is constructing the entire BCP’s
|
Yes
It is constructing the entire BCP’s
|
(c) a
structure meant predominantly for use for non commercial purposes
|
Yes
The structure being constructed is meant for non commercial purposes
|
Yes
The structure being
constructed is meant for non commercial purposes
|
In case of ABC all 3 conditions are fulfilled hence
the Contractual receipts in its hands will be exempt from Service Tax, but in
case of DEF Ltd only 2 conditions get satisfied hence he cannot avail the
exemption under serial no. 12.
Transaction 2
ABC sub contracts the entire contract to DEF Ltd.
for 90 Cr. Is he taxable?
As seen in the discussion foregoing paragraph DEF
Ltd is not exempt under entry no. 12 of the said notification. The Board under
stood this issue and brought in entry no. 29 (h) which lays down exemption for
sub contractors on fulfilment of certain conditions as under
Sr No.
|
Condition
|
Condition Satisfied (Yes / No)
|
1
|
Sub-contractor
|
Yes
DEF is appointed by ABC
and hence is a sub contractor of ABC
|
2
|
providing
services by way of works Contract
|
Yes
He has taken the entire contract on back to back basis hence his
services to ABC are also classifiable under WCS
|
3
|
to
another contractor
|
Yes
ABC is also a contractor
|
4
|
providing works contract services
|
Yes
ABC is providing WCS to
GoG
|
5
|
which
are exempt
|
Yes
Services in the hands
of ABC are exempt
|
All Conditions of entry no. 29 (h) are getting
satisfied in case of DEF Ltd hence the Contractual receipts of Rs. 90 Cr in its
hands will be exempt from Service Tax.
Transaction 3
Designing, architect and engineering Services are sub
contracted for Rs. 5 Cr and they are not classifiable under Works contract
services hence they do not satisfy the second condition of entry no. 29 (h) as
explained in above table, hence they will not be exempt under the new law. They
were taxable in the old law as well. They will have to pay a tax @ 12.36% on 5
Cr which comes to Rs. 61.80 Lacs.
Transaction 4
DEF Sub contracts a work for construction of a Road
(with material) for Rs. 50 Cr. Services for construction of road for general
public are exempt under entry no. 13 (a) of 25/2012, hence the same will be
exempt.
But here the question will arise that which entry
will apply to the person constructing a stand alone road – entry no. 13 a is
for person constructing road and entry no. 29 (h) is for a sub contractor. Here
the company is indeed constructing a road and it is a sub-contractor as well.
Transaction 5
DEF Sub contracts a work for construction of a
building (with material) to XYZ Pvt Ltd. for Rs. 15 Cr. Services provided by
XYZ are classifiable under WCS and hence all conditions specified in entry no.
29 (h) get satisfied, hence entire contractual receipts of XYZ will be exempt
from levy of Service tax.
Transaction 6
Site formation and excavation work is sub contracted
for Rs. 10 Cr to PQR Pvt Ltd. and they too are not classifiable under Works
contract services because site formation job does not involve any transfer of
property in goods, hence they do not satisfy the second condition of entry no.
29 (h) as explained in above table, therefore they will not be exempt under the
new law. They will have to pay a tax @ 12.36% on 10 Cr which comes to Rs. 1.236
Cr. They were taxable in the old law as well.
Considering the tax outflow in the entire contract
it can be seen that total tax payable comes to Rs. 1.854 Cr
WHAT IF SAME CONTRACT IS EXECUTED ON BOT BASIS
Transaction No. 1
GoG gives a Contract to ABC wherein it will get a
right to collect User fee from each vehicle visiting the BCP’s for the next 20
years.
Under BOT contracts ABC is said to construct the BCP’s
for the government but the concessionaire keeps the right to grant access for a
specified period and there is no transfer of property in goods involved from
ABC to GoG. After the lapse of the predefined period the project gets
transferred to the Government. As there is no transfer of property in goods
from ABC to GoG, there is no liability of VAT on ABC hence the contract cannot
be classified under Works Contract Services (WCS).
