Service Tax on Works Contract

Last Updated at: May 02, 2020
140310
Works Contract
Latest news update:

The Indian GST regime, with its “One Nation One Tax” has removed the confusion regarding the tax treatment on work contracts. In this regime, works contracts are treated as service and tax would be charged accordingly (not as goods or part goods/part services).

 

Please Note: Service Tax does not apply any more. Kindly refer to GST Registration instead.

A works contract is one under which there is a transfer of goods as part of a service contract. This is common during contracts involving repair, renovation and installation of heavy infrastructure.

On account of the dual nature of the work, a works contract has its own definition under section 65(105) of the Finance Act, 1994. In the invoice, the works contract will include both, the value of materials used as well as the value of the service provided in the installation, construction, completion, erection, fitting, renovation or alteration of the works contract.

As per Rule 2A of the Service Tax Rules (Determination of Value) Rules, 2006, “the service portion involved in the execution of original works is 40% of the total works contract and the service portion involved in the execution of works contract other than original works is 70% of the total works contract”.

Make Your Business GST Ready

Typically, the service tax liability is shared by the service provider and the customer. Whereas the customer usually pays service tax in full, a works contract is unique. Therefore, service tax is paid at 15% (prevailing rate as of August 2016) on 40% of the total contract or 70% of the service portion by the contractor and the recipient of the service equally.

Scope of Works Contract

As noted, a works contract is one with a service element attached to the material being transferred in a sale. Therefore, value-added tax (VAT) is payable on the material being transferred, and service tax is payable on the service component. The service provider should have a service tax registration in this case.

[table file=”https://vakilsearch.com/advice/wp-content/uploads/2016/08/WorksRate.csv”][/table]

 

Examples of Works Contracts:

1. Renovation of Building: In case of renovation of a building, there are various jobs involved, including painting, demolishing, tiling, scraping, etc. All charges for labour in this case will attract service tax. However, any work outsourced to a sub-contractor by the contractor will not attract any service tax.

2. Repair of Car: When a car is being repaired, there is material that is involved and a service element. Any materials used to repair the car will attract VAT, whereas the service component (the labour, primarily) will attract service tax.

3. Two-floor Houses: Service tax on construction of two-floor houses, in case both are capable of being transferred separately, must be paid separately.

4. Construction of Pipeline: Contracts for construction of a pipeline or conduit are covered under works contracts.

Note: Pure labour contracts are not considered works contracts as the essential conditions of work contract is to have transfer of property in goods. Architectural and consultancy services are provided in relation to works contracts and are, therefore, not exempt.

Valuation of Service Tax

According to this method, the value of work contract = Gross amount charged for the works contract LESS Value of transfer of property involved in the execution of work contract, where:

Gross amount includes:
1. Value of material transferred
2. Labour charges
3. Amount paid to sub-contractors for labour and services
4. Charges for planning, designing, and architects’ fees
5. Charges for obtaining, on hire or otherwise, machinery and tools used in the execution of the works contract
6. Cost of consumables such as water, electricity, and fuel
7. Other similar expenses related to supply of labour and services
8. Profit

Composition scheme according to Rule 2A

The government has unveiled three composition schemes, which, just like the VAT Composition scheme, allows the service provider to pick a fixed portion on which service tax is to be paid. This makes it easier to calculate the service tax component and, in most cases, cheaper than paying the actual amount. Of course, you need not opt for the composition scheme; however, if you do elect to use it, you cannot use any other exemption.

[table file=”https://vakilsearch.com/advice/wp-content/uploads/2016/08/Comp-Scheme.csv”][/table]

Composition Scheme for Builders

As the service tax calculation can be particularly difficult for buildings, the government has introduced a special composition scheme. This removes the confusion of separating the service portion and the goods portion. What it has done is introduced the concept of declared services. Under declared services, various services are listed and explanations to separate the service portion from the total service is provided in Service Tax (Determination of Value) Rules, 2006. A works contract is also part of these declared services and service tax on works contract is determined accordingly.

[table file=”https://vakilsearch.com/advice/wp-content/uploads/2016/08/Comp-Scheme-2-1.csv”][/table]

Service Tax Works Contract Exemptions

The list of various work contract services that are exempted from service tax are as follows:
a. Service provided to the government, a local authority or a governmental authority;
b. Construction for the use of the general public;
c. Original work pertaining to infrastructure;
d. Sub-contractor services.

Work contract and reverse charge mechanism

If a works contract service is provided by any individual, HUF, firm, or Association of Persons to a business entity as a body corporate, then 50% of service tax is paid by service provider and 50% is paid by service receiver.
In case a works contract is provided by the government or local authority in the nature of a support service, 100% of the service tax is paid by the service receiver. In all other cases, 100% of the service tax is paid by the service provider.

