Works Contract is composition supply for rate of tax under GST

Executive Summary

Issue of tax rate on works contract has become an intricate issue in GST. The issue has become complicated as Para 6(a) of Schedule II of CGST Act states that composite supply of 'works contract' shall be treated as 'supply of services'. General rate of GST on composite supply of works contract services is 18%. If the plant or machinery or equipment or other material used in execution of works contract carries GST rate of 18%, the question of tax rate does not arise. However, if the plant or machinery or equipment or other material used in execution of works contract (where goods is principal supply) has GST rate of less than 18% (Nil, 5%, 12%) or more than 18% (28%), issue of rate of tax on works contract for GST becomes critical.

In my view, works contract is a composite supply and tax rate will be on basis of principal supply. [Other view is that works contract has been defined as 'deemed supply of service' and tax rate should be 18% in all the cases].

The issues are discussed in this Article.

Background

Works Contract has been a litigation prone issue right from beginning. It was hoped that the issue will become irrelevant when GST is introduced as distinction between goods and services will disappear and concept of 'works contract' will be given a decent burial. However, the concept of 'works contract' has been continuing in GST, though luckily, it is now limited to immovable property only.

Sr No. 6(a) of Schedule II of CGST Act states that composite supply of 'works contract' shall be treated as 'supply of services'. This is a deeming provision, as clarified in section 7(1)(d) of CGST Act.

Critical issue is whether this 'deeming provision' should apply to rate of tax.

If works contact is held to be 'service' for purpose of rate, strange results will follow. For example, if the plant or machinery or equipment or other material used in execution of works contract which is principal supply, has GST rate of less than 18% (Nil, 5%, 12%) or more than 18% (28%), the tax rate on such works contract in all cases will be 18%.





Statutory provisions

Definition of works contract - "Works contract" means a contract for building, construction, fabrication, completion, erection, installation, fitting out, improvement, modification, repair, maintenance, renovation, alteration or commissioning of any immovable property wherein transfer of property in goods (whether as goods or in some other form) is involved in the execution of such contract- section 2(119) of CGST Act.

Works contract is composite supply and deemed supply of service - Works contract as defined in section 2(119) of CGST Act is a composite supply and shall be treated as 'supply of service' - para 6(a) of Schedule II of CGST Act.

Since the provision clearly states that it is 'composite supply', this deeming provision has to be read with definition of 'composite supply'.

Works Contract is deemed sale of goods as per Constitution - A tax on the transfer of property in goods (whether as goods or in some other form) involved in the execution of a works contract is deemed sale of goods under Article 366(29A) of Constitution of India. [Note that this Article in the Constitution of India is continuing even after Constitutional amendment].

Works contract is not limited to construction - The tern 'works contract' is not limited to construction services. It covers all activities relating to plant, machinery r equipment which are immovable.

Is the deeming provision in CGST Act valid?

The Constitution of India states that 'works contract' is deemed sale of goods, while CGST Act states that it is 'deemed supply of service'.

The deeming provision in GST law is clearly against provision in Constitution. A deeming provision can be against another law, but can a deeming provision be against Constitutional provision? Can it be argued that the deeming provision is void?

Why works contract is stated as deemed supply of service?

It is not very clear why the works contract has been defined as 'deemed supply of service', contrary to provision of Article 366(29A) of Constitution. It is indeed anybody's guess.

Since goods involved in works contract may fall under different tariff heads, these cannot be classified in a particular HSN Code. That may be one of the reasons that it is defined as deemed service. Another possible reason is that definition of 'services' is much wider than definition of goods and hence it is easier to fit works contract in definition of services.

Rate of works contract

As per Sr No. 3(ii) of Notification No. 11/2017-CT (Rate) dated 28-6-2017, the tax rate of 'composite supply of works contract as defined in section 2(119) of CGST Act' is 18%. However, this Serial Number falls under heading 9954 i.e. construction service. This rate cannot apply to other works contracts. Even there the term 'composite supply' cannot be ignored.

If all works contracts are to be taxed @ 18%, the words 'composite supply' becomes redundant. Thus, this rate should at the most apply only to 'construction services' and not all works contracts.

Composite supply and mixed supply

The provisions of tax liability of composite supply are as follows.

The tax liability on a composite or a mixed supply shall be determined in the following manner — (a) a composite supply comprising two or more supplies, one of which is a principal supply, shall be treated as a supply of such principal supply (b) a mixed supply comprising two or more supplies shall be treated as supply of that particular supply which attracts the highest rate of tax - section 8 of CGST Act.