As per serial no. 12 (c) of 25/2012 following
conditions need to be satisfied for claiming exemption:
Condition
|
Condition Satisfied (Yes / No)
|
|
For ABC
|
For DEF Ltd
|
|
Services provided to the Government, a
local authority or a governmental authority
|
Yes
ABC is appointed by GoG hence it is constructing the BCP’s for the
Government
|
No
DEF is appointed by ABC
and hence is providing services to ABC and not GoG
|
By way of construction, erection,
commissioning, installation, completion of
|
Yes
It is constructing the entire BCP’s
|
Yes
It is constructing the entire BCP’s
|
(c) a
structure meant predominantly for use as a non commercial
establishment
|
Yes
The structure being constructed is meant for Non commercial purposes
|
Yes
The structure being
constructed is meant for Non commercial purposes
|
In case of ABC all 3 conditions are fulfilled, but
there is no consideration flowing from GoG to ABC hence exemption will not have
any meaning.
Of course ABC will collect User fee from the visitors
but that will be for granting ‘Right to access’ the BCP’s which is not exempt
under the new law. Section 66D (h) grants exemption to service by way of access
to ROAD or BRIDGE.
66D.
The negative list shall comprise of the following
services, namely:––
(h) service by way of access to a
road or a bridge on payment of toll charges;
Hence User fee (inclusive of tax) collected by ABC
will be taxable @ 12.36%. Assuming the user fee so collected to be 100 Cr. over
a period of 20 years, ABC will have to pay 11.00 Cr on reverse calculation.
In case of DEF Ltd only 2 conditions get satisfied as
he is not providing services to the government, hence he cannot avail the
exemption under serial no. 12.
Transaction 2
ABC sub contracts the entire contract to DEF Ltd.
for 90 Cr. Is he taxable?
As seen in the foregoing paragraph DEF Ltd is not
exempt under entry no. 12 of the said notification. Does he satisfy conditions
of 29 (h).
Sr No.
|
Condition
|
Condition Satisfied (Yes / No)
|
1
|
Sub-contractor
|
Yes
DEF is appointed by ABC
and hence is a sub contractor of ABC
|
2
|
providing
services by way of works Contract
|
Yes
He has taken the entire contract on back to back basis hence his
services to ABC are also classifiable under WCS
|
3
|
to
another contractor
|
No
ABC is not a contractor,
he is a concessionaire
|
4
|
providing works contract services
|
No
ABC is not providing
WCS
|
5
|
which
are exempt
|
No
Services in the hands
of ABC are not exempt
|
3 Conditions out of 5 (of entry no. 29 (h)) are NOT getting
satisfied in case of DEF Ltd hence the Contractual receipts of Rs. 90 Cr in its
hands will be fully taxable @ 4.944% resulting into a tax outflow of Rs. 4.45 Cr.
These services were exempt in the old law.
Transaction 3
Designing, architect and engineering Services are
sub contracted for Rs. 5 Cr and they are not classifiable under Works contract
services hence they do not satisfy the second condition of entry no. 29 (h) as
explained in above table, hence they will not be exempt under the new law. They
were taxable in the old law as well. They will have to pay a tax @ 12.36% on 5
Cr which comes to Rs. 61.80 Lacs. Albeit DEF will get credit of these services
hence net outflow will remain same.
Transaction 4
DEF Sub contracts a work for construction of a Road
(with material) for Rs. 50 Cr. Services for construction of road for general
public are exempt under entry no. 13 (a) of 25/2012, hence the same will be
exempt.
Transaction 5
DEF Sub contracts a work for construction of an
entire floor (with material) to XYZ Pvt Ltd. for Rs. 15 Cr. Services provided
by XYZ are classifiable under WCS. It satisfies 4 conditions out of 5. Last
condition is not satisfied whereby the services provided by DEF also must be
exempt. Hence Services provided by XYZ will also be taxable. They were not
taxable in the old law. They will have to pay a tax @ 4.944% on 15 Cr which
comes to Rs. 74.16 Lacs. Albeit DEF will get credit of these services hence net
outflow will remain same.
Transaction 6
Site formation and excavation work is sub contracted
for Rs. 10 Cr to PQR Pvt Ltd. and they too are not classifiable under Works
contract services because site formation job does not involve any transfer of
property in goods, hence they do not satisfy the second condition of entry no.
29 (h) as explained in above table, therefore they will not be exempt under the
new law. They will have to pay a tax @ 12.36% on 10 Cr which comes to Rs. 1.236
Cr. They were taxable in the old law as well. Albeit DEF will get credit of
these services hence net outflow will remain same.
Considering the tax outflow in BOT model it can be
seen that total tax payable comes to Rs. 11.00 Cr in the hands of ABC, and Rs.
