Though there is plethora of judgments of Hon’ble SC on works contract taxability relating to VAT/sales tax, this is the first judgment delivered by SC on service tax front. It essentially brings out 5 important ratios:

A) It has held that works contract is a separate specie of transaction both in commerce and in law, distinct from sale simplicitor and service simplicitor;

B) A composite works contract or a Lumpsum Turnkey contract involves both goods and services empowering both Union and States to tax same transaction within respective domains, therefore, it is imperative that neither Union nor States can encroach into the taxing domain of other partner and should restrict the exercise of power within its own boundaries, failing which the levy would be constitutionally infirmed;

C) The Parliament for the first time had created a charge along with a supporting computation machinery in line with the principle laid down by the Constitutional bench in second Gannon Dunkerly case w.e.f. 1-6-2007 prospectively. Works contract service therefore, cannot be taxed prior to said date.

D) Consequently, various tax services mainly consulting engineer, erection commissioning and installation and commercial and industrial construction service, construction of residential complex would only cover service simplicitor or pure service and not works contract service.

E) After referring to definition of works contract service, the definition excludes infrastructure contracts like airports, tunnel, bridges, etc. It is inconceivable to presume a works contract tax on these projects prior to 1-6-2007. Further, the Finance Minister’s speech also makes it clear that the levy gets created for the first time w.e.f. 1-6-2007.

This finally puts an end to an otherwise unending controversies on account of divergent views expressed in the past by Division Benches resulting in Third member reference, Larger Bench (LB) judgment comprising of 3 members and a LB judgement of 5 members where again it was a strict verdict of 3:2.

This judgment has finally given a quietus and a great relief to the infrastructure sector.

In a significant development the Supreme Court in Larsen & Toubro has declared that service tax on works-contract can be charged only from June 2007 and not earlier. This ends a lot of uncertainty on the issue, in favour of the tax-payers. This issue was heavily litigated and there were a number of conflicting decisions including those of High Courts. The Supreme Court has relied upon its earlier decisions in context of sales tax to hold that works contract is an amalgam of goods and services and therefore in the absence of clear rules demarcating the service element in such contract, service tax cannot be levied. These rules were prescribed effective June 2007. This decision also highlights the point that for tax charge to be effective the machinery provisions are equally important as the statutory provisions so much so that in the absence of the former, tax cannot be levied. Significantly, the Supreme Court has held that circulars and departmental instructions cannot fill the void in the provisions to levy the tax.

The decision is crucial even otherwise as it vindicates the tax-payers’ position that service tax can be charged only on the service element in a transaction and it is obligatory on the part of the tax-authorities to demarcate such element before imposing the levy. The decision may also attain vital significance at a later date in the context of GST which purportedly seeks to tax goods and services differently and thus taxability of works-contract therein will require scrutiny.

In terms of settled legal theory, the decisions of Supreme Court apply to all pending cases. Therefore, as a way forward, all unresolved disputes or those pending in appeal will now be settled in light of this decision and refunds would likely be granted to those who have paid service tax on works contract prior to June 2007. The decision, however, does not affect those cases which are decided and closed prior to this decision as there would not be automatically revived. 

While the issue of applicability of Service tax, in pre-2007 period, to  indivisible “works contracts” (as defined in State VAT Laws),  is settled conclusively by very clear and categorical judgment of  Supreme Court in CCE, Kerala Vs M/S Larsen & Toubro Ltd and Others [TS-437-SC-2015-ST], will the following be the flavor of the next season ?

• Taxability of indivisible contracts involving intangibles –State VAT and Service Tax-both or none?

These type of contracts are essentially service contracts.  Take for example, Franchise Agreements, Brand Licensing and Support Service Agreements, which involve provision of service besides permitting use of brand/trade name. 

