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INTRDUCTION

A works contract is an agreement which is a mixture of service or


labour and transfer of goods. Under a works contract the contractor agrees
to do certain job in execution whereof, certain goods are transferred to the
contractee. A contract for carrying out any work which includes assembling,
construction, building, altering, manufacturing, processing, fabricating,
erection, installation, fitting out, improvement, repair or commissioning of
any movable or immovable property is a works contract. In relation to a
works contract only that part of consideration which represents transfer of
property in the goods involved in execution of the works contract, shall be
taxable.
Where the works contract is in the nature of a taxable SERVICE,
service tax will be liable on the value of such contract.
Where goods are transferred and form integral part of the execution of
such contract, VAT would be liable on such value of contract.
[

MEANING OF WORKS CONTRACT IN TN VAT


A contract is defined as: "an agreement made between two or more
parties which is enforceable by law to provide something in return for
something else from a second party". The essential elements of contract are
competent parties, proper subject matter, consideration, agreement, proper
form, consent of the parties.
Section 2(43) defines as Works Contract includes any agreement for
carrying out for cash, deferred payment or other valuable consideration,
building

construction,

manufacture,

processing,

fabrication,

erection,

installation, fitting out, improvement, modification, repair or commissioning


of any movable or immovable property.
The act has not given the exact and exclusive definition but the
definition specifically includes the activities/ nature of transactions covered
under the Works Contract. In the absence of the exclusive definition for the
words/ phrase Works Contract one need to refer the definition of works
contract

under

the

General

Clauses

pronouncements from time to time.

Act

and

relevant

judicial

VAT ASPECTS OF WORKS CONTRACT


Contractor can discharge VAT on value of materials incorporated
under the following three options:
i. Regular Method: Under Regular Method, material value can be arrived by
following methods

Value Deduction Mode (or)

Value Addition Mode

Value Deduction Mode


Under this mode, taxable value of materials will be arrived after
allowing the deductions towards labor charges; payment to Sub-contractor
for labor/services; charges for planning, designing & architect; Charges for
obtaining on hire the machinery & tools; cost of consumables such as water,
electricity, fuels etc., and other similar expenses or cost of establishment
relatable to supply of labor/services.
Tax is payable at applicable rate to those taxable materials under
State VAT Tariff. State can also levy uniform rate of tax on value of materials
incorporated in work under a separate item in Tariff and such rate may be
different from applicable rate to materials individually. States like Assam,
Delhi, Karnataka, Kerala, West Bengal etc., have specified a uniform rate on
materials other than Declared Goods as specified under CST Act,1956.
Value Addition Mode
Under this mode Contractors can arrive material value by adding cost
of

goods,

cost

of

conversion

and

all

other

expenses

such

as

loading/unloading, transport etc., plus margin of profit on them.


Tax cost will be less under Regular Method when compared to other
options since VAT is payable only on actual value of materials incorporated
in the work after adjustment of VAT Input Credit. However, Contractor has to
maintain proper books of accounts and other records to identify value of
materials and labor.

ii. Composition Method


Composition Scheme is simple and convenient for Contractors who
cannot maintain proper accounts. Under this method tax is payable on total
contract value including labor at specified lumpsum rate. In States like
Karnataka, Tamilnadu, Orissa, Delhi etc., Composition Option is to be
exercised for all Works Contracts executed during financial year and not
permissible to opt each contract wise. VAT Input Credit is not available
under this option except in Maharashtra State. Purchase tax is payable in
States like Kerala, Karnataka etc., on interstate purchases but deduction of
such turnover is allowed from total turnover and tax is payable on balance
turnover only. Composition Option is not permissible in States like Gujarat,
Himachal Pradesh, Tamilnadu etc if goods are imported from outside State.
Composition Method may be opted where contract price is inclusive of taxes
and consisting of substantial portion of materials value with marginal
element of labor/services.
iii. Standard Deduction Method
Standard labor deductions are prescribed under VAT Laws to arrive at
taxable value based on type of contract. Tax is payable at the specified rate
on taxable value arrived after standard labor deduction in States like
Andhra Pradesh, Jharkhand, Punjab, Assam etc., whereas at applicable VAT
rates of such goods in other States like Gujarat, Rajasthan, Maharashtra,
Uttar Pradesh, Tamilnadu etc. However VAT input credit is available under
this method in most of States except in few States like Andhra Pradesh,
Jharkhand & Punjab. Tax cost is high under this option and hence not
advisable to adopt it.
DIFFERENCE BETWEEN (I) VALUE OF THE WORKS CONTRACT UNDER
THE FIRST METHOD AND (II) TAXABLE TURNOVER UNDER THE
SECOND METHOD - (composition and non-composition method)
The total consideration received or receivable in future in respect of
the works contract agreement, accounted under the regular accounting
practice of the dealer whether on Mercantile or an accrual basis. To say the
value received plus receivable plus escalation if any due in future is called
Value of Works Contract.
3

The Taxable Turnover means, the value of the works contract adjusted
by the component of exempted goods and services included or inbuilt in
execution of the works contract. To cover an example(s) is/are: labour
charges paid on execution of the civil works, equipments or apparatus
covered under Part-B of Fourth Schedule (Sec. 15). It is to be noted that the
value of VAT charged in the Invoice is not part of the value of the works
contract.

ASSESSMENT OF TAX LIABILITY ON TAXABLE TURNOVER


The dealer is liable to pay tax at the rates specified in the First
Schedule on the taxable turnover. If the inputs/ purchases for execution of
the projects are covered by more than one tariff category/ group of goods
and services fall under more than one rate of tax, then the taxable turnover
is divided in to more than one group in the same ratio of the inputs
category/ group.

