Maharashtra VAT Taxation of Works Contracts

Subject : Month-Year : Author/s : Topic : Indirect Taxes Aug 2005 Govind G. Goyal Chartered Accountant Maharashtra VAT Taxation of Works Contracts

Article Details : Taxation of works contracts has always been a matter of curiosity, controversies and complications. Ever since evolution of the concept of deemed sales under the sales tax laws, it has remained a mystery as to which transactions are liable to tax under the guise of works contract. The 46th amendment to the Constitution of India, amending Article 366 in the year 1983, gave power to the States to levy tax on the transfer of property in goods (whether as goods or in some other form) involved in the execution of a works contract. Various States all over India very happily amended their sales tax laws to expand the coverage of tax net by incorporating the above referred coined words in the definition of sales. However, most of them fail to define what a works contract is. In the absence of a definition of works contract, it is not possible to find out whether a particular transaction involving transfer of property in goods, is liable for sales tax or not ? But for last more than 22 years the tax is being levied by the Government and paid by the dealers, sometimes without any argument and sometimes after battling through the Courts. High Courts of various States as well as the Honble Supreme Court of India have to intervene time and again to decide whether a particular transaction can be taxed or not under the sales tax laws of a particular State. There are number of judgements pronounced by the most knowledgeable and honorable judges of the highest courts of the States as well as the Apex Court. And there are number of judgements which are contradicted by another judgement of the same court and there are many cases still awaiting justice. It was expected that with the introduction of Value Added Tax (VAT), the controversy and complications about the taxation of works contracts will get resolved, but it seems that the Courts may still have to guide all of us to understand what is a works contract. Be that as it may, lets try to understand the provisions contained in the Maharashtra VAT Act for levy of tax on works contracts. Assuming that a particular contract is a works contract, tax can be levied by the State Government on the value of the transfer of property in goods (whether as goods or in some other form) involved in the execution of such a contract. It may be noted that under the sales tax laws, tax can be levied on the sale price of goods. The term goods has been well defined to include all kinds of movable properties (with certain exceptions). However, immovable properties are not considered goods, hence cannot be taxed under the sales tax laws. For example, sale of land or a building standing thereon is not liable to tax. But cement and bricks, etc. used by a contractor, in a construction contract, may be considered as passing of property in goods i.e., cement and bricks, etc., being movable goods, hence may be subjected to tax as works contract. But such a contract is normally a composite contract wherein the contractor is required to use his material as well as labour and skill. It is not just a contract for sale of cement and bricks. But a contract for constructing building, in the execution of which, property in certain goods passes from the contractor to the contractee.

The State can levy tax only on the value of goods and not on the labour and service portion of the contract. In all such cases of composite contracts, the question that arises is what is the value of goods on which tax can be levied ? Under the earlier law, which was prevalent in the State of Maharashtra, till 31st March 2005, i.e., Maharashtra Tax on the Transfer of Property in Goods involved in the Execution of Works Contracts (re-enacted) Act 1989, a simple method was used whereby the purchase price of the goods was considered as the sale price for the purposes of levying tax under the said Act and there were specific rates of tax for such goods so used in the execution of works contract. However, in the VAT law of Maharashtra, there are no such provisions. Instead it provides for the determination of sale price of goods in a particular manner. Works Contract Sale Price : Works contracts, involving transfer of property in goods in the execution of such contracts, are liable to tax under the provisions of the Maharashtra Value Added Tax Act 2002 (MVAT Act). The rate of tax shall be the same as applicable to the commodity as per Schedules A to E. The sale price of goods liable to tax, has to be determined in accordance with Rule 58 of the Maharashtra VAT Rules 2005, which states : 58. (1) The value of the goods at the time of the transfer of property in the goods (whether as goods or in some other form) involved in the execution of a works contract may be determined by effecting the following deductions from the value of the entire contract, in so for as the amounts relating to the deduction pertain to the said works contract : (i) Labour and service charges for the execution of the works where the labour and service done in relation to the goods is subsequent to the said transfer of property; (ii) Amounts paid by way of price for sub-contract, if any, to sub-contractors; (iii) Charges for planning, designing and architects fees; (iv) Charges for obtaining on hire or otherwise, machinery and tools for the execution of the works contract; (v) Cost of consumables such as water, electricity, fuel, used in the execution of works contract, the property in which is not transferred in the course of execution of the works contract; (vi) Cost of establishment of the contractor to the extent to which it is relatable to supply of the said labour and services; (vii) Other similar expenses relatable to the said supply of labour and services, where the labour and services are subsequent to the said transfer of property; (viii) Profit earned by the contractor to the extent it is relatable to the supply of said labour and services : Provided that where the contractor has not maintained accounts which enable a proper evaluation of the different deductions as above, or where the commissioner finds that the accounts maintained by the contractor are not sufficiently clear or intelligible, the contractor

