CA Sandesh Mundra
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Impact of Point of Taxation rules on the Construction Sector
Service tax being an Indirect tax levy, was always considered as a pass-through and more so due to cash basis of service tax collection by the government. The rules have recently been amended by which service tax now may become payable even before the service provider has collected the same from his customer. At the outset, it means cash flow impact – more working capital required!!
The Point of Taxation Rules (PoT Rules) for Service tax introduced with effect 1 April 2011 makes the above significant change in the manner which Service tax will not be collected by the government. The PoT Rules have advanced the liability to pay service tax to the point earliest of ‘completion of service’, ‘issue of invoice’ or ‘receipt of consideration’. While the PoT Rules will mean a lot for industry not only from a finance management perspective but also from compliance and therefore IT systems change management viewpoint. Fortunately after many representations in this regard, the government has provided a breather to the industry in the form of transition provisions. These transition provisions provide an option to the tax payer to shift to the new PoT regime from 1 July 2011 instead of 1 April 2011 subject of course to certain conditions.
The general rule under PoT to determine point of taxation shall now be earlier of issuance of invoice, receipt of payment including advance, or the date of completion of service, where invoice is not issued within 14 days of completion of service. There are special rules for contracts which qualify as continuous supply contracts, exports, transactions with associated enterprises etc. While there is a definition to determine a continuous supply of service, there are certain services that have been notified to be continuous supply by default i.e. irrespective of whether they fulfill the criterion of continuous supply applicable for other services. For real estate industry, construction services – both residential and commercial and works contract service, have been notified as ‘continuous supply services’.
The point of taxation for continuous supply contracts is earlier of ‘invoice date’, ‘receipt of payment including advance’ or ‘date of completion of service where invoice is not issued within 14 days of completion of service’. Here, the date of completion of services has been defined to be the date of completion of that event which requires periodic payment (ie date of milestone payment) as per the contract between the service provider and service recipient. This would essentially mean that the point of taxation for construction services is also similar to the general rule except that in a case where a date for milestone payment is mentioned in the contract, the same needs to be considered as ‘date of completion’ to evaluate point of tax. In the case of construction contract it is difficult to ascertain completion of service due to complexities of services and deliverable involved. However, it is common in such contracts that certain milestone are defined for triggering payment to be made by the service recipient to the service provider. The new law requires service tax to be paid on triggering of such milestones irrespective of whether invoice is raised or payment is received. It may be advisable to examine existing contracts to determine completion of service point in such contracts or milestone payment points and carefully ascertain such points of tax.
In certain cases it may be appropriate to amend the contract to specifically define such milestones to avoid any penal action from the tax authorities for delayed payment of service tax due to dispute over completion date of the service. For services other than construction or works contract service, the real estate industry also covers certain other services such as renting, architect, interior decorator, real estate agent. Since these services have not been defined to be continuous supply service by default, the general rules to determine point of tax for these services will apply unless these services are to be provided under a contract, for a period exceeding three months in which case, they will qualify as continuous supply contracts. To avoid disputes with the authorities, it will always be advisable to specifically agree in the contract as to how completion of service is understood between the contracting parties. For example, an architect may specify that upon issuing duly signed designs or drawings the service shall be deemed to be completed. Renting contracts will generally be for more than 3 months and hence they will qualify as continuous supply contracts. In such contracts a milestone of payment, say 10th of the following month, may be prescribed to provide clarity on point of tax. Further, it is common in the real estate industry especially for renting contracts that services spill over to two tax-rate regimes. There are specific provisions to point of tax in these situations.
For export services, however, the point of tax is retained to be receipt of payment provided the payment is received within the time stipulated to receive such payment by the RBI. The other consequential areas to watch out for are amendments in the Cenvat law. The Cenvat credit which was so far available only after making payment to the service receiver can now be availed on mere receipt of invoice. However, if payment is not made to the service vendor within 3 months of invoice date, then the credit originally availed needs to be expunged only to be reclaimed after making payment to the service vendor. Further, the recent budget put lot of restrictions on the customers of real estate sector to claim credit on the services generally provided by real estate industry. This may push customers to negotiate prices.
Fortunately, the law now provides more liberal provisions than before to adjust any excess service tax paid under the new accrual system under the PoT rules on account of subsequent price negotiations. The PoT rules require serious review of existing business processes and systems related to the tax payment and compliance to ascertain the change management and implementation areas. Due to the upcoming GST regime, a lot of emphasis is being provided to documentation discipline and invoice-discipline is one such measure. The PoT rules largely revolve around the invoice date and at this juncture one can hardly afford to loose sight of prosecution provisions re-introduced under the service tax in this Budget. Non- issuance of invoice is no longer a procedural error but a trigger for the tax authorities to initiate prosecution. In summary, introduction of PoT rules will need significant investment of time and efforts from the businesses to keep unwanted service tax proceedings at bay.
Prasad Paranjape, Partner, PDS Legal