New concerns as tax net is cast wider

In accordance with the policy of the government to widen the service tax base, the Finance Act, 2007, has, with effect from June 1, brought seven new services in the service tax net including two significant services relating to renting of immovable property and to execution of works contracts.

Perhaps the most controversial category of taxable service brought under the ambit of service tax is "renting of immovable property" for the furtherance of business or commerce. The value of taxable service has now been defined as the rental amount less the amount of property tax actually paid for the period in question.

This deduction on account of the property tax would provide some respite to those renting out property in metro cities in view of the high incidence of a property tax in these cities. However, no exemption for any interest or penalty paid in relation to the property tax is allowed.

The Service Tax Rules, 1994, have been amended to allow for adjustment of any excess service tax paid on account of non availment of property tax deduction at the time of payment of service tax, for the reason of the subsequent payment of the property tax.

On the tax itself, it is a fact that rentals of immovable property used for business or commerce are chargeable to GST (goods and services tax) in several countries that follow the VAT system.

However, it is also the case that in such countries, a well developed and integrated GST system exists whereby the GST on rentals of commercial property is a pass-through cost for almost all businesses and is therefore similar to any other element of input taxes.

In India, however, in the absence of an integrated VAT, there will be no opportunity to offset these taxes against output taxes, given that this tax cannot be offset against the State VAT. This predicament will be faced by a large section of the retail and information technology sector for whom property rentals are a large part of the cost.

Another problem that needs to be addressed is the aspect of the offset of the service/excise taxes paid in relation to the construction of the commercial property against the service tax on the property rental.

Another major category is that of services in relation to execution of works contracts. The taxable service is related to the execution of works contracts in relation to construction, erection, commissioning or installation and turnkey projects, including Engineering, Procurement and Construction or Commissioning projects.

For valuation of works contract for the purpose of charging service tax, the Service Tax (Determination of Value), Rules, 2006, have been amended by way of an insertion of new Rule 2A, which provides that the value of taxable service is equal to gross amount charged for the works contract less the value of transfer of property in goods involved in the execution of the said works contract as well as the VAT/ Sales tax paid thereon.

The value of transfer of property in goods is the value of goods on which the VAT/Sales Tax has been paid. This option is available where proper records are maintained to evidence the actual value of transfer of property in goods. However, the identification of the taxable value of such contracts on the basis of records maintained by the assessee could be problematic.

The government has also identified certain "add-ons" to the value of taxable service like the cost of establishment of the contractor relatable to supply of labour and services, the profit earned by the service provider relatable to the supply of labour and services, the cost of consumables such as water, electricity and fuel, used in the execution of a works contract, the property in which is not transferred in the course of execution of such works contract.

To give some relief to the service providers, however, the government has provided for a composition scheme wherein the service providers can pay, as service tax, a sum equivalent to a fixed percentage of the total value of the works contract. In this regard, a complete set of rules, namely the Works Contract (Composition Scheme for payment of Service Tax) Rules, 2007 have been introduced.

These rules provide for payment of service tax on works contracts on a composition basis. Under the said rules, the service provider has an option to pay service tax at the rate of 2 per cent on the gross amount charged for the works contract, not including the VAT/sales tax paid on transfer of property in goods involved in the execution of the said works contract.

This option is to be exercised before commencement of the works contract and is applicable for the entire works contract and is irrevocable until the completion of the said works contract. An important point to be noted is that assessees opting for composition scheme will not be entitled to avail Cenvat credit in respect of input goods.

This option of discharging service tax at 2 per cent under the composition mode, on the total value of works contract, is comparatively simple to administer and on a backward computation, amounts to taxing 17 per cent of the total contract value at standard service tax rate.

This new levy could possibly bring to an end the ambiguity surrounding the service taxability of such works contracts. However, it covers only specified works contracts, the erstwhile ambiguity continues with respect to other works contracts involving services such as maintenance and repair.

There is no clarity as to whether the services of erection, commissioning or installation provided under a works contract would be more specifically covered under the category of erection, commissioning or installation services or under the new taxable category of execution of works contracts.

The idea seems to be to possibly deny the benefit of the composition scheme under the new definition to service providers covered under this category.

A far more important point is whether the introduction of the new taxable category would mean that the services in relation to the specified works contracts were not taxable earlier. The circular issued by the government in this regard states that the works contract can be vivisected for both sales tax/VAT as well as for service taxes.

This would imply that the services in relation to the specified works contract could possibly be chargeable to the service tax under the erstwhile definitions and that with the insertion of the new definition, all that has changed is the classification of such services under the more specific heading pertaining to works contracts as opposed to the erstwhile generic headings that continue to be prevalent even now.

This is an important point and will certainly come up for judicial scrutiny and decision in due course. The financial implications of this particular fine point are significant for a variety of sectors.