4.45 Cr in the hands of DEF Ltd. ABC will also not get credit of the tax paid
by DEF because as per the definition of Input Services – Works contract
services are excluded for persons providing services other than Works contract
services. ABC is providing services by way of access to use the BCP’s and works
contract services. So total outflow would be 15.45 Cr.
Question to answered here is – did ABC make money –
the answer is no.
User fee Recd - 100
Cr (tax included)
Less: Amt paid to DEF - 94.45 Cr (tax included)
Profit - 5.55
Cr
Less: Tax paid by ABC - 11.00
Cr
Loss - (5.45 Cr)
Then who made money – The Central Government!!!!
Sum and summation of the above is explained in the
following table:
Service
Provider / Service
|
Traditional
|
BOT
|
ABC
Ltd
(Main
Contractor)
|
Exempt
|
Taxable
Tax
payable Rs.11 Cr.
|
DEF
Ltd
(Main
Sub Contractor)
|
Exempt
|
Taxable
Tax
payable Rs.4.45 Cr.
|
Design
+ Architect
|
Exempt
|
Taxable
Tax
payable Rs.0.61 Cr.
|
Road
|
Exempt
|
Exempt
|
Building
|
Exempt
|
Taxable
Tax
payable Rs.0.74 Cr.
|
Excavation/Other
labour contracts
|
Taxable
Tax
payable Rs.1.24 Cr.
|
Taxable
Tax
payable Rs.1.24 Cr.
|
Total
Net Tax Outflow
|
Rs.1.24
Cr.
|
Rs.15.45
Cr.
|
What if the same was a Road project where BOT
model is a preferred route?
Service
Provider / Service
|
Traditional
|
BOT
|
ABC
Ltd (Main Contractor)
|
Exempt
|
Exempt
|
DEF
Ltd (Main Sub Contractor)
|
Exempt
|
Exempt
|
Street
Lights / other similar works
|
Exempt
|
Exempt
|
Protection
work
|
Exempt
|
Exempt
|
Building
|
Exempt
|
Exempt
|
Excavation
/ any other labour work (assumed to be Rs.30 Cr.)
|
Taxable
Tax
payable Rs.3.71 Cr.
|
Taxable
Tax
payable Rs.3.71 Cr.
|
Total
Net Tax Outflow
|
Rs.3.71Cr.
|
Rs.3.71Cr.
|
It can be seen that in case of road there is not
much of a difference in taxability between traditional and BOT based contracts.
But the exemption which was there earlier for site formation and other labour jobs
earlier seems to be withdrawn, hence its a back door way of taxing the
infrastructure sector which will hit the razor thin margins of the companies
operating in this sphere.
Conclusion
Better Infrastructure is and should be priority area for the Government
and taxing the same on a back door basis would create unwanted confusion in the
industry already ridden with many other operational and fiscal issues. Coupled
with the fact that taxation under reverse charge mechanism will hit them hard
as majority of the sub contractors who are the back bone of this sector are
constituted under non corporate format.
Following issues need to be clarified by the department:
- Clarification given in educational guide under point no. 6.2.5 saying that under BOT the ownership of the project lies with the concessionaire and hence the said projects will be taxable seems to be factually wrong and needs to be revisited. The Concessionaire is not the owner of the project by any means, he is just the constructor of it and as the government does not pay it upfront due to fiscal issues, it transfers its right of collection of toll to the concessionaire for a pre-determined period. It is rather a deferred method of making the payment more than anything else. This is demonstrated by the fact the user fee is notified by the concerned governments and the concessionaire has no right to collect a single paisa more than the amount being notified.
- Entry no. 29 (h) is a bit harsh as demonstrated in above example on genuine service contracts which ideally are a necessity for execution of the infrastructure project. Site formation, Excavation, utility transfers, laying jobs, digging, boring etc cannot be classified as works contract as no material passes hands. Hence they will never satisfy the conditions inscribed in the entry. The entry must be made more benevolent and status quo with situation pre 1.07.2012 must be maintained.
- Reverse charge must be mandatory for those companies only which are having a turnover above 10 Crores as many small and medium corporates are not having the requisite infrastructure to cope with the rigours of RCM. In my belief the field offices of the department are already overburdened and this will make compliances near impossible to attain.
Nitesh
Jain
Chartered
Accountant.
www.niteshjain.co.in
