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Taxability of the Infrastructure sector under Negative List

Introduction
Since 2005 the service tax law was made applicable to the Construction sector its been smooth sailing for the infrastructure
sector. Construction of roads, airports, ports, Dam, non commercial structures etc were exempted from the levy of Service tax
on wholesome basis. Only certain service providers like Engineers, Consultants to these projects were made to pay the taxes.
Departments circular no. 147/16/2011-ST dated 21.10.2011 clarified this position very aptly.

This article is an attempt to analyse the taxability scenario for these infrastructure projects under the Comprehensive
Approach or Negative List based Service tax law. In my personal view there are some hidden demons which I will try to
analyse and put the same in public domain so that an informed debate on the same can take place.

Trade Practice of this Sector

First step for analyzing the taxability of any transaction is to understand the substance of the same. There are basically 2
models on which this sector works.

1. Government or Government appointed body gives a contract to a successful bidder (hereinafter referred to as
Contractor) who quotes the lowest Amount.
2. The contract is awarded to a concessionaire on BOT (Build Operate Transfer) basis. In this model the Contractor
does the work and raised periodical invoices to a government appointed body which after due verifications releases
the payments. Under this model the concessionaire has to construct the whole project as per the design and
specifications of the Government but the government does not pay him anything, instead the concessionaire gets a
right to use and grant access to others for which it can collect a government notified User Fee for a specified period
ranging up to 30 years or more. This model is a preferred mode and is popularly known as PPP model (Public Private
Partnership). Paucity of funds with the government and need for quality infrastructure is reason why Central as well
as State Governments are opting for this model.


Main thrust of this article would be to analyze taxability of BOT based models more than the traditional contracts.

Legal Abstracts
Before going into the taxability I would like to reproduce some legal abstracts from the Finance Act, 1994 and Mega Exemption
Notification 25/2012 which are relevant for the discussion:

66E (h) service portion in the execution of a works contract;

65B (54) "works contract" means a contract wherein transfer of property in goods involved in the execution of such contract is
leviable to tax as sale of goods and such contract is for the purpose of carrying out construction, erection, commissioning,
installation, completion, fitting out, repair, maintenance, renovation, alteration of any moveable or immovable property or for
carrying out any other similar activity or a part thereof in relation to such property

Mega Exemption Notification 25/2012
12. Services provided to the Government, a local authority or a governmental authority by way of construction, erection,
commissioning, installation, completion, fitting out, repair, maintenance, renovation, or alteration of -
(a) a civil structure or any other original works meant predominantly for use other than for commerce, industry, or any other
business or profession;

13. Services provided by way of construction, erection, commissioning, installation, completion, fitting out, repair, maintenance,
renovation, or alteration of,-
(a) a road, bridge, tunnel, or terminal for road transportation for use by general public;

29. Services by the following persons in respective capacities -
(h) Sub-contractor providing services by way of works contract to another contractor providing works contract services
which are exempt;

Taxability Analysis

To analyse the taxability of infrastructure projects I will take 2 live examples and operationally dissect them.

Example 1:
Construction of a Government Border Check Post under traditional contract method vis--vis under BOT (Build Operate
Transfer)

Government of Gujarat (GoG) wants to build 30 Border Check Posts (BCP) in Gujarat and issues a tender in that regards
wherein the contractor has to build the BCPs on turnkey basis.
There are 2 formats announced
a. One is where GoG will pay the contract amount to the contractor on periodic basis looking at the
construction done; and
b. Other is on BOT basis wherein the Concessionaire will be given a right to collect User Fee from all the
vehicles who visit the BCPs for the next 20 years.

A company named ABC Pvt Ltd bids and wins the contract for constructing the project BCPs for Rs. 100 crores.

It decides to do the work in following manner:


Please note that 10 Cr is the profit of DEF Ltd and sub contracting is worth 80 Cr.

TAXABILITY STUDY OF A CONTRACT UNDER TRADITIONAL SYSTEM

Transaction No. 1

GoG gives a Contract to ABC for 100 Crores.
Services provided by ABC to GoG are classifiable under Works Contract Services (WCS) because it has to construct the BCPs
on turnkey basis. Having done the classification lets analyse whether the same is exempt from the levy of service tax under
Mega Exemption notification 25/2012.

