JANUARY 29, 2008

By S Sivakumar

THE latest TRU Circular would seem to have generated a lot of heat, which is unprecedented, if the opinions that are getting expressed thro 'TIOL, is any indication. I had an opportunity to discuss some of the aspects of this Circular with Mr K S Ravi Shankar, one of the well known and most widely respected experts in indirect taxation, and incidentally, my gur. I thought it fit to share some of these issues, which have wide ramifications from the point of levy of service tax on works contracts and especially those involving the construction industry.

A. Service tax on Composite Works Contracts

1. Levy of service tax on composite contracts and especially, construction contracts has been a subject matter involving a lot confusion.. Though we have had the Supreme Court holding in CCE, Vadodara vs M/s Daelim Industrial Co. Ltd [2004-TIOL-66-SC-ST] that a composite contract cannot be vivisected for purposes of levy of service tax, the Government has been busy bringing in several categories of composite contracts into the service tax net. In terms of the construction industry, it was firstly, Commercial or Industrial Construction Services which were subjected to service tax from September 10, 2004. Levy of service tax on 'Construction of Complex'services followed, with effect from June 16, 2005. A new category of taxable service was added on June 1, 2007, in the form of levy of service tax on 'Works Contractors'. While one can debate if the Government was empowered to levy tax on composite contracts at a time when the Supreme Court's decision rendered in Daelim's case is still binding, one cannot perhaps deny the fact that the Government intention was to vivisect composite contracts for levying service tax.

2. Look at the way the Government has sought to justify the levy of service tax on composite contracts'. In its Post-Budget clarificatory circular dated May 22, 2007, this is what the Board said in Para 9.1..

'9.1Works contract is a composite contract for supply of goods and services. A composite works contract is vivisected and,-

(i)VAT / sales tax is leviable on transfer of property in goods involved in the execution of works contract [Art.366(29A)(b) of the Constitution of India], and

(ii)service tax will be leviable on services provided in relation to the execution of works contract.'

It is very clear that the Government's view at the time of introduction of the service tax levy on works contracts was that, a composite works contract should be vivisected for levy of service tax on the component pertaining to services.

3. Look at what the same Board says, in its latest famous or infamous Circular, while justifying the denial of the benefit of the Composition Scheme in respect of on-going contracts as of June 1, 2007:

'Vivisecting a single composite service and classifying the same under two different taxable services depending upon the time of receipt of the consideration is not legally sustainable'.

With limited skills in the wonderful English language, I am not able to exactly read the Government's mind, in terms of the contradictory views expressed in the two Circulars. Is the Government saying that it will vivisect a composite works contract for purposes of levying service tax, but will not allow vivisection of a 'composite service'for the purpose of extending of a benefit intended to be given to the tax payer by the Legislature'. As tax payers, are we to assume that the Government, in the course of the last seven months or so, since its earlier Circular dated May 22, 2007, has changed its mind and is currently of the view that no vivisection is possible for purposes of service tax. AND CONSEQUENTLY, CAN WE NOW ASSUME THAT THE GOVERNMENT'S VIEW ON NON-VIVISECTION COULD LEAD TO A SITUATION OF WORKS CONTRACTORS NOT BEING HELD LIABLE FOR SERVICE TAX?

5. The view that no service tax can be levied on works contracts related to construction of immovable properties gets further strengthened by the usage of the words in the latest TRU Circular, which are reproduced below.

'Commercial or industrial construction service or works contract service is an input service for the output namely immovable property. Immovable property is neither subjected to central excise duty nor to service tax'.

A plain reading of these words clearly reflect the view of the Board that commercial or industrial or works contract services are input services for the output, viz. 'immovable property'. These words no further clarification as it is well known that both the 'input services'and the 'output services'pertain to the same 'immovable property', which the Board has very rightly held to be neither goods nor services. Now, how can any service used for creating immovable property, which is outside the purview of the central levies, be subjected to service tax, is the question. Given the view of the Government expressed in its latest Circular, it would look like no service tax can be charged on any service resulting in the creating of or related to an immovable property. This would lead to a view that no service tax is payable by service providers under the heads 'Commercial or Industrial Construction'services and 'Construction of Residential Complex'services, as these result in the output, namely, immovable property.

Writing in TIOL earlier, I had written that, based on the view expressed in the Circular. one could take a view that no service tax can be levied on 'Renting of Immovable Property'services.

B : Extension of the benefit of Composition Scheme to on-going contracts

6. I can't understand behind the usage of the words 'composite service'in the Circular. In terms of several CESTAT decisions, a 'composite service'means a combination of different taxable services. Now, how could the same service falling under different heads could be called a 'composite service'is any body's guess. Perhaps, the words 'composite service'are used synonymously with the words 'composite contract'. That the Board is confused between 'composite contracts and 'composite service'is evident in terms of the wordings used in the TRU Circular. While replying to a query on whether the benefit of the Composition Scheme could be extended to on-going composite contracts as of June 1, 2007, the Circular repeated talks of 'composite service'.

7. The Circular justifies its view to deny the benefit of the Composition Scheme in respect of on-going contracts, by using the following words:

'a service provider who paid service tax prior to 01.06.07 for the taxable service, namely, erection, commissioning or installation service, commercial or industrial construction service or construction of complex service, as the case may be, is not entitled to change the classification of the single composite service for the purpose of payment of service tax on or after 01.06.07 and hence, is not entitled to avail the Composition Scheme'.

These wordings are opposite to the wordings used by the same Board, in its earlier circular dated May 22, 2007, which had clearly indicated the right of an assessee to change the classification of his service, following the introduction of the 'Works Contractor's services'. The wordings used in the May 22, 2007 Circular are reproduced below:

'9.8 Presently, erection, commissioning or installation service [section 65(105)(zzd)], commercial or industrial construction service [section 65(105)(zzq)] and construction of complex service [section 65(105)(zzzh)] are separate taxable services.

9.9 Various trade and industry associations have raised apprehension in respect of classification of a contract either under the newly introduced works contract service or under erection, commissioning or installation and commercial or residential construction services'.

Now, are we to assume that the Board, having taken the view in May 2007 that service providers providing services under the existing heads like Commercial or Industrial Construction Services could change their classification to the newly introduced head, viz. 'Works Contractor's services'has now completely changed its mind and is of the view that such a reclassification is not possible and hence, the benefit of the Composition Scheme cannot be extended to on-going contracts?

C: Under what provision are these Circulars being issued?

8. One wonders under what provisions of law, these Circulars are being issued. As is well known, Section 37B of the Central Excise Act is made applicable by Section 83 of the Finance Act 1994, in respect of Circulars issued by the Board in respect of service tax. It was customary for all Circulars from the Board to refer to Section 37B of the CE Act. Now, this practice seems to have been given a go-by as there is no mention of Section 37B in the latest Circular. In terms of the two important Master Circulars issues on August 23, 2007, only one of them, i.e. Circular No. 97/2007 talks of Section 37B. Are we then to assume that the other Circulars which do not specifically mention Section 37B, including the latest one, are not issued under Section 37B of the CE Act and consequently, have no legality and have therefore to be ignored by the assessees.

The Board is clearly caught on the wrong foot. With more things continuing to come out of the proverbial Pandora's Box, it's clearly busy season ahead for advocates and consultants.

(The author is Bagalore-based Director of S3 Solutions)