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Service Tax on Works Contract

140310
Latest news update:

The Indian GST regime, with its “One Nation One Tax” has removed the confusion regarding the tax treatment on work contracts. In this regime, works contracts are treated as service and tax would be charged accordingly (not as goods or part goods/part services).

 

Please Note: Service Tax does not apply any more. Kindly refer to GST Registration instead.

A works contract is one under which there is a transfer of goods as part of a service contract. This is common during contracts involving repair, renovation and installation of heavy infrastructure.

On account of the dual nature of the work, a works contract has its own definition under section 65(105) of the Finance Act, 1994. In the invoice, the works contract will include both, the value of materials used as well as the value of the service provided in the installation, construction, completion, erection, fitting, renovation or alteration of the works contract.

As per Rule 2A of the Service Tax Rules (Determination of Value) Rules, 2006, “the service portion involved in the execution of original works is 40% of the total works contract and the service portion involved in the execution of works contract other than original works is 70% of the total works contract”.

Make Your Business GST Ready

Typically, the service tax liability is shared by the service provider and the customer. Whereas the customer usually pays service tax in full, a works contract is unique. Therefore, service tax is paid at 15% (prevailing rate as of August 2016) on 40% of the total contract or 70% of the service portion by the contractor and the recipient of the service equally.

Scope of Works Contract

As noted, a works contract is one with a service element attached to the material being transferred in a sale. Therefore, value-added tax (VAT) is payable on the material being transferred, and service tax is payable on the service component. The service provider should have a service tax registration in this case.

[table file=”https://vakilsearch.com/advice/wp-content/uploads/2016/08/WorksRate.csv”][/table]

 

Examples of Works Contracts:

1. Renovation of Building: In case of renovation of a building, there are various jobs involved, including painting, demolishing, tiling, scraping, etc. All charges for labour in this case will attract service tax. However, any work outsourced to a sub-contractor by the contractor will not attract any service tax.

2. Repair of Car: When a car is being repaired, there is material that is involved and a service element. Any materials used to repair the car will attract VAT, whereas the service component (the labour, primarily) will attract service tax.

3. Two-floor Houses: Service tax on construction of two-floor houses, in case both are capable of being transferred separately, must be paid separately.

4. Construction of Pipeline: Contracts for construction of a pipeline or conduit are covered under works contracts.

Note: Pure labour contracts are not considered works contracts as the essential conditions of work contract is to have transfer of property in goods. Architectural and consultancy services are provided in relation to works contracts and are, therefore, not exempt.

Valuation of Service Tax

According to this method, the value of work contract = Gross amount charged for the works contract LESS Value of transfer of property involved in the execution of work contract, where:

Gross amount includes:
1. Value of material transferred
2. Labour charges
3. Amount paid to sub-contractors for labour and services
4. Charges for planning, designing, and architects’ fees
5. Charges for obtaining, on hire or otherwise, machinery and tools used in the execution of the works contract
6. Cost of consumables such as water, electricity, and fuel
7. Other similar expenses related to supply of labour and services
8. Profit

Composition scheme according to Rule 2A

The government has unveiled three composition schemes, which, just like the VAT Composition scheme, allows the service provider to pick a fixed portion on which service tax is to be paid. This makes it easier to calculate the service tax component and, in most cases, cheaper than paying the actual amount. Of course, you need not opt for the composition scheme; however, if you do elect to use it, you cannot use any other exemption.

[table file=”https://vakilsearch.com/advice/wp-content/uploads/2016/08/Comp-Scheme.csv”][/table]

Composition Scheme for Builders

As the service tax calculation can be particularly difficult for buildings, the government has introduced a special composition scheme. This removes the confusion of separating the service portion and the goods portion. What it has done is introduced the concept of declared services. Under declared services, various services are listed and explanations to separate the service portion from the total service is provided in Service Tax (Determination of Value) Rules, 2006. A works contract is also part of these declared services and service tax on works contract is determined accordingly.

[table file=”https://vakilsearch.com/advice/wp-content/uploads/2016/08/Comp-Scheme-2-1.csv”][/table]

Service Tax Works Contract Exemptions

The list of various work contract services that are exempted from service tax are as follows:
a. Service provided to the government, a local authority or a governmental authority;
b. Construction for the use of the general public;
c. Original work pertaining to infrastructure;
d. Sub-contractor services.

Work contract and reverse charge mechanism

If a works contract service is provided by any individual, HUF, firm, or Association of Persons to a business entity as a body corporate, then 50% of service tax is paid by service provider and 50% is paid by service receiver.
In case a works contract is provided by the government or local authority in the nature of a support service, 100% of the service tax is paid by the service receiver. In all other cases, 100% of the service tax is paid by the service provider.

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A lawyer with 14 years' experience, Vikram has worked with several well-known corporate law firms before joining Vakilsearch.