Works Contract - Main Contractor - Sub Contractor - Who should pay Service Tax?
RESPONDING to our story on the subject yesterday, a leading lawyer who is an expert in VAT, mailed to me, "Take a case where A Ltd would take up a project for Rs 1,000 Crores and outsource it entirely for Rs 750 Crores to a sub contractor, say B. Now Govt will get ST on Rs 750 Crores and not 1000 crores." - well that seems to be the position.
There was a similar situation in the case of Larsen & Toubro Ltd before the High Court of Andhra Pradesh -
To put it in simple terms, there are three parties here.
1. Employer who has entrusted a works contract to the main contractor
2. Main Contractor - in this case L&T
3. Sub contractors, to whom the main contractor has entrusted the work.
The question before the High Court was, "who should pay VAT?" - the Contractor or the sub contractor or both.
Whether in a transaction of entrustment of a works contract by the contractor to the sub-contractor, there is one taxable event under the VAT Act or two.
Revenue argued that there are two deemed sales - one from main contractor to contractee and the other from sub-contractor to the main contractor.
The High Court observed,
The sub-contractor is only an agent of the contractor and the property in goods passes directly from the sub-contractor to the employer and therefore there can only be one sale.
To hold that there are two taxable events in such a transaction, enabling the State to levy and collect tax both from the sub-contractor and the contractor in our view would be violative of Article 14 also for the reason that wherever a contractor executes a works contract himself without employing the sub-contractor the deemed sale of goods involved in such execution of works contract would attract the tax only once and whenever the contractor employs a sub-contractor, the transfer of property in the same goods involved in the execution of such works contract attracts the tax twice over, which in our view is plainly irrational and violative of Article 14 of the Constitution of India.
We reported this case in November 2006 and in our analysis we mentioned, "Similar situations will crop up in Service Tax matters also where the contractors and sub contractors are providing the same service. Will the same logic apply to Service Tax?"
This case did not attract much attention in Service Tax.
Two years later the Supreme Court upheld the AP High Court's judgement. We reported this case as
Noting that "works contract" involves transfer of property and also element of service or work rendered, the Supreme Court held that even if there is no privity of contract between the contractee and the sub-contractor that would not do away the principle of transfer of property by the sub-contractor by employing the same on the property belonging to the contractee. This reasoning is based on the principle of accretion of property in goods.
Reporting the Supreme Court in August 2008, we again asked, "Now will this have any implications in Service Tax?" Again it did not attract much attention.
Service Tax litigation in Works Contract Service was just brewing.
In the IVRCL case - the Counsel heavily relied on the Supreme Court Judgement, but the Tribunal did not make any comments.
In Bhayana Builders case - also, the Counsel relied on the Supreme Court Judgement - again, no comments from the Bench.
In the Ramky case - the Counsel made a strong plea thatthe transfer of property in goods used in the execution of such contracts was from the sub-contractors to the Government and not from the appellant to the Government and therefore the execution of such contracts would not be covered by the definition of "works contract". The Tribunal did not accept this argument for two reasons:
1. this plea was not raised by the appellant in their reply to the show-cause notice or in their subsequent written submissions filed before the adjudicating authority. Therefore this plea cannot be entertained at this stage.
2. the definition of "works contract" does not stipulate that, where the contracts were executed by the contractor through a subcontractor, there should be transfer of property from the contractor directly to the contractee (service recipient). To our mind, it is enough if transfer of property in goods is involved in the execution of the contract and the same is exigible to sales tax as is the case under consideration.
This was totally against the Supreme Court Judgement, but strangely it appears that the Supreme Court Judgement was not brought to the notice of the Tribunal.
A Single Member Bench of the CESTAT in the case of Akruti Projects - 2014-TIOL-1925-CESTAT-MUM followed the judgement of the Supreme Court in a recent order and held that the sub-contractor was not liable to pay Service Tax.
And in the order delivered by the Circuit Bench of the CESTAT at Hyderabad on 02.02.2015, which we reported yesterday (2015-TIOL-342-CESTAT-HYD), the facts were:
The appellant-petitioner was the principal contractor and had entered into agreement with the Irrigation and Command Area Development (I & CAD) Department of Government of Andhra Pradesh for rendition of the works contract. The appellant entered into "Back to Back basis" agreements with sub-contractors. The total works were executed under the 'back to back basis' agreements entered into between the respective sub-contractors and the appellant-petitioner.
The Tribunal observed, "The Supreme Court clarified that in a construction works contract, the property used in the construction of a building/project passes from the builder to the owner of the land on which the building is constructed when the goods or materials used are incorporated in the building and that is so, even if there is no privity of contract between the contractee and the sub-contractor, since the deemed transfer of property in goods is based on the principle of accretion of property in goods. On the basis of the law declared by Hon'ble Supreme Court supra, it prima facie appears that no 'works contract service' was provided by the appellant to the Government of Andhra Pradesh since it was the sub-contractors who transferred the property in goods to the State Government by the process accretion of such goods into the property of State Government, during execution of works contract by the sub-contractors."
Though, it is a Stay order, it is a path breaking one and has clearly and precisely imported into Service Tax, the ratio of the judgement of the Supreme Court in L&T which was a VAT case.
Now coming back to the issue mentioned in the beginning as agitated by my lawyer friend - "Take a case where A Ltd would take up a project for Rs. 1,000 Crores and outsource it entirely for Rs 750 Crores to a sub contractor, say B. Now Govt will get ST on Rs. 750 Crores and not 1000 crores."
Yes Sir, that is what the Supreme Court said in relation to VAT and that is what the CESTAT said (though in a Stay Order) in relation to Service Tax - because the transfer of property took place between the sub-contractor and the contractee (employer) and there was only one deemed sale and so only one works contract service - for the amount of Rs. 750 crores.
It is not as if the Service Tax is lost to the Government on the remaining Rs. 250 crores; it may fall under some other service, but not works contract service.
A VAT decision eminently usable in Service Tax - GST in the pipeline!