Taxation of Works Contracts under TN VAT Vs Profit maximization in project execution (3rd Revision)

[Jagadeeswaran P]

Meaning of Works Contract in TN VAT:  Sec 2(43) defines as “Works Contract” includes any agreement for carrying out for cash, deferred payment or other valuable consideration, building construction, manufacture, processing, fabrication, erection, installation, fitting out, improvement, modification, repair or commissioning of any movable or immovable property.

It need to be very careful while reading these lines that the act has not given the exact and exclusive definition but the definition specifically includes the activities/ nature of transactions covered under the Works Contract. In the absence of the exclusive definition for the words/ phrase “Works Contract” one need to refer the definition of works contract under the General Clauses Act and relevant judicial pronouncements from time to time.

Taxation under TN VAT! The works contract is been governed by two different methods and the option is left to the choice of the dealer.

First Method: This method is also known as Method of Composition or Composite method of tax payment. In this case the dealer is liable to pay tax on the total value of the works contract at the applicable rates. The applicable rates are 2 percent for civil works and civil maintenance works & 5 percent (4 percent till the amendment on 13/2/2012) for all other works. And the highlighting points under this method are (a). The dealer has to present his option of payment of tax under this method with the assessing authority before 20^th of May of the financial year or along with the first month return after commencement of the works contract execution, as the case may be,  (b) The dealer is not required to maintain books of accounts under this act., and it does not mean that he/ she need not maintain books of accounts under the other law(s) in the land, and (c) The dealer cannot take Input Tax Credit on the purchases or on the inputs, and more importantly (d) the tax has to be paid out of his margin earned or to be precise he has no rights to collect the tax portion from his customer(s). The reader may mark these facts/ points are covered under sec.  6 of the TN VAT  Act.

Second Method: It is opposite to the first method and it is known as Non-composition in general and the properties are:

(a)  the dealer is not liable to pay tax on the total value of the works contract/ total turnover at the applicable rates but on the taxable turnover only and again the percentage of tax payable on the said turnover is based on the form of the property and its applicable rate as listed in the different parts of the First Schedule of the Act.

(b) Unlike the other method the dealer need not place his/her option of payment of tax liability under Non-composition. Once the dealer fails to present the option, it is automatic that he is liable to pay tax under Non-composition method.

(c) The dealer is required to maintain books of accounts under this act and to produce the evidence(s) with the appropriative authorities, as and when required by them.

(d) The dealer is entitled for Input Tax Credit on the purchases or on the inputs, subject to certain restrictions, as prevalent from time to time.

(e) The dealer cannot take Input tax credit on the purchases under CST act.

The reader may mark these facts/ points are covered under sec.  5 of the TNVAT  Act.

Common for both the cases/ Methods: The option opted as above is final and binding and the dealer has no option to switch over to other method with in the financial year. However switching from one method to another is possible from the next financial year, even if the project is continued to be in execution and this switch over is subject to the fact that the dealer may have to forgo if the dealer who want to switch over from Non-composite method to Composite method and not vise versa.

Difference between (i) Value of the Works Contract under the first method and (ii) Taxable Turnover under the second Method:

The total consideration received or receivable in future in respect of the works contract agreement, accounted under the regular accounting practice of the dealer whether on Mercantile or  an accrual basis. To say the value received plus receivable plus escalation if any due in future is called Value of Works Contract.

The Taxable Turnover means, the value of the works contract adjusted by the component of exempted goods and services included or inbuilt in execution of the works contract. To cover an example(s) is/are: labour charges paid on execution of the civil works, equipments or apparatus covered under Part-B of Fourth Schedule (Sec. 15). It is to be noted that the value of VAT charged in the Invoice is not part of the value of the works contract, for the purpose of taxable turnover.

Assessment of Tax Liability on Taxable Turnover: The dealer is liable to pay tax at the rates specified in the First Schedule on the taxable turnover. If the inputs/ purchases for execution of the projects are covered by more than one tariff category/ group of goods and services fall under more than one rate of tax, then the taxable turnover is divided in to more than one group in the same ratio of the inputs category/ group.  Now the splited taxable turnover be charges on the respective tax rates as per the first schedule to arrive the tax payable.

Illustration:  Dealer Company ‘A’ has accepted an assignment of Design, Development, Commissioning of sewerage water treatment plant from Govt. department ‘B’ for a consideration of Rs.100 lakhs plus applicable VAT.  In this case the contractor company ‘A’ has spent labour expenses in construction a sum of Rs.32.00 lakhs, Design charges a sum of Rs.1.50 lakhs, Purchase of Pumps from the dealer situated in other state a sum of Rs.10.00 lakhs, Purchase of Pumps & motors from the dealer situated within the state a sum of Rs8.50 lakhs, Purchase of cements from the dealer situated within the state a sum of Rs.8.50 lakhs, Purchase of bricks, blue metals etc from the dealer situated within the state a sum of Rs.8.50 lakhs  and Purchase of Electrical goods from a dealer situated outside the state a sum of Rs.7.00 lakhs and dealer situated with in the state a sum of Rs.15.00 lakhs. Based on this stimulated data’s lets assess the tax liability of the dealer to the VAT authorities.

(1)If the dealer wishes to pay tax on composition/ first method, the tax payable is 5 percent on the total contract value of Rs.100.00 lakhs. (ie 5 .00 lakhs) PLUS applicable purchase tax on all the interstate purchases, to the extent of the opportunity revenue loss to the state government, since the dealers are not permitted to buy the goods from a dealer who located outside the state of Tamil Nadu, as he/she has opted composite method.

