Introduction

 

CONSTRUCTION service was brought under service tax ambit with effect from 10.09.2004. The services specifically included Construction of new building or civil structure or part thereof or repair alteration or restoration or similar services in relation to building or civil structure, which has been used for industrial or commercial purposes. While Construction of new residential complex, completion and finishing work thereto repair alteration, renovation or similar services in relation to residential complex was subjected to service tax by Finance Act 2005 effective from 16-06-2005.

 

In order to ensure high quality in the execution of such construction service, owners/service recipient generally supplied steel, cement & other materials to the construction contractors. Usually such free supply of materials from the service recipient where excluded from the value of the contract . Due to such exclusion, the contractors started facing enquiry & show cause notice proceedings from the department as to show valid reasons for the ignorance on the part of the contractors on exclusion of the value of such free supply of material while discharging the service tax liability. On the other hand in certain instances value of such free supply being integral to the execution of construction service was subject to service tax levy.

 

Divergent view expressed by Tribunals in case of taxability of free supply created huge confusion. Please refer analysis below :

 

(a) in Cemex Engineers vs. CST, Cochin - 2009 and

 

(b) in Jaihind Projects Ltd. vs. CST, Ahmedabad - 2010

 

In Cemex Engineers- The appellant was engaged in providing taxable construction services and paid service tax, after availing abatement of 67%, in terms of Notification Nos. 15/2004-ST; 18/2005-ST and 1/2006-ST & 12/2003 but did not include free supply of material for the purpose of service tax payment. Proceedings were initiated against appellant contending that the value of materials supplied free of cost by the recipient should be subject to service tax if benefit is to be claimed under the Notifications. However the Tribunal held that Section 67 of the Act, which specifies that the value of taxable service shall be gross amount charged by the service provider for providing such service. Hence gross amount charged by the service provider cannot include Free supply of material by the client for service tax levy , in terms of Section 67 since no value or amount is charged in respect of the same from the service receiver.

 

On the other hand in Jaihind Projects Ltd. a contrary view was expressed. The appellants were engaged for laying pipelines and providing (commercial or industrial construction) service & various materials including pipes were provided by the service recipient in the execution of the service. The appellant availed the abatement benefit in pursuance of the exemption Notification No. 15/2004-ST. The Tribunal held since section 67 of Finance Act provided for inclusion of both monetary and non-monetary consideration in the taxable value, the pipes being an essential component and essentially required for providing the pipeline service (though supplied free of cost by the service recipient), “must be treated as consideration other than in the form of money i.e non monetary consideration”; and the value of such pipes must be included in the gross value to be offered for taxation and once an assessee opts for the “benefits of abatement under the said Notification” he must include the value of the goods irrespective whether goods are supplied by the service provider or provided by the recipient including free supply irrespective of the source of supply.

 

Payment of service tax on material cost is not the intention of Government so why the question of including free supply of material cost in the value of taxable service.

 

Works Contract is covered under “Declared Services” under Section 66E of the Act & Declared services, shall constitute, Service portion in the execution of a works contract.” So from the definition also we can understand that where value of taxable service would include material cost, service tax would be paid on material cost which is not the intention of Govrnment since the main purpose is to tax the service portion in the execution of the works contract. The dilemma is further aggravated in the case of composite construction contracts where the value of material and labour cannot be bifurcated & taxing the gross amount would lead to taxing material cost which is also subject of state sales tax(in case of transfer of property in material cost). Hence we can understand that the whole objective of providing abatement as per the exemption notifications is elimination of the material cost to arrive at the value of taxable service to avoid the burden of double taxation to the extent possible so why increase the burden by including free supply of material.

 

A further break analysis of the cases can help us a better insight of the exemption notifications as to whether for availing the abatement benefit under exemption notifications as cited in case laws discussed above, the free issue of material supplied by the owner/service recipient should be included in the gross amount charged by the service provider in respect of value of taxable service provided to the service recipient.

 

Ambiguity with the word” used” referred in Explanation to Notification 15/2004ST, 18/2005 ST & 1/2006-ST

 

In all the exemption notifications the following common phrase has been used surrounding which confusion regarding the inclusion of free supply arose.

 

“gross amount charged shall include the value of goods and materials supplied or provided or used by the provider of the commercial or industrial construction service for providing such service”

 

According one school of thought the value of taxable service is gross amount charged by the contractor which includes goods and material provided or supplied or used by the contractor and the value of free issue of material received from the contractee and used by the contractor . It appears that the meaning of the words "used by the provider" is interpreted to include the material supplied free of cost to the contractor i.e. to say the value of such goods & materials irrespective of source are to be included. The words can also be interpreted as the material brought & used by the contractor himself. The notification does not explicitly state that the value of free issue of material is to be included in the gross amount charged. On the other hand, benefit under Notification No 12/2003 is available if value of goods sold by service provider to the recipient of a taxable service. Hence no benefit under the said Notification is applicable as in case of free supplies by the recipient, there is no sale or transfer of goods & materials in favour of service provider. However the ambiguity surrounding the word “used” in the explanation to Notification No 15/2004ST, does not help to resolve the issue of its applicability on free supply due to the various interpretations applied.

 

In view of conflicting decisions of the Tribunal Larger Bench rules that cost of free-issue materials by the service recipient in the case of construction contracts is not required to be included in the value for purpose of service tax.

 

The Larger Bench concluded that:

 

• As per section 67, value of taxable service shall be gross amount charged by the service provider in respect of value of taxable service provided. Secondly the value of taxable service for service tax levy includes monetary & non-monetary consideration. However, since no value is provided in respect of free supply of material, can the same be treated as consideration received by service provider for providing taxable services? To eliminate such confusions, Section 67 of the Finance Act, 1994 (‘Finance Act') read with Service Tax (Determination of Value) Rules, 2006 (Valuation Rules) envisaged ‘consideration received'. Further emphasizing the same, Hon’ble Larger Bench held that any consideration, monetary or otherwise should flow from service recipient to service provider & benefit should accrue to the later. However in this case, no benefit is accrued to service provider as the material freely supplied will be used by the service provider in executing service for the benefit of service receiver & no benefit will be retained by the former. It is thus concluded that;

 

“Value of goods / materials supplied free of cost by service recipient being neither monetary or non- monetary consideration, would be outside the gross amount charged within the meaning of Section 67.”

 

• Ambiguity surrounding as to whether explanation to Notification 15/2004-ST in respect of the interpretations surrounding the word “used” in the said notification, interprets to include free supply is resolved. Since explanation to Notification 15/2004-ST is inconsistent with the provisions of section 67 which clearly states that free supply will not be included in the gross amount charged hence the exemptions notification will not apply to free supply. Thus for availing the abatement benefit under the exemption notifications free supply shall not be included for service tax levy.

 

Conclusion:

 

In the light of confusing affairs in respect of treatment of free issue, it is advisable that ratio of decision of larger bench shall be provided in categorical terms in agreements/invoices and like documents to avoid any unprotected litigation.

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