Taxability of Works Contract Under VAT & Service Tax

Taxability of Works Contract Under VAT &Service Tax

STUDY ON TAXABILITY OF WORKS CONTRACT UNDER VAT & SERVICE TAX

In order to constitute a works contract, two basic cumulative conditions need to be satisfied,

i) there must be a transfer of property goods involved in the execution of specified works contract,

ii) Such transfer is leviable to tax as sale of goods under the relevant Sales Tax / Vat Laws.

Position under Vat:

Ordinarily all types of indivisible works contracts for supply of material and application of labour are liablefor wct vat under the MVAT Act, 2002. However, if the contract is divisible into material and labour, then itwill be a contract of sale and supply of labour. It will not amount to be a works contract. Under the Mvat Act,2002, three options are given to the assessee. The rate for specified construction contracts is 5%, other thanconstruction contracts, the rate will be 8% or at the scheduled rate of goods of 5%, 8% or 12.5% as the casemay be. The option of choosing the rate of tax is left on the dealer executing the works contract.

Section 42(3) of the MVAT Act, 2002 specifies the rate of tax for construction contracts @ 5% on the fullvalue of the contract with the rider that only 1% set off will be available to the dealer. In case the dealer optsfor 8% tax on the full value of the contract, then 64% set off will be available from the full set off and 36%will be the retention of set off.

Rule 58 of the MVAT Rules 2005 provides a deduction / reduction for all services / labour portion and tax willbe needed to levy on the material portion as per the rates specified in Schedules C, & E of the Mvat Act,2002. In short tax will have to be levied at the specified rates as mentioned in the Schedules and not flat rateof 12.5% as some people understand. If this method is followed by the dealer, then full set off on thematerials involved in the execution of the works contract will be available to him.

Alternatively, if the dealer is unable to keep the record of the materials used in the execution of workscontract (construction of building), then a flat deduction of 30% of the full contract value will be allowed andvat @ 12.5% needs to be paid on the 70% of the full contract value. In such a scenario, the dealer will be

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entitled for full set off on the materials used in the execution of works contract. In case of any other contractas specified under Rule 58, a flat reduction of 25% is given for labour service component and specified ratesof tax is required to be paid on the material component. If specified rates are not possible, then full rate of75% is required to be paid on the total contract value. The validity of a hassle free composition rate of tax hasbeen upheld by the Supreme Court in the case of Mycoon Construction v/s the State of Karnataka (2002) 127STC 105 (S C)

Principal Contractor & Sub Contractor / Sub Contractors

The Mvat Act allows the Principal Contract either to execute the contract fully or either subcontract the sameto a subcontractor or subcontractors fully or partially. In such a situation, it shall be the liability of theprincipal contractor to pay the tax under the Mvat Act, 2002 to the Government. Alternatively, he cansubcontract part of the contract or fully subcontract the whole contract, and if the subcontractor undertakesto pay the tax, then the principal contractor will be exempt from paying tax as it is a single contract. Viceversa if the principal contractor undertakes to pay the tax, then the subcontractor is exempt from paying tax.

To avail this benefit, the following conditions need to be fulfilled:

In case the principal contractor undertakes to pay the tax, then Form 406 and Form 409 is required to beissued by the principal contractor to the subcontractor for claiming exemption. Similarly in case thesubcontractor undertakes to pay the tax, then Form 407 & Form 408 is required to be issued by thesubcontractor to the principal contractor for claiming exemption. This is a statutory requirement of law and incase this is not complied with, there will be a tax liability both on the principal contractor and thesubcontractor as the principle of joint and several liability comes into play as defined under Section 45 of theMvat Act, 2002.

Position under Service Tax

The Works Contract Services were notified for the first time by the Finance Act 2007 to be effective from1/6/2007.

Sub-clause (zzzza) of Section 65 (105) of the Finance Act, 1994 defines the taxable service in relation to theexecution of a works contract, excluding works contract in respect of roads, airports, railways, transportterminals, bridges, tunnels and dams.