or, as the case may be, the Commissioner, may in lieu of the deductions as above, provide a lump sum deduction as provided in the Table on the next page and determine accordingly the sale price of the goods at the time of the said transfer of property. It may be noted that a dealer, executing works contract, is eligible for full input tax credit as per the normal provisions. (The provisions regarding Input Tax Credit are discussed elsewhere in this issue of BCAJ, hence not reproduced here.) He is also entitled to collect tax separately by issuing a Tax Invoice. (2) The value of goods so arrived at under sub-rule (1) shall, for the purposes of levy of tax, be the sale price or, as the case may be, the purchase price relating to the transfer of property in goods (whether as goods or in some other form) involved in the execution of a works contract. Rate of Tax : After determining the sale price through any one of the above methods, the contractor is required to pay tax at the rate at which such goods (used in the execution of works contract) is liable to tax as per Schedule A to E (see Table below). Schedule A Essential commodities (Tax-free) Schedule B Gold, silver, precious stones, pearls, etc. Schedule C Declared goods, industrial inputs, and such other specified goods Nil 1% 4%

Schedule D Foreign liquor, country liquor, Motor 20% at Spirits, etc. specified rates Schedule E All other Goods (not covered by A to D) 12.5%

Thus if the goods used in the execution of a works contract are, falling under say, Schedule A, the rate of tax shall be Nil, if falling under Schedule C, the rate of tax shall be 4%, and likewise if they are Schedule E goods, the rate of tax is 12.5%. TABLE Works Contract Sale Price Sr. No. *Amount to be deducted from the contract price (%) 15% 10% 15%

Type of Works Contract

1 Installation of plant and machinery 2 3 Installation of air conditioners and air coolers Installation of elevators (lifts) and escalators

4 5 6

Fixing of marble slabs, polished granite stones and tiles (other than mosaic tiles) Civil works, like construction of buildings, bridges, roads, etc. Construction of railway coaches or undercarriages supplied by Railways

25% 30% 30% 20% 15% 20% 20% 20% 40% 40% 20%

Ship and boat building including 7 construction of barges, ferries, tugs, trawlers and dredgers 8 Fixing of sanitary fittings for plumbing, drainage and the like Construction of bodies of motor vehicles and construction of trucks

