Works Contract Services under GST-deciphering chaos
DECEMBER 01, 2017
By R Sahana & Balaji Sai Krishnan
THE concept of 'works contract service' is not novel, rather, it has been subject to scrutiny under the erstwhile taxation laws. Under the erstwhile taxation regime, the activity of works contract was subjected to both service tax as well as VAT which in turn resulted in multiple litigations wherein the State and Central Govt traversed beyond their legislative competence to levy tax on such works contract. Although, with the advent of GST, the Government has tried to simplify the tax implications arising out of a works contract, it would not be entirely accurate to state that the activity is free from dispute.
We shall proceed to discuss these issues.
Understanding Works Contract
The term 'Works Contract' has been defined under Section 2(119) of the CGST Act, 2017 as under: -
"Works Contract meansacontract 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".
Breaking down the aforesaid definition, three specific conditions must be satisfied for any contract to qualify as a works contract. They are as follows:
1) The contract must be for undertaking the activities of building, construction, fabrication, completion, erection, installation, fitting out, improvement, modification, repair, maintenance, renovation, alteration or commissioning
2) The contract should involve transfer of property in goods in the execution of the contract.
3) The activities must result in an immovable property.
The last condition stated above is the moot of the issue under articulation.
The 3rd condition, as aforesaid is that the activities undertaken under a contract should result in an immovable property. The term 'immovable property' has not been defined under the GST law. Therefore, reliance is placed on various definitions and judicial precedents that have developed tests to determine whether something is an immovable property or not.
+ Law lexicon by P. Ramanatha Aiyer 2 nd edition, defines immovable as "something which is fixed, not liable to be removed and permanent."
+ Webster's Third New International dictionary, 1993 defined immovable as "one that cannot be moved, lands, houses thereon, and all things adhering or belonging there by nature (as trees, minerals or by act of man)."
Further, Section 2(26) of the General Clauses Act, 1897 defines immovable property to include
" land, benefits to arise out of land, and things attached to the earth or permanently fastened to anything attached to the earth "
From a bare reading of these definitions and dictionary meanings, it seems as though anything which is permanently embedded into earth and cannot be moved as such would be called an immovable property. However, the test is not as simple, specifically when the same has to be applied to an instrument or machine that is annexed to the earth through nuts and bolt. This has been recognised by Courts in numerous instances, discussed infra , thereby transgressing upon the topic and laying down twin tests to determine whether a thing attached to earth is immovable property or not. They are:-
a) Mode or degree of annexation
b) Object of annexation
The question as to whether the twin tests have to cumulatively satisfied is still open to interpretation. We shall discuss the same below.
a) Mode or degree of annexation
According to this principle, if the intention of annexation of the property is that the chattel annexed cannot be removed without substantial damage, it has been annexed for permanently improving the premises; it has to be considered to be an immovable property.
The theory of Degree of annexation is explained by Lord Blackburn of the Court of Appeals in Wake v Halt (1883), 8 App Cas 195, p 204 as follows:
"the degree and nature of annexation is an important element for consideration; for where a chattel is so annexed that is cannot be removed without great damage to the land, it affords a strong ground for thinking that it was intended to be annexed in perpetuity to the land "
b) Object of annexation
According to this test, the object behind an annexation is relevant to determine as to whether a chattel annexed would amount to an immovable property or not. Courts, in several circumstances, have held that this test has been decided on the basis of surrounding circumstances and the nature of the chattel. The test is what a reasonable person would consider to be the reason for attaching the item to the land.
On this point, Hon'ble Supreme Court in the landmark case of Municipal Corporation of Greater Bombay & Ors v. Indian Oil Corporation, (1991) 2 SCC 18 = 2002-TIOL-202-SC-PT, considered an issue as to whether a petrol tank which was resting on earth on its own weight (without being fixed with nuts and bolts) could be considered to be erected permanently without being shifted from place to place. The Apex Court recognised that the test was one of permanency. It was stated that if the chattel was movable to another location for use in the same position then the chattel would be movable property. However, if the movement of the chattel was possible only on dismantling and re-erecting the same, the chattel is said to be attached to the earth.
