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Category: Articles

VAT & Works Contracts

Jun 21 2013

S. M. Kulkarni
Senior General Manager Corporate Sales Tax, Mahindra & Mahindra Ltd, Mumbai

1. What is indivisible Works Contract ?
( Difference between Normal Sale & Works Contract )

The works contracts are not normal sales. In the normal sale there is a transfer of property in definite or ascertained goods. The goods remain same before and after the delivery of the goods. However, in works contracts it does not happen. The goods before the delivery and after the execution of works contracts are different, many times in different form also. For example, at the site of construction of a building, before the Construction (works contract) commences, the goods like cement, steel, sand etc. are lying but after the Construction a building (immovable goods) comes to an existence. This is the difference between the ` Normal” sale and the “deemed sale” in the indivisible works contract .

The Supreme Court of India, in its various landmark judgments has confirmed in the following wordings the difference between a normal sale (as defined under the sale of goods Act) and an indivisible / composite works contract;
“In a contract of sale, the main object is the transfer of Property and delivery of the possession of Chattel as a Chattel to the buyer, where it is not so, it is a contract of Works & Labour” (Hindustan Aeronautics Ltd. 55-STC 314-SC).
“If the thing to be delivered has any individual existence before the delivery as the property of the party who is to deliver it, then it is a sale. If the main object of the work undertaken is not the transfer of a Chattel qua Chattel, the contract is one for work and labour” (Hindustan Shipyard – 119 STC 533-SC).
“The activity is a sale or works contract depends upon the facts, the terms and conditions and the intention of the parties” (Mekenzis Ltd.-165 STC-58 SC)
In normal practice, we can identify many indivisible/composite works contracts namely construction of a Building, erection of Plant & Machinery, Processing jobs, Job works, Repair jobs, Electrical Fittings, Annual maintenance Contracts (AMCs). Installation of Elevators, Air Conditioners, Repairs of Vehicles, Re-trending of old tyres, Customized Printing Jobs, Electro Plating, electro-galvanizing, anodizing etc. We would discuss later , the levy of Sales Tax/VAT on such activities which are indivisible works contracts.

