3-D

Lao Tzu said The key to growth is the introduction of higher dimensions of consciousness into our awareness. Thinking about an issue only from one-dimension may result in faulty action. This is also true for indirect taxes. One has to think from all points of view to get the best answer. This column attempts to discuss various issues pertaining to indirect taxes from all the three dimensions i.e. Central Excise, Service Tax & VAT. FREE SUPPLY IN CONSTRUCTION CONTRACTS Many times contratee agrees to supply certain goods (steel and cement for instance) free of cost to the contractor during the execution of construction contract. This may be because contractee wants to ensure that proper quality of materials are used in construction or contractee wants to keep complete physical control on the goods or contractee can extract favourable terms from the supplier if it is directly purchased. This free supply poses valuation problems under indirect taxes. SERVICE TAX Under construction service, service provider has two options to discharge the tax liability. Either he can pay the service tax on the actual value of service or in case if he is unable to ascertain actual value of service, he can pay under composition scheme on total value. In case where service provider discharges liability on actual value of service there is no question of including value of free supply of materials as value of material is not subjected to service tax (it may be subjected to VAT (refer next article on VAT implications)). If service provider is not able to ascertain actual value of service he can discharge service tax under composition scheme on total value by claiming abetment/exemption. Question here is whether value of free supply has to be added to total value? BEFORE NEGATIVE LIST BASED REGIME Sec. 67 of Finance Act, 1994 provides mechanism for valuation of taxable service. Relevant provisions of Sec. 67(1)(i) & (ii) are reproduced for ready reference:
SECTION 67 Valuation of taxable services for charging service tax (1) Subject to the provisions of this Chapter, where service tax is chargeable on any taxable service with reference to its value, then such value shall, (i)in a case where the provision of service is for a consideration in money, be the gross amount charged by the service provider for such service provided or to be provided by him; (ii)in a case where the provision of service is for a consideration not wholly or partly consisting of money, be such amount in money as, with the addition of service tax charged, is equivalent to the consideration; Explanation. For the purposes of this section, (a)consideration includes any amount that is payable for the taxable services p rovided or to be provided

Thus Sec. 67(1)(i) will apply when consideration is in money and Sec. 67(1)(ii) will apply when consideration also includes anything in kind. Can free supply be considered as consideration in kind and thus included in total value? Hon. Supreme Court in case of Ku. Sonia Bhatia v. State of UP and others (AIR 1981 SC 1274) held that consideration means a reasonable equivalent for other valuable benefit passed on by the promisor to the promise. Free supply cannot be considered as a consideration to the service

provider as no part of the goods accrues to or is retained by the service provider. Service provider enjoys no benefit out of it. Hence free supply cannot be considered as a consideration. In such case value will be calculated as per Sec. 67(1)(i) wherein only money to be received will be considered in total value and not u/s 67(1)(ii). Hon. Delhi High Court in case of Intercontinental Consultants and Technocrats Pvt. Ltd. v. Union of India [2013 (29) STR 9] struck down Rule 5 of Service Tax (Determination of value) Rules, 2006 which purports to levy service tax on reimbursement amount as unconstitutional as what can be subjected to service tax u/s 66 & 67 is value for providing the service (quid pro quo) and not reimbursement. On this ground as well, value of free supply should not be included as it is not the consideration for providing the service. Initially notification no. 15/2004 provided for exemption of service tax in case of construction services which is in excess of thirty-three percent of gross amount charged. This notification was replaced by notification no. 1/2006 which provided for abetment of 67% of gross amount charged. An explanation was added to both the notifications which defined gross amount charged. It is reproduced for ready reference:
Explanation - For the purposes of this notification, the gross amount charged shall include the value of goods and materials supplied or provided or used by the provider of the construction service for providing such service.