Now the splitted taxable turnover be charges on the

respective tax rates as per the first schedule to arrive the tax payable.
[[

Illustration:
Dealer

Company

has

accepted

an

assignment

of

Design,

Development, Commissioning of sewerage water treatment plant from Govt.


department B for a consideration of Rs.100 lakhs plus applicable VAT. In
this case the contractor company A has spent labour expenses in
construction a sum of Rs.32.00 lakhs, Design charges a sum of Rs.1.50
lakhs, Purchase of Pumps from the dealer situated in other state a sum of
Rs.10.00 lakhs, Purchase of Pumps & motors from the dealer situated
within the state a sum of Rs8.50 lakhs, Purchase of cements from the dealer
situated within the state a sum of Rs.8.50 lakhs, Purchase of bricks, blue
metals etc from the dealer situated within the state a sum of Rs.8.50 lakhs
and Purchase of Electrical goods from a dealer situated outside the state a
sum of Rs.7.00 lakhs and dealer situated with in the state a sum of
Rs.15.00 lakhs. Based on this stimulated datas lets assess the tax liability
of the dealer to the VAT authorities.
(1) If the dealer wishes to pay tax on composition/ first method, the
tax payable is 5% on the total contract value of Rs.100.00 lakhs. (ie 5 .00
lakhs) PLUS applicable purchase tax on all the interstate purchases, to the
4

extent of the opportunity revenue loss to the state government, since the
dealers are not permitted to buy the goods from a dealer who located outside
the state of Tamil Nadu, as he/she has opted composite method.
(2) If the dealer wishes to pay tax on Non-composition/ second
method, the process of assessment of tax liability is illustrated bellow:
A

Value of works contract

Input

services

100.00 lakhs

considered

for

execution of contract
Labour & Design charges

33.50

lakhs

Input goods covered under Part Value Rs. In Lakhs


C

of

first

Schedule

(inputs covered under 5% TN Gross


VAT)

Basic VAT

CST

Purchase of pumps (CST)

10.00

9.80

0.20

Purchase of pumps & motors

8.50

8.10 0.40

8.50

8.10 0.40

Purchase of electricals (CST)

7.00

6.86

Purchase of electricals

15.00

14.29 0.71

Sub total:

49.00

47.15 1.52 0.33

Purchase of bricks, blue metals


etc

Value of good covered under Part


B of first schedule

0.14

47.48

Input goods covered under Part Value Rs. In Lakhs


D

of

first

Schedule

(inputs covered under 14.5% TN Gross


VAT)

Basic VAT

CST

Purchase of Cements

8.50

7.42 1.08

sub total:

8.50

7.42 1.08

Value of good covered under Part


B of first schedule

7.42

Cost of execution of the project

= 33.50 +

47.48 + 7.42 = 88.40 lakhs


Ratio among the exempted and taxable goods would
be 33.50 : 47.48 : 7.42
Accordingly the exempted turnover and the taxable
turnover would be assessed as under:
Turnover

Exempted

(100/88.40)X 33.50 =
Turnover

Taxable

5%

(100/88.40)X47.48 =
Turnover Taxable @ 14.5% =
(100/88.40)X 7.42
Total Turnover

37.896
53.706
8.398

Lakh
s
Lakh
s
Lakh
s

100.00 Lakh
0

Assessment of tax to be collected Basic

VAT

Turnover Taxable @ 5%

53.706 2.685

Turnover Taxable @ 14.5%

8.398

Total value of TN VAT to be collected from


the customer

Assessment of Tax to be paid to


VAT authorities

1.218
3.903

Lakh
s
Lakh
s
Lakh
s

Total of VAT collected from the

3.903

customer
Less: input credit eligible

2.600

Balance of Payment to be made

1.303

to VAT authorities

Lakh
s
Lakh
s
Lakh
s

Considering the relevant provisions in the act and in the agreement


the maximum billing could be possible under composite method is
Rs.100.00 lakhs and under non-composite method is Rs.103.903.
The table given bellow is the illustrative comparisons on the changes
in profit element owing to the option excised by the dealer, in the given
hypothesis:
Rs in Lakhs
Comparisons of results with key
factor of tax liability
Total turnover
customer
Total receipts
:

Payments

U/s 6

100.000 100.000

Add: Tax collected from the

Less

U/s 5

3.903

0.000

103.903 100.000
made

to

vendors/ others
Less : Payments made/ to be
made to VAT authorities
Less: Purchase tax paid/ to be
paid to VAT authorities
Profit/ Margin element

91.00

91.000

1.303

5.000

0.000

0.850

11.600 3.150

Additional facts

If the dealers opt to pay tax on the first method/ composition method
of tax liability, he can not apply for Form S with the authorities unless he
makes the full payment in advance. In the absence of Form S, The customer
is bound to deduct 5% on the works contract value. In case if the dealer
wishes to avoid this, he has the option to pay the VAT taxes billed in the
invoice in advance to the assessing authorities and obtain the Form S and
avoid the TDS process.
INDIVISIBLE WORKS CONTRACT
DIFFERENCE BETWEEN NORMAL SALE & WORKS CONTRACT
The works contracts are not normal sales. In the normal sale there is
a transfer of property in definite or ascertained goods. The goods remain
same before and after the delivery of the goods. However, in works contracts
it does not happen. The goods before the delivery and after the execution of
works contracts are different, many times in different form also. For
example, at the site of construction of a building, before the Construction
(works contract) commences, the goods like cement, steel, sand etc. are lying
but after the Construction a building (immovable goods) comes to an
existence. This is the difference between the Normal sale and the deemed
sale in the indivisible works contract .
The Supreme Court of India, in its various landmark judgments has
confirmed in the following wordings the difference between a normal sale (as
defined under the sale of goods Act) and an indivisible / composite works
contract;
In a contract of sale, the main object is the transfer of Property and
delivery of the possession of Chattel as a Chattel to the buyer, where it is not
so, it is a contract of Works & Labour1
If the thing to be delivered has any individual existence before the
delivery as the property of the party who is to deliver it, then it is a sale. If
the main object of the work undertaken is not the transfer of a Chattel qua
Chattel, the contract is one for work and labour2
1 Hindustan Aeronautics Ltd. 55-STC 314-SC.
2 Hindustan Shipyard 119 STC 533-SC.
8

