CA Sandesh Mundra
Consult Us For Construction
Liability of Sub-Contractors when main contractor is exempt
Liability of Sub-Contractors when main contractor is exempt
Sub-contracting is very common in business – particularly in construction industry. Rather, contractor himself executing the contract is uncommon in construction industry! There are many situations where the construction work is exempt. Sub-contractors often assume that they are exempt from service tax too. However, this view is usually not accepted by the department. Recent circular dated 23-8-2007 issued by CBE&C has added fuel to the fire. In this article, the issues arising out of the circular are discussed.
Construction service is taxable only if it is ‘commercial or industrial’. Non-commercial construction like construction for Government, non-profit organisations like Educational Institutions, religious places etc. is not taxable.
Construction services provided in respect of roads, airports, railways, transport terminals, bridges, tunnels and dams have been excluded from definition of construction service itself.
Construction services provided within SEZ to SEZ unit or SEZ developer are exempt vide Notification No. 17/2011-ST dated 1-3-2011 (Earlier Notification No. 9/2009-ST dated 3-3-2009).
Construction of residential complex service provided to Jawaharlal Nehru National Urban Renewal Mission and Rajiv Awaas Yojana is fully exempt from service tax [Notification No. 28/2010-ST dated 22-6-2010].
It is normal practice in construction industry to give work to sub-contractor. It may either be a back to back contract or some part of construction work is entrusted to sub-contractor.
In such case, issue arises about tax liability of such sub-contractor.
1.1 Earlier department circulars that intermediary not liable to service tax
Earlier, Department had clarified that a service provided to person in same category is not taxable e.g. service provided by architect to another architect, as the principal person providing service is liable to pay tax. However, service tax would be required to be paid in case of sub-contracting to a different service category e.g. architect providing service to consulting engineer or a market research agency providing service to an advertising agency even if the consulting engineer/advertising agency pays service tax on total bill which includes amount paid to provider of sub-contract – Pune-I Commissionerate TN 8/98-ST dated 13-10-1998 – parallel Indore Commissionerate TN 5/98-ST dated 14-10-1998.
In view of these instructions, in Synergy Audio Visual Workshop v. CST (2008) 14 STT 321 (CESTAT), it was held that when main advertising agency has paid service tax, sub-contractor is not eligible – same view in Ruth Shipping Agencies v. CCE (2010) 26 STT 438 (CESTAT SMB).
These circulars have been withdrawn vide Para 6 of CBE&C Circular No. 96/7/2007-ST dated 23-8-2007.
1.2 Subsequent view of department
In supercession of the earlier circulars, CBE&C, vide circular No. 999.03/23.8.07 dated 23-8-2007 has clarified that a sub-contractor is also a taxable service provider. His services are taxable even if these are used by main provider for completion of his work. The sub-contractor is liable even if the service is input service of the main contractor.
Ref Code 079.01/23.8.07 of CBE&C Circular No. 96/7/2007-ST dated 23-8-2007 states as follows - In a case where the builder, promoter, developer or any such person builds a residential complex, having more than 12 residential units, by engaging a contractor for construction of the said residential complex, the contractor in his capacity as a taxable service provider (to the builder / promoter / developer / any such person) shall be liable to pay service tax on the gross amount charged for the construction services under ‘construction of complex’ service [section 65(105)(zzzh)].
The aforesaid view has been reiterated in CBE&C circular No. 108/02/2009-ST dated 29-1-2009.
1.3 Recent clarification issued by CBE&C
Recently, CBE&C, vide its circular No. 138/7/2011-ST dated 6-5-2011, has clarified that a sub-contractor is liable even if main contractor is exempt from service tax, if the service provide by sub-contractor falls in a category where the service is not exempt from service tax. It seems from the circular that ‘Jaiprakash Associates Limited, Noida’ had filed a writ petition and Hon. High Court had asked department to clarify their views on the issue (exact details of High Court order are not clear).
Issue raised - The issue raised by Jaiprakash Associates Limited, Noida was as follows - The Works Contract Service (WCS) in respect of construction of Dams, Tunnels, Road, Bridges etc. is exempt from service tax. WCS providers engage sub-contractors who provide services such as Architect’s Service, Consulting Engineer’s Service, Construction of Complex Service, Design Services, Erection Commissioning or Installation Service, Management, Maintenance or Repair Service etc. The representation by assessee was that the benefit of such exemption to main works contractor should be extended to the sub-contractors providing various services to the WCS provider, as the service provided by the sub-contractors are ‘in relation to’ the exempted works contract service and hence they deserve classification under WCS itself.