"Principal supply" means the supply of goods or services which constitutes the predominant element of a composite supply and to which any other supply forming part of that composite supply is ancillary - section 2(90) of CGST Act.

"Composite supply" means a supply made by a taxable person to a recipient comprising of two or more taxable supplies of goods or services or both, or any combination thereof, which are naturally bundled and supplied in conjunction with each other in the ordinary course of business, one of which is a principal supply. Illustration: Where goods are packed and transported with insurance, the supply of goods, packing materials, transport and insurance is a composite supply and supply of goods is a principal supply - section2(30) of CGST Act.

"Mixed supply" means two or more individual supplies of goods or services, or any combination thereof, made in conjunction with each other by a taxable person for a single price where such supply does not constitute a composite supply. Illustration: A supply of a package consisting of canned foods, sweets, chocolates, cakes, dry fruits, aerated drink and fruit juices when supplied for a single price is a mixed supply. Each of these items can be supplied separately and is not dependent on any other. It shall not be a mixed supply if these items are supplied separately - section 2(74) of CGST Act.

Works contract is composite supply

From the aforesaid definition of 'composite supply' and also clear words used in para 6(a) of Schedule II of CGST Act, works contract is a 'composite supply'.

The words 'composite supply' in para 6(a) of Schedule II of CGST Act cannot be ignored and cannot be treated as superfluous or otiose.

It is well established rule of construction that Court would not adopt a construction which would render some of the words in a statutory provision nugatory and/or superfluous - Royal Hatcheries (P.) Ltd. v. State of AP 1994 taxmann.com 748

In J K Cotton Weaving & Spinning Co. Ltd. v. State of UP [1961] 3 SCR 185, it was observed - 'The Courts always presume that the legislature inserted every part thereof for a purpose and the legislative intention is that every part of statute should have effect. - quoted with approval in Mohammad Ali Khan v. CWT [1997] 92 Taxman 52 (SC) - quoted with approval in Ram Phal Kundu v. Kamal Sharma AIR 2004 SC 3240 (SC 3 member bench) - same view in Nathi Devi v. Radha Devi Gupta AIR 2005 SC 648 (SC 5 member bench) * R & B Falcon (A) Pty Ltd. v. CIT [2008] 169 Taxman 515 (SC).

Thus, definition of 'composite supply' cannot be ignored and hence the tax rate should be on basis of 'principal supply'.

Absurd results if GST rate is determined treating it as supply of service

If works contract is treated as supply of services in all cases, strange results will follow.

For example, erection and commissioning of air conditioner is 'works contract'. Tax rate of an air conditioner is 28%. However, if erection and commissioning is treated as service, the tax rate on entire works contract (including value of air conditioner) would be 18%.

Solar water heater system is taxed at 5%, but if it is supplied with erection and commissioning, and if the supply is treated as service, the tax rate on entire works contract (including value of solar water heater system) would be 18%.

Though tax rate on agricultural machinery or dairy machinery is 12%, if erected, tax rate on entire amount would be 18%, if the works contract is treated as supply of service.

Thus, intention of legislation in giving tax relief to certain specified plant, machinery and equipment and levying higher rate of luxury goods will be lost.

Interpretation which leads to absurd results should be avoided

If a literal interpretation leads to absurd consequences, it should be avoided and a purposive interpretation be given - Rishab Chand Bhandari v. National Engg [2009] 10 SCC 601 - same view in Sarah Mathew v. Institute of Cardio Vascular Diseases [2014] 2 SCC 62 (SC 5 member bench).

In Belapur Sugar v. CCE 1999 AIR SCW 1316, it was held that law is well settled that unless there is anything contrary in the Act, Rules or Notification, if there be two possible interpretations, it is that interpretation which subserve the object and purpose should be accepted - same view in State of Maharashtra v. Swanstone Multiplex Cinema (P.) Ltd. [2010] 3 taxmann.com 534 (SC).

When plain literal interpretation produces manifestly absurd result, which could never have been intended by Legislature, Court might modify the language or even do some violence to it, so as to achieve the obvious intention of the Legislature and produce a rational construction - K P Varghese v. ITO [1981] 7 Taxman 13 (SC).

In Printers (Mysore) Ltd. v. Asstt. CTO 1994 taxmann.com 755 (SC), it was held that where the context does not permit or where it would lead to absurd or unintended result, the definition of an expression need not be mechanically applied.

Literal rule of interpretation of statute can be departed from if literal interpretation leads to absurd consequences - Sonic Surgical v. National Insurance Co. Ltd. [2010] 1 SCC 135 * State of Jharkhand v. Tata Steel Ltd. [2016] 55 GST 102/68 taxmann.com 33 (SC) -quoted with approval in Southern Motors v. State of Karnataka [2017] 59 GST 502/77 taxmann.com 251 (SC).