The activity is a sale or works contract depends upon the facts, the
terms and conditions and the intention of the parties3
Sometimes, the construction activity may not be undertaken on behalf
of a client/customer but may be undertaken by the builder/developer on his
own account and the constructed property sold to buyers. In such
situations, there would be no liability under service tax as there is no
distinct service provider and service receiver and the builder/developer
cannot provide service to himself4.
In normal practice, we can identify many indivisible/composite works
contracts namely construction of a Building, erection of Plant & Machinery,
Processing jobs, Job works, Repair jobs, Electrical Fittings, Annual
maintenance Contracts (AMCs). Installation of Elevators, Air Conditioners,
Repairs of Vehicles, Re-trending of old tyres, Customized Printing Jobs,
Electro Plating, electro-galvanizing, anodizing etc.
DEEMED SALE
Under the State Sales Tax Laws, before the 46 th Amendment to the
Constitution of India, the Sales Tax was applicable only on the sales covered
under the sale of goods Act (Normal sale). The indivisible works contracts
were not covered under the State Sales tax Acts since works contracts were
not normal sales. The Supreme Court confirmed this legal status in its land
mark judgment in the case of The State of Madras v. Gannon Dunkerley
& Co. (Madras) Ltd5. Due to this legal status, the states were denied the
levy of Sales Tax on the indivisible works contracts. Such contractors were
outside the clutches of sales tax laws. Then the Finance Ministers of the
States have requested the then Union Finance Minister to take necessary
legal steps so as to levy Sales Tax on indivisible works contracts.
Finally, the 46th amendment to the Constitution of India has been
made on 2 nd February, 1983 to add a sub-article (29-4) as under,

3Mekenzis Ltd.-165 STC-58 SC


4 Magus Construction (P) Ltd Vs UOI (2008 (05) LCX 0057)
5 [1958] 009 STC 0353
9

(b) a tax on the transfer of property in goods (whether a goods or in


some other form) involved in the execution of a works contract.
After the said 46th Amendment to the Constitution, the States were
empowered to levy Sales Tax / Works Contract Tax on such sales, called as
Deemed sales involved in the execution of works contract. Due to the said
amendment, the concept of `Deemed Sale was introduced.
The important features of deemed sales are as under,
(a) It is not a normal sale as defined under sale of goods Act but a
deemed sale of goods subject to sales tax by the States.
(b) In the `deemed sales the states can levy Sales tax only on `the
transfer of property in goods . In other words , the states can levy Sales
Tax / VAT only on the `Material Value of the works contract and not on the
`labour portion of the works contract.
(c) If in a contract there is no transfer of property in goods from the
contractor to the contractee, then No sales tax is applicable on such
contracts, called as Pure Labour Jobs.
(d) Under the deemed Sale , an artificial break up of indivisible works
contract has to be made to arrive at the `material value and the `labour
value of the contract.
Therefore, after the 46th Amendment to the Constitution of India, the
States are empowered to levy sales tax (now VAT) on such deemed sales but
only on the `Material Value of the works contract. The High Courts and the
Supreme Court have suggested methods on How to arrive at a material
value from the total Contract Price6.
The Supreme Court has also allowed the States to come out with an
alternative method to levy Sales Tax on Works contract, if to arrive at
material value is difficult. The states have come out with a alternative
method called as Composition Tax method to tax the indivisible works
contract, which is a non-legal /alternative method. The small percentage like
1%, 2%, 4%, 8% as Composition Tax is levied but on the total contract price
without any deduction which is available in the legal options under the State
6 Gannon Dunkerlys SC Judgement 1993 (88) STC 204

10

Sales Tax / VAT Acts. After, the said amendment to the Constitution certain
States a namely Maharashtra & Delhi have come out with separate `Works
Contract Acts. The other states incorporated the separate provision to levy
Sales Tax on the deemed sales in the works contracts.
Under the State Sales Tax Acts or separate Works Contract Acts, No
contractor or contractee were entitled to claim any set off of Sales Tax paid
to their vendors. There was a double taxation in the hands of Contractors in
the Sales Tax Regime.
POST VAT SCENARIO LEVY OF VAT ON INDIVISIBLE WORKS
CONTRACTS (DEEMED SALES)
The states have introduced the new value Added Tax (VAT) System
from 1 st April 2005. The other five States have also followed from 1st April,
2006 and the State of Tamil Nadu has introduced VAT System from
1.1.2007. At present , only Uttar Pradesh and Pondicherry (U.T.) have not
joined the VAT States / UTs . They may join from 1 st April, 2007. Therefore,
the VAT system is in force in most of the States and the Union Territories in
India.
All the VAT States have incorporated in their respective State VAT
Acts, the provisions of `Works Contracts for levying the Sales Tax /VAT on
the deemed sales involved in the execution of works contracts. There is no
Works Contract Tax (WCT) now, it is a VAT on the Works Contract
transactions (Deemed Sales). The Advantage to the Contractors is that
under the VAT system, the Contractors like manufacturers can avail VAT set
off / Credit of the VAT paid to the local vendors, which was not available in
the Pre-VAT Regime.
There is an Uniform Scheme of Taxation for levy of VAT on Works
Contracts under all the State VAT Acts. There is no separate or different
taxation schemes in different States like in pre-VAT period for works
contracts. There is a uniformity under the works contract provisions in the
Post VAT Regime. This is a positive factor for Contractors under VAT Regime.
In all the State VAT provisions, there are three options available for the
Contractors to levy VAT on deemed sales (Works Contracts) and VAT is
leviable on the `Material Value of the Contract.