VAT Authorities have been holding that such contracts involve “transfer of right to use goods” and are liable to tax as “deemed sales” in terms of Article 366(29A)(d) of The Constitution of India read with concerned State VAT Law.  It is a settled position in law that intangibles constitute “goods” and, for this purpose, let us presume that transfer of right to use goods includes that of  intangibles ( it is a matter which will require judicial interpretation – cases where such transfer is exclusive and where, it is not).  Absent any provision for computation of the consideration attributable to such “deemed sale”, VAT Authorities seek to levy VAT on the entire consideration.

 On the other hand, Service Tax Authorities are construing such indivisible contracts as service contracts simplicitor and demanding Service tax on entire consideration.

Assuming that the position of the VAT authorities is right (though, it is strongly arguable that mere permission to use brand/trade name is distinct from “transfer of right” to use brand/trade name), such contracts will constitute indivisible contracts involving both, “sale” and “service”.  There is no provision even under Service Tax Law to compute value of taxable “service” component of such indivisible contracts.

Hon’ble Supreme Court, in L & T judgment [TS-437-SC-2015-ST],  has, reiterated, the settled position in law that lack of computational provisions make the levy non-existent in law.

Does it, therefore, mean that such indivisible contracts are outside the tax net?

A new match begins….

The Supreme Court by its landmark decision has finally cleared the air around the issue of leviability of Service tax on indivisible works contracts prior to 1^st June, 2007, i.e. before the introduction of the taxable category of “works contract services”.  The Apex Court has held that Works Contract is a separate specie of contract distinct from simpliciter service contracts, and therefore cannot be made leviable to tax under the pre-existing taxable service categories such as erection, commissioning or installation service, commercial and industrial construction service, etc.  The Apex court heavily relied upon the second Gannon Dunkerley decision of the Supreme Court and held that prior to 1.06.2007 there was no charging or machinery provision to levy and assess service tax on indivisible works contracts - no service tax can be levied in absence of a provision for determining the value of service component in an indivisible works contract.

In mycomments on the CESTAT (Larger Bench) decision on this matter, expressed earlier in Taxsutra, I had stated that the CESTAT decision does not satisfactorily deal with the fundamental objection that if Section 67 read with the service tax valuation rules provided for deduction of value of goods from the service tax taxable base for composite contracts, what was the need to provide for exemptions/ abatements under Section 93 of the Finance Act (since exemptions are in the nature of exceptions/largesse from the statutory mandate). On this point, the Supreme Court in this decision has categorically held that “….Section 67 of the Finance Act, which speaks of “gross amount charged”, only speaks of the “gross amount charged” for service provided and not the gross amount of the works contract as a whole from which various deductions have to be made to arrive at the service element in the said contract.”The Supreme Court has specifically overruled the decision of Delhi High Court in the case of G.D. Builders and held that the interpretation of the MahimPatram decision by the Delhi High Court was completely erroneous.

Not only has the decision settled a protracted dispute, the Supreme Court by this decision has strongly reiterated and re-emphasized the fundamental legal principle that no tax can be levied without a charging or a machinery provision providing for determination of value and rate at which tax would be imposed. This would have impact on service tax leviability in areas other than works contracts too. Many activities, especially after introduction of the negative list, involving element of sale have been made subject to Service tax. In some of these cases, there is no machinery provision for determining the value of service portion involved in such activities. For example, under Section 66E the service portion of any activity relating to supply of food and beverages has been made liable to service tax.

However, Rule 2C of the Service Tax (Determination of Value) Rules, 2006, relating to determination of value of service involved in supply of food and beverages, provides computation provision only for the activity of supply of food at a restaurant or outdoor catering. There is no machinery provision to determine the value of service in supply of food or beverages at places other than restaurant, such as food supplied in the hotel rooms (in-room dining). Following the ratio laid down by the Supreme Court, the service tax levied on such activities may need reconsideration.
 

Introduction of the taxable service of Works Contract was introduced in June 2007. As it usually happens in Indian context it gave birth to a controversial issue as to whether rendition of service under a composite works contract was already taxable in terms of various taxable services such as Commercial or Industrial Construction Services, Construction of Complex Services, Erection, Commissioning or Installation Services and Consulting Engineers services prior to June 2007.

