[The Viewpoint] Unravelling GST issues in works contract agreements

While GST law has removed certain anomalies prevalent in the erstwhile regime, doubts still prevail in respect of taxability of liquidation damages, ITC, classification and rate of tax under the current regime.
[The Viewpoint] Unravelling GST issues in works contract agreements
Smita Singh and Ayush Gupta

The levy of indirect tax on infrastructure and construction projects has been a concerning issue for quite a long time now. Contrary court verdicts combined with ambiguous provisions in the law have only made the disputes more challenging and complex.

In the pre-GST regime, a works contract, in spite of being a single activity, was taxed by different indirect tax laws by dissecting the activities involved. This resulted in various disputes regarding treatment and contradictory judgments on the taxability of a works contract. For example, supply of goods was subject to VAT/CST, supply of services to Service Tax and in case a new product appears in the process of performing the works contract, Central Excise Duty was leviable.

Meaning and levy under GST

With the advent of Goods and Services Tax (GST), the industry was hoping for much-needed clarification and stability to this issue in order to put an end to the uncertainty involved. A works contract under GST has been defined as "a contract, wherein transfer of property in goods (whether as goods or in some other form) is involved in the execution of such contract and includes a contract for building, construction, fabrication, completion, erection, installation, fitting out, improvement, modification, repair, maintenance, renovation, alteration or commissioning of any immovable property."

Further, it is also important to note that by virtue of Section 7(1A) read with Schedule II, composite supply of a works contract qualifies as ‘supply of services’ and tax would be charged not as goods or part goods/part services. Works contracts in relation to buildings, complexes or any civil structures are treated as supply of service if it is sold before completion of construction. However, where full consideration on a works contract is received after issuance of the completion certificate, wherever required, by the competent authority or before first occupation, whichever is earlier, then no GST is leviable since it becomes immovable property.

Whether or not an immovable property is created under a contract depends upon the intention of the parties to the contract. In Surya Roshni LED Lighting Projects Limited, the Authority for Advanced Ruling (AAR), Odisha held that though a contract for installation of streetlights, poles and panels involves the creation of immovable property. The objective is not to enjoy the benefit of immovable property, but to ensure the effective functioning of the goods supplied. Therefore, the supply cannot be termed as a ‘works contract’ but a composite supply for the supply of goods. Such analysis is crucial for the classification of the activity performed in relation to goods or services, and accordingly applies the relevant rate of GST.

Applicable rate of GST

A works contract is taxable @18% under GST. However, concessional rates have been prescribed in respect of specific supplies made to the government and related authorities. For example, construction of railways and metros attract 12% GST. Exemption from GST has been provided on works contract service to the government with respect to specified functions as provided under Schedule XI and XII of the Constitution, if the value of goods constitutes less than 25% of the value of supply.

Further, for government contracts, the same rate of GST as applicable on the main contract will be applicable on the sub-contracted work. GST @ 12% is levied on works contract services in respect of offshore works contract relating to oil and gas exploration and production (E&P) in the offshore area beyond 12 nautical miles.

Time of supply

Works contracts are usually long-term contracts that require substantial time for completion. Under GST law, works contracts are in the nature of continuous supply of services and tax becomes payable at the time when the payment becomes due or an event defined in the agreement is completed. In certain cases, as per the terms of the contract, the recipient may be required to conduct various pre-requisite tests such as quality, physical inspection, etc. before releasing payment and acceptance of the invoice. However, service will be deemed to be completed only after such inspection work has been carried out.

Input Tax Credit (ITC) eligibility

Every registered person shall, subject to specified conditions and restrictions, be entitled to take credit of input tax charged on any supply of goods or services or both, used or intended to be used in the course or furtherance of business.

However, ITC in respect of works contract services has been restricted to the recipient when supplied for construction of an immovable property (other than plant and machinery), excluding where it used for further supply of works contract service. However, the recipient of works contract service will be eligible to take ITC even if its final output is not works contract services in the following two scenarios:

a) where works contract service is used for construction not resulting in capitalization to the said immovable property.

b) where works contract service is rendered for construction of plant and machinery, ITC of the tax paid to the works contractor would be available to the recipient, whatever is the business of the recipient.

Liquidation damages and bonus for early completion

In order to incentivize contractors to complete projects on a timely basis, contracts usually provide for bonus as a percentage of contract revenue to be paid to the contractor. We understand that the bonus in the contract is provided as an incentive and is not per se for the performance of construction services. The consideration for supply of works contract services is already agreed upon separately between parties and has no relation with the bonus amount. Similarly, the liquidation damages which are payable for delay in completion are only to ensure timely completion of the contract and not to tolerate any act of delay. These charges are levied to compensate the recipient and to deter the contractor from delay in the completion of the contract.

It is important to note that consideration as per the Contracts Act must flow at the desire of the promisor i.e. the recipient, who would never desire a delayed completion of the contract. Therefore, the liquidation damages do not come within the ambit of consideration for the service. The same principle was discussed by the Customs, Excise & Service Tax Appellate Tribunal (CESTAT) in the case of CST vs M/s Repco Home Finance Limited.

Conclusion

In the light of the above, it can be said that a decision on taxability can be made only after a careful understanding of the terms of the agreement. While GST law has removed certain anomalies prevalent in the erstwhile regime, doubts still prevail in respect of taxability of liquidation damages, ITC, classification and rate of tax under the current regime. Amidst contradictory rulings passed by various courts, with the passage of time, hopefully complex interpretational issues involved in works contracts should get more clarity.

Smita Singh is a Partner and Ayush Gupta is an Associate at Singh & Singh Associates.

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