A works contract is a contract for work which involves both a transfer of property in, and hence a sale of, goods and also an element of provision of service. Such contracts are therefore typically composite contracts comprising both supply of goods and provision of services.
The indirect taxation of works contracts has been a complex area both under the State VAT, under which they have been charged to the goods tax for more than two decades, and, much more recently, under the service tax provisions, in regard to services.
One of the challenges relating to taxation of works contracts has been with regard to work carried out by sub-contractors. Typically, contracts for carrying out works are entered into between the project owners or contractees and the principal contractors. The principal contractors, in turn, enter into contracts with sub-contractors. Consequently, the privity of contract is only between the contractee and the principal contractor and does not extend to the sub-contractors.The indirect taxation of the sub-contractors’ activities is therefore complex. An additional dimension to the matter is that the sub-contracting can either be for the entire value of the contract or a part thereof.
With regard to the VAT treatment of sub-contracted work, the law has varied over time and across the States since its introduction. Initially the law provided for the turnover of the works contracts, after considering the deductions towards labour charges, consumables and similar expenses unrelated to goods and the profits earned on the contracts in relation to the aforesaid elements, to be charged to tax in the hands of the main contractor alone, without separately charging the sub-contractor’s turnover to tax. Alternately, the sub-contractor’s turnover was charged to tax and a deduction or exclusion in relation to the value of the sub-contract was allowed while charging the main contractor to the tax.
A third option, which is now largely in force, is for the tax to be paid by both the main contractor and the sub-contractor with input tax credits being available with regard to the taxes paid by the sub-contractor. The underlying principle however has been very clear i.e. that only the goods portion of the works contract is charged to the VAT and that too once and once only.
However, the mechanism by which double taxation is sought to be avoided regarding sub-contracted work has been subject to prolonged litigation. In a recent landmark case in State of Andhra Pradesh Vs. Larsen & Tourbro Ltd. (2008-TIOL-158), the Supreme Court had occasion to pronounce on the taxability of works contracts, with particular reference to sub-contracts. While the decision was with regard to the relevant Sections of the Andhra Pradesh Value Added Tax Act 2005 and is hence is limited to that Act, nevertheless certain general principles of goods taxation are discernible.
The Court held that in terms of the charging Section, tax was to be paid by sub-contractors on their sales consideration. Since the underlying contract was one of work, transfer of property in goods could only be effected by the sub-contractors who actually carried out the works. Further, since transfer of property in works contracts passed by way of accretion to goods, the main contractor could not, in terms, effect a further transfer of property in such goods which had already been erected by the sub-contractor.
Consequently, the Court held that notwithstanding the absence of privity of contract between the sub-contractors and the project owner (contractee), transfer of property in the goods erected by the sub-contractors happened only once i.e. from the sub-contractor to the contractee. Consequently, the Supreme Court, while upholding the earlier order of the Andhra Pradesh High Court in the matter, held that there could not be two deemed transfers of property in the goods erected by the sub-contractor; one from the main contractor to the contractee and the other from the sub-contractor to the main contractor.
The ratio of this decision is clearly that in relation to works contract, property can only pass in goods used therein through an accretion to the works. If that be the case, the sub-contractor alone is liable to discharge the VAT in relation to his portion of the work, in which property will necessarily pass, through the appropriate charging section, from him to the contractee, notwithstanding the lack of privity of contract between the two.
The Supreme Court does enter a caveat that this principle is subject to any contract to the contrary. It is thus possible to visualise a situation where the work carried out by the sub-contractor could arguably be an ‘input’ for the work to be carried out by the main contractor, in which case the option of availing inputs tax credits on the taxes paid by the sub-contractor is available.
This is indeed presently the position in VAT law and indeed the AP Act was itself amended, pursuant to the above Andhra Pradesh High Court decision, in order to allow input tax credits, as above. But the principles upheld by the Supreme Court with regard to transfer of property in works upon accretion thereto and from the sub-contractor to the contractee, in the absence of any contrary intent, are important.
The aforesaid decision is of course with regard to the VAT treatment of works contracts. As regards the service taxation of the labour and service element of such works contracts, the provisions require the value of works contract services to be based on the gross amount charged for the works contract less the value of the goods used in the contract.
As regards treatment of sub-contracted work, a similar mechanism of input service tax credit is available to the main contractor. There are alternate mechanisms available on how the tax may be determined and discharged, either through the composition route or through following a methodology to determine the services element separately, and these options are available to both the main contractor and the sub-contractor.
It is therefore clearly the principle that both the VAT and the service tax will apply on the sub-contracted work in a manner that they are taxed once only and this is presently fully ensured through operation of the input tax credit mechanism in both VAT and service tax law.
The author is Leader, Indirect Tax Practice, PricewaterhouseCoopers.
pwctls.nd@in.pwc.com
