Service Tax on Turnkey Projects in the nature of work contracts ? Construction Services or Erection / installation and commissioning services

[Surender Gupta, FCA]

In this article we are trying to highlight the anomalies and misconception about service tax on turnkey projects which are in the nature of work contract.

To understand the concept of service tax on turnkey projects in clear terms we have divided the whole issue in the following question and commented upon each issue individually.

1 What constitute Turnkey project?

2  Can there be a service tax on the turnkey projects which are substantially in the nature of work contract?

3  Whether the principal laid down by the honorable tribunal in the matter of M/s. DAELIM INDUSTRIAL CO. LTD [2005 -TMI - 97 - CEGAT, NEW DELHI] is applied only to Consulting Engineering Services?

4   Whether the existence of Exemption notification like 12/2003 dated 20/6/2003 and / or 1/2006 dated 1/3/2006 would mean that a service become taxable which is not taxable otherwise.

1 Can there be a service tax on the turnkey projects which are substantially in the nature of work contract?

It is strange that in the service tax provisions there is no definition of the key term "Service" what is service and what is not. But, it does not mean that all the activities which are in the nature of work contract become the service contract. If the legislature wants to levy service tax on the turnkey projects / work contracts, they have to amend the statutory provisions and include the concept of service tax on work contract within the scope of Chapter V of the Finance Act, 1994. The following paragraphs would make the situation more clear.

2 Whether the principal laid down by the honorable tribunal in the matter of M/s. DAELIM INDUSTRIAL CO. LTD. [2005 -TMI - 97 - CEGAT, NEW DELHI]  applied only to Consulting Engineering Services?

In the matter of Dealim Industrial Co. Ltd. v. CCE reported in 2006(3) STR 124 (Tri.) Del. And 2005-TMI-97 - CEGAT Delhi, the honorable tribunal has held that: -

Para 6: - "Thus, a perusal of the clauses of the contract leaves no doubt that the appellant contract with IOC was a work contract on turnkey basis and not a consultancy contract. It is well settled that a work contract cannot be vivisected and part of it subjected to tax."

A turnkey project may involve various activities depends on its nature and terms. For example it may involve designing services, architect services, consultancy services, know how services, supply of labour services, supply of material and goods etc.

A turnkey project which is in the nature of Works contract in the respective state's sales tax (VAT) laws does not mean that since they are having a service element, these contracts become a service contract. Where the supply of material and goods having a substantial bearing on the whole contract, the same make the whole project is not liable to service tax in the present scenario.

If we see the classification provisions of services under section 65A of the Chapter V of the Finance Act, 1994, we find that as per the clause (b) of sub section (2) where a "composite service consisting of a combination of different services which cannot be classified in clause (a), shall be classified as if they consisted of a service which gives them essential character, in so far as this criterion is applicable."

Thus it is clear from the above that, the legislature recognize the concept of composite service. And in case of a composite service, the essential character is to be determined.

Therefore, in case of a composite contract, where the essential character is turkey contract in the nature of works contract and special bearing of supply of material and goods, the same becomes a non service contract and not liable to service in the present situation.

3 Whether the existence of Exemption notification like 12/2003 dated 20/6/2003 and / or 1/2006 dated 1/3/2006 would mean that a service become taxable which is not taxable otherwise.

I have heard from the certain sections that in case of composite contracts, the legislature has issued various exemption notifications to nullify the effect of turnkey project in the nature of work contract by way allowing either to claim rebate of value of material or good sold in the course of services or by claiming ad-hock rebate (i.e. 67% in certain cases)

I think that the proposition given by these sections are not good since the exemption notification is issued to grant the relief or benefit where the interest of public is involved. No exemption notification  can be issue to make a non taxable service as a taxable service.

Under the provision of service tax (Chapter V of Finance Act, 1994) the power of issue exemption notification vested with the Central Government under section 93.  The provisions of Section 93(1) are read as under: -

"If the Central Government is satisfied that it is necessary in the public interest so to do, it may, by notification in the Official Gazette, exempt generally or subject to such conditions as may be specified in the notification, taxable service of any specified description from the whole or any part of the service tax leviable thereon"

Further, in MECHANICAL PACKING INDUSTRIES PVT. LTD. reported in  2006 -TMI - 754 - HIGH COURT OF JUDICATURE AT BOMBAY (decided in 1987) the honorable Bombay High Court has held that: "If there has to be any exemption, or classification that necessarily must be done by the legislature and not by virtue of any power to issue exemption notification under Rule 8(1) or (2) of the Central Excise Rules"

Conclusion

In my opinion there can not be any service tax on the turnkey projects which are in the nature of work contract and having a substantial bearing of the goods and material supplied in the course of execution of contract.

There are certain other technical reasons which may or may not be applicable in each contract have not been discussed hereinabove due to complicated and detailed in nature.

Discussions to this article

[Rabindra kr singh]

Please advice,if work contract with material,contract amt rs.1670000.00,what amt will be material part for tax & what amt will be labour part for service tax,in both condition if same state or interstate.