(2)If the dealer wishes to pay tax on Non-composition/ second method, the process of assessment of tax liability is illustrated bellow:

A	Value of works contract	100.00	lakhs
B	Input services considered for execution of contract
	Labour & Design charges	33.50	lakhs
C	Input goods covered under  Part B of first Schedule (inputs covered under 5 percent TN VAT)	Value  Rs. In Lakhs
		Gross	Basic	VAT	CST
	Purchase of pumps (CST)	10.00	9.80		0.20
	Purchase of pumps & motors	8.50	8.10	0.40
	Purchase of bricks, blue metals etc	8.50	8.10	0.40
	Purchase of electricals (CST)	7.00	6.86		0.14
	Purchase of electricals	15.00	14.29	0.71
	Sub total:	49.00	47.15	1.52	0.33
	Value of good covered under Part B of first schedule	47.48
D	Input goods covered under  Part C of first Schedule (inputs covered under 14.5 percent TN VAT)	Value  Rs. In Lakhs
		Gross	Basic	VAT	CST
	Purchase of Cements	8.50	7.42	1.08
	sub total:	8.50	7.42	1.08
	Value of good covered under Part B of first schedule	7.42
	Cost of execution of the project       = 33.50 + 47.48 + 7.42 = 88.40 lakhs
	Ratio among the exempted and taxable goods would be  33.50 : 47.48 : 7.42
	Accordingly the exempted turnover and the taxable turnover would be assessed as under:
	Turnover Exempted under Rule 8(5)(d) (30 percent )	30.000	Lakhs
	Turnover Taxable at the rate of 5 percent = (70*47.48)/(47.48+7.42)	60.535	Lakhs
	Turnover Taxable at the rate of 14.5 percent = (70*7.42)/(47.48+7.42)	9.465	Lakhs
	Total Turnover	100.000	Lakhs
	Assessment of tax to be collected	Basic	VAT
	Turnover Taxable at the rate of 5 percent	60.535	3.027	Lakhs
	Turnover Taxable at the rate of 14.5 percent	9.465	1.372	Lakhs
	Total value of TN VAT to be collected from the customer		4.399	Lakhs
	Assessment of Tax to be paid to VAT authorities
	Total of VAT collected from the customer		4.399	Lakhs
	Less: input credit eligible		2.600	Lakhs
	Balance of Payment to be made to VAT authorities		1.799	Lakhs

 Considering the relevant provisions in the act and in the agreement the maximum billing could be possible under composite method is Rs.100.00 lakhs and under non-composite method is Rs.103.903, in the given hypothesis. The table given bellow is the illustrative comparisons on the changes in profit element owing to the option excised by the dealer, in the given hypothesis : 

	Rs in Lakhs
Comparisons of results with key factor of tax liability	U/s  5	U/s 6
Total turnover	100.000	100.000
Add: Tax collected from the customer	4.399	0.000
Total receipts	104.399	100.000
Less : Payments made to vendors/ others	91.00	91.000
Less : Payments made/ to be made to VAT authorities	1.799	5.000
Less: Purchase tax paid/ to be paid to VAT authorities	0.000	0.850
Profit/ Margin element	11.600	3.150

       

 Notes to the hypothesis considered:

(i) being the nature of works falls under electro mechanical works, the dealer will get the deduction under rule 8(5)(d) is 30 percent   (ii) TDS under VAT act a sum of Rs.5.00 lakhs to be made by the customer to be adjusted against the dues to the dept, has not been considered in the illustration exhibited above, as the issue been dealt in a separate article as “TDS under TN VAT Rules ( revised)” (iii) if the agreement/ works order specifically says that the rates quoted is inclusive of VAT, then the entire workings need to be done separately and the author may be reached for professional supports in this regard.

Additional facts:

If the dealers opt to pay tax on the first method/ composition method of tax liability, he can not apply for Form S with the authorities, the tax liability and the VAT TDS are one and the same. In the absence of Form S, the employer contractor (customer) is bound to deduct 5 percent on the works contract value. In case if the dealer wishes to avoid this, he has the option to pay the VAT taxes billed in the invoice in advance to the assessing authorities and obtain the Form S and avoid the TDS process.

Interpretation(s): 

The VAT Rules provides the fact that if the sub-contractor is registered dealer filing the returns under VAT Act., the main contractor turnover to the extent of the payment made to the subcontractor is exempted from works contract value/ taxable turnover.  The VAT Act or Rules has not given effect of exemption in the hands of sub-contractor, even if the main contractor has opted to pay tax under non- composition method (under sec 5 of the act.),  and in addition to this the Rule 8(5)(d) provides to assess the exemption from the taxable turnover in the absence of data’s in the books of accounts, but the rule has failed to restrict the allowance subject to the maximum amount as calculated under this rule or actual amount spent, whichever is lower, so as to tax the profit element behind the project.

For any further clarifications the reader may reach the author P.Jagadeeswaran, VAT Practitioner by mobile no.: 9176038176 or by post/ courier to No.3, GF-2, VOC Street, Ayyappakkam, ICF Colony, Ambattur, Chennai – 600077 and/or email: eswaran60 at the rate of yahoo.com & eswaran1960 at the rate of gmail.com

(Revision made on 01 10 2013)

The readers are informed to note that the facts and information’s stated in this article is only the opinion of the author and assesses can use the concepts and logical used in this article in support of their cases.