As per serial no. 12 (c) of the notification following conditions need to be satisfied for claiming exemption:

Condition
Condition Satisfied (Yes
/ No)
For ABC For DEF
Ltd
Services provided to
the Government, a
local authority or a
governmental
authority
Yes
ABC is
appointed
by GoG
hence it is
constructing
the BCPs
for the
Government
No
DEF is
appointed
by ABC and
hence is
providing
services to
ABC and
not GoG
By way of
construction,erection,
of
Yes
It is
constructing
the entire
BCPs
Yes
It is
constructing
the entire
BCPs
(c) a structure meant
predominantly for
use for non
commercial purposes
Yes
The
structure
being
constructed
is meant for
non
commercial
purposes
Yes
The
structure
being
constructed
is meant for
non
commercial
purposes

In case of ABC all 3 conditions are fulfilled hence the Contractual receipts in its hands will be exempt from Service Tax, but in
case of DEF Ltd only 2 conditions get satisfied hence he cannot avail the exemption under serial no. 12.

Transaction 2

ABC sub contracts the entire contract to DEF Ltd. for 90 Cr. Is he taxable?

As seen in the discussion foregoing paragraph DEF Ltd is not exempt under entry no. 12 of the said notification. The Board
under stood this issue and brought in entry no. 29 (h) which lays down exemption for sub contractors on fulfilment of certain
conditions as under


Sr
No.
Condition Condition
Satisfied (Yes /
No)
1 Sub-contractor Yes
DEF is
appointed by
ABC and hence
is a sub
contractor of
ABC
2 providing
services by way
of works
Contract
Yes
He has taken the
entire contract
on back to back
basis hence his
services to ABC
are also
classifiable
under WCS
3 to another
contractor
Yes
ABC is also a
contractor
4 providing works
contract
services
Yes
ABC is
providing WCS
to GoG
5 which are
exempt
Yes
Services in the
hands of ABC
are exempt


All Conditions of entry no. 29 (h) are getting satisfied in case of DEF Ltd hence the Contractual receipts of Rs. 90 Cr in its
hands will be exempt from Service Tax.

Transaction 3
Designing, architect and engineering Services are sub contracted for Rs. 5 Cr and they are not classifiable under Works
contract services hence they do not satisfy the second condition of entry no. 29 (h) as explained in above table, hence they will
not be exempt under the new law. They were taxable in the old law as well. They will have to pay a tax @ 12.36% on 5 Cr
which comes to Rs. 61.80 Lacs.

Transaction 4
DEF Sub contracts a work for construction of a Road (with material) for Rs. 50 Cr. Services for construction of road for general
public are exempt under entry no. 13 (a) of 25/2012, hence the same will be exempt.

But here the question will arise that which entry will apply to the person constructing a stand alone road entry no. 13
a is for person constructing road and entry no. 29 (h) is for a sub contractor. Here the company is indeed constructing
a road and it is a sub-contractor as well.

Transaction 5
DEF Sub contracts a work for construction of a building (with material) to XYZ Pvt Ltd. for Rs. 15 Cr. Services provided by XYZ
are classifiable under WCS and hence all conditions specified in entry no. 29 (h) get satisfied, hence entire contractual receipts
of XYZ will be exempt from levy of Service tax.

Transaction 6
Site formation and excavation work is sub contracted for Rs. 10 Cr to PQR Pvt Ltd. and they too are not classifiable under
Works contract services because site formation job does not involve any transfer of property in goods, hence they do not satisfy
the second condition of entry no. 29 (h) as explained in above table, therefore they will not be exempt under the new law. They
will have to pay a tax @ 12.36% on 10 Cr which comes to Rs. 1.236 Cr. They were taxable in the old law as well.

Considering the tax outflow in the entire contract it can be seen that total tax payable comes to Rs. 1.854 Cr


WHAT IF SAME CONTRACT IS EXECUTED ON BOT BASIS

Transaction No. 1

GoG gives a Contract to ABC wherein it will get a right to collect User fee from each vehicle visiting the BCPs for the next 20
years.

Under BOT contracts ABC is said to construct the BCPs for the government but the concessionaire keeps the right to grant
access for a specified period and there is no transfer of property in goods involved from ABC to GoG. After the lapse of the
predefined period the project gets transferred to the Government. As there is no transfer of property in goods from ABC to
GoG, there is no liability of VAT on ABC hence the contract cannot be classified under Works Contract Services (WCS).