Department’s view – Department expressed following view – ‘The services received by the WCS provider from its sub-contractors are distinctly classifiable under the respective sub-clauses of section 65(105) of the Finance Act by their description. When a descriptive sub-clause is available for classification, the service cannot be classified under another sub-clause which is generic in nature. As such, the services that are being provided by the sub-contractors of WCS providers are classifiable under the respective heads and not under WCS.
Departments view is technically correct - Technically, what this circular says is correct. Architect’s service cannot be classified as ‘Works Contract Service’ simply because that service is in relation to a works contract [If the assessees’ vies is accepted, telecommunication, rent-a-cab and goods transport agency service provided to works contractor would have to be classified as a ‘Works Contract Service’].
No clarification about situation where sub-contractor providing construction service itself – The aforesaid circular does not talk about a situation where the sub-contractor provides construction service itself. However, it is possible that at lower level, over zealous officers may take a stand (by misinterpreting the circular), that sub-contractor is liable to service tax even in cases where he provides construction service.
This will indeed open a Pandora’s box.
2 Sub-contractor providing construction service to or through main contractor
Section 65(25b) of Finance Act, 1994, defines commercial or industrial construction as follows –
“Commercial or industrial construction means— (a) construction of a new building or a civil structure or a part thereof; or (b) construction of pipeline or conduit; or (c) completion and finishing services such as glazing, plastering, painting, floor and wall tiling, wall covering and wall papering, wood and metal joinery and carpentry, fencing and railing, construction of swimming pools, acoustic applications or fittings and other similar services, in relation to building or civil structure; or (d) repair, alteration, renovation or restoration of, or similar services in relation to, building or civil structure, pipeline or conduit,
which is— (i) used, or to be used, primarily for; or (ii) occupied, or to be occupied, primarily with; or (iii) engaged, or to be engaged, primarily in,
commerce or industry, or work intended for commerce or industry, but does not include such services provided in respect of roads, airports, railways, transport terminals, bridges, tunnels and dams.
Non-commercial work does not become commercial simply because done by sub-contractor - Let us assume that a contractor has been awarded a contract for construction of road or bridge. Now, he gives sub-contract to a sub-contractor for construction of road or bridge (party or fully). The work done by sub-contractor still continues to be ‘road or bridge construction service’ and hence should be outside the service tax net.
Similarly construction of Government or educational building continues to be construction of Government or educational building whether done by contractor or sub-contractor.
In fact, para 4 of the CBE&C circular No. 138/7/2011-ST dated 6-5-2011 specifically states that service provided by the sub-contractors/consultants and other service providers are classifiable as per section 65A of the Finance Act under respective clause of sub-clause (105) of section 65 of Finance Act, 1994.
If the construction is not commercial or is relating to road, bridges etc., or is for personal residential use of customer, the main person (builder or developer or main contractor) is not liable. The definition of ‘construction service’ refers to type of construction and not to type of contract. The exemption/exclusion depends upon type of construction. Thus, even if the work is done by contractor/sub-contractor, the nature of construction does not change and hence it would not be subjected to service tax.
Service tax liability depends on nature of construction – Some times, an argument is raised that relation between sub-contractor is on commercial basis and hence service provided by sub-contractor to main contractor is ‘commercial’ even if the work of contractor is not commercial. This argument is fallacious since the taxability depends on nature of civil construction. The nature of construction does not change simply because the work is done by sub-contractor.
This can also be justified by ‘rule of purposive construction’ as discussed later in this Article.
Better to make disclosure – No doubt, department may not accept this view and you may have to enter into litigation. Hence, if you intend to take aforesaid view as explained by me, it is advisable to make full disclosure to department in advance to avoid charge of suppression of facts.
2.1 Finishing, renovation or repair services provided by sub-contractor
The aforesaid principle equally applies to finishing, repair, alteration or renovation services provided by sub-contractor also, since these services also fall within the definition of service.
2.2 Works contract service
Relevant extract from definition of works contract service [section 65(105)(zzzza) of Finance Act, 1994] are as follows –
(a) - - -
(b) - - -
(b) construction of a new building or a civil structure or a part thereof, or of a pipeline or conduit, primarily for the purposes of commerce or industry; or
(c) construction of a new residential complex or a part thereof; or
(d) completion and finishing services, repair, alteration, renovation or restoration of, or similar services, in relation to (b) and (c); or
Thus, the principle discussed above would apply in case of works contract service provided by sub-contractor, since the definition of ‘works contract service’ relates to nature of construction. This can also be justified by ‘rule of purposive construction’ as discussed later in this Article.
