Inclusion of Free Supplies by Service Recipient – implication post Larger Bench decision under new Service Tax Regime

[R.S. Mangal]

We as a human being have the tendency to get excited about an issue which is widely debated and especially when an outset it seems to be in our favor. This article of us will be basically covering the judgment so Larger Bench of Tribunal and its probable impact in new service tax regime if any according to our opinion :

Judgment of  Bhayana Builders (P) Ltd. v/s Commissioner of Service Tax, Delhi - 2013 (9) TMI 294 - CESTAT NEW DELHI

Recent judgment so announced by the larger Bench, Principal Bench, CESTAT (New Delhi  in the case of Bhayana Builders (P) Ltd. v/s Commissioner of Service Tax, Delhi - 2013 (9) TMI 294 - CESTAT NEW DELHI , has on the one hand addressed some of the legal ambiguities prevailing in service tax and on the other hand has raised some legal issues.

Above Judgment has sought to explain and clarify two issues:

Issues:

(a)  Whether free supplies by the service recipient to the Service provider can be considered as gross amount charged under Section 67 of the finance Act, 1994?

(b)  Whether Notification can enjoin the condition that free supplies should be included in the gross amount charged, especially when two things are considered:

(i)   When the phraseology used in the notification cannot be said to be specified and is not denuded of ambiguity.

(ii)  When ‘Explanation’ has not by itself introduced the expression “gross amount charged” into the Notification. It has seek to define “gross amount charged”, an expression already employed in the preamble to Notification No. 15/2004-ST; and in the preamble the expression is used in the context of Section 67, a provision dealing with valuation of taxable services.

Judgment:

The answer to the above issues in the light of judgment is in negative-e. The judgment so pronounced says:

(a)  The value of goods and materials supplied free of cost by a service recipient to the provider of the taxable construction service, being neither monetary or non-monetary consideration paid by or flowing from the service recipient, accruing to the benefit of service provider, would be outside the taxable value or the gross amount charged, within the meaning of the later expression in Section 67 of the Finance Act, 1994; and

(b)  Value of free supplies by service recipient do not comprise the gross amount  charged under Notification No. 15/2004-ST, including the Explanation thereto as introduced by Notification No. 4/2005-ST.

Why: An comprehensive analysis of the Judgment

Key interpretations of the decision are –

• There is no transfer of title to goods from service recipient to service provider -

“…In case of free supplies by service recipient there is no sale or transfer of title in the goods and material in favor of the service provider, at any point of time…..” [Head note – para 4]

• FOC material supplies is not consideration to service provider -

“The value of goods and materials supplied free of cost by a service recipient to the provider of the taxable service, being neither monetary or non-monetary consideration paid by or flowing from the service recipient, accruing to the benefit of service provider, would be outside the taxable value or the gross amount charged, within the meaning of the later expression in the Section 67 of the Finance Act, 1994” [Para 16 (a)]

Implicit in this legislative architecture is the concept that any consideration whether monetary or otherwise should have flown or should flow from the service recipient to the service provider and should accrue to the benefit of the later. “Free supplies”, incorporated into construction (cement or steel for instance), even on an extravagant inference, would not constitute a non-monetary consideration remitted by the service recipient to the service provider for providing a service, particularly since no part of the goods and materials so supplied accrues to or is retained by the service provider [Para 8 (v)]

• Contention that FOC material  are essential in providing construction service cannot  be considered for inclusion of its value in non-monetary consideration-

“…the analysis… that since the goods supplied by service recipients are essential components for providing the agreed service, these must be treated as non-monetary consideration and included in the value of the taxable service, proceeds on a flawed interpretation of the provisions of Section 67…….” [Para 8 (ix)]

“…This is not to say that an exemption notification cannot enjoin a condition that the value of free supplies must also go into the gross amount charged for valuation of the taxable service. If such intention is to be effectuated the phraseology must be specific and denuded on ambiguity…..”

• Whether the notification 15/2004 can provide for inclusion of FOC material in value of service and it would be legal under Section 67 -  

Conditionthat gross amount charged includes value of material supplied or provided or usedintroduced as Explanation to the Notification would normally indicate that the specified exemption is granted subject to a condition which requires a wider incorporation into the value of the taxable service, for the limited purpose of computing the extent of exemption. A condition expanding the scope of “gross taxable value” for the limited purpose of granting exemption would therefore only mean that the exemption provided is not so generous as facially appears. Any such condition in an exemption Notification would not therefore and per - se violate the provisions of Section 67 of the Act and for that singular reason. The interpretive problematic however is that the ‘Explanation’ has not by itself introduced the expression “gross amount charged” into the Notification and proceeded to define it. The Explanation, on the other hand seeks to define “gross amount charged”, an expression already employed in the preamble to Notification No. 15/2004-ST; and in the preamble the expression is used in the context of Section 67, a provision dealing with valuation of taxable services.

