By TIOL News Service

NEW DELHI, NOV 19, 2013: SERVICE TAX on works contract - rather the explanation that the gross amount charged shall include the value of goods and materials, in computing the abatement given to construction services by various notifications at different points of time - is under challenge in these 11 writ petitions on the grounds:-

(i) Service tax levied from time to time by Finance Act, 1994 and subsequent amendments is in exercise of power under residual entry 97 of List I of the Seventh Schedule of the Constitution of India. It is levied on taxable service as defined in Section 65(105) read with definition clauses.

(ii) Service tax is applicable only in respect of service element and the Central Government does not have any power under the residual entry to impose tax on entries under List II of the Seventh Schedule of the Constitution.

(iii) The Parliament cannot impose service tax on material or goods used in execution of works/composite contract. Central Sales Tax is payable and levied on material used in "works contract" with effect from 11th May, 2002 after amendment of the Central Sales Tax Act, 1956 vide Finance Act, 2002.

(iv) The "composite or works contracts" are excluded from the ambit of levy of service tax under Section 65(105)(zzq) and (zzzh).

(v) Section 65(105)(zzq) and (zzzh) apply only to "service contracts" and not to "composite or works contract", therefore, exemption under notification to the extent of 67% to set off value of the goods involved in execution of "composite contract" is contrary to the charging provision and a nullity, as it amounts to enlarging and widening of charging section and would have the effect of including or imposing service tax even on goods or material used in a "composite/works contract". It is well settled that a notification cannot expand or enlarge the charging section or even amend the statutory provisions or the main enactment.

(vi) The exemption notifications by which 67% of the contract value in a "composite contract" is abated has the effect of imposing service tax on "composite or works contract" which is not covered by the main statutory provision. Thus, what is not covered and cannot be covered by the principal enactment, have been covered and brought under the service tax ambit by the explanations appended to the notifications. Thus, abatement granted in the notifications is invalid and contrary to main enactment. The said argument is equally applicable to column 4 of serial numbers 5, 7 and 10 of the 2006 notification.

(vii) As per Section 93 of the Finance Act, 1994, the Central Government is empowered to grant exemption from levy of service tax either wholly or in part but as "composite contracts" and "works contracts" are not covered under Section 65(105)(zzq) or (zzzh) Central Government cannot grant exemption by way of notification.

(viii) Service tax has been imposed on services involved in execution of "composite/works contract only with effect from 1st June, 2007 under Section 65(105)(zzzza). Rule 2A of Service Tax (Determination of Value) Rules, 2006 determines value of services involved in "works/composite contracts" and it is levied @ 2%, enhanced to 4% with effect from 1st March, 2008. The said levy is not applicable to "services" covered under Section 65(105)(zzq) and (zzzh).

(ix) There is a conflict between Section 65(105)(zzzza), (zzq) and (zzzh) and what is covered by Section 65(105)(zzzza) cannot be covered by Section 65(105)(zzq) and (zzzh). The two sets of provisions cannot co-exist. Subsequent legislation shows that the earlier legislation will not cover "composite or works contract."

(x) Section 66 is the charging section and provisions of Section 67 are the valuation provisions. Value of taxable services under Section 67 is the gross amount charged by the service provider for such "services provided or to be provided. Service tax can be charged only for the specified "taxable services" as defined in sub-clauses of Section 65(105). Tax can be only on the value of services and not beyond. There is no provision for a notional value or to enable the authorities to reduce or subtract value of material or goods. The gross amount charged or the value of service cannot include value of goods and material supplied/used.

(xi) Vagueness or uncertainty makes a levy invalid and illegal.

Legislative History

Section 65(105)(zzq) imposed service tax with effect from 10th September, 2004 on any service provided by a commercial concern in relation to construction service.

By Finance Act 2005 service tax was imposed under Section 65(105)(zzq) on any service provided or to be provided, to any person by a commercial concern in relation to "commercial or industrial construction service".

Finance Act 2005 also saw introduction or service tax on construction of complexes (residential complexes) under section 65(105)(zzzh) with effect from 16th June, 2005.

Section 65(105)(zzzza) introduced service tax in respect of works contract service with effect from 1st June, 2007 by Finance Act, 2007.

The High Court noted:

Service tax in the facts in question has been imposed in three stages. In the first stage, service tax was imposed on construction of industrial and commercial complexes. In the second stage, service tax was imposed on residential complexes of 12 or more residential units and in the third stage, service tax was imposed on works contracts of any nature except for the exclusion in respect of roads, airports, railways, transport terminals, bridges, tunnels and dams. Each provision or levy has its own scope and ambit, while the first two provisions were primarily specific and targeted, the third inclusion i.e. works contract is very broad and wide term and will include within its ambit and scope construction of industrial and commercial complex or construction of residential complexes as specified. Introduction and imposition of service tax on works contract by Finance Act, 2007 does not mean that we have to read down, the scope and ambit of the provisions enacted levy tax on contracts relating to "commercial and industrial construction service or "construction of (residential) complexes" services as specified by Finance Act 2004 and Finance Act 2005 respectively. The new levy imposed by Finance Act 2007 does not indicate or show that works contract relating to "construction of industrial and commercial complexes" or "construction of (residential) complexes" as specified, would be only applicable when the contractor was providing labour or service and was paid for the same and not to composite contracts when the contractor was providing labour/services as well as goods used for construction of industrial and commercial complexes or residential complexes as specified. It would cover any and every contract, when the contractor was only supplying labour or undertaking construction services, whether with or without supply of material, i.e. composite contract. The levy is valid when the provisions of Section 65(105)(zzh) and 65 (105)(zzq) of the Act are satisfied. The only condition and requirement is that the service tax should be levied and imposed on the "service" element and not levied and charged on material or goods used, as the power to levy sales tax or value added tax on the sales of goods is with the State Governments .