2. What is a Deemed Sale ?
Under the State Sales Tax Laws, before the 46 th Amendment to the Constitution of India, the Sales Tax was applicable only on the sales covered under the sale of goods Act (Normal sale). The indivisible works contracts were not covered under the State Sales tax Acts since works contracts were not normal sales. The Supreme Court confirmed this legal status in its land mark judgment in the case of Gammon & Dunkerely (9 STC 353). Due to this legal status, the states were denied the levy of Sales Tax on the indivisible works contracts. Such contractors were outside the clutches of sales tax laws.
The then Finance Ministers of the States have requested the then Union Finance Minister to take necessary legal steps so as to levy Sales Tax on indivisible works contracts.
Finally, the 46 th amendment to the Constitution of India has been made on 2 nd February, 1983 to add a sub-article (29-4) as under,
“(b) a tax on the transfer of property in goods (whether a goods or in some other form) involved in the execution of a works contract”.
After the said 46 th Amendment to the Constitution, the States were empowered to levy Sales Tax / Works Contract Tax on such sales, called as “Deemed sales” involved in the execution of works contract. Due to the said amendment, the concept of `Deemed Sale’ was introduced. The important features of deemed sales are as under,
(a) It is not a normal sale as defined under sale of goods Act but a deemed sale of goods subject to sales tax by the States.
(b) In the `deemed sales’ the states can levy Sales tax only on `the transfer of property in goods” . In other words , the states can levy Sales Tax / VAT only on the `Material Value’ of the works contract and not on the `labour portion’ of the works contract.
( c ) If in a contract there is no transfer of property in goods from the contractor to the contractee, then No sales tax is applicable on such contracts, called as “ Pure Labour Jobs”.
(d) Under the deemed Sale , an artificial break up of indivisible works contract has to be made to arrive at the `material’ value and the `labour’ value of the contract.
Therefore, after the 46 th Amendment to the Constitution of India, the States are empowered to levy sales tax (now VAT) on such deemed sales but only on the `Material Value’ of the works contract. The High Courts and the Supreme Court have suggested methods on “How to arrive at a material value from the total Contract Price”. (Gannon Dunkerly’s SC Judgement 1993 ) (88 STC 204).
The Supreme Court has also allowed the States to come out with an alternative method to levy Sales Tax on Works contract, if to arrive at material value is difficult. The states have come out with a alternative method called as “Composition Tax” method to tax the indivisible works contract, which is a non-legal /alternative method. The small percentage like 1%, 2%, 4%, 8% as Composition Tax is levied but on the total contract price without any deduction which is available in the legal options under the State Sales Tax / VAT Acts. After, the said amendment to the Constitution certain States a namely Maharashtra & Delhi have come out with separate `Works Contract’ Acts. The other states incorporated the separate provision to levy Sales Tax on the deemed sales in the works contracts. Under the State Sales Tax Acts or separate Works Contract Acts, No contractor or contractee were entitled to claim any set off of Sales Tax paid to their vendors. There was a double taxation in the hands of Contractors in the Sales Tax Regime.
3. Post VAT Scenario – Levy of VAT on Indivisible Works Contracts (Deemed Sales)
The states have introduced the new value Added Tax (VAT) System from 1 st April 2005. The other five States have also followed from 1st April, 2006 and the State of Tamil Nadu has introduced VAT System from 1.1.2007. At present , only Uttar Pradesh and Pondicherry (U.T.) have not joined the VAT States / UTs . They may join from 1 st April, 2007. Therefore, the VAT system is in force in most of the States and the Union Territories in India.
All the VAT States have incorporated in their respective State VAT Acts, the provisions of `Works Contracts’ for levying the Sales Tax /VAT on the deemed sales involved in the execution of works contracts. There is no Works Contract Tax (WCT) now, it is a VAT on the Works Contract transactions (Deemed Sales). The Advantage to the Contractors is that under the VAT system, the Contractors like manufacturers can avail VAT set off / Credit of the VAT paid to the local vendors, which was not available in the Pre-VAT Regime.
Please note that there is an Uniform Scheme of Taxation for levy of VAT on Works Contracts under all the State VAT Acts. There is no separate or different taxation schemes in different States like in pre-VAT period for works contracts . There is a uniformity under the works contract provisions in the Post VAT Regime. This is a positive factor for Contractors under VAT Regime. In all the State VAT provisions, there are three options available for the Contractors to levy VAT on deemed sales (Works Contracts) and VAT is leviable on the `Material Value’ of the Contract. The said three options (Uniform in all the VAT States) are as under,
A-1 – Actual Labour Deduction (Legal Option)
A-2 – Standard Labour Deduction (Legal Option)
B – Composition Tax (Non Legal or Alternative Option)
Under the legal options A-1 and A-2, the State Governments can levy VAT only on the `Material Value” of the Contract and not on the `Labour Portion’ of the Contract. Please note that the States are empowered to levy tax on “Material Value” and not on “Material Cost” in the works contract. For example, VAT is applicable on `Cement Block Value’ and not on ` Cement Cost’. Similarly, VAT is applicable on `Wooden Furniture Value ’ and not on `Timber/Wood Cost’ in the hands of the Contractor.
I have explained below, the said three options available for the Contractor, executing indivisible Works Contract under the State VAT Acts (Uniform Across the States). Except the Rates of Composition Tax, the Rates of TDS deductions, Returns and Payment dates, most of the Major Provisions are Similar / Uniform under the State VAT Acts;
Actual Labour Deduction Option
A-1 Option (Levy of VAT on Works Contracts in the hands of the Contractor)
Under the legal option A-1, the VAT is payable on the `Material Value’ of the Contract. The deductions are available for arriving at the Material Value from the total contract price. Such deductions are specified in the corresponding provisions of the state VAT Acts which are based on the guidelines given by the Supreme Court in the case of Gannon Dunkerley (88 STC 204) or the Contractors can arrive at the Material value / price of the Contract by adopting cost + value Addition method. In this method, the Contractor adds to the `Material Cost’ which is determined by considering all the purchase bills of the materials (imports, outside the State and within the State), the margin on such material cost plus any incidental expenses attributed towards the material value. In other words, the Contractor determines the Material Price after adding Material Cost and Margin to such cost .
The 4% or 12.5% VAT would be applicable on such Material Value /Price, depending upon the classification of such materials (Steel 4%, others 12.5% VAT) in which the property passes to the contractee . In this option A-1, the Contractor can avail full VAT set off / credit of the VAT paid to the local vendors (Not on CST paid to the outside the State Vendors) provided he obtains corresponding `Tax Invoices’ from his local vendors. Therefore, the cost of VAT is zero for the Contractors in this legal option. Similarly, the Contractee /Customer also can avail the full benefit except on the purchases covered under the Negative list under the State VAT Act on which No VAT set off/Credit is available. Mostly the Civil Works , Construction jobs, errection of immovable property (Structures) are covered in the Negative lists. On the other works contract purchases, the full VAT set off / Credit is available to the contractee /customer. The T.D.S. (works contract) provisions are applicable to the contractee in this option which are discussed later.
In nutshell, in the option A-1 (Legal), the Contractor gets full VAT set off / credit on the VAT paid on the inputs and the Contractee also gets the credit, if it is not in the Negative list (Like processing Jobs, Job works, Printing Jobs, Repair Jobs etc.) The Contractors are benefited under VAT System as the Contractors can avail full set off / credit.
However, in this option the Contractor has to maintain proper books of accounts and the other records to identify the material value of the Contract.
A-1 option is the Best option available since the Contractor levies VAT only on the `Actual Material Value’ of the contract, even though it is litigation prone option. Many Contractors who execute big indivisible works contracts, Turnkey Jobs opt for legal option A-1.
Option A-2 (Standard Labour Deduction)
(Legal) (levy of VAT in the hands of the Contractor)
Under the legal option A-2, the VAT is payable on the `Material Value’ of the Contract. The Material value is calculated after deducting the `Labour Portion’ from the total contract value / Price.
However, in this option a table is available in the State VAT Act / Rules which shows `Standard Labour portion’ attributed to the various works contracts. The Contractor has to deduct such `Standard Labour portion’ shown in such tables from the total Contract price to arrive at the `Material value’. The Contractor would charge 12.5% VAT, on such material value. Each State has provided the said `Standard Labour’ table , under this option. (Like in Maharashtra for Civil Works it is 30%, for Plant & Machinery 15% , for AMCs 40% and for others 25% (Residuary)) .
The advantage in this option compare to the A-1 option is that it is litigation free. The Sales Tax Departments would allow the said ` labour portion deductions’ as the same are provided in the VAT Rules itself. Also no identification record has to be maintained by the contractor for the materials used in the contracts. However, the Contractor has to consider both the options A-1 and A2 in the case where the Contractee/ Customer does not get the VAT set off / credit and then selecting the cheaper option.
Like in A-1 option, in A-2 option also, the Contractor gets full credit / set off on the VAT paid on the inputs and the Contractee also gets full set off of the VAT paid provided the said purchases are not in the Negative list of VAT set off / credit. The TDS provisions are applicable to the contractee in this option also which are discussed later.
Option-B — Composition Tax (Alternative / Non legal option)
( Levy of VAT in the hands of the Contractor )
Option B is the “Composition Tax” option. This is a non legal alternative option, simplier option for those Contractors who cannot maintain the proper Accounts, Record of the material and other portion in their contracts. The contractee / customer prefers this option as small amount of Composition Tax 2% / 4% is payable to the Contractor instead of 12.5% VAT payable in legal options. A-1 and A-2 . However , VAT credit/set off is not be available to them in this option ( in this option , VAT Credit is available only in the state of Maharashtra ) .
Under the “Composition” option, the Contractor has to pay Composition Tax (VAT) on the total Contract value / price, No deduction of labour is available in this option. Similarly, No VAT set off / Credit is available on the purchases of inputs to the Contractors and the same is not available to the Contractees also. (Except under Maharashtra VAT Act/Rules, partial VAT Credit is available to both Contractor and Contractee in the Composition Tax option). The Rates of Composition Tax differ from state to state. Generally it is 2% (for civil contracts) @ 4% for other Contracts. However, exception is in Maharashtra State where the Rate of Composition Tax is 5% on Civil Contracts and 8% on other Contracts. In Maharashtra, in this option , in excess over 4% Credit is available on the input purchases for civil contracts (where composition Tax Rate is 5%) and 64% of the total credit available for other Contracts ( where Composition Tax Rate is 8%). Thus , partial VAT Credit is available to the Contractors in the Composition Tax option. However, full credit is available to the Contractee in this option in Maharashtra provided such purchases are not included in the Negative list under MVAT Rules.
Therefore, except in Maharashtra, in all other states No VAT set off / credit is available to both the Contractor and the Contractee in the Composition tax option. The TDS provisions of Works Contract are applicable to Conctractee in this option which are discussed later.
In Short, in all the States only the said 3 options (A-1, A-2 and B) are available in the hands of the Contractors for levy of VAT on the local works contract transactions in the VAT system. If no VAT set off/Credit is available to the Contractee / Customer, then the Composition Tax option is the Cheapest since the Rate of Composition Tax is lower than 12.5% VAT. Therefore , if the Contractee / Customer can not avail the VAT set off / Credit in all the three options , then , the VAT / Composition Tax paid to the contractor is the cost to such Contractee /Customer, hence in such cases the Contractor and Contractee should select the Best option available after considering the Actual Figures in all the three options.
The States have provided separate sections / Rules under the respective State VAT Acts for the works contracts transactions which include said three options of levy of VAT , TDS , VAT Credits and Negative lists .
4. General Negative list Items for Works Contracts under State VAT Act & Rules
(a) Purchases effected by way of works contract where the contract results into an immovable Property .
(b) Purchases of Building material which are not resold but are used in the activity of Construction. (Free issues)
(c) Purchases of works contracts made by the Contractee in Civil Contracts .
(d) Any purchases of Consumables or of goods treated as Capital Assets by the Contractor/dealer where he is principally engaged in doing job work or labour work and is not engaged in the business of manufacturing of goods for sale by him.
(Please refer to the specific provisions of works contracts under the relevant state VAT Acts for such Negative lists)
5. Tax deducted at source (TDS) provisions of works contracts under the State VAT Act & Rules
In most of the State VAT Acts, the provisions of Tax deducted at source (TDS) are incorporated. The logic behind the TDS (WC) provisions is that the Contractors are not organized in many cases and they do not pay taxes on time , therefore in this provision the contractee / customer deducts the prescribed % of TDS from the Contract Price and pays the same before the prescribed dates, directly, to the respective State Government through the specified challan. The TDS is to be deducted by the specified customers only as notified by the State Governments. Generally, the dealers registered under the State VAT Acts, State and Central Governments, Corporations, Government Undertakings, Co-operative Societies only have to deduct the said TDS (WC) and not by all the Customers. The monetary limit of the turnover is prescribed between Contractor and Contractee for such deduction in the hands of the Customer in most of the VAT Acts.
It is responsibility of the Contractee / Customer to deduct the prescribed % of TDS (As provided in the relevant VAT Act & Rules) and pay the same to the State Government before the prescribed date, otherwise interest / penalty is leviable on such Contractees / Customers.
However, as per the State VAT Act provisions, the Seller (Contractor) is liable to pay VAT, if No TDS is made by the Contractee/Customer. The State Governments have prescribed different VAT Forms under the provision of TDS (WC). In certain States, the Contractee has to obtain TANs (Tax deductible Account Number) and file Annual Returns of TDS under the TDS provisions .
In Maharashtra, under MVAT Act, 4% TDS is applicable (instead of 2%) in the case where the Contractor has not obtained the VAT TIN certificate (URD Contractor).
6. Provisions of Works Contract for Main and Sub-Contractor under the State VAT Laws.
The following two types of VAT levies are provided for the transactions of works contracts between the Main contractor and the Sub-Contractor,