9 Painting and polishing 10

11 Laying of pipes 12 Tyre re-treading 13 Dyeing and printing of textiles 14 Any other works contract

* The percentage is to be applied after first deducting from the total contract price, the amounts paid by way of price for the entire sub-contract to sub-contractors, if any. If in a particular contract, there are several commodities used, which may be falling under more than one schedule, then it would be necessary to divide the sale price in the same proportion in which the goods of various categories have been used in the execution of such a contract. For example : In a textiles processing contract, the goods used are mainly colour and chemicals. Some of the items may be falling under Schedule C and some others may be in Schedule E. Say, the total contract value is Rs.100000/-. The goods used (the property which is considered to be passed on to the contractee), say, dyes (purchase value Rs.20000, liable to tax @ 4%) and chemicals (purchase value Rs.10000, liable to tax @ 12.5%), labour charges and other similar expenses incurred by the contractor Rs.50000. In such a case, the contractor has two options : I. Determine the sale price under sub-rule (1) i.e., by deducting from the contract value the amount of labour charges and other similar expenses as well as profit margin on such labour charges. As there is no definite formula to determine the profit margin, it will have to be worked out on proportionate basis. Considering, for the time being, that there are no other expenses, the net profit of the contractor in this example is Rs. 20000, which may have to be apportioned in the ratio of the cost of material : labour charges, i.e., Rs.30000 : 50000 = 7500 : 12500. Thus, the sale price of this works contract for the purpose of levy of tax will be Rs. 47500 (i.e., 100000-50000-12500). On this sale price, tax payable shall be worked out as follows : @ 4% on Rs.31667 (47500*20000/30000) Rs. 1267

@ 12,5% on Rs.15833 (47500*10000/30000) Total Tax payable

Rs. 1979 Rs.

3246

The contractor is entitled to claim input tax credit i.e., set-off of tax paid on purchases amounting to Rs.2050 (i.e. 4% on 20000 + 12.5% on 10000). II. Determine the sale price, under sub-rule (2), by adopting the Table. According to which, the deduction permitted for such types of contract is 40% of the contract value. Thus, the sale price under this method shall be Rs.100000 - 40000 = 60000. Tax payable : @ 4% on Rs.40000 (60000*20000/30000) @ 12,5% on Rs.20000 (60000*10000/30000) Total Tax payable Rs. 1600 Rs. 2500 Rs. 4100

In both these methods, it may be observed, that the sale price has to be apportioned in the ratio of purchase value of the material used in the execution of such contract. It may not be an easy exercise, particularly when the contractor has undertaken several contracts and the material purchased during a period, may have been used in various contracts. Further, in certain labour-intensive contracts, the contractor would like to adopt the first method which is certainly beneficial to him, but whether the assessing officer will agree with such a determination of sale price ? There are serious doubts about the same. In all such cases, it is feared that the assessing officers will raise one or other objection and the contractors may be forced to adopt the Table. Whether it is Table or reduction method, one thing is certain that the contractors would not be able to quote the exact amount of tax they will charge to their customers. In large contracts running over several months or several years, it may be very difficult for the contractors to collect correct amount of tax from their customers and much more difficult to discharge their exact tax liability on periodic basis. It may be noted that under the Maharashtra VAT Act, a dealer is required to file periodic returns, which may be monthly, quarterly or six monthly, depending upon the total tax liability of the dealer during the previous year. All such returns are required to be filed correct and complete in all respect. An incomplete or incorrect return may lead to stringent penalties and even prosecution. Works Contract Composition Scheme : S. 42(3) of the MVAT Act provides for a Works Contract Composition Scheme, whereby a dealer, at his option, may choose to pay tax @ 8% on the total contract value. (After deducting therefrom the amount paid towards sub-contract, if any.) If a contractor chooses to opt for the composition scheme, then the set-off is restricted to 64% of the total eligible set-off in respect of such goods used in the execution of such works

contract. However, he is eligible to collect tax by issuing a Tax Invoice. A contractor is free to choose either the sale price method or the composition scheme, as he may deem fit, qua each contract. There is no requirement of any prior approval, etc. Looking into the difficulties of determining the sale price under Rule 58(1) and (2) and paying tax through such most complicated and litigation-prone method, the dealers may like to opt for the composition scheme. The scheme is simple wherein the total contract value is considered as the sale price of goods and tax is levied at a fixed percentage. There is no difficulty in giving a quotation or charging tax through the running bills and there should not be any difficulty in discharging the correct tax liability on all or any such contracts during any given period. A composition scheme may be considered the safest way for a contractor. Under the earlier Law also that was the most preferred path. But, it seems, the lawmakers do not believe in simple laws. This may be the best example how simple VAT has been made so complicated. The real difficulty, under the newly drafted composition scheme, arises with respect to the quantum of tax, with such a high rate of composition coupled with an artificially restricted input tax credit. Under the earlier Law, the rate of composition was just 4%, of course without any facility of set-off. But there were no hassles; it was the easiest method whether for the contractor or for the employer (contractee). 4% on the total contract value and no deductions except payment made to sub-contractor. Now it is 8%, which by any standard of a composition scheme is too high. If we just compare the tax liability of a contractor with reference to the earlier example of textile processor, the tax payable under the composition scheme works out to Rs.8000 (8% on the total contract value of Rs.100000). Further, the amount of set-off, under the composition scheme, will be restricted to Rs.1312 (64% of the eligible input tax credit Rs.2050). Lets now consider the net amount of tax payable by a contractor under each of the above methods : I. Sale Price u/r 58(1) Method II. Sale Price Table Method III. Composition Scheme 4100 - 2050 = 2050 8000 - 1312 = 6688 3246 - 2050 = 1196