Implication of above judgment in the new service tax regime:

In the current service tax regime construction services are taxable under sole category of “Work contract service” if there is transfer of goods leviable to VAT for execution of said contract. 

Tax can be paid for Other pure labor contracts either under Commercial or Industrial Construction or Construction of Complex or Erection or Commissioning Services depending on the nature of services (though all these services no more exist in new regime but still tax is paid using old service tax codes)

Valuation of Construction Services under New Service Tax Regime:

(Valuation and Abatement)

Valuation of Service in “ Work Contract “ Service as provided by valuation Rules : Option –I

Pay service tax on value of services after deducting value of goods from the gross value Option – II

(a)  In case of original works – pay service tax on 40 percent   of value. (b)  In case of maintenance or repair or reconditioning or restoration    or  servicing of any goods – pay service tax on 70 percent of value. (c)  All other works contract –Pay service tax on 60 percent of value.

Explanation 1.- For the purposes of this rule,- "total amount" means the sum total of the gross amount charged for the works contract and the fair market value of all goods and services supplied in or in relation to the execution of the works contract, whether or not supplied under the same contract or any other contract, after deducting-  the amount charged for such goods or services, if any; andthe value added tax or sales tax, if any, levied thereon: Provided that the fair market value of goods and services so supplied may be determined in accordance with the generally accepted accounting principles.

Valuation of Service inother  construction service :

Construction Services	percent taxable	Conditions
Construction of a complex, building, civil structure or a part thereof, intended for a sale to a buyer, wholly or partly, except where entire consideration is received after issuance of completion certificate by the competent authority,- (a) for a residential unit satisfying both the following conditions, namely:– (i) the carpet area of the unit is less than 2000 square feet; and (ii) the amount charged for the unit is less than rupees one crore;	25	(i) CENVAT credit on inputs used for providing the taxable service has not been taken under the provisions of the CENVAT Credit Rules, 2004; (ii) The value of land is included in the amount charged from the service receiver.]
(b) for other than the (a) above.	30

The amount charged ……………………………….Provided that the fair market value of goods and services so ……………………….

• From the above two provisions it is quite clear that there is clear intention to include the value of free supplies in the gross amount charged as there is provision to include the value of free market value of all goods supplied by the recipient after deducting the amount charged for such goods to the service provider.

Reasons :

(a)  Rule 2 (a) has not gone on to define gross amount charged rather it has defined “Total amount” which is sum addition of Gross amount charged as defined in Section 67 of the Finance Act, 1994 and any free sup[plies made by service recipient to service provider.

(b)  Secondly value of goods so supplied are intended to be included at their fair market value after deducting the amount charged for such goods to the service provides which clearly speaks of the legislative intent under Rule 2 (A) to include free supply of goods.

Issue in New Service Tax Regime in the context of said judgment

Now question arises whether the said judgment can hold good in the context of above provisions particularly when Rule 2 (A) of Service Tax valuation Rules does not seek to define Gross  Amount charged whereas it seeks to define “Total Amount “which is sum total of gross amount charged as defined in Section 67 of the Finance Act, 1994 and the fair market value of goods and services supplied in or in relation to the execution of work contract 

Opinion:

a)  Certainly the free supplies cannot be said to be gross amount charged in the light of above judgment.

b)  But the important distinguishing point is that whereas Notification No. 15/2004 went on to define gross amount charged a term already defined in the legislature while Rule 2(A) for the purpose of abatement of 40 percent or 60 percent seek to defined “Total amount” which is the sum addition of Gross amount charged and the supplies made by the service recipient to the service provider at their fair market value. Thus an important legal aspect considered in the judgment that can Notification go on to tax something which is not taxable under Section 67 does not seem to get satisfied in the new service tax regime.

c)  Thirdly benefit of Noistiur Solicitus was given in said judgment while considering the Notification No. 15/2004 in which phraseology used to defined gross amount charged was not specific whereas currently Rule 2(A)  firstly does not define gross amount charged and secondly it clearly defined total amount as the sum addition of gross amount charged and supplies by recipient to provider at fair market value for the purpose of calculation of abatement and hence phraseology is more specific and clear and even does not seem to intervene with the legislature as defined in Section 67.

Thus in our opinion is clearly tilted towards that while calculating abatement of 40 percent or 60 percent value of free supplies must be added in the gross amount charged so as to calculate total amount even considering the above judgment.

Therefore though at the outset looking at the said judgment it seems that free supplies should not be added to gross amount charged but on further analysis of the said rule 2A from our side it seems that said judgment does not hold good,  when the service tax liability is discharged on abated value.