The Explanation under this sub clause defines the works contract for this purpose as follows:


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For the purpose of this sub clause, works contract means a contract wherein

a) transfer of property in goods involved in the execution o such contracts is leviable as sale of goods (liableto tax under vat) and

b) such contract is for the purpose of carrying out

i) erection commissioning and installation of plant equipment or machinery.

ii) construction of new building or civil structure or a part thereof for the purposes of commerce or industry.

iii) construction of a new residential complex or part thereof.

iv) completion of finishing services in relation to ii) & iii).

v) turnkey & EPC projects.

The essential ingredients to constitute a works contract liable to tax as works contract services are as follows:

The service provided or to be provided in execution of works contract which satisfy the conditions asspecified in the Explanation above will be liable to works contract services under the Finance Act, 1994.

Para 9.1 of MF(DR) Circular No B1/16/2007-TRU dated 22/05/2007 clarifies as follows:

Works contract is a composite contract for supply of goods and services, A composite contract is vivisectedand vat / sales tax is leviable on the transfer of property involved in the execution of works contract videArticle 366 (29A) (b) of the Constitution of India and service tax will be leviable on services provided inrelation to the execution of works contract.


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Further Para 9.10 of the aforesaid Circular clarifies as under:

Contracts which are treated as works contract for the purposes of levy of vat / sales tax shall also be treatedas works contract for the purposes of levy of service tax. This is clear from the definition under section 65(105) (zzzza) of the Finance Act, 1994.

Service Tax under Composition Scheme.

The rate of service tax on works contract services is 4.12% (including cess) of the total contract value.

According to the Service Tax (Determination of Value) Rules, the service tax on works contract can also bepaid on the value of the services component, after determining the value adopted for vat purposes for the levyof vat. Supposing the value of the total contract is Rs 100/- Under Rule 58 of the Mvat Rules, 2002, vat canbe paid as per the scheduled rates of 5%, 8% or 12.5%. Once this value for vat is adopted, then the balancevalue of the contract becomes the assessable value and service tax @ 10.3% may be paid on the balanceamount.

An assessee has the following four options to pay vat and service tax under a works contract.

1) Pat vat / sales tax under composition scheme @ 5% in case of specified construction contract and 8% inother contract and service tax @ 4.12% under composition scheme.

2) Pay vat / sales tax under composition scheme and service tax @ 10.3% on actual labour servicecomponent.

3) Pay vat / sales tax on actual scheduled rates of goods @ 5%, 8% or 12.5% and service tax @ 10.3% onactual labour service component.

4) Pay vat / sales tax on actual scheduled rates of goods @ 5%, 8% or 12.5% and service tax undercomposition rate @ 4.12%

Value of taxable services


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The value of taxable service shall be the gross value excluding vat but including all items of materialcomponent as well as labour service component.

Cenvat Credit on Inputs, Input Services & Capital Goods

There is restriction in availing service tax credit on inputs in both the cases where the assessee pays servicetax at actual or under composition scheme.

The assessee can avail service tax credit on input services directly related to the provision of works contractservices. Common input services credit need to be avoided as now there is a restriction to avail such creditunder the Cenvat Credit Rules, 2004.

Regarding capital goods, as per Rule 2 (a) of the Cenvat Credit Rules, capital goods really means the goodswhich are used for providing output service and not those used in or while providing taxable services.

Secondly if a subcontractor pays service tax on the total contract value after availing the input credit, then theprincipal contractor can avail credit only to the extent of 40% of such credit.

General Exemptions

Full exemption of service tax has been granted to the following recipients provided by a service provider.

a) Services provided to United Nations or an International Organization declared by the Central Govt.

b) Services provided to a developer of SEZ or to a SEZ unit subject to certain conditions.

c) Value of materials or goods sold by the service provider to the recipient of the service provided that noCenvat credit has been taken on such inputs, and if such cenvat credit has been taken, the same needs to bereversed before effecting the sale.

Specific Exemptions


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Following are the specific exemptions :

1) Construction and works contract services relating to ports exempt only upto 1.7.2010, but no exemption tofinishing or repairing services

2) Works relating to roads, bridges, tunnels, dams, airport, etc.

3) Construction of canals for government agencies.

4) Exemption to works contract services provided within airport.

5) Exemption to works contract service provided within port or other port.

6) Exemption to works contract services provided for specified construction services in relation to specifiedprojects.

Source : www.anpllp.com -


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Taxability of Works Contract Under VAT & Service Tax

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