In the light of the above, one may imagine the plight of dealers as well as of the employers. The above example may be an extreme example and may not hold good for various other contracts. The calculations will differ from case to case, contract to contract and dealer to dealer. There may be cases where the material value may be much higher or there may be totally different proportion of taxable purchases at different rates. But the basic steps will remain the same. The dealers may have to work out all the options in their own cases before deciding to adopt any one or more than one method in respect of contracts undertaken by them.

Ongoing contracts : Contracts, which have already commenced before 31st March 2005 and are ongoing, are liable to tax as per the provisions of the MVAT Act with effect from 1st April 2005. However, it has been provided that total liability in respect of such contracts shall be restricted to the total liability as per the earlier law. Works Contract TDS : S. 31 of the MVAT Act provides that the Commissioner may, by notification, require any dealer or person or class of dealers or persons (hereafter referred as the employer) to deduct tax on such amount payable on the purchases effected by them, as may be notified. All such employers shall have to : (a) Take a Tax Deduction Number (Works Contract) from the Sales Tax Department. Application to be made, in Form 401, within three months from the day he becomes liable to deduct TDS. (b) Deduct tax, at prescribed rate, from the amount paid or payable to a contractor during a given period. (c) Deposit the amount so deducted with the Govt. treasury within 10 days from the end of month in which such tax is deducted or is required to be deducted. (d) Issue a certificate of deduction of tax, immediately, in Form 402. (e) Submit monthly (quarterly) statement of tax deducted at source, in respect of each of such contractors, to the respective prescribed officer, in Form 403, within 20 days from the end of the month. (f) Maintain necessary records in prescribed format, Form 404. (g) File an annual return of TDS, in Form 405, within 3 months from the end of the year. (h) Attend and produce records before the assessing authority as and when asked to do so. Notes : 1. A contractor, awarding sub-contracts, is not required to deduct TDS from such subcontractor. 2. TDS provisions are not applicable in respect of works contract liable to tax under the CST Act. 3. TDS not required to be deducted where the amount or the aggregate of the amount payable to a dealer by such employer is less than Rs.5 lakh during any year. Employers notified for the purposes of TDS : 1. The Central Government and any State Government,

2. All Industrial, Commercial or Trading undertakings, Company or Corporation of the Central Government or of any State Government, whether set up under any special law or not, and a Port Trust set up under the Major Ports Act, 1963, 3. A Company registered under the Companies Act, 1956, 4. A local authority, including a Municipal Corporation, Municipal Council, Zilla Parishad, and Cantonment Board, 5. A Co-operative Society including a Co-operative Housing Society registered under the Maharashtra Co-operative Societies Act, 1960, 6. A Registered Dealer under the Maharashtra Value Added Tax Act, 2002. 7. An Insurance or Finance Corporation or Company; and any Bank included in the Second Schedule to the Reserve Bank of India Act, 1934, and any Scheduled Bank recognised by the Reserve Bank of India. 8. Trusts, whether public or private. Rate of TDS : The notified employers are required to deduct TDS, from the amount payable to a contractor @ 2%, if the contractor is a Registered Dealer, otherwise @ 4%.