  • In certain States, (like Maharashtra) Main and Sub Contractors are treated as single legal Entity. Therefore, there is no VAT/TDS applicable between the transactions of the Main and the Sub-Contractor . The VAT Forms are exchanged between the Main and the Sub Contractors to declare that they have discharged VAT liability for their portions of the Contracts. In such cases, the Main Contractor gets the deduction of the value of the work executed by the Sub Contractor. The main and the Sub Contractor are jointly and severally responsible for the compliance under the works contract provisions of the VAT Act .
  • In certain states ( other than Maharashtra), the Main and the

Sub Contractors are treated as separate legal Entities, like separate two dealers under the VAT Act. Therefore, in such provisions , Sub contractor charges applicable VAT/Composition Tax to the Main Contractor, avails Credit of the VAT paid on the inputs and the Main contracts also charges VAT/Composition Tax applicable to the Contractee/Customer and avails the Credit available to him against the VAT paid to the Sub-Contractor. They are assessed / audited separately under the State VAT Act provisions.
It is advisable that the Main Contractor and the Sub Contractor should discuss all the relevant VAT provisions before opting for the specific method of levy of VAT / Composition Tax to avoid complications at a later date.
7. VAT & Service Tax, both , Applicable on certain Works Contracts.
On certain Works Contracts both VAT (WC) & Service Tax are applicable on the Contract price since there involves the transfer of property in goods (sale of goods / materials) subject to VAT levied by the State Government and rendering of Taxable Service subject to Service Tax levied by the Central Government. Thus, the both the state & the Central Governments levy VAT & Service tax on the same taxable base i.e. Contract Price, respectively.
The Contracts /Taxable services where both VAT and Service Tax are applicable are shown as under ,

  • Construction contracts, Civil Jobs
  • Annual Maintenance Contracts (AMCs)
  • Errection of Plant and Machinery etc.

Please note that in such Works Contracts / Taxable Services, the working for levy of VAT & Service Tax is to be done, separately, as per the provisions of VAT & Service Tax. Only in the case where the Contractor opts for A-1 legal option of actual labour deduction method, he can pay Service Tax on the actual labour portion and VAT on actual Material value. Otherwise only A-2 (Standard deduction) and B (Composition Tax) options are available under VAT and No deduction for levy of Service Tax for the Contractor. The Abatements are available under the Service Tax law for specific Taxable Services towards the value of material / goods involved in the same. Like 67% Abatement from the contract value is available under the Construction Services .

