In a recent judgement the larger bench of Delhi CESTAT in the case of Larsen and Toubro Ltd held that works contracts which could have been appropriately classified under ‘commercial or industrial construction’, ‘construction of complex’ or ‘erection, commissioning or installation’ services were liable to service tax under the respective service category even prior to 1 June, 2007 i.e the date on which the ‘works contract services’ were first introduced as taxable services. The decision has been taken with a borderline majority.

The foremost argument by the majority was that a composite contract in toto is a service contract and the Central Government has the constitutional right to levy service tax on the gross value of the works contract i.e inclusive of the value of goods supplied. Only for the deeming fiction created by Article 366 (29A) of the Constitution wherein the State Governments have been allowed to levy sales tax on goods supplied while executing such contracts, the Central Government has voluntarily allowed an exemption towards the supply portion to avoid dual taxation.

However, this does not seem to be very strong reasoning. It seems difficult to accept that a works contract is a service contract. If one concedes that it is composite contract, then it readily follows that to tax the service element in a composite contract requires constitutional authority in the way it has been done for sales tax.

The issue of leviability of service tax on composite transactions involving supply of goods and provision of services prior to 2007 (when the specific taxable category of “works contract services”) has been a vexed issue and has led to several, often contradictory, court decisions in the past. The recent decision of the 5-member larger bench of the CESTAT in the case of L&T has to be understood in the above backdrop.

The majority conclusion in this case was written by the Hon’ble Technical Members (in a 3:2 majority) which categorically held that composite transactions involving supply of goods and provision of services were indeed leviable to service tax prior to 2007. One cannot help but note, with greatest of respect, that this is a rare instance of clear dichotomy of views between the Judicial and Technical members.

While the majority view would hold the field for the time being, in my humble opinion, it does not appear to satisfactorily address the fundamental objections raised by the minority judgment; viz.:

(i) If Section 67 read with the service tax valuation rules provided for deduction of value of goods from the service tax taxable base, what was the need to provide for exemptions/ abatements under Section 93 of the Finance Act? Exemptions are in the nature of exceptions/largesse from the statutory mandate – if the statute itself envisaged the deduction, why resort to a largesse under Section 93; and

(ii) It is a fundamental principle of statutory interpretation that no portion of the statute should be rendered superfluous – if composite transactions were already covered under the pre-existing service tax categories, what was the need to introduce a new category along with a specific valuation provision?

Clearly, this is not the end of this story. As noted in the order itself, this issue is already pending before the hon’ble Supreme Court (in appeal against earlier CESTAT orders on this issue). For the sake of finality, the assessees would need to wait and watch as to how the Apex Court is going to decide on this matter.

CESTAT Five Member  Bench  decision in the case of Larsen & Toubro Ltd ( L & T) vs CST reinforces the complexity relating to taxation of construction, erection, installation, commissioning and like transactions ( referred to as “building contracts” hereafter).  The aspects that will now need focus when the matter reaches Supreme Court are:  Was the coverage in the entries prior to specific entry of “Works Contract Service” different? Could there have been services simplicitor in building contracts?  If not, is it any different from a Works Contract, a contract involving goods and services/labour? Is Entry 97 adequate to enable Central Government to impose tax on service element of such building contracts?  Deliverable in a building contract is not “service” but immovable property.  That is the reason, a specific entry was needed to enable taxation of “goods” element where property in the goods is transferred in execution of such contracts.  Do we not need such specific entry to deem service element of such contract as “deemed service” or will it suffice to say that “goods” element, which is in the taxation domain of States, is specifically carved out and the balance element is only that of service?  If that be so, is it not more likely that the Larger Bench view of the CESTAT will find favour with Supreme Court?

Placing reliance on the 46th Amendment to the Constitution and various supreme court judgments upholding bifurcation of composite contracts  for levy of sales tax, the larger bench of Hon’ble CESTAT held that turnkey/ construction contracts, entered into prior to June 01,  2007, would be chargeable to service tax under the pre-existing taxable service categories.

The majority judgment did not lay down specific guidelines with respect to how taxable value of such services would be determined and only made passing references to abatement notifications allowing deduction towards value of goods. In view of the same, valuation of such services during the relevant period may become a subject matter of fresh disputes especially where the composite contracts include land or free supplies etc. It would now be imperative for the government to issue appropriate guidelines on how the taxable value of such services would be determined to avoid further litigation. 