As per serial no. 12 (c) of 25/2012 following conditions need to be satisfied for claiming exemption:

Condition
Condition Satisfied (Yes
/ No)
For ABC For DEF
Ltd
Services provided to
the Government, a
local authority or a
governmental
authority
Yes
ABC is
appointed
by GoG
hence it is
constructing
the BCPs
for the
Government
No
DEF is
appointed
by ABC and
hence is
providing
services to
ABC and
not GoG
By way of
construction, erection,
commissioning,
installation,
completion of
Yes
It is
constructing
the entire
BCPs
Yes
It is
constructing
the entire
BCPs
(c) a structure meant
predominantly for
use as a non
commercial
establishment
Yes
The
structure
being
constructed
is meant for
Non
commercial
purposes
Yes
The
structure
being
constructed
is meant for
Non
commercial
purposes

In case of ABC all 3 conditions are fulfilled, but there is no consideration flowing from GoG to ABC hence exemption will not
have any meaning.

Of course ABC will collect User fee from the visitors but that will be for granting Right to access the BCPs which is not exempt
under the new law. Section 66D (h) grants exemption to service by way of access to ROAD or BRIDGE.

66D. The negative list shall comprise of the following services, namely:
(h) service by way of access to a road or a bridge on payment of toll charges;

Hence User fee (inclusive of tax) collected by ABC will be taxable @ 12.36%. Assuming the user fee so collected to be 100 Cr.
over a period of 20 years, ABC will have to pay 11.00 Cr on reverse calculation.

In case of DEF Ltd only 2 conditions get satisfied as he is not providing services to the government, hence he cannot avail the
exemption under serial no. 12.

Transaction 2
ABC sub contracts the entire contract to DEF Ltd. for 90 Cr. Is he taxable?

As seen in the foregoing paragraph DEF Ltd is not exempt under entry no. 12 of the said notification. Does he satisfy conditions
of 29 (h).

Sr
No.
Condition Condition
Satisfied (Yes
/ No)
1 Sub-contractor Yes
DEF is
appointed by
ABC and
hence is a sub
contractor of
ABC
2 providing
services by
way of works
Contract
Yes
He has taken
the entire
contract on
back to back
basis hence
his services to
ABC are also
classifiable
under WCS
3 to another
contractor
No
ABC is not a
contractor, he
is a
concessionaire
4 providing works
contract
services
No
ABC is not
providing WCS
5 which are
exempt
No
Services in the
hands of ABC
are not exempt

3 Conditions out of 5 (of entry no. 29 (h)) are NOT getting satisfied in case of DEF Ltd hence the Contractual receipts of Rs. 90
Cr in its hands will be fully taxable @ 4.944% resulting into a tax outflow of Rs. 4.45 Cr. These services were exempt in the old
law.

Transaction 3
Designing, architect and engineering Services are sub contracted for Rs. 5 Cr and they are not classifiable under Works
contract services hence they do not satisfy the second condition of entry no. 29 (h) as explained in above table, hence they will
not be exempt under the new law. They were taxable in the old law as well. They will have to pay a tax @ 12.36% on 5 Cr
which comes to Rs. 61.80 Lacs. Albeit DEF will get credit of these services hence net outflow will remain same.

Transaction 4
DEF Sub contracts a work for construction of a Road (with material) for Rs. 50 Cr. Services for construction of road for general
public are exempt under entry no. 13 (a) of 25/2012, hence the same will be exempt.

Transaction 5
DEF Sub contracts a work for construction of an entire floor (with material) to XYZ Pvt Ltd. for Rs. 15 Cr. Services provided by
XYZ are classifiable under WCS. It satisfies 4 conditions out of 5. Last condition is not satisfied whereby the services provided
by DEF also must be exempt. Hence Services provided by XYZ will also be taxable. They were not taxable in the old law. They
will have to pay a tax @ 4.944% on 15 Cr which comes to Rs. 74.16 Lacs. Albeit DEF will get credit of these services hence net
outflow will remain same.

Transaction 6
Site formation and excavation work is sub contracted for Rs. 10 Cr to PQR Pvt Ltd. and they too are not classifiable under
Works contract services because site formation job does not involve any transfer of property in goods, hence they do not satisfy
the second condition of entry no. 29 (h) as explained in above table, therefore they will not be exempt under the new law. They
will have to pay a tax @ 12.36% on 10 Cr which comes to Rs. 1.236 Cr. They were taxable in the old law as well. Albeit DEF
will get credit of these services hence net outflow will remain same.