The issue appeared to have been adversely decided for taxpayers when the Delhi High Court held that levy of tax by aforementioned services was good enough to tax indivisible composite works contracts on the proposition that even when rules are not framed for computation of tax, tax would be leviable. However, the recent decision of Supreme Courtin the case of Larsen & Toubro and others (TS-437-SC-2015) has settled the issue holding that composite indivisible works contract are not subjected to service tax prior to June 2007 for the reason that prior to June 2007, there was no charging or machinery provision in the Finance Act 1994 to levy and assess service tax on indivisible composite works contract.

Presently, there are various sectors wherein there is a simultaneous levy of VAT and service tax. Such simultaneous levy arises by virtue of the charging section incorporated in both VAT and service tax law. Restaurant services and Software salescan be taken for instance. However, what differs in both the cases is existence or otherwise of machinery provision. For levy of service tax on restaurant services, Rule 2C of Service Tax Rules, 1994 provides mechanism for determining the value on which service tax is assessed. No such provisions exist in VAT laws where the entire consideration is charged to VAT by virtue of clause (f) of Article 366 (29A) of the Constitution. The software industry howeverstill awaits some kind of machinery provision so that multiple tax incidence on the same value of transaction can be avoided.

Though, the issue dealt by Supreme Court in the case of Larsen & Toubrois different in the sense that levy of multiple taxes on same transaction was not the issue before the Supreme Court, it can only be hoped that the said decision prompts the lawmakersto ensure that there is appropriate machinery provision incorporated for assessment of tax.

To an ardent tax student, what comes out as a lesson is the way the Hon'ble SC analyzed that a) Composite Works Contracts as a positive service became taxable only after 1 June 2007 b) and the incision like view, about its earlier decision on Mahim Patram critically laying down that, borrowing machinery provisions or rules when provided in the parent law is something different from no machinery and computation provisions .

This is a learning for every tax student to understand the context, law considerations and factual pattern in which decisions are rendered before using its ratio in similar cases.

This judgement is probably the “Gannon Dunkerley” of the Service tax law, succinctly bringing out the principle that service tax cannot be ‘levied’ - without an effective and clear charging provision and ‘collected’ - without an effective machinery provision.

The Supreme Court agreed that both, the Centre and the States have powers to levy taxes on works contracts – viz. States on the goods portion and the Centre on the services portion. However, what weighted in favour of the assessee was that the Centre did not choose to exercise its power till 1 June 2007 when, for the first time, it levied service tax on works contracts. Consequently, services such as consulting engineer, commissioning, installation, etc., composed in an indivisible works contracts cannot be levied with service tax prior to 1 June 2007.

This judgement once again reinforces the principle that a charge does not get established merely because there is an exemption notification. The Supreme Court discarded the argument of the Revenue that the Centre has the power to levy service tax on certain services comprised in an indivisible works contract due to existence of certain exemption notifications purportedly granting exemption towards the goods portion of the consideration.

Having defined jurisdictional boundaries for the State and the Centre in the case of works contract taxation, it’s time that the Supreme Court delivers a judgement on the taxation of software and other intangibles to hold that both VAT and service tax should not be levied simultaneously on the same value. One may have to also examine whether the principle laid down by the Supreme Court can be pressed into service to argue that no machinery provisions are enacted or notified to segregate the value on which the Centre can levy service tax.

The Supreme Court has enunciated a principle that the government could levy and collect service tax on works contract only after the valuation provision permitted to ascertain the value of works contract in a prescribed manner and when such manner was prescribed by notifying specific rulesfor this purpose. This  principle may help assessees in other similarly placed disputes such as ascertaining the value in the case of non-declaration of retail sale price on the goods which are covered by section 4A of the Central Excise Act, 1944. This dispute is doing rounds before various Benches of the Tribunal.