11

The said three options (Uniform in all the VAT States) are as under,
A-1 Actual Labour Deduction (Legal Option)
A-2 Standard Labour Deduction (Legal Option)
B - Composition Tax (Non Legal or Alternative Option)
Under the legal options A-1 and A-2, the State Governments can levy
VAT only on the `Material Value of the Contract and not on the `Labour
Portion of the Contract. Please note that the States are empowered to levy
tax on Material Value and not on Material Cost in the works contract. For
example, VAT is applicable on `Cement Block Value and not on ` Cement
Cost. Similarly, VAT is applicable on `Wooden Furniture Value and not on
`Timber/Wood Cost in the hands of the Contractor.
The said three options available for the Contractor, executing
indivisible Works Contract under the State VAT Acts (Uniform Across the
States) are stated below. Except the Rates of Composition Tax, the Rates of
TDS deductions, Returns and Payment dates, most of the Major Provisions
are Similar / Uniform under the State VAT Acts;
ACTUAL LABOUR DEDUCTION OPTION
Option A-1 (Levy of VAT on Works Contracts in the hands of the
Contractor)
Under the legal option A-1, the VAT is payable on the `Material Value
of the Contract. The deductions are available for arriving at the Material
Value from the total contract price. Such deductions are specified in the
corresponding provisions of the state VAT Acts which are based on the
guidelines given by the Supreme Court in the case of Gannon Dunkerley (88
STC 204) or the Contractors can arrive at the Material value / price of the
Contract by adopting cost + value Addition method. In this method, the
Contractor adds to the `Material Cost which is determined by considering
all the purchase bills of the materials (imports, outside the State and within
the State), the margin on such material cost plus any incidental expenses
attributed towards the material value.
In other words, the Contractor determines the Material Price after
adding Material Cost and Margin to such cost .The 4% or 12.5% VAT would
12

be applicable on such Material Value /Price, depending upon the


classification of such materials (Steel 4%, others 12.5% VAT) in which the
property passes to the contractee . In this option A-1, the Contractor can
avail full VAT set off / credit of the VAT paid to the local vendors (Not on CST
paid to the outside the State Vendors) provided he obtains corresponding
`Tax Invoices from his local vendors. Therefore, the cost of VAT is zero for
the Contractors in this legal option.
Similarly, the Contractee /Customer also can avail the full benefit
except on the purchases covered under the Negative list under the State VAT
Act on which No VAT set off/Credit is available. Mostly the Civil Works ,
Construction jobs, errection of immovable property (Structures) are covered
in the Negative lists. On the other works contract purchases, the full VAT set
off / Credit is available to the contractee /customer. The T.D.S. (works
contract) provisions are applicable to the contractee in this option which are
discussed later.
In nutshell, in the option A-1 (Legal), the Contractor gets full VAT
set off / credit on the VAT paid on the inputs and the Contractee also
gets the credit, if it is not in the Negative list (Like processing Jobs,
Job works, Printing Jobs, Repair Jobs etc.) The Contractors are
benefited under VAT System as the Contractors can avail full set off /
credit.
However, in this option the Contractor has to maintain proper books
of accounts and the other records to identify the material value of the
Contract.
A-1 option is the Best option available since the Contractor levies VAT
only on the `Actual Material Value of the contract, even though it is
litigation prone option. Many Contractors who execute big indivisible works
contracts, Turnkey Jobs opt for legal option A-1.
STANDARD LABOUR DEDUCTION
Option A-2 (Legal) (levy of VAT in the hands of the Contractor)

13

Under the legal option A-2, the VAT is payable on the `Material Value
of the Contract. The Material value is calculated after deducting the `Labour
Portion from the total contract value / Price.
However, in this option a table is available in the State VAT Act /
Rules which shows `Standard Labour portion attributed to the various
works contracts. The Contractor has to deduct such `Standard Labour
portion shown in such tables from the total Contract price to arrive at the
`Material value.
The Contractor would charge 12.5% VAT, on such material value.
Each State has provided the said `Standard Labour table , under this
option. (Like in Maharashtra for Civil Works it is 30%, for Plant & Machinery
15% , for AMCs 40% and for others 25% (Residuary)) .
The advantage in this option compare to the A-1 option is that it is
litigation free. The Sales Tax Departments would allow the said ` labour
portion deductions as the same are provided in the VAT Rules itself. Also no
identification record has to be maintained by the contractor for the materials
used in the contracts.
However, the Contractor has to consider both the options A-1 and A2
in the case where the Contractee/ Customer does not get the VAT set off /
credit and then selecting the cheaper option.
Like in A-1 option, in A-2 option also, the Contractor gets full credit /
set off on the VAT paid on the inputs and the Contractee also gets full set off
of the VAT paid provided the said purchases are not in the Negative list of
VAT set off / credit. The TDS provisions are applicable to the contractee in
this option also which are discussed later.
COMPOSITION TAX (ALTERNATIVE / NON LEGAL OPTION)
Option-B ( Levy of VAT in the hands of the Contractor )
Option B is the Composition Tax option. This is a non legal
alternative option, simplier option for those Contractors who cannot
maintain the proper Accounts, Record of the material and other portion in
their contracts. The contractee / customer prefers this option as small
amount of Composition Tax 2% / 4% is payable to the Contractor instead of
14

12.5% VAT payable in legal options. A-1 and A-2 . However , VAT credit/set
off is not be available to them in this option ( in this option , VAT Credit is
available only in the state of Maharashtra ) .
Under

the

Composition

option,

the

Contractor

has

to

pay

Composition Tax (VAT) on the total Contract value / price, No deduction of


labour is available in this option. Similarly, No VAT set off / Credit is
available on the purchases of inputs to the Contractors and the same is not
available to

the Contractees also.