3. Liability of sub contractor when the main contractor is liable to service tax
It is now well settled that if the sub-contractor is liable to pay service tax even if service tax is paid by main contractor. In such case, the main contractor should not pay service tax under 33% abatement scheme. The reason is that if he pays service tax under 33% scheme, he cannot avail Cenvat credit of service tax paid by sub-contractor. He should pay service tax under 4.12% scheme (if he is paying works contract tax). Alternatively, he can calculate value of service and pay service tax on the value of service. In such case, he can avail the Cenvat credit of service tax paid by the sub-contractor.
3.1 Liability of sub-contractor when main contractor is liable
In my view, when main person (builder/developer) is liable to service tax, the liability of sub-contractor can be summarised as follows –
Post construction services - Post construction services of completion and finishing are taxable w.e.f. 16-6-2005. Services of repair, alteration, renovation or restoration services in relation to building, civil structure, pipeline or conduit of work related to commerce or industry is also taxable.
Similarly, in respect of construction of residential complex, finishing services are covered under clause (b) of definition as per section 65(30a). Services of repair, alteration, renovation or restoration services in relation to residential complex are also taxable w.e.f. 16-6-2005.
Sub-contractors providing these services (to main contractor or to any other person) will be liable to service tax, as services are taxable if provided to ‘any person’.
Construction of part of building - In other cases, the service should be ‘construction of new building or civil structure or a part thereof’. Thus, if a sub-contractor undertakes work to complete the building or part of building, his services will be taxable.
A ‘part’ should be functional and identifiable as a separate unit itself (e.g. spare part). One flat out of the complex or one gala or shop of commercial building is a ‘part’ as it is complete in itself.
Pre-completion work - If a sub-contractor does some pre-completion work like foundation of building, construction of structure, brick laying etc, it cannot be said that he is undertaking work to complete ‘part of building’ and his services should not be taxable under ‘construction service’. However, the service may get covered under ‘Business Support Service’ at least w.e.f. 1-5-2011, since now this service also covers ‘operational or administrative assistance in any manner’.
4. Services provided in SEZ by sub-contractor to main contractor may be taxable
Issue relating to construction service provided sub-contractor in SEZ is more complicated.
Exemption Notification No. 17/2011-ST dated 1-3-2011 (relating to SEZ) reads as follows –
In exercise of the powers – -, the Central Government, - - , hereby exempts the taxable services specified in clause (105) of section 65 of the Finance Act, chargeable to tax under section 66 or section 66A of the Finance Act, received by a Unit located in a Special Economic Zone (hereinafter referred to as SEZ) or Developer of SEZ for the authorised operations, from the whole of the service tax, education cess and secondary and higher education cess leviable thereon.
The earlier exemption Notification No. 9/2009-ST dated 3-3-2009 relating to SEZ also used the same words i.e. ‘received by a developer or units of a Special Economic Zone’.
It is learnt that Department is taking a view that the services of sub-contractor are received by contractor and not by the developer or SEZ Unit. Hence, the exemption as given in the notification is not available.
4.1 Provisions of SEZ Act and Rules
Section 26(1)(e) of SEZ Act states that developer and the entrepreneur shall be entitled to exemption from service tax under Chapter V of Finance Act on taxable services provided to a developer or Unit to carry on the authorised operations in the SEZ.
As per second proviso to rule 10 of SEZ Rules amended w.e.f. 3-2-2009, the exemptions, drawbacks and concessions on goods and services allowed to developer or co-developer will also be available to contractor or sub-contractor appointed by such developer or co-developer. All documents shall bear name of developer or co-developer along with contractor or sub-contractor and shall be filed jointly.
Thus, services provided to contractors for ultimate use of developer should also be exempt.
However, this proviso applies only in respect of SEZ Developer and co-developer and not in respect of SEZ units manufacturing or providing services.
Note that SEZ Act and Rules have over-riding effect. As per section 51 of SEZ Act, provisions of SEZ Act will apply notwithstanding anything inconsistent contained in any other law or instrument having force of law. Moreover, SEZ Act is a special Act and other Acts like Customs Act, Central Excise Act etc. are general Acts. Thus, SEZ Act provisions have overriding effect.
