How Will GST Impact Works Contract?

Works contract means a service contract involving supply of goods to execute the contract. Hence, works contracts are a mixture of service and transfer of goods. Examples of works contracts are the construction of a new building, erection, installation of plant and machinery.The article covers applicability of GST on works contracts in detail.

Works contract under pre-GST regime

Works contracts consisted of three kinds of taxable activities as per the previous law. It involved supply of goods as well as supply of services. If a new product was created during the works contract, then such manufacture became a taxable event. Previously, the supply of goods was taxable in the form of VAT and the service was taxable under service tax. 

If a new product appeared in the process of completing a works contract, Central Excise duty was levied. So, different aspects of one single activity were taxed by different laws. This caused a lot of confusion regarding treatment and taxability which is why there were so many legal disputes related to works contracts. GST aims to put an end to the uncertainty for the legislature.

Taxability of works contract under GST

Unlike the previous VAT and Service Tax regulations, the term “Works Contract” has been limited to any work performed for a “Immovable Property” under GST. Whereas, erstwhile laws considered contracts for movable property into account.

As per GST, A contract for the construction, fabrication, completion, erection, installation, fitting out, improvement, modification, repair, maintenance, renovation, alteration, or commissioning of any immovable property in which the transfer of property in goods (whether as goods or in another form) is involved in the execution of such contract is referred to as a “works contract”.

Any such composite supply on products, such as a fabrication or paint job in an automotive body shop, will not fall under the GST definition of term works contract per se. Such contracts would continue to be composite supply, but they would not be considered a Works Contract for GST purposes.

GST Schedule II clearly mentions that the following are supply of service–

• Construction of a complex, building, civil structure or a part thereof, including a complex or building intended for sale to a buyer, wholly or partly,
• Works contract including transfer of property in goods (whether as goods or in some other form) involved in the execution of a works contract

Thus, GST has removed the confusion regarding the tax treatment. This means works contract will be treated as service and tax would be charged accordingly (not as goods or part goods/part services).

This treatment of works contracts as service and not as supply of goods will bring in much needed clarification to the works contracts. Under the previous regime, different states had different schemes for VAT. There were different composition schemes with different VAT rates. Service tax too was complex with 60% abatement on new works and 30% abatement on repair contracts. GST solves such with a much simpler straightforward calculation.

Input Tax Credit (ITC) not available on some works contract

GST Law mentions that input tax credit is not available for-

• works contracts services when supplied for construction of immovable property, other than plant and machinery, except where it is an input service for further supply of works contract service.
• goods or services received by a taxable person for construction of an immovable property on his own account, other than plant and machinery, even when used in course or furtherance of business.

Input tax credit is available to both a builder and a taxable person while constructing plant and machinery. But input tax credit is not available to any taxable person who constructs on his own account even if it is for business use. 

As a result, ITC for works contract can only be obtained by someone who is in the same line of business as them and is using the services they have received to supply more works contract services. A building developer, for example, may hire a subcontractor to complete a section of the project. In the tax invoice sent to the principal contractor, the subcontractor will charge GST.

Because his output is a works contract service, the main contractor will be able to claim ITC on the tax invoice raised by his subcontractor. However, if the primary contractor supplies a company in the IT industry with a works contract service (other than plant and machinery), the ITC of GST paid on the invoice created by the works contractor will not be available to the IT company.

Abatement is not provided under GST

No abatement had been prescribed for works contract service under GST. Previously, VAT was payable on the works contract. Service tax was paid @15% on either 40% (on new work) or 70% (on repair, maintenance work). 

Due to no abatement/ composition is provided, it has led to significant increase in tax burden, especially the works contract is taxed at standard GST rate (which is 18%) and even though  subjected to lower tax rate (12%).

GST rate on works contract

The GST rates applicable for various class of works contracts are as follows:

*1. Provided that the carpet area of the affordable residential apartments as specified in the entry in column (3) relating to this item is not less than 50% of the total carpet area of all the apartments in the project. 

2. Provided also that for the purpose of determining whether the apartments at the time of supply of the service are affordable residential apartments covered by subclause (a) of clause (xvi) of paragraph 4 below or not, the value of the apartments shall be the value of similar apartments booked nearest to the date of signing of the contract for the supply of the service specified in the entry in column (3) relating to this item. 

3. Provided also that in case it turns out that the carpet area of the affordable residential apartments booked or sold before or after completion, for which the gross amount actually charged was forty five lakhs rupees or less and the actual carpet area was within the limits prescribed in sub-clause (a) of clause (xvi) of paragraph 4 was less than 50% of the total carpet area of all the apartments in the project, then the recipient of the service, i.e. the promoter will be liable to pay such amount of tax on reverse charge basis equal to the difference between the tax payable on the service at the applicable rate but for the rate prescribed herein and the tax actually paid at the rate prescribed herein.

Maintenance of records by a works contractor

According to Section 56(14) of the Central Goods and Services Tax (CGST) Rules, a person executing works contracts must maintain separate accounts for works contracts showing

(a)The names and addresses of the persons on whose behalf the works contract is executed
(b) The description, value, and quantity (wherever applicable) of the goods or services received for the execution of the works contract 
(c) The description, value, and quantity (wherever applicable) of the goods or services utilised in executing the works contract 
(d) The details of payments received in respect of each works contract
(e) The names and addresses of suppliers from whom they have received goods or services from.

Value of supply of works contracts

The value of a works contract service is determined by whether the contract includes a land transfer as part of the works contract. In the case of a service supply involving the transfer of property in land or an undivided share of land, the value of the service and commodities element of the supply shall be equal to the entire amount charged for the supply less the value of the land or undivided share of land, as the case may be.

One third of the entire price paid for such supply will be deemed to constitute the value of land or an undivided share of land, as the case may be.

Place of supply of works contracts

Immovable property would be required for a GST works contract. As a result, where both the supplier and the recipient are located in India, Section 12(3) of the IGST Act, 2017 governs the location of supply. The location of the immovable property would be the source of supply.

If the immovable property is located outside of India but both the supplier and the recipient are in India, the place of supply will be determined by the proviso to Section 12(3) of the IGST Act, 2017.

When either the Supplier or the Recipient is located outside India, the place of supply is the place where the immovable property is located or planned to be located, according to Section 13(4) of the IGST Act, 2017.

Availability of composition scheme to works contractors 

Composition scheme is available to works contractors from April 2019 provided turnover is up to Rs.50 lakhs. Earlier, the composition scheme was not available to service providers and was open to only available to suppliers of goods. This was a big blow to the small sub-contractors who cannot opt for the composition scheme. They were forced to register for the normal taxation scheme increasing their compliances and costs. With the composition scheme extended to service providers, small service providers can benefit.