(Except

under Maharashtra

VAT

Act/Rules, partial VAT Credit is available to both Contractor and Contractee


in the Composition Tax option). The Rates of Composition Tax differ from
state to state. Generally it is 2% (for civil contracts) @ 4% for other
Contracts. However, exception is in Maharashtra State where the Rate of
Composition Tax is 5% on Civil Contracts and 8% on other Contracts. In
Maharashtra, in this option , in excess over 4% Credit is available on the
input purchases for civil contracts (where composition Tax Rate is 5%) and
64% of the total credit available for other Contracts ( where Composition Tax
Rate is 8%).
Thus partial VAT Credit is available to the Contractors in the
Composition Tax option. However, full credit is available to the Contractee in
this option in Maharashtra provided such purchases are not included in the
Negative list under MVAT Rules.
Therefore, except in Maharashtra, in all other states No VAT set off /
credit is available to both the Contractor and the Contractee in the
Composition tax option. The TDS provisions of Works Contract are
applicable to Conctractee in this option which are discussed later.
In Short, in all the States only the said 3 options (A-1, A-2 and B)
are available in the hands of the Contractors for levy of VAT on the
local works contract transactions in the VAT system. If no VAT set
off/Credit is available to the Contractee / Customer, then the
Composition Tax option is the Cheapest since the Rate of Composition
Tax is lower than 12.5% VAT. Therefore , if the Contractee / Customer
can not avail the VAT set off / Credit in all the three options , then ,
the VAT / Composition Tax paid to the contractor is the cost to such
Contractee /Customer, hence in such cases the Contractor and
15

Contractee should select the Best option available after considering


the Actual Figures in all the three options.
The States have provided separate sections / Rules under the
respective State VAT Acts for the works contracts transactions which include
said three options of levy of VAT , TDS , VAT Credits and Negative lists .
PROVISIONS OF WORKS CONTRACT FOR MAIN AND SUB-CONTRACTOR
UNDER THE STATE VAT LAWS
The following two types of VAT levies are provided for the transactions
of works contracts between the Main contractor and the Sub-Contractor,

In certain States, (like Maharashtra) Main and Sub Contractors are


treated as single legal Entity. Therefore, there is no VAT/TDS
applicable between the transactions of the Main and the SubContractor . The VAT Forms are exchanged between the Main and the
Sub Contractors to declare that they have discharged VAT liability for
their portions of the Contracts. In such cases, the Main Contractor
gets the deduction of the value of the work executed by the Sub
Contractor. The main and the Sub Contractor are jointly and severally
responsible for the compliance under the works contract provisions of
the VAT Act .

In certain states ( other than Maharashtra), the Main and the Sub
Contractors are treated as separate legal Entities, like separate two
dealers under the VAT Act. Therefore, in such provisions , Sub
contractor charges applicable VAT/Composition Tax to the Main
Contractor, avails Credit of the VAT paid on the inputs and the Main
contracts also charges VAT/Composition Tax applicable to the
Contractee/Customer and avails the Credit available to him against
the VAT paid to the Sub-Contractor. They are assessed / audited
separately under the State VAT Act provisions.
It is advisable that the Main Contractor and the Sub Contractor

should discuss all the relevant VAT provisions before opting for the specific
method of levy of VAT / Composition Tax to avoid complications at a later
date.

16

TAXATION OF WORKS CONTRACT UNDER TAMIL NADU VALUE ADDED


TAX ACT(TNVAT Act)
Under TNVAT Act the Works contract is taxed under two sections. The
relevant section are section 5 and section 6 of the TNVAT Act. Section 5
deals with the levy of tax on the goods involved in the execution of works
contract. Section 6 is a simplified system of payment of VAT on the works
contract. These two sections are mutually exclusive. Both the sections will
not apply at the same time.
SECTION 5 OF THE TNVAT ACT
According to this section the dealer shall pay a tax on his taxable
turnover, relating to his business of transfer of property in goods involved in
the execution of works contract, either in the same form or some other form,
which may be arrived at in such manner as may be prescribed, at such rates
as specified in the First Schedule. So here the crucial words are transfer of
property in goods involved in the execution of works contract. So the tax is
only the value of goods. But the rate of tax for each type of goods involved in
the execution of works contract has to be worked out separately.
In case of building contract the separate rate of tax for sand, cement,
blue metal, steel, wood, electrical goods, plumbing material has to be worked
out and tax has to be paid. But this is very difficult in construction
contracts.
This is due to the fact that construction will be going on in several
sites. But the materials will be purchased in a centralised manner and sent
to various sites. This will pose problem of giving itemised bill to the
contractee by the contractor. So the construction companies follows the
method of adding a specified percentage, say 10% or 15%, to purchases
made during the month and pay VAT on that amount.
The specified percentage is added to cover the gross profit margin to
the contractor. Under this method the dealer contractor can take input tax
on the good purchased by him within the state.
Section 5 says that the transfer of property in goods involved in the
execution of works contract, either in the same form or some other form,
which may be arrived at in such manner as may be prescribed,..
17

So the taxable turnover with regard to goods involved in the execution


of works contract has to be determined with regard to the manner
prescribed. This manner is prescribed in rule 8 (5) of TNVAT rules, 2007.
According to this rule from the total turnover of the dealer the
following deductions should be made to arrive at the value of goods involved
in the execution of works contract.
(a) All amounts involved in respect of goods involved in the execution
of works contract in the course of export of the goods out of the territory of
India or in the course of import of the goods into the territory of India or in
the course of inter-State trade or commerce;
(b) All amounts relating to the sale of any goods involved in the
execution of works contract which are specifically exempted from tax under
the Act;
(c) All amounts paid to the sub-contractors as consideration for
execution of works contract whether wholly or partly: Provided that no such
deduction shall be allowed unless the dealer claiming deduction, produces
proof that the sub-contractor is a registered dealer liable to pay tax under
this Act and that the turnover of such amount is included in the return filed
by such sub-contractor;
(d) All amount towards labour charges and other charges not
involving any transfer of property in goods, actually incurred in connection
with the execution of works contract;
(e) all amounts, including the tax collected from the customer,
refunded to the customer or adjusted towards any amount payable by the
customer, in respect of unexecuted portion of works contract based on the
corrections on account of measurements or check measurements.
Sometimes the for the purpose clause; (d) above the labour charges
cannot be correctly ascertained from the books of accounts maintained by
the dealer.