Deeming provision is a legal fiction and should not lead to absurd results

Treating works Contract is as supply of service is a deeming provision.

A deeming provision cannot be pushed too far so as to result in an anomalous or absurd position - Maruti Udyog Ltd. v. Ram Lal AIR 2005 SC 851.

Specific provision prevails over general provision

Provisions relating to 'composite supply' are specific provisions in section 8 and these should prevail over a general provision under section 7 of CGST Act, which defines works contract as deemed supply of service. This is particularly so when the para 6 of Schedule II of CGST Act itself says that works contract is a 'composite supply'.

Special provisions prevail over general provisions. - State of Bombay v. United Motors (India) Ltd. AIR 1953 SC 252. * State of Gujarat v. Patel Ramjibhai Danabhai 1979 taxmann.com 319 (SC) * Municipal Board v. Bharat Oil Company 1990 taxmann.com 1490 * State of Rajasthan v. Gopi Kishan Sen AIR 1992 SC 1754.

Ambiguity in favour of taxable person

If a provision is capable of two meanings, construction beneficial to citizen/assessee should be adopted - CIT v. Vegetable Products Ltd. [1973] 88 ITR 192 (SC). * CIT v. Podar Cement (P.) Ltd.[1997] 92 Taxman 541 (SC) (SC 3 member bench) * Mysore Minerals v. CIT [1999] 239 ITR 775/106 Taxman 166 (SC) * * CTO v. Binani Cements Ltd. [2014] 44 GST 103/42 taxmann.com 529 (SC).

Vivisection of works contract

Can a works contract be vivisected i.e. whether it can be treated as a divisible contract.

In Indian Hume Pipe Co. Ltd. v. State of Rajasthan [2017] 63 GST 468/84 taxmann.com 274 (SC), the works contract for laying of pipeline was divided in two parts. Assessing Authority held that this was a divisible contract. This view was upheld by Supreme Court. It was held that by forty sixth amendment in Constitution, a single and indivisible contract is at par with a contract containing two separate agreements.

In CCE v. BSBK (P.) Ltd. [2010] 26 STT 263 (New Delhi - CESTAT) 3 member LB also, it was held that Article 366(29A) of Constitution of India provides for 'deemed sale of goods' which envisages and allows vivisection of indivisible contracts. Hence, a turnkey contract can be vivisected and discernible service elements involved therein can be segregated and classifiable as well as valued for levy of service tax under Finance Act, 1994.

In National Organic Chemicals Industries Ltd. v. State of Maharashtra [2012] 54 VST 271/[2013] 29 taxmann.com 516 (Bom HC DB), it was observed as follows - Distinction between a divisible contract and an indivisible contract came to an end after forty sixth Amendment to Constitution'.

In Builders' Association of India v. UOI 1989 taxmann.com 1302 (SC 5 member constitution bench), it has been observed : 'After the 46th amendment, the works contract which was indivisible one, is by a legal fiction altered into one for sale of goods and the other for supply of labour and services.

Thus, it can be argued that the contract can be split into supply of goods and supply of services and charge separately for both supplies. This may be a better and somewhat safer course of action.

Conclusion

The CGST Act consistently treats works contract as 'composite supply'. Thus, provisions in section 8 of CGST Act relating to rate of tax cannot be given a goby. Provisions relating to composite supply are specific provisions. These should prevail.

The deeming provision is clearly against definition in Constitution and hence its validity is not beyond doubt.

Treating all works contract as supply of service would lead to absurd results and would not serve the purpose of Legislature which specifies different rates for different categories of goods.

The tax rate of 18% specified in Sr No. 3(ii) of Notification No. 11/2017-CT (Rate) dated 28-6-2017 is only for composite supply of construction services [and even here, the words 'composite supply' cannot be treated as redundant].

Assuming some ambiguity, it should be resolved in favour of taxable person and in favour of intention of legislature.

Hence, in my view, the rate of tax in case of works contract (even in construction services) should be on basis of principal supply.

There is no doubt that issue is litigation prone and would lead to different interpretations and different views (though obviously decision of department will always be in favour of revenue)..

on basis of case law cited above, it seems possible to vivisect the works contract into supply of goods and supply of services and specify separate values for both in contract. Of course this also is not a fool proof litigation free exercise, but seems less litigation prone.

In short, there are interesting times ahead in respect of works contract rates for Advocates and tax Practitioners and nightmare for taxable persons.