  • Concept & Levy of C.S.T. on Inter state Works Contracts

The Central Government amended the definition of ` Sale’ under the Central Sales Tax Act, 1956 from 11.5.2002. With the said amendment, the states are empowered to levy C.S.T. on the interstate works contract. By the said amendment, the concept of `Interstate works contract’ was introduced in the C.S.T. Act by inserting in the definition of `Sale’ , the words “Transfer of Property in goods involved in execution of works contract” .
When the Contractor dispatches his goods from one State to another under a individuals works contract, it is a interstate works contract. The sections 3,4,5 of the C.S.T. Act are applicable to such deemed sales in the interstate works contract. Accordingly, the State of dispatch can collect the Central Sales Tax on such deemed interstate sales . The Contractors may not be allowed the interstate depot transfers in the cases of indivisible works contracts since such dispatches are made to the sites of the contractee situated in other state and the same are earmarked for the specific contractee. The Contractor would invoice to the Contractee from the state of dispatch and would charge CST as applicable , with or without C/D Forms.
Recently, the CST Act was further amended to explain, the deductions available on the total contract price to the Contractor to arrive at the material value. Please note that in interstate works contracts also, the C.S.T. is payable only on the Material Value/Price’ of the Contract and not on the Labour’ portion of the Contract.
The examples of interstate works contract would be that of Contractor from Mumbai, dispatching goods from his Mumbai plant to the site in Chennai (Tamil Nadu) under a indivisible works contract or A Manufacture in Mumbai dispatching his own material to a processor in Surat and the processor returns back the processed material back to the Mumbai Manufacturer. The Surat processor would charge 4% CST against `C’ form on the material value of his invoice amount being a interstate works contract in his hands .
Please note that when it is an interstate works contract, the Contractee would raise an invoice on the Customer situated in other state with applicable rate of CST on the Material value of the contract, but the Customer would not deduct any amount towards TDS since there is no provision of T.D.S. under the CST Act. TDS is to be deducted only in the local works contracts where the Contractor has charged VAT/Composition Tax.
In short, if the Contractor dispatches goods from his state to the State of the Contractee (Customer) under an indivisible works contract, it is a interstate Works contract in the hands of such Contractor subject to levy of CST which is collected by the state of dispatch . However, in the interstate works contracts also , C.S.T. is payable only on the `Material Value’ of the Contract .
9. How the Contractee / Customer should look into the Works Contract purchases for Minimum cost.
Under the VAT System, the Contractee/Customer can avail the full VAT Credit/Set off of the VAT paid to the Contractor through the tax Invoices, provided such purchases are not in the Negative list of set off/VAT Credit.
However, in the cases where the Contractees / Customers do not get any VAT set off / Credit, they should note the following points to reduce their VAT Cost,
(a) To decide the Best option of “Levy of VAT/Composition Tax” before the execution of the Works Contract Commences.
(b) To insist the Contractor to buy maximum inputs from local vendors only and the VAT Credit thereof should be passed on to the Contractee by reducing his sale price , accordingly .
( c ) In case of free issues supplied by the Contractee / Customer to the Contractor , if the price of the contractor is `Net off’ the material value supplied by the Contarctee then there is no negative VAT impact to the Contractee . Otherwise, there is VAT cost in the hands of the contractee with regards to the VAT paid on the purchases made by the Contractee and given as free issues to the Contractor.
(d) Prescribed % of TDS payment to the government and timely issuance of TDS certificates to the Contractors.
(e) To insist the Contractor to show the VAT applicable, separately on the invoice (Tax Invoice, in the case if the Contractee can avail the credit)
(f) To add the clause in the agreement with the Contractor, “If any additional liability on Account of VAT (WC) arises at a future date shall be borne by the Contractor”.
10. The summary of the Main Points with regard to provisions of levy of VAT/Composition Tax under the State VAT Act & Rules.

  • Deemed Sales (WC) are taxed under the provisions of the State VAT Act, there are no separate Works Contract Acts.
  • For local works contract transaction State VAT (WC) is applicable and for interstate works contract transaction , the Central Sales Tax (C.S.T.) is applicable as covered under the CST Act.
  • No VAT/CST is applicable on the pure labour Jobs (No material of the Contractor / Job worker is involved)
  • Under the State VAT Acts, VAT is applicable on the `Material Value” of the Contracts only as determined by the three options as discussed earlier and under the C.S.T.Act also CST is applicable on the `Material Value’ only.
  • In the contracts , `where both the sale of goods and rendering of Taxable service are involved, both VAT & Service Tax is payable on the same contract price subject to the relevant provisions under both the VAT & Service Tax Laws.
  • Proper clauses of VAT/CST should be incorporated in the Agreements between the Contractor and Contractee to avoid litigation.
  • Under the VAT System both the Contractor and the Contractee can avail full VAT set off/Credit subject to the Negative List.
  • The Contractee should ask for the price reduction from the Contractor to pass on the `VAT Benefit’ availed by the Contractor on his local purchases.
I am sure the Readers will get useful information in this article on “VAT & Works Contracts” and both the Contractor and Contractee can plan their works contracts transactions in a better and cheaper way in future.

Developers’ liability to pay VAT on sale of flat during construction of flat, premises etc.

Jun 21 2013

By Pradeep S. Shah & Mukesh J Bhavsar


The Commissioner of Sales tax, Maharashtra, by Circular No 14 T of 2012 dated August 6, 2012 ("the Circular") conveys that VAT is payable on sale of flat during construction by a developer or builder ("the sale of flat") and seeks to induce the developers to pay tax on the sale of flat by providing administrative relief etc.
Subsequent thereto, there were questions about huge liability in the hands of the purchasers.
Apparently, thereafter, on its website Sales tax Department has put up "Basic information in case of tax on developers" and "Frequently asked questions" (hereafter collectively referred as "FAQs") and seeks to explain various matters.

Prima facie, it is felt that the basics and other information set out in the Circular or FAQs do not give a correct picture in accordance with the provisions of law and/or creates certain misunderstanding or misgivings about the inferences and, in particular, in relation to the ultimate cost of VAT embedded in the cost of flat. The objective of this write up is to examine the same.

The Circular as well as FAQs start with a basic premise that pursuant to the amendment carried out in VAT laws (in Maharashtra), with effect from June 20, 2006, a builder or developer is liable to tax on the sale of flat. The amendment reads as follows:

"an agreement for carrying out for cash, deferred payment or other valuable consideration, the building, construction, manufacture, processing, fabrication, erection, installation, fitting out, improvement, modification, repair or commissioning of any movable or immovable property".
The above definition, as such, is based on various court decisions to cover various types of activities carried out by a contractor in relation to the movable or immovable property. In other words, the definition does not say anything new. Even otherwise the listed activities carried out by a contractor were treated as works contract.
Further, the definition does not create any fiction to the effect that when a builder undertakes the activity of construction with an intention to sell the premises to intending purchasers, such activity would be considered as a works contract, that is, building or construction of an immovable property under an agreement. For the purposes of levy of service tax, the Central Government did create such a fiction, in service tax law, to levy service tax on the service portion involved in construction of buildings intended for sale.
The amendment was challenged and Bombay High Court in MCHI v State of Maharashtra & Others case held that the amendment was constitutionally valid. However, nowhere the Court held that the sale of flat amounts to a works contract; in fact,it observed that it needs to be determined in assessment.
Prior to the amendment in Maharashtra VAT laws, in various determinations given by the Commissioner of Sales tax, Maharashtra (during the years 1988 to1995) had held that the sale of flat is not liable to tax (or works contract tax, as is commonly known) as if it is a works contract, under the laws in force at that point in time.
As discussed earlier, the amendment in the definition, as such, has not carried out any changes which suggest that the sale of flat amounts to works contract liable to tax.

Hence, the basic premises on which the Circular and FAQs are issued cannot be considered as based on the correct interpretation of law. In other words, presently, “the belief” of the Commissioner that the sale of flat is liable to VAT is the basis and not the law.

Methods for determining sale price
The Basic information ("FAQs") sets out three options, as specifically stated in the provisions of law.
VAT is payable on the turnover of sales defined to mean the aggregate of sale price, that is, consideration received or receivable for the sale of goods.
Thus, the tax is payable on the sale price on sale of goods.
The law does not provide that the methods stated therein are the only methods and that no other method can be followed, to determine the sale price.
For the purposes of computing tax, what is relevant is "sale price". While prescribing a method, the relevant Rule 58 itself uses the language "may" signifying that it is only a directory and not mandatory. In other words, the said Rule itself recognises that there could be other methods of determining sale price. To illustrate, where the sale price of the goods supplied or used in execution of works contract is determinable on the basis of list of sale price of the ultimate suppliers and/or in the agreement itself, such price can be adopted and the law does not rule out the possibility of adopting such sale price.
To the above extent, the Basic information ("FAQs") does not accord with the specific provisions of law providing for determination of turnover of sales.