4.2 Meaning of ‘received by SEZ Unit or SEZ Developer’
The SEZ Exemption notification uses the term ‘received by SEZ Unit or SEZ Developer’. The notification does not use the words ‘directly received by SEZ Unit or SEZ Developer’. Thus, even if the service is provided by sub-contractor, ultimately it is ‘received by SEZ Unit or SEZ Developer’.
4.3 Only one deemed sale and one taxable event even when work is done by sub-contractor
In Larsen & Toubro Ltd. v. State of Andhra Pradesh (2006) 148 STC 616 (AP HC DB), L&T were main contractors. L&T had given various work to others on sub-contract basis. Contractee (Principal) had no agreement with sub-contractors and there was no legal relationship between contractee (Principal) and sub-contractors. Department contended that there are two sales i.e. one by sub-contractor to main contractor and other by main contractor to contractee. However, High Court observed that property in goods passes through accretion. Sub-contractor acts only as agent of Contractor. Hence, there is only one taxable event. Property in goods directly passes on from sub-contractor to the contractee. Hence, there is only one ‘sale’. Thus, sales tax can be collected either from contractor or sub-contractor and not both. – view confirmed in State of Andhra Pradesh v. Larsen & Toubro (2008) 16 STT 501 = 17 VST 1 (SC), where it was held that main contractor is not liable to Vat on turnover of sub-contractor. There is only one deemed sale and not two, even if sub-contractor had no privity of contract with the contractee. The property in goods passes to owner/contractee on its incorporation in the works contract [Main contractor i.e. L&T had not taken input tax credit of tax invoice of sub-contractor].
4.4 Applicability of the aforesaid decision to service tax
Though aforesaid decision is relation to Vat, it can be argued that the sub-contractors act only as agents of contractor to pass on the service tax to the SEZ Unit or SEZ Developer. This can also be justified on the basis of rule of purposive construction discussed below.
5. Rule of Purposive Construction
The rule of purposive construction states that interpretation of statute should be done having regard to the purpose of the Statute. An eminent jurist of UK (Late) Lord Denning (1899 - 1999) has evolved this rule of construction.
Lord Denning had observed – ‘It is true that the words used, even in their literal sense, are the primary and ordinarily the most reliable source of interpreting the meaning of any writing : be it a statute, a contract or anything else. But it is one of the surest indexes of a mature and developed jurisprudence not to make a fortress out of the dictionary; but to remember that statutes always have some purpose or object to accomplish, whose sympathetic and imaginative discovery is the surest guide to their meaning'. - quoted with approval in K P Varghese v. ITO - (1981) 131 ITR 597 = AIR 1981 SC 1922. = 1982 (1) SCR 629 = (1981) 4 SCC 173 = 7 Taxman 13 (SC) * DLF Universal Ltd. v. Appropriate Authority 243 ITR 730 = 2000 AIR SCW 1838 = 110 Taxman 315 (SC) – same view in Amrendra Pratap Singh v. Tej Bahadur Prajapati 2004 AIR SCW 4103 * In N Kannadasan v. Ajoy Khose (2009) 7 SCC 1.
In Standard Chartered Bank v. Directorate of Enforcement (2005) 4 SCC 530 = 145 Taxman 154 = 275 ITR 81 = 125 Comp Cas 513 = 60 SCL 217 = AIR 2005 SC 2622 (SC 5 member bench majority decision), it was observed, ‘The distinction between a strict construction and a more free one has disappeared in modern times and now mostly the question is ‘what is true construction of statute’? - - Statutes are to be construed with reference to the true meaning and real intention of the Legislature’.
If there exists some ambiguity in the language or the same is capable of two interpretations, it is trite that the interpretation which serves the object and purpose of the Act must be given effect to. In such a case, the doctrine of purposive construction should be adopted – Nathi Devi v. Radha Devi Gupta AIR 2005 SC 648 = (2005) 2 SCC 271 (SC 5 member bench).
When an expression is capable of more than one meaning, the Court would attempt to resolve the ambiguity in a manner consistent with the purpose of the provision, having regard to the consequences of alternative constructions - Prakash Kumar v. State of Gujarat AIR 2005 SC 1075 (SC 5 member bench) – same view in South Eastern Coalfields v. CCE 2006 (200) ELT 357 (SC).
5.1 Applicability of the rule of purposive construction
The rule is applicable both in case of construction services relating to road, bridges, tunnels, or non-commercial construction where when contractor is not liable. The principle would also apply to services provided by sub-contractor in SEZ.
Based on aforesaid decisions, the conclusions are as follows –
* * * * *