As seen from above definition there is a conflict between the term gross amount charged appearing in Sec. 67(1)(i) and the Explanation. Explanation purports to add value of goods and materials supplied or provided or used by the provider to gross amount charged. Larger bench of Hon. Delhi Tribunal in case of Bhayana Builders (P) Ltd. v. Commissioner of Service Tax, Delhi [2013 (32) S.T.R. 49 (Tri. - LB)] held that value of free supply will not be included in gross amount charged under the said explanation. Reasoning of Hon. Delhi Tribunal is as under: 1) In case of ambiguity aid of noscitur principle of interpretation can be taken. Said principle posits that a statutory term is recognized by its associated words i.e. in an associated context, whereby the word or phrase is not construed as if stood alone but in the light of its surroundings. Hon. CESTAT relied on number of judgments approving the application of noscitur principle. 2) Words gross amount charged appears in the preamble/explanation of the notification no. 15/2004 has to be read along with the same words appearing in Sec. 67(1)(i). Words used by the provider appearing in the explanation will take colour from words gross amount charged. As per discussion in above paragraphs, value of free supply cannot be considered as a consideration u/s 67 and hence will not form part of gross amount charged even under the explanation. AFTER NEGATIVE LIST BASED REGIME Post 01/07/2012 service tax law is based on negative list. Sec. 67 as cited above which deals with valuation of service remains the same under the negative list regime. Hence even under present scenario, value of free supply cannot be considered as a consideration and thus will not form part of total value. Rule 2A of Service Tax (Determination of value) Rules, 2006 provides mechanism for determination of value of service portion in execution of works contract. Rule 2A(i) provides for determining actual value of service by deducting value of goods involved in execution of works contract. Value of free supply will not form part of it as it excludes value of goods. Under this option service tax is to be paid on actual service charge. If the service provider is not able to ascertain actual service charge,

composition scheme provided under Rule 2A(ii) will apply. Said sub-rule is reproduced for ready reference:
RULE 2A(ii)Where the value has not been determined under clause (i), the person liable to pay tax on the service portion involved in the execution of the works contract shall determine the service tax payable in the following manner, namely :(A)in case of works contracts entered into for execution of original works, service tax shall be payable on forty per cent of the total amount charged for the works contract; (B)in case of works contract entered into for maintenance or repair or reconditioning or restoration or servicing of any goods, service tax shall be payable on seventy per cent of the total amount charged for the works contract; (C)in case of other works contracts, not covered under sub-clauses (A) and (B), including maintenance, repair, completion and finishing services such as glazing, plastering, floor and wall tiling, installation of electrical fittings of an immovable property, service tax shall be payable on sixty per cent of the total amount charged for the works contract;

Explanation 1 to said Rule defines total amount as under:

(b) total amount means the sum total of the gross amount charged for the works contract and the fair market value of all goods and services supplied in or in relation to the execution of the works contract, whether or not supplied under the same contract or any other contract, after deducting(i) (ii) the amount charged for such goods or services, if any; and the value added tax or sales tax, if any, levied thereon :

Provided that the fair market value of goods and services so supplied may be determined in accordance with the generally accepted accounting principles.

Whether value of free supply can be construed as goods supplied in or in relation to the execution of works contract and thus will form part of total value as per above explanation? According to our view free supply should not form part of total value due to following reasons: 1) Sec. 67 of Finance Act, 1994 provides that service tax shall be charged with reference to its value and value shall be gross amount charged if entire consideration is in money. Larger Bench of Hon. Delhi Tribunal (supra) held that gross amount charged will not include value of free supply. Even assuming that Rule 2A(ii) provides for inclusion of value of free supply, Rules cannot override the Act. Legislators should have amended Sec. 67 along with introduction of Rule 2A(ii) to make it effective. Rule which overrides the Act cannot be followed. 2) Rule 2A(i) provides for determination of value of service portion in the execution of works contract by allowing the deduction of actual value of goods on which VAT is paid from gross amount charged. As discussed in above judgment of Larger Bench gross amount charged will not include value of free supply as it is not a consideration. Rule 2A(ii) starts with words where the value has not been determined under clause (i) value shall be determined under composition scheme mentioned therein. One will take recourse to composition scheme only if one is not able to segregate gross amount charged into value of service and value of goods. In this case logically one will pay tax on gross amount charged (without claiming any deduction of actual value of goods) less deemed value of goods (e.g. 60% in case of original works). If value of free supply is not included in Rule 2A(i), how can it be included in Rule 2A(ii).

3) Explanation 1 stated above provides for addition of fair market value of all goods and services less the amount charged for said goods and services. If the service receiver has charged for goods supplied by him it will form part of gross amount charged as service provider will include the value of same in his consideration. In such situation there was no need to add fair market value of said goods again to gross amount charged. Only interpretation possible is that in cases where amount charged for goods supplied by service receiver is less than fair market value, the difference has to be added to gross amount charged. This is to plug the loophole where service receiver used to under-value the goods supplied by him to lower the total amount. This will not apply to free supply as service receiver does not charge anything to service provider. Total amount will only be gross amount charged and that will not include value of free supply. CONCLUSION To conclude, value of free supply will not form part of total value under old as well as new negative list based regime. Aspects of free supply pertaining to VAT and EXCISE will be discussed in next article.