Three methods

First: Derived value of goods [as per Rule 58 (1)], that is :
Value of contract                                                                                       xxx
Less :(i) labour charges etc and profit                     
          thereon as specified in Rule 58(1)                xxx
         (ii) Land cost                                                  xxx
Sale Price                                                                                                 xxx
Second: It is a variant of the above method, where labour charges etc cannot be easily ascertained. Derived value of goods [as per Proviso to Rule 58 (1)], that is:
Value of contract                                                                                         xxx
Less: (i) payments to works contractors                         xxx
         (ii) Land cost                                                          xxx
         (iii) 30% of contract value as reduced                   xxx
          by payments to sub-contractors.
SALE PRICE                                                                                              xxx
Third: Composition payment under section 42 (3) @ 5% of the contract value.
While explaining the methods, it mentions about availability of set off and the relevant part reads as follows:
First and second method: "the tax computed as above is reduced after considering the tax paid on the purchases of building material (that is, input tax credit). The tax so determined is required to be finally paid".

Third method: "this tax liability is reduced by the amount of taxes paid on purchases, that is, input tax credit. The balance tax liability so computed is to be discharged".

The above does not explain that :

  • The methods were devised for works contractors and not for the sale of flat in case of developer. The methods were prescribed prior to amendments in law without contemplating a situation like in case of the sale of flat.
  • There is no method specifically prescribed for the sale of flat, save deduction of land cost and 1% composition scheme enacted effective April 1, 2010.
  • The set off may not be available of the entire amount, on account of non-allowance or reduction;
  • the set off is not available in respect of Interstate purchases;
  • the set-off on capital assets or in respect of purchases in which property in goods does not pass; and
  • the set off, in case of the third method, is available only after reduction of 4% of the purchase price; in other words, the entire set off is not available.

Thus, to the extent the set off is not available, it forms part of the cost of VAT embedded in the cost of the builder or developer and obviously in the sale price of the purchaser. The effect of the above is illustrated little later.

Apart from the above, the language extracted above suggests that the effective VAT cost is the final amount required to be paid, which factually and in law is not correct. As per the theory and practice of VAT, the tax is payable on value addition and is collected at each stage of value addition. As per the invoice method followed by Maharashtra government, the tax is collected at each stage and after allowance of set off, the net amount is payable. The net amount does not constitute the cost of VAT; it only reflects the amount payable by a dealer at that stage after set off. The set off is allowed in respect of the VAT already paid to government on the earlier sale. Thus, the amount charged to the ultimate customer is the costs of VAT. This is illustrated little later. To put it differently, in case of Third method, it cannot be said that the cost to the purchaser of the flat is less than 5% on account of set off available inasmuch as the builder collects 5% from the purchaser and after availing the set off (being amount already paid on purchases) pays net amount to the government. In other words, the set off does not reduce the cost of VAT passed on to the purchaser.

Land cost in case of third method

VAT is on the transfer of goods involved in the execution of a works contract. Section 42 (3) contemplates payment of composition amount on the value of works contract and not the agreement value. In spite of that, it is provided that the composition payment needs to be paid on the entire contract value without deducting land cost.

In other words, although, not authorised under the law to levy tax on an item other than goods, through the Circular, tax is sought to be collected also on the value of land. If the builder follows other methods, the land cost is allowed to be deducted.

Even in case of composition payment this cannot be done is recognised by the legislature and, therefore, while specifying the rate of composition, in respect of one percent scheme, the rate of composition was reduced, although, the value of land was included therein. In other words, an adjustment was allowed for the value of land by adjusting the rate of composition.

Tax effects of the above methods can be better understood through the following illustration.

To illustrate:

  • Agreement value, say, is Rs 100;
  • Land cost, say, is Rs 20;
  • Material cost is 40% of agreement value (i.e. Rs. 40);
  • 50% of the material used (i.e. Rs. 20) attracts tax at 4%; and
  • The balance 50% of the material used (i.e. Rs. 20) attracts tax at 12.5%.

VAT on purchases would be: Rs 3.30
(4% on Rs 20, that is, 80 paise and 12.5% on Rs 20, that is, Rs 2.50).

As per second method, VAT payable could be:

  • Agreement value Rs 100

less: land value Rs 20
less: Labour etc @ 30% Rs 100, that is, Rs 30

  • Sale price of goods used in construction Rs 50.
  • Tax at 4% on Rs 25 will be Re 1.
  • Tax at 12.5% on Rs 25 will be Rs 3.13.
  • Total tax, which can be charged to the purchaser will be Rs 4.13, that is,

     4.13% of agreement value.

  • Amount of tax to be paid by the builder/developer to government will be Re 0.83 inasmuch as he has already paid Rs 3.30, by way of VAT, on purchases.

As per the third method, the position could be:

To take the benefit of such simplified scheme, the builders or developers may opt for the same, since they would be in a position to recover the amount from the buyer.

On composition basis, the builder or developer will charge Rs 5 as tax on Rs 100, which he would recover from the purchaser.
While making payment, he would get set off of about Rs 1.70 (out of total VAT paid Rs. 3.30 on its purchases, set off @ 4% of its purchase price would not be allowed and, therefore, make net payment to government of Rs 3.30.)
Thus, the aggregate VAT cost would be Rs 6.60 (i.e. aggregate of disallowed set-off Re. 0.80 on purchases attracting 4% VAT plus Re.0.80 on purchases attracting 12.5% VAT plus 5% composition tax) and would form part of cost of developer and sale price to the purchaser.
Now, when the matter was in dispute, by and large, a builder may have built in the cost of VAT in the purchase price of flat. Thus, in the above example, Rs. 3.30 was recovered and included in the sale price. In addition thereto, now, Rs 5 would be recovered by way of tax. On the top of that, interest3 at 15% per annum, in terms of the contract, may be recovered from the buyer. Suppose, the buyer had purchased the flat sometime in August 2008; the builder decides to pay the tax in August 2012. Thus, the builder will have to pay 60% by way of interest on the amount of VAT payable (Rs 3.30); however, in terms of the agreement, a builder may be able to recover interest on Rs 5, which would work out to Rs 3. Thus the aggregate cost to the buyer would be about Rs 11.30 that is 11.3%.

It may not be out of place to mention that even in case of purchase of goods, the retailer or the supplier charges VAT at applicable rate, that is, 5% or 12.5%, as the case may be, on the entire amount, and while paying VAT collected, considers the set off available to him. In other words, the set off is not passed on to the ultimate purchaser.