Considering the tax outflow in BOT model it can be seen that total tax payable comes to Rs. 11.00 Cr in the hands of ABC, and
Rs. 4.45 Cr in the hands of DEF Ltd. ABC will also not get credit of the tax paid by DEF because as per the definition of Input
Services Works contract services are excluded for persons providing services other than Works contract services. ABC is
providing services by way of access to use the BCPs and works contract services. So total outflow would be 15.45 Cr.

Question to answered here is did ABC make money the answer is no.

User fee Recd - 100 Cr (tax included)
Less: Amt paid to DEF - 94.45 Cr (tax included)
Profit - 5.55 Cr
Less: Tax paid by ABC - 11.00 Cr
Loss - (5.45 Cr)

Then who made money The Central Government!!!!


Sum and summation of the above is explained in the following table:

Service
Provider /
Service
Traditional BOT
ABC Ltd
(Main
Contractor)
Exempt
Taxable
Tax payable
Rs.11 Cr.
DEF Ltd
(Main Sub
Contractor)
Exempt
Taxable
Tax payable
Rs.4.45 Cr.
Design +
Architect
Exempt
Taxable
Tax payable
Rs.0.61 Cr.
Road Exempt Exempt
Building Exempt
Taxable
Tax payable
Rs.0.74 Cr.
Excavation/Other Taxable Taxable
labour contracts Tax payable
Rs.1.24 Cr.
Tax payable
Rs.1.24 Cr.
Total Net Tax
Outflow
Rs.1.24 Cr. Rs.15.45 Cr.



What if the same was a Road project where BOT model is a preferred route?

Service
Provider /
Service
Traditional BOT
ABC Ltd
(Main
Contractor)
Exempt Exempt
DEF Ltd
(Main Sub
Contractor)
Exempt Exempt
Street Lights
/ other
similar
works
Exempt Exempt
Protection
work
Exempt Exempt
Building Exempt Exempt
Excavation /
any other
labour work
(assumed to
be Rs.30
Cr.)
Taxable
Tax payable
Rs.3.71 Cr.
Taxable
Tax payable
Rs.3.71 Cr.
Total Net
Tax
Outflow
Rs.3.71Cr. Rs.3.71Cr.


It can be seen that in case of road there is not much of a difference in taxability between traditional and BOT based
contracts. But the exemption which was there earlier for site formation and other labour jobs earlier seems to be
withdrawn, hence its a back door way of taxing the infrastructure sector which will hit the razor thin margins of the
companies operating in this sphere.

Conclusion
Better Infrastructure is and should be priority area for the Government and taxing the same on a back door basis would create
unwanted confusion in the industry already ridden with many other operational and fiscal issues. Coupled with the fact that
taxation under reverse charge mechanism will hit them hard as majority of the sub contractors who are the back bone of this
sector are constituted under non corporate format.
Following issues need to be clarified by the department:

Clarification given in educational guide under point no. 6.2.5 saying that under BOT the ownership of the project lies with the
concessionaire and hence the said projects will be taxable seems to be factually wrong and needs to be revisited. The
Concessionaire is not the owner of the project by any means, he is just the constructor of it and as the government does not
pay it upfront due to fiscal issues, it transfers its right of collection of toll to the concessionaire for a pre-determined period. It
is rather a deferred method of making the payment more than anything else. This is demonstrated by the fact the user fee is
notified by the concerned governments and the concessionaire has no right to collect a single paisa more than the amount
being notified.
Entry no. 29 (h) is a bit harsh as demonstrated in above example on genuine service contracts which ideally are a necessity
for execution of the infrastructure project. Site formation, Excavation, utility transfers, laying jobs, digging, boring etc cannot
be classified as works contract as no material passes hands. Hence they will never satisfy the conditions inscribed in the
entry. The entry must be made more benevolent and status quo with situation pre 1.07.2012 must be maintained.
Reverse charge must be mandatory for those companies only which are having a turnover above 10 Crores as many small
and medium corporates are not having the requisite infrastructure to cope with the rigours of RCM. In my belief the field
offices of the department are already overburdened and this will make compliances near impossible to attain.
Law should be structured in a way that compliance becomes hassle free and tax should not be felt as a burden. Infrastructure
sector needs tax free status for some more time to come and back door taxation is not the solution. If need be tax it upfront and
without confusions.

Nitesh Jain
Chartered Accountant.
www.niteshjain.co.in

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