The said judgment would not impact the cases where notices have not been issued and are barred by limitation.

The 5 member bench (“5 MB”) of the Tribunal has held by majority (3:2) that even prior to June 1, 2007, service elements in a composite works contract (“WCT”) involving transfer of property in goods and rendition of services are subject to levy of service tax under the categories of ‘commercial or industrial construction service’ (“CICS”) or construction of complex service (“COCS”) or Erection, commissioning or installation (ECIS”), as the case may be. 

The genesis of the issue is the introduction of a specific category for levying tax on works contracts under section 65(105)(zzzza) of the Finance Act, 1994 (“Act”) with effect from June 1, 2007, which also seemingly includes CICS, COCS and ECIS within its ambit. 

In the case of GD Builders (GDB Ruling”), the Delhi High Court categorically held that a WCT is liable to service tax prior to June 1, 2007 and that merely because no rules were framed for computation, it does not follow that no tax is leviable.  The 5 MB had to primarily consider whether the GDB Ruling covered the issue referred.

All the 5 members agreed that GDB Ruling did not arise out of concession by the taxpayer.  Majority held that the GDB Ruling is not per incuriam.  Majority also held that the Rulings of Karnataka High Court in Turbo Precision Engineering and the Madras High Court in Strategic Engineering are different and distinguishable.  However, this aspect has not been sufficiently dealt and in fact, the GDB Ruling does not refer to these High Court Rulings.

The Revenue’s appeals against the larger bench decisions in Jyoti Limited and Indian Oil Tanking Limited have been admitted by the Supreme Court and are pending disposal.  However, since the 5 MB has ruled on the reference following the GDB Ruling and held against the taxpayer, these Rulings would now prevail unless stayed and the issue has to be finally settled by the Supreme Court. 

The 5 MB Ruling captures the entire legislative history on levy of tax on WCT including the legal fiction introduced by the 46^th amendment to the Constitution of India and the catena of decisions on WCT taxation starting from the first Gannon Dunkerley Ruling to the latest Ruling of the larger bench of the Supreme Court in Prolab and others. This Ruling also contains a treatise on certain principles of interpretation including per incuriam, sub silentio, stare decisis, ratio decidendi, dominant intention test, degree of enforceability test, relevance of budget speech, judicial discipline etc. This is an excellent compilation for reference and is a very valuable read.

One of the interesting observations in the Ruling is that the legal fiction created by Article 366(29A) does not change the basic character of a works contract or a catering contract, both of which are service contracts.  It is thus observed that a specific constitutional provision and machinery was required only for the State Government to tax the goods portion in a service transaction and not for charge of service tax by Central Government. 

The issue dealt in this Ruling relates to pre June 2007 and is not recurring, though the thesis on the provisions and principles would be very useful for future periods as well.  While there is broad consensus on the taxability of WCT post June 2007, debates on classification and valuation still continue.  Some of the issues to ponder in the context of taxability of WCT include:

• Levy of service tax pre  June 2007 on ‘turnkey projects’, which are recognised as a separate class of WCT as defined under section 65(105)(zzzza) of the Act;
• Applicability of GDB Ruling and 5MB Ruling rendered in the context of CICS, COCS and ECIS to such turnkey projects;
• Resolution of the overlap of categories of WCT, CICS, COCS and ECIS and applicability of principles of classification post June 2007; and
• Valuation mechanism for services categorized under CICS, COCS and ECIS post June 2007.

The major WCT issue which is still debated and unresolved is whether multiple contracts for supply of goods and services with cross fall breach clause/umbrella contract together constitute a single composite WCT.  Hope these complexities do not arise in a Goods and Service Tax (“GST”) regime and a separate and clear scheme of taxation is laid out for GST on WCT.

At the outset, the judgement is relevant only for the period prior to 1-6-2007, and no fresh demands can now be raised by the Department, since even the longer limitation period has expired. The judgment would therefore only affect pending adjudication / appellate proceedings, which have already been initiated against assessees. In such pending cases, the fact of a 3:2 split between the Larger Bench may support the position that the issue is one of interpretation and the longer period of limitation ought not to be invoked.

On the merits of the issue, while the majority judgement of the Larger Bench held that Parliament had sufficient legislative competence to levy Service Tax on composite contracts prior to 1-6-2007, it still needs to be debated whether a constitutional amendment is required for this purpose.