One percent composition scheme

The Basic information (“FAQs”) states that pursuant to various Developers Associations’ representations, 1% composition scheme was evolved and is applicable with effect from April 1, 2010. In case of 1% composition scheme, broadly stated, subject to fulfilment of conditions:

  • 1% is payable on agreement value or stamp duty value (which includes land value), whichever is higher; and
  • no set off is allowed.

Thus, even under 1% composition scheme, based on the above illustration, it is clear that VAT cost, in case of the sale of flat would be about 4.3%.

It is learnt that the builders or developers had represented that 1% scheme may be applied even in respect of past transactions. However, for whatever reasons, the representations were not accepted.

Collections by Builders

After June 20, 2006, on account of uncertain position, apparently, the industry evolved a practice of collecting amounts, in respect of VAT liability, if any, in escrow accounts or in a manner which safeguards the interests of both the builders and/or the purchasers.

They were advised that such collections, by way of deposit and in the like manner, do not amount to collection of VAT. Thus the amounts were collected to meet any contingency.

In the circumstances, it is not clear as to how the Basic information states that the builders have failed to discharge their tax liability by depositing the collected tax (except in a case where the amounts were actually collected as VAT).

Replies to various questions

In that, a reference to one reply, pervading throughout the FAQs, is necessary. The liability is linked to the agreement value or the amounts received or receivable under the agreement value. The receipt of value is not the taxable event. The taxable event is the transfer of property in goods in the course of execution of Works contract.

Having regard to the above, it is felt, the Circular and/or FAQs, it appears, are like built-up area or super built-up area or carpet area or actual available area confusion in the minds of the purchasers. They do not reflect the position in law which would be applicable to the sale of flat for determining whether it is liable to VAT and, if yes, what could be the amount thereof.

Way forward
Would it not be advisable for the Government to adopt 1 % composition scheme even for the period 20.06.2006 to 31.03.2010? It would save a lot of efforts on the part of Government; Builders; and Purchasers. Effectively, the Government would collect 4 % or more by way of VAT -1% on agreement value and about 3.3% being VAT paid on purchases, which would not be available as set off.

M/s Bhadani Associates, M/s Unit Arsens Developers,M/s Paranjape Builders Pvt Ltd- DDQ-          1088/C/40/Adm-  12 Dated: 10.03.1988
   M/s K. E. Builders-DDQ-WC-1492/43/Adm-12 Dated: 18.02.1993
   M/s D. S. Kulkarni and Associates-DDQ-WC-1489/88/Adm-12 Dated:13.06.1994
   M/s D. S. Kulkarni and Associates-DDQ-WC-1489/87/Adm-12 Dated: 31.03.1995

(Derived value as explained earlier)

3 Presently, it is not waived and it may be inferred that Supreme Court has not barred the levy of interest.

Preparing for Goods & Service Tax

Jun 21 2013

By Shri R. S. Bhatt
Senior Executive Vice-President,
Reliance Industries Ltd.

“Be prepared- Goods and Service Tax (GST) is coming with effect from 01.04.2010”, declared the Finance minister in his Budget Speech for 2009-10. Collaborative efforts led by Empowered Committee of State Finance Ministers have helped reached an agreement on the basic structure of GST in keeping with the principals of fiscal federalism enshrined in the Constitution. The GST would result in abolition of multiple types of taxes on goods and services. Going by global experience, the GST can be a big boon if it has right kind of rate and legislation. It is high time for all concerned, including Chartered Accountants, to start preparing for smooth introduction, implementation and operation of GST. This article explores the concept.

In the speech of Budget 2009-10, the Finance Minister Mr Pranab Mukherjee has given a clarion call: “Be prepared – Goods & Service Tax (GST) is coming w.e.f. 01.04.2010.”In two paras he has referred GST.
Para 82: “……. Tax reform, like all reforms, is a process and not an event. Therefore, I propose to pursue structural changes ………….. in indirect taxes by accelerating the process for the smooth introduction of the Goods and Service Tax (GST) with effect from 1st April, 2010.”
Para 85: “I have been informed that the Empowered Committee of State Finance Ministers has made considerable progress in preparing the road map and the design on the GST. Officials from the Central Government have also been associated in this exercise. I am glad to inform House that, through their collaborative efforts, they have reached an agreement on the basic structure in keeping with the principals of fiscal federalism enshrined in the Constitution. I compliment the Empowered Committee of State Finance Ministers for their untiring efforts. The broad contour of the GST Model is that it will be a dual GST comprising of a Central GST and a State GST. The Centre and States will each legislate, levy and administer the Central GST and State GST, respectively. I will reinforce the Central Government’s catalytic role to facilitate the introduction of GST by 1st April, 2010 after due consultations with all stake holders.”
Dr. Asim K. Dasgupta, chairman of Empowered Committee and Revenue Secretary Mr. P. V. Bhide have also reiterated that GST is coming w.e.f. 1.4.2010.
Our Ex-Finance minister  Mr. P. Chidambaram had been making this call in his four budget speeches as given below, which will also throw some light on the type of GST that is coming.
Budget Speech 2004-05 : Para 119: “Now I turn to my indirect tax proposals …. It is my intention to align India’s tariff structure to those of ASEAN countries. Eventually, there should be a uniform rate of tax on goods and services.”
Budget Speech 2005-06 : Para 94: “In the medium to long term, it is my goal that the entire production – distribution chain should be covered by a National VAT, or even better a goods and service tax, encompassing both the Centre and State.”
Budget Speech 2006-07 : Para 155:  “It is my sense that there is large consensus that the country should move towards a National level Goods and Service Tax (GST) that should be shared between the Central and the State. I propose that we set April 1, 2010 as the date for introduction of GST. World over goods and services attract the same rate of tax. That is the foundation of the GST. People must get used to the idea of GST. Hence we must progressively converge the service tax rate and the CENVAT rate…….”
Budget Speech 2007-08 : Para 116:  I wish  to  record my deep  appreciation of  the spirit of co-operative federalism displayed by State Governments and especially their Finance Ministers. At my request, the Empowered Committee of State Finance Ministers has agreed to work with the Central Government to prepare a roadmap for introducing a national level Goods and Services Tax (GST) with effect from April 1, 2010.
Thus it is very clear that GST is coming. So let us be prepared for the same. Industries, trading communities, Central Government and State Government, would be practitioners for GST and as such, all, including we Chartered Accountants, should prepare for the smooth introduction and operation of GST.
Before we list our segment wise required preparations, we must know what happened after the initial above mentioned announcements by Ex-Finance Minister Mr P. Chidambaram and what sort of GST is being proposed.
The real work started with the appointment of Joint Working Group (JWG) by the Empowered Committee of State Finance Ministers to give recommendations regarding detailed framework to be adopted for GST, in May 2007. JWG was given the task to suggest a model for the base and rate structure for GST. The working group was instructed to keep the following in mind:-

  • GST should be so designed that it should be revenue neutral to Centre and States. Interest of the Special Category, North Eastern State and Union Territories have to especially kept in mind.
  • The group will examine different models and see that power of levy, collection and appropriation of revenue needs to be vested in the Centre and the states by looking at the pros and cons.
  • The various models suggested by the working group should ensure that double taxation is avoided.
  • The working group would ensure that the suggested model tasks into account the problems face during interstate transactions and any revenue loss.
  • The working group should consider how zero-rated goods and services and Non-Vat items  such as petroleum goods and alcohol might be treated under new regime.
  • The model developed should reflect the interest of the Centre, State, trade, Industry, agriculture and services.