In such a case an adhoc deduction for the labour and other charges as
per the following table.

18

Sl.No

Type of works contract

Labour or other charges as a


Percentage value of the works
contract

1.

Electrical Contracts

15

2.

All structural Contracts

15

3.

Sanitary Contracts

25

4.

Watch and/or clock

50

repair contracts
5.

Dying contracts

50

6.

All other contracts

30

SECTION 6 OF TNVAT ACT


Section 6 is a simplified system of collecting VAT on the Works
Contract. It is called compounding system. Under this system the dealer has
to pay VAT on the total value of Works Contract. The rate of tax is prescribed
in the section itself.
Sl.N
o
1.

2.

3.

Type of contract

Rate of Tax

Civil works

two per cent of the total contract value

contract

of the civil works executed.

Civil maintenance

two per cent of the total contract value

works contract

of the maintenance works executed.

All

other

contracts

works five per cent of the total contract value


of the works executed.

The benefit of this compounding system is that dealer is not be


required to maintain accounts of his business under this Act or the rules
made thereunder except the records in original of the works contract, extent
of their execution and payments received or receivable in relation to such
works contract, executed or under execution.

19

CONDITIONS FOR AVAILING THE COMPOUNDING SYSTEM UNDER


SECTION 6 OF TNVAT ACT
This simplified system of Taxation of works contract under TNVAT
comes with many conditions. If these conditions are not met with then the
assessing officer will try to tax the dealer under section 5 at the maximum
rate of 14.5%. The following are the conditions: 1. The dealer should apply to
the assessing authority along with the first monthly return for the financial
year or in the first monthly return after the commencement of the works
contract that he wants to opt for compounding system of tax payment for
works contract. 2. The dealer should not make any interstate purchases. 3.
The dealer should not collect the tax from the contractee. 4. The dealer
should not take input tax credit on the goods purchased by him. 5. The
option exercised once shall be final for that financial year.
GENERAL NEGATIVE LIST ITEMS FOR WORKS CONTRACTS UNDER
STATE VAT ACT & RULES
(a) Purchases effected by way of works contract where the contract
results into an immovable Property .
(b) Purchases of Building material which are not resold but are used
in the activity of Construction.
(c) Purchases of works contracts made by the Contractee in Civil
Contracts .
(d) Any purchases of Consumables or of goods treated as Capital
Assets by the Contractor/dealer where he is principally engaged in doing job
work or labour work and is not engaged in the business of manufacturing of
goods for sale by him.
RELATION BETWEEN THE TNVAT ACT PROVISIONS AND SERVICE TAX
LIABILITY
The reason for explaining the TNVAT Act provisions above is to
highlight the relation between the TNVAT act and the determination of the
service tax liability for works contract. The determination of value of taxable

20

portion under the service tax provisions depends upon whether a person is
paying VAT under section 5 or 6 of the TNVAT act.
Whenever a query is put to a tax consultant, as to how the service tax
has to be paid for construction contracts, the immediate answer will be that
on the 40% contract value service tax has to be calculated at 12.36%. But
this answer is wrong. Because before answering this question, the
consultant should see how the client is paying VAT tax. Depending upon
this method only the service tax liability can be determined. The method of
calculating service tax liability will vary for a person paying VAT under
section 5 of TNVAT act and for a person paying VAT under section 6 of
TNVAT act. To high light this point only in this article an elaborate
discussion on the VAT provisions have been discussed above.
SERVICE TAX (DETERMINATION OF VALUE) RULES, 2006
Service tax is on the value of taxable services. Section 94(1)(aa) of
Finance Act, 1994 enables the central government to make rules
determining the value of taxable services for the purpose of section 67 of
Finance Act, 1994.
Rule 2A of the Service Tax (Determination of Value) Rules, 2006 is
prescribed to determine the value of service portion in the execution of a
works contract. This rule has got two clauses.
According to clause (i) of Rule 2A, Value of service portion in the
execution of a works contract shall be equivalent to the gross amount
charged for the works contract less the value of property in goods
transferred in the execution of the said works contract.
This clause (i) covers the case of an assessee who pays VAT as per
section 5 of the TNVAT act. As per section 5 the value of the goods is
charged to VAT as per the rates prescribed in the Schedule to the TNVAT act.
For the purpose of clause (i) of Rule 2A
Service Portion in the execution of works contract = Gross amount
charged from the Contractee - Value of goods declared in the VAT return
Clause (ii) of Rule 2A only prescribes the following percentage of the total
amount charged for works contract as value of taxable service.

21

Sl.N

Type of contract

% consolidated
as

taxable

portion
Orginal Works
40
works contract entered into for maintenance or repair
70

1.
2.

or reconditioning or restoration or servicing of any


goods
in case of other works contracts, not covered under

3.

60

serial number (1) and (2), including maintenance,


repair, completion and finishing services such as
glazing, plastering, floor and wall tiling, installation
of electrical fittings of an immovable property
This clause (ii) begins with the wordings, Where the value has not
been determined under clause (i). In view of these wordings where the
separate determination is not done for the goods and services only, the
clause (ii) will apply. So this clause will apply only when the VAT has been
paid under section 6 of the TNVAT act.
VAT & SERVICE TAX, BOTH, APPLICABLE ON CERTAIN WORKS
CONTRACTS
On certain Works Contracts both VAT (WC) & Service Tax are
applicable on the Contract price since there involves the transfer of property
in goods (sale of goods / materials) subject to VAT levied by the State
Government and rendering of Taxable Service subject to Service Tax levied
by the Central Government. Thus, the both the state & the Central
Governments levy VAT & Service tax on the same taxable base i.e. Contract
Price, respectively.
The Contracts /Taxable services where both VAT and Service Tax are
applicable are shown as under ,

Construction contracts, Civil Jobs

Annual Maintenance Contracts (AMCs)

Errection of Plant and Machinery etc.