The High Court relied on a number of decisions to arrive at the above conclusion and added,

The contention of the petitioners that the impugned notifications override the statutory provisions contained in Section 65(105), which defines the term "taxable service”, Section 66, which it is claimed is a charging section, and Section 67, the valuation provisions of the Finance Act, 1994, has to be rejected. We have, as already stated above, rejected the argument of the petitioners on bifurcation/vivisect and held that as per the provisions of Section 65(105)(zzq) and (zzzh), service tax is payable and chargeable on the service element of the contract for construction of industrial and commercial complexes and contract for construction of complexes as specified and in case of a composite contract, the service element should be bifurcated and ascertained and then taxed. The contention that the petitioners are paying sales tax or VAT on material in relation to execution of the contract under composite contracts for construction of industrial/commercial complexes and construction contracts as specified under Section 65(105) (zzq) and (zzzh) therefore fails. The contention that there was/is no valid levy or the charging section is not applicable to composite contracts under clauses (zzq) and (zzzh) of Section 65(105) stands rejected. But the petitioners have rightly submitted that only the service component can be brought to tax as per provisions of Section 67 which stipulates that value of taxable service is the "gross amount charged by the service provider for such services provided or to be provided by him and not the value of the goods provided by customers of service provider and the service tax cannot be charged on the value of the goods used in the contract.

Abatement legally Valid : The High Court observed,

The notifications in questions dated 10th September, 2004, 7th June, 2005 and 1st March, 2006 granting exemption of 67% towards the value of the material used for computing the service tax payable ensure that the service element is taxable. It is an alternative to an otherwise subjective determination in each case, which may be cumbersome and require a detailed examination for ascertainment of the service element. The formula prescribed is not mandatory or compulsory. Further, it will apply at the option of an assessee. It will be applicable only when the required parameters are met and is not illegal and ultra vires the Act, i.e. the Finance Act, 1994. It is also not contrary to the charging section/provisions of the Finance Act imposing levy of service tax. The aim and purpose of the said notifications is to provide a convenient, alternative, optional and hassle free method for payment of service tax, provided the requirements mentioned in the notifications are satisfied .

From various judgements, the High Court highlighted the following facets/principles:

(1) After 46th Amendment to the Constitution, composite contracts can be bifurcated to compute value of the goods sold/supplied in contracts for construction of buildings with labour and material.

The service portion of the composite contracts can be made subject matter of service tax. Aspect doctrine is applied for bifurcating/vivisect the composite contract

(2) Service tax can be levied on the service component of any contract involving service with sale of goods etc. Computation of service component is a matter of detail and not a matter relating to validity of imposition of service tax. It is procedural and a matter of calculation. Merely because no rules are framed for computation, it does not follow that no tax is leviable.

(3) The notifications in question are in alternative and optional. An assessee may take advantage or benefit of the notifications, but cannot be compelled to pay service tax on the proportion or value of a composite contract as per the notification. This is because the formula framed by way of delegated legislation is presumptuous and based on assumption.

(4) However, if an assessee wants to take benefit of the notification, he must comply and adhere to the terms and conditions stipulated as per the notification.

(5) An assessee to claim benefit or advantage as per a notification must meet the preconditions or stipulations stated therein. An assessee cannot take benefit or advantage of a part of a notification but claim that the other part of the notification should be ignored and thus not acted upon. Notification has to be applied in entirety.

(6) Notification has to be read as a whole keeping in mind its objective and purpose. Notification may provide a convenient, hassle free and adopt a non-discretionary formula for computing value of the service element in a composite contract. This curtails litigation, ambiguity, ensures clarity and consistency. A notification cannot be declared as invalid or ultra vires for this reason, provided it is optional.

(7) Authorities cannot compel and force an assessee to accept the notifications in question and pay tax accordingly, as seeking coverage under the notification is voluntary. An assessee can state that the service component of a composite contract should be computed in a fair and reasonable manner and accordingly taxed.

(8) The notifications meet the tests laid down under Section 93 and 94 of the Act because they relate to manner and mode of computation of service tax in a composite contract. The object and purpose is not to tax as non-service element or to include non-taxable part of the composite contracts.

(9) It has not been shown and established that the formula or the value prescribed in the notifications is absurd or irrational. The said notifications are not per se an arbitrary exercise and contrary to data or formula for computing service element. In taxation matters, classification should not be struck down as discriminatory unless there are strong and compelling reasons that show absurdity and, therefore, violation of Article 14 of the Constitution.

The writ petitions are dismissed.

(See 2013-TIOL-908-HC-DEL-ST)