The Hon’ble Supreme Court in the landmark judgment has once again re-emphasised the settled judicial principle that no tax can be levied without appropriate charging and machinery provisions for levy or assessment of tax. It held that no service tax was payable on indivisible works contracts prior to June 01, 2007 i.e. before introduction of specific taxable service category of ‘works contract services’.

The Hon’ble Supreme Court noted that works contract is a separate species of contract which is distinct from simple service contracts and could not be taxed under the five taxable services i.e. erection, commissioning or installation services, construction of complex services etc. which existed prior to June 2007. In view of the Supreme Court such categories only referred to simple service contracts and did not contemplate composite works contracts.

The Hon’ble Supreme Court also observed that the Delhi High Court in G.D. Builders v. UOI and Anr., 2013 [32] S.T.R. 673 (Del.), while deciding the same issue has incorrectly relied on the judgment of Supreme Court in Mahim Pratam Private Limited v. Union of India 2007 (3) SCC 668 to arrive at a proposition that tax can be levied even when rules are not framed for computation of tax and held that the same was not the correct interpretation of the said judgment.

The said judgment is a welcome relief especially for struggling Infrastructure Industry and would finally settle the disputes being litigated for more than a decade. In view of this judgement, any service tax paid by any assessee under protest during the pendency of litigation should be available as refund to such assessees. However, availability of refund to assessees who had paid the service tax voluntarily and were not disputing the levy would be a subject matter of dispute. The question, whether the limitation period of one year for claiming the refund would apply to such assesses requires further deliberations.

The question that recently came up before the Supreme Courtin the case of Larsen & Toubro [TS-437-SC-2015-ST] was whether service tax could be levied on indivisible contracts prior to its introduction on 01-06-2007. The Court’s findings and conclusions came as a beacon of hope to the already troubled Real Estate and Construction industry as it answered the question in the negative.

It specifically held that the service  element in an indivisible Works Contract, classified under Commercial or Industrial Construction Service (“CICS”), Construction of Complex Service (“COCS”), or Erection, Commissioning or Installation Service (“ECIS”),  was not subject to the levy of Service tax under the Finance Act, 1994 (“the Finance Act”)  prior to its introduction on 01-06-2007.

The Apex court’s findings were based on the following grounds:

(1) Before 2007, Finance Act, 1994 didn't lay down any charge or machinery to levy and assess service tax on indivisible composite works contracts. It was specifically made taxable by thee insertion of Section 65 (105) (zzzza).

(2) The taxable services referred to in the charging Section 65(105) would refer only to service contracts simpliciter and not to composite works contracts. This is clear from the very language of Section 65(105) which defines "taxable service" as "any service provided". All the services referred to in the said sub-clauses are service contracts simpliciter without any other element in them.

A very interesting point to note from this judgement is that the Court has ignored the abatement/ composition schemesthat already existed prior to 01-06-2007 for valuation purposes. Does this mean that AMC contracts, Operation & Maintenance contracts, outdoor catering service etc, that involve elements of supply of goods and services during their execution are also outside the purview of service tax? This is despite the fact that such species of contracts were kept out of the definition of WCS even on 01-06-2007.Also, this ground can be taken up at the appellate stages as a legal submission in matters that are already in appeal against works contract tax demands.

The above decision could also provide relief for matters contesting on the non-availability of composition scheme with respect to continuing contracts under works contract service for the period after 1.6.2007.

All the Civil Appeals decided by this Judgment are cases prior to June 2007. From 1^st June 2007 Service Tax on Works Contract was introduced. Subsequently, various amendments were made in the sections of the Finance Act by which Works Contracts which were indivisible and composite were split so that only the labour and service element of such contracts would be taxed under Service Tax.

Works Contract is a composite contract which is inseparable and indivisible, and which consists of several elements which include not only a transfer of property in goods but labour and service elements as well.

