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Manner of Execution of Contract - Key for Service Tax Liability

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IN the new Service Tax regime, a service provider is required to pay Service Tax if he does not fall within the Negative List (s. 66D of the Finance Act, 1994) or if he is not exempted under the Mega Exemption notification 25/2012-ST dated 20.06.2012.

The opportunities and problems the New Service Tax regime has posed to the Professionals and the industry in mind-boggling.

One needs to carefully draw up his contracts lest he is drawn into the Service Tax net.

In this article the author would like to point out two instances where the structuring of the contract will reverse the effect of taxation.

A) Single Contractor or multiple Contractors

Let us take a scenario of construction of an Airport.

Case 1 - The AAI awards the contract to two different persons – one, ‘X' for construction of the Airport and another to ‘Y' for painting and interiors.

The Construction of the Airport will be an "Original Works". In terms of S.No.14 of the Mega Notification (25/2012-ST dated 20.06.2012), original works relating to Airport are exempt. Hence, the construction activity of ‘X' will be exempt.

However, the painting and interior will not be an “Original Works” and as the aforesaid exemption is available only for Original Works, the painting and interior will be liable for service tax.

Case 2 – In Case 1, if AAI awards the entire contract for construction, painting as well as interiors to only one single person (X). X in turn sub-contracts the painting and interior to another person (Y).

The entire contract awarded to X is an "Original Works" and accordingly as discussed above, the same will be exempt under S.No. 14 of Mega Notification.

The Y's activity is also a works contract but not an “Original Works”. However, under S.No.29 of the Mega Notification, if the main works contractor is exempt from tax, the sub-contractor's Works Contract is also exempt. For ease of reference, the S.No. 29 is reproduced hereunder:

"(h) sub-contractor providing services by way of works contract to another contractor providing  works contract services which are exempt"

On a close reading of the above entry, the exemption is available to all works contracts and not only for “Original Works”. Accordingly, since X's Works Contract is exempt, the sub-contracted works contract portion to Y will also be exempt.

This is a classic case where the work done by X & Y remains same in both the Case 1 & 2 above, but in one case, Y is liable for Service Tax and in another case, Y is exempt.

B) Pure labour vs. Works Contract

Staying with the Case 2 above, i.e., i.e., entire works awarded to X and X in turn sub-contracts painting & interior works to Y, wherein we had seen that both X & Y are exempt from tax.

Let us alter the manner of execution of contract. Y will undertake the painting & interiors but all the materials will be supplied free of cost by X.

In such a case, since there is no transfer of property of goods from Y, the activity of Y is not a works contract but a pure labour contract. Since, the exemption under S.No.29 is available only for a works contract, the activity of Y, which is in the nature of pure labour work, is not exempt and the same will be liable for service tax.

A main contractor, to ensure quality of works, may supply the material which adversely affects the service tax liability. Thus, the same painting activity when executed as a Works Contract is exempt from tax, but when executed as a Labour contract the same is liable for service tax.

To conclude, one must be prudent while executing a contract so that the Service liability can be avoided. After all, avoidance of tax by tax planning is not illegal.

By Shiva Kumar G, CA

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  • Consult Construction
    Consult Construction Tuesday, 27 August 2013

    Thanks for useful information

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