JWG submitted the report in October 2007 after making study of GST Act of several countries and making study tours of Brazil, Australia and Singapore.
Before we look at the recommendations briefly, let us understand the simple words as to WHAT IS IDEAL GST?
GST is comprehensive value added tax on goods and services it is levied and collected on value addition at each stage of sale or purchase of goods or supply of services based on input tax credit method but without State boundaries. There is no distinction between taxable goods and taxable services   and they are taxes at a single rate in a supply chain of goods and services till the goods/services reach the consumer. The administrative power will be vested with a single authority to levy tax on goods and services. The main features of GST are as under:-

  • It is based on the principal of value added tax and either “input tax credit method” or “subtraction” method, with emphasis on voluntary compliance and accounts based system.
  • Comprehensive levy and collection on both goods and service at the same rate with benefit of input tax credit or subtraction of value of penultimate transaction value.
  • Minimum floor rates of tax, generally not exceeding two rates.
  • No scope for levy of cess, re-sale tax, additional tax, special tax, turnover tax, etc.
  • No scope for multiple levy of tax on goods and services such as sales tax, entry tax, octroi, entertainment tax, luxury tax etc.,
  • Zero rating of exports and interstate sales of goods and supply of services.
  • Taxing of capital goods and inputs whether goods and services relatable to manufacture at lower rate, so as to reduce inventory carrying cost and cost of production.
  • A common law and procedure throughout the country under one single administration.

Main Advantage of Comprehensive GST

  • Introduction of GST would result in abolition of multiple types of taxes on goods and services.
  • Reduces effective rates of tax to one or two floor rates.
  • Reduces compliance cost and increases voluntary compliance.
  • Removes cascading effect of taxation and removes distortion in the economy.
  • Enhances manufacturing and distribution efficiency, reduces cost of production of goods and services, increases demand and production of goods and services.
  • As it is neutral to business processes, business models, organisation structure, geographic location and product substitutes, it will promote economic efficiency and sustainable long term economic growth.
  •  Will give competitive edge in international market for goods and services produced in India, leading to  increased exports.
  • Reduces litigation, harassment and corruption
  • Will result in widening tax base and increased revenue to the centre and State.
  • Reduces administrative cost for the Government

Now we will look at recommendations of the Working group
Recommendations of Joint Working Group

  • JWG has recommended a dual GST. It means that there will be Central GST to be administered by the Central Government and at the same time there will be State GST to be administered by the State Government .
  • Central GST will replace existing Cenvat and Service Tax and the State GST will replace State VAT
  • Central GST should subsume following Indirect Taxes on supplies of goods and services:-
  • Central excise duties and additional excise duties levied on pan masala, petroleum and tobacco products and those levied under Additional Duties of Excise (Goods of special importance) Act, 1957.
  • Additional Custom duties in the nature of countervailing duties
  • CVD and other domestic taxes impose on imports to achieve a level playing field between domestic and imported goods which are currently classified as customs duties
  • Cesses levied by the Union viz, cess on manufactured bidis, rubber, tea, coffee and cess on unmanufactured tobaccos.
  • Surcharges levied by the Union viz., National Calamity contingent duty, education cess, special additional duties on excise on motor spirit and hig speed diesel (HSD)
  • State GST should subsume following State taxes:-
    • Purchase tax
    • State Excise duty
    • Entertainment Tax
    • Luxury Tax
    • Octroi
    • Entry tax in lieu of Octroi
    • Taxes on Lottery, betting and gambling
    • Tax on consumption or sale of electricity
  • The proposed GST should have two components – Central Gst and State GST – the rates of which will be prescribed separately keeping in view the revenue considerations, total tax burden and the acceptability of the tax.
  • More than 40 services are identified on which service tax should be levied /collected by States.
  • For the purpose of assessment and administration of different assesses following categorisation has been recommended:-
  • Gross turnover of goods up to Rs.1.5 Crore should be assigned exclusively to the State;
  • Gross turnover of Services up to Rs. 1.5 Crore should be assigned exclusively to the Centre; and
  • Gross turnover of above Rs.1.5 Crore should be assigned to both the Governments – for the administration of CGST to the centre and for the administration of SGCT  to the State
  • Exports should be Zero-rated and should be relieved of all embedded taxes and levies at both Central and State level
  • The JWG has also proposed list for exempted goods which includes items such as life saving drugs, fertilizers, agricultural implements, books and several food items.

Expectation from forthcoming GST
We have just now studied above as to what ideal GST means. Going by global experience, GST can be a big boon, if it has right kind of rate and legislation. Coming GST should fulfil expectations of different segment of society in particular the expectations of trade and Industry. Le us examine these expectations:

  1. Expectations from the Central & State Government – Preparations by both Government of GST
  • Centre State interaction

Considering the federal nature of our country and Centre State relationships, Central Government should be prepared to pass more powers of taxation to State and share more revenue with the States if GST has to be successful.

  • Constitutional amendments

Under the scheme of our constitution no tax can be levied without the authority of law. Power to levy tax on goods and services are vested with both Central Government and State Government under Article 246 and List –I and List-II of the VII Schedule of the Constitution. Neither the Central Government nor the State Government can usurp the powers of the others without amending several provisions of the Constitution. Following articles need to be amended by the central Government.

    • Article 246- relating to subject matter of laws made by Parliament and by the legislature of the State.
    • Article 269 – relating to taxes levied and collected by the Union but assigned to the State.
    • Article 270 – relating to taxes levied and distributed between the Union and the States.
    • Article 286 – relating to restrictions as to imposition of tax on the sale or purchase of goods.
    • List I & II of the VII Schedule of the Constitution – some of the important entries.
    • Article 366 – important definitions.

(c ) Re-engineering of Central & State employees-
                 There should be a thorough re-engineering of the department of GST at Central level as well as State level. This is very much required to clearly define, understand and administer functions in such a way that the responsibility, accountability and authority of each tax department at the Central and State level are clearly understood.