Even, Works Contract (Composition Scheme for Payment of Service Tax) Rules, 2007 was also notified in which service providers could opt to pay service tax at percentages ranging from 2 to 4 of the gross value of the works contract. Service Tax (Determination of Value) Rules, 2006 laid down the mechanism for the determination of values. In pursuance to above, the value of the goods involved in the execution of a works contract is determined by taking into account the value of the entire works contract and deducting therefrom the charges towards 8 items of labour and services

The dispute whether service tax can be levied on indivisible works contracts prior to the introduction, on 1st June, 2007 has a long history. In MALAR CONSTRUCTIONS vs CCE, and Daelim Industrial Co Ltd. v. Commissioner, which was upheld by the Supreme Court also, stated that Works Contract was not a taxable service before 1-6-2007

Similarly, Madras High Court in Strategic Engineering and Karnataka High Court in Turbotech  case held that works contract service can be taxed only from 1.6.2007.

However, the Delhi High Court in the case of GD Builders - TS-205-HC-2013(DEL)-ST , held that Service Tax can be levied on the service component of any contract involving service with sale of goods. This judgment has been declared invalid by the Hon’ble Supreme Court. The Apex Court followed and developed further second Gannon Dunkerley judgment reported in (1993) 1 SCC 364 = 2002-TIOL-103-SC-CT-CB, where the modalities of taxing composite indivisible works contracts were dealt in great detail.

The Supreme Court found the GD Builders decision incorrect on the ground that it ignored second Gannon Dunkerley judgment and other vital issues of law and concluded that there was no Charge or machinery to levy and assess Service Tax prior to 1^st June 2007.

In my view there was no ambiguity and precious judicial time has been wasted by the CBEC to harvest undue revenue. Way back during Budget Speech of 2007 in para 154 Finance Minister said that,

“State Governments levy a tax on the transfer of property in goods involved in the execution of a works contract. The value of services in a works contract should attract service tax. Hence, I propose to levy service tax on services involved in the execution of a works contract”.

Even the TRU letter of 2007 mentioned ‘execution of works contract' as a new service in continuation of the policy of widening the service tax base.

Then how this distortion in understanding of the CBEC happened? Somehow CBEC in the zeal of revenue bias and collecting even undue tax thought that this Works Contract service which was brought under the service tax net with effect from 1.6.2007 was always taxable under different headings like construction, erection, commissioning etc mentioned above.

In bunch of Civil Appeals filed by Parties and Revenue, Hon’ble Supreme Court finally decided on 20.08.2015 that service tax is not leviable  on indivisible works contracts prior to 1st June, 2000 related to 5 services like Commissioning and Installation Service, Technical Testing and Analysis Service, Consulting Engineering Service, Commercial Construction Service, Construction of  Complex Service. These Services are mere Service Contract Simplicitor and not Works Contract before June 2007.

Just to decide that whether a tax introduced from 1 June 2007 can be made applicable to some services existing prior to that date; it took years of litigation, the unusual five member bench of Tribunal, High Court decisions and at last the Apex Court’s involvement, over a period of 8 years!

The Apex Court has finally put an end to the debate on taxability of ‘works contract services’ prior to 1 June 2007 and held that prior to introduction of a separate taxable category of ‘works contract service’, indivisible / composite contracts cannot be vivisected and the service component cannot be subjected to tax by classification under any other taxable category such as ‘commercial or industrial construction service’, ‘construction of complex service’, 'erection, commissioning & installation service’, etc.  

Now, it would be interesting to see the treatment of such composite contracts under negative list regime wherein any activity performed for consideration is charged to service tax. In such cases, whether services involved in the composite contract would be vivisected and charged to service tax or not, still remains an open question.

Also, it would be prudent to weigh the impact of this decision on classification issues in respect of services which are naturally bundled such as mining of mineral, oil or gas services (from 1 June 2007) vis-à-vis survey and exploration of minerals, oil and gas services (from 10 September 2004), etc., wherein the specific taxable category was introduced at a later date but part of such service was in existence under different taxable categories prior to such specific category.