However in such Works Contracts / Taxable Services, the working for

levy of VAT & Service Tax is to be done, separately, as per the provisions of
22

VAT & Service Tax. Only in the case where the Contractor opts for A-1 legal
option of actual labour deduction method, he can pay Service Tax on the
actual labour portion and VAT on actual Material value. Otherwise only A-2
(Standard deduction) and B (Composition Tax) options are available under
VAT and No deduction for levy of Service Tax for the Contractor. The
Abatements are available under the Service Tax law for specific Taxable
Services towards the value of material / goods involved in the same. Like
67% Abatement from the contract value is available under the Construction
Services .
CONCEPT & LEVY OF C.S.T ON INTER STATE WORKS CONTRACTS
The Central Government amended the definition of ` Sale under the
Central Sales Tax Act, 1956 from 11.5.2002. With the said amendment, the
states are empowered to levy C.S.T. on the interstate works contract. By the
said amendment, the concept of `Interstate works contract was introduced
in the C.S.T. Act by inserting in the definition of `Sale , the words Transfer
of Property in goods involved in execution of works contract .
When the Contractor dispatches his goods from one State to another
under a individuals works contract, it is a interstate works contract. The
sections 3,4,5 of the C.S.T. Act are iapplicable to such deemed sales in the
interstate works contract. Accordingly, the State of dispatch can collect the
Central Sales Tax on such deemed interstate sales . The Contractors may
not be allowed the interstate depot transfers in the cases of indivisible works
contracts since such dispatches are made to the sites of the contractee
situated in other state and the same are earmarked for the specific
contractee. The Contractor would invoice to the Contractee from the state of
dispatch and would charge CST as applicable , with or without C/D Forms.
Recently, the CST Act was further amended to explain, the deductions
available on the total contract price to the Contractor to arrive at the
material value. Please note that in interstate works contracts also, the C.S.T.
is payable only on the Material Value/Price of the Contract and not on the
Labour portion of the Contract.
The examples of interstate works contract would be that of Contractor
from Mumbai, dispatching goods from his Mumbai plant to the site in
Chennai (Tamil Nadu) under a indivisible works contract or A Manufacture
23

in Mumbai dispatching his own material to a processor in Surat and the


processor returns back the processed material back to the Mumbai
Manufacturer. The Surat processor would charge 4% CST against `C form
on the material value of his invoice amount being a interstate works contract
in his hands .
However when it is an interstate works contract, the Contractee would
raise an invoice on the Customer situated in other state with applicable rate
of CST on the Material value of the contract, but the Customer would not
deduct any amount towards TDS since there is no provision of T.D.S. under
the CST Act. TDS is to be deducted only in the local works contracts where
the Contractor has charged VAT/Composition Tax.
In short, if the Contractor dispatches goods from his state to the
State of the Contractee (Customer) under an indivisible works
contract, it is a interstate Works contract in the hands of such
Contractor subject to levy of CST which is collected by the state of
dispatch . However, in the interstate works contracts also , C.S.T. is
payable only on the `Material Value of the Contract.

THE CONTRACTEE / CUSTOMER SHOULD LOOK INTO THE WORKS


CONTRACT PURCHASES FOR MINIMUM COST
Under the VAT System, the Contractee/Customer can avail the full
VAT Credit/Set off of the VAT paid to the Contractor through the tax
Invoices, provided such purchases are not in the Negative list of set off/VAT
Credit.
However, in the cases where the Contractees / Customers do not get
any VAT set off / Credit, they should note the following points to reduce
their VAT Cost,
(a) To decide the Best option of Levy of VAT/Composition Tax before
the execution of the Works Contract Commences.
(b) To insist the Contractor to buy maximum inputs from local vendors
only and the VAT Credit thereof should be passed on to the Contractee by
reducing his sale price , accordingly .
24

(c) In case of free issues supplied by the Contractee / Customer to the


Contractor , if the price of the contractor is `Net off the material value
supplied by the Contarctee then there is no negative VAT impact to the
Contractee . Otherwise, there is VAT cost in the hands of the contractee with
regards to the VAT paid on the purchases made by the Contractee and given
as free issues to the Contractor.
(d) Prescribed % of TDS payment to the government and timely
issuance of TDS certificates to the Contractors.
(e) To insist the Contractor to show the VAT applicable, separately on
the invoice (Tax Invoice, in the case if the Contractee can avail the credit)
(f) To add the clause in the agreement with the Contractor, If any
additional liability on Account of VAT (WC) arises at a future date shall be
borne by the Contractor.
WORKS CONTRACT TAX AND TAXABLE EVENT
The 46th Amendment to the Constitution of India in 1983, by
insertion of clause (29A)(b) of Article 366, introduced a new definition to the
word Sale which has enlarged the scope of tax on sale or purchase of
goods by inclusion of a provision for tax on transfer of property in goods
(whether as goods or in some other form) invoked in the execution of Works
Contract being a deemed sale.
Following Guidelines are drawn from various court judgments to
ascertain taxable event of Works Contract:

There must exist an indivisible works contract and divisible contracts


are outside scope.

Both goods and services must be involved in execution of works


contract.

Transfer of goods must be in tangible property and pass on either in


the same form or in other form when incorporated in work. Form of
goods has no relevance.