Hon'ble Apex Court in the case of CCE v. Solid & Correct Engineering Works - 2010-TIOL-25-SC-CX, placed reliance on some of the above discussed judgements and examined as to whether Asphalt Drum Hot Mix Plant assembled at site should be treated as movable property. The Apex Court held that the machines in question were, by their very nature,intended to be fixed permanently to the structures which were embedded in the earth. The structures were also custom-made for fixing of such machines without which the same could not become functional.The machines thus becoming a part and parcel of the structures in which they are fitted were no longer moveable goods. It was in those peculiar circumstances that the installation and erection of machines at site were held to be by this court, to be immovable property that ceased to remain moveable or marketable as they were at the time of their purchase.
An application of the tests enumerated above would elucidate the repercussions under the GST Regime. For this purpose, we shall consider an illustration where Entity X requires a machine to be installed at their factory. X reaches out to Y for this purpose, whereby, X and Y enter into composite contract for the supply of the machine and the services of testing, installation and commissioning. It is recognised that the rate of tax applicable to the machine supplied is 28% and the rate of tax applicable on the services of testing, installation and commissioning is 18%. The parties are then left in a fix as to which rate of tax has to be adopted considering the contract is a composite one for the supply of both goods and services and Works Contract as such attract only 18% tax.
The answer to this question depends upon whether the scope of work undertaken under the contract can be said to be a works contract service. In this regard, it is requisite to examine whether the aforesaid trinity of conditions, stands satisfied.
No doubt the scope of work in case of contract entered into for the supply of a machine also involves services like that of testing, installation, commissioning etc. along with the transfer of property in the equipment required for setting up the machine. Therefore, the first two conditions discussed above stand satisfied and what needs to be seen is whether the system results in the existence of an 'immovable property', thereby satisfying all requirements under GST for a works contract service.
In order to determine whether the machine is an immovable property or not, the tests of Object of annexation and Mode/Degree of annexation needs to be applied to the case at hand.
Firstly, we need to understand the motive behind setting up the machine. No doubt that X wants to procure the machine to ensure a permanent provision in his factory that would enable X to continue his production process without hindrances. This fact placates the test of object of annexation laid down by the Courts as elucidated above. Secondly, the machine is such that it can be affixed to earth through nuts and bolt. If the machine can be removed and re-located from one location to another without any substantial damage to the equipment, it can be argued that the test of degree of annexation also stands satisfied.
Applying the aforementioned tests to the hypothetical situation considered above upon taking into account factors like that of weight of the equipment, permanency, mobility without causing substantial damage etc. it can be said that the machine installed by Y in X's premises results in an immovable property, thereby satisfying the last test laid down by the definition of the term 'Works Contract' under GST. Since the supply provided by Y also involves services like that of erection, installation, repair etc. along with the transfer property in goods which result in an immovable property, the activity can be said to be a Work Contract which is deemed to be a composite supply of service under Schedule II of the CGST Act, 2017.
The factors to be taken into consideration in order to determine whether a particular equipment is immovable property or not is no doubt subjective in nature and may vary on a case to case basis depending upon the nature of the system under consideration. Further, the question as to whether the twin tests of object and degree of annexation have to necessarily be collectively satisfied is open to interpretation. Thus, there is a requirement to study every project undertaken on a case to case basis in order to determine the implications of GST on the same.
In conclusion, the law is not free from doubt and the impact on several industries could be gigantic. It would not be completely erroneous to say that the situation is even chaotic. But that said, just as the Nobel laureate José Saramago put it, 'Chaos is merely order waiting to be deciphered'.
(The authors are Associates with Lakshmikumaran and Sridharan, Chennaiand the views expressed are strictly personal.)
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