25

In case goods are consumed and their identity is lost then no transfer
of property occurs in those goods. Example:- electrodes, lubricants,
power, fuel, gas, waste cotton etc.,

PASSING OF PROPERTY UNDER WORKS CONTRACT


The property in goods passes under the theory of Accretion,
Accession or Blending when materials are incorporated in execution of
works contract and not on bringing of goods to project site. Bills may be
raised as and when materials are brought on site or by stages at agreed
terms & conditions, but it will not have any effect on the above principle of
passing of property in goods as explained belowAccretion:
A Contractor constructs a building on the land of Contractee using his
own steel, bricks, sand, cement etc., which belongs to him till the stage of
incorporation. But once the cement pasted and bricks are applied on the
land, these ingredients fasten themselves to the land and not possible to
remove without fundamental damage. Thus the ownership in these
materials gets transferred to contractee by inference through Accretion.
Accession:
A Car Garage undertakes the work of painting a car of Customer. The
paint belongs to Car Garage till the stage of application on car. But once the
paint is applied on car, the liquid paint gets attached on the metal of car and
it is not possible to remove it without fundamental damage. Thus ownership
in paint gets transferred to Customer by inference through Accession.

Blending:
Another situation of Works Contract could be a case where multiple
movable goods owned by Contractor are blended together to create new
movable goods which are non-marketable in nature. For example, a printer
who uses paper and ink to print cheque books for a bank.

26

THE SUMMARY OF THE MAIN POINTS WITH REGARD TO PROVISIONS


OF LEVY OF VAT/COMPOSITION TAX UNDER THE STATE VAT ACT &
RULES

Deemed Sales (WC) are taxed under the provisions of the State VAT
Act, there are no separate Works Contract Acts.

For local works contract transaction State VAT (WC) is applicable and
for interstate works contract transaction , the Central Sales Tax
(C.S.T.) is applicable as covered under the CST Act.

No VAT/CST is applicable on the pure labour Jobs (No material of the


Contractor / Job worker is involved)

Under the State VAT Acts, VAT is applicable on the `Material Value of
the Contracts only as determined by the three options as discussed
earlier and under the C.S.T.Act also CST is applicable on the `Material
Value only.

In the contracts, where both the sale of goods and rendering of


Taxable service are involved, both VAT & Service Tax is payable on the
same contract price subject to the relevant provisions under both the
VAT & Service Tax Laws.

Proper clauses of VAT/CST should be incorporated in the Agreements


between the Contractor and Contractee to avoid litigation.

Under the VAT System both the Contractor and the Contractee can
avail full VAT set off/Credit subject to the Negative List.

The Contractee should ask for the price reduction from the Contractor
to pass on the `VAT Benefit availed by the Contractor on his local
purchases.

CONCLUSION

27

To conclude, if a person pays VAT for works contract as per section 5


of TNVAT Act, then he has to determine the value of taxable services as per
Clause (i) of Rule 2A of Service Tax (Determination of Value) Rules, 2006. If
a person pays VAT as for works contract under compounding system as per
section 6 of TNVAT Act, then he has to determine the value of taxable
services as per Clause (ii) of Rule 2A of Service Tax (Determination of
Value) Rules, 2006.
Thus works contract is, the predominant intention of the parties to
the contract is not to sale or purchase the goods but to carry out certain
works for a lump sum price.
BIBLIOGRAPHY

Value-Added Tax: Indian and Global Experiences by Astha Ahuja, New


Century Publication 2004.

Economics of Value Added Tax 2nd Edition by M.P. Shrivastava, Aph


Publishing Corporations, 2012.

Tolley's Value Added Tax, 2nd Volume, 1st Edition by davies, rhianon,
LexisNexis, 2011

VAT Planning: VAT and Customs Duties, by multi-author, Tottel


Publishing, 2007.

28

INDEX

Pg.No.

INTRODUCTION

MEANING OF WORKS CONTRACT IN TN VAT

VAT ASPECTS OF WORKS CONTRACT

REGULAR METHOD

COMPOSITION METHOD

STANDARD DEDUCTION METHOD

ASSESSMENT OF TAX LIABILITY ON TAXABLE TURNOVER

INDIVISIBLE WORKS CONTRACT

DEEMED SALE

POST VAT SCENARIO LEVY OF VAT ON INDIVISIBLE WORKS CONTRACTS

10

(DEEMED SALES)
ACTUAL LABOUR DEDUCTION OPTION

11

STANDARD LABOUR DEDUCTION

12

COMPOSITION TAX (ALTERNATIVE / NON LEGAL OPTION)

13
14

PROVISIONS OF WORKS CONTRACT FOR MAIN AND SUB-CONTRACTOR


UNDER THE STATE VAT LAWS
15
TAXATION OF WORKS CONTRACT UNDER TAMIL NADU VALUE ADDED TAX
ACT(TNVAT ACT)
GENERAL NEGATIVE LIST ITEMS FOR WORKS CONTRACTS UNDER STATE

18

VAT ACT & RULES


RELATION BETWEEN THE TNVAT ACT PROVISIONS AND SERVICE TAX

18

LIABILITY
SERVICE TAX (DETERMINATION OF VALUE) RULES, 2006

19

VAT & SERVICE TAX, BOTH, APPLICABLE ON CERTAIN WORKS CONTRACTS

20

CONCEPT & LEVY OF C.S.T ON INTER STATE WORKS CONTRACTS

20

THE CONTRACTEE / CUSTOMER SHOULD LOOK INTO THE WORKS

22

CONTRACT PURCHASES FOR MINIMUM COST


WORKS CONTRACT TAX AND TAXABLE EVENT

22

PASSING OF PROPERTY UNDER WORKS CONTRACT

23

THE SUMMARY OF THE MAIN POINTS WITH REGARD TO PROVISIONS OF

24

LEVY OF VAT/COMPOSITION TAX UNDER THE STATE VAT ACT & RULES

29

CONCLUSION

25

BIBLIOGRAPHY

25

30