   (d)    Single authority to deal with
                 As it is known that  number of official at Central level is less as compared to State level officials it is expected that Central officials be assigned special task to monitor the operations of large dealers (who have pan India operations) under CGST and SGST. The day-to-day operations related to registration, payment of tax and submission of returns for all the dealers (irrespective of their size) should be assigned to the State.
            The assessees with specific turnover, say, up to Rs.500 crore and the assessees whose operations are limited to one State only should be assessed by State Department for both CGST and SGST. In general, the idea is that assessees should interact with one tax authority only.

            Presently, under the recommendation of JWG, CGST will be monitored by the Central Government and SGST will be monitored by the State Government. It means that the assesees will have to deal with two authorities which may be unacceptable by all dealers. Because from the past practical experience, everyone knows that interpretations, procedures, whims and approach widely differ at both levels.

            The above concept will be discussed further while understanding about expected model of GST.

(e)       Tax Payment
            Payment of CGST should be made in the bank accounts of Central Government. Similarly payment of SGST should be made in the bank accounts of State Government.

(f)        Verification Agency.
             Cross verification of documents should be strengthened under GST to avoid evasion and wrong claims. In France, the Government has created organisation called “National Directorate of Verification” which verifies transactions above 300 million Francs involving  national and international  dealings. Similarly, there is Regional Directorate of   Verification which verifies similar transactions within the districts / divisions. Similar arrangements should be made under our GST regime also.

(g)       MIS amongst different Government Departments.
            MIS has to be an integrated  activity of the SGST and CGST offices as well as other Government Departments. The integration of activities of SGST, CGST, customs and income tax through PAN numbers, TINXYS should be  an essential part of GST regime.

(h)       Creation of IT infrastructure –GST Public Services Offices(PSO)

            Cross verification, MIS and interaction between different department and dealers necessitate complete computerisation of all Government departments in all States and as well as availability of computer facility    with each and every dealer covered under GST. Even today it is observed that computers and Internet facilities are not easily available     in villages and towns. Lack of knowledge of computer in such areas is a  hard reality. Therefore, there is a need to bring the awareness about the computer amongst the dealers across India. In the initial period of five years opening of Government sponsored kiosks at various centres facilitating compliance of law through Internet and computers should be seriously considered. In fact, we are reminded of Mr. Sam Pitroda who created the Centre for Development of Telematics (CDOT), an autonomous telecom R&D organisation which made yellow signed Public Call Offices (PCO) ubiquitous throughout India. In the same fashion we highly expect that GST PSO (Public Service Offices) should be created in every village in the form of computer kiosks.

(i)        Training of Staff

            Today excise and service tax staff do not very conversant  about VAT provisions. Similarly, State employees administering VAT Act do not know excise and service tax provisions. Thus both Central and State staff will require learning and training in the administration of GST Act.

(j)        Stability of GST Act rates

            As recommended by Dr. Kelkar, there should be an agreement between Central Government and all State Governments that there should not be any change in the GST Act or rates without concurrence of both Central and State Governments. This only can lead to stability of GST Act.

B.        Expectation from the GST Act.

            (a)       Present lacuna to be removed

Finance Ministers of all State are jubilant because of the buoyancy in the collection of VAT revenue and feel that by the large harmonisation has been achieved in the VAT laws throughout the country with deviation in rates being less than 3% of the cases. However, we all know that everything is not right as far as dealers are concerned. Following lacuna found in the present VAT laws should be removed from the GST Act.

             (i) Today we are finding separate VAT laws in all States. There should be one GST Act applicable to whole of India.
             (ii) The description of entries prescribing rate of tax is not uniform in present VAT laws which results into same commodities being taxed differently in different States. Under GST there should be common schedules applicable in all States

             (iii) (a)  Input tax credit is not given of the tax paid on each and every goods used in business. Different States follow different rules  in granting tax credit. Under the GST Act, it is expected that all the tax paid on all inputs should be available for adjustment against output tax. This only  can bring removal of cascading effect and one price pan India making entire India one national market.

                  (b)  If dual GST is introduced, i.e. CGST at Central level and SGST at State level, it is proposed that input tax credit  for CGST will be given only against the payment of CGST. Similarly, input tax credit of CGST will be given only against the payment of SGST. In other words, if there is a balance input tax credit available in either of the GSTs, it cannot be adjusted interchangeably, i.e. input tax credit of CGST cannot be adjusted against payment of SGST. This is not acceptable to trade and industries. Input tax credit of one GST should be allowed to be adjusted against other GST if balance is available.

(iv)  The procedural provisions relating to:-

  • Granting of registrations
  • Preparation of bills
  • Filing of returns
  • Scrutiny of returns
  • Assessments
  • Granting of refund
  • Audit
  • Cross-verification
  • Appeal
  • Allowance of credit notes etc.

      are different in different States. Under GST Act, same procedural rules should be prescribed for all States.

(v)  It is highly expected that all steps are taken to ensure that no pending work relating to either sales tax, VAT or other indirect taxes remains outstanding before implementation of GST so that everybody can concentrate on the new laws. It is therefore, suggested that some schemes for summary disposal for all the pending cases should be pronounced before GST comes into operations.

b)        GST Rate

i) Fixation of revenue neutral rate The Success of GST will largely depend on the determination of ideal rate at Central level as well as State level which should be acceptable by public and revenue neutral to Government.

The golden rule for collection of tax is given by world’s oldest economist Kautilya alias Chanakya  Muni more than 1000 yeas ago. He said that the king should collect           tax from different persons as the bumble bee collects honey from different flowers without making any harm to them.  Thus all efforts should be made to keep the GST rate as low as possible.

  • The standard rate of 16% adopted for CENVAT (now first  lowered to 14% then 12% and then 8% under various schemes), along with the residuary rate of VAT 12% beings the overall rate to 28.5%, which is too high a rate compared globally. Some of the global rates of GST as given below will be really an eye opener.
  • Taiwan/Japan-5%
  • European Union (EU)- 19.5%(average)
  • Organisation for Economic Co-operation and Development (OECD) counties -17.7%.
  • Asia Pacific countries-10.8%
  • South American countries-14.2%
  • Mexico – 15%
  • Australia-10%
  • Canada -6%
  • Hong Kong /Bahrain-Nil

Ideally, GST rate  may be kept at about 18% considering the fact that now CGST will also be available on value added transactions which will enhance Government revenue to a large extent.

(ii)  No SGST on CGST

As per legal position today, sales tax / VAT are charged on excise duty element also. Under the new system, excise duty, i.e. CGST will be levied on each value added transactions up to consumers. It means that, SGST will further increase on such element with each value added transaction. For example, if CGST is 10% and SGST is also 10%, with each value added transaction, there will be additional burden of 1% of SGST (10% SGST on 10% CGST). Ultimately, there will be a heavy burden on consumers. Hence, it is recommended that no SGST should be levied on any CGST element.

(c)  Interstate transactions

It is presumed that Central Sales Tax will be phased out with the introduction of GST, but issue of GST on interstate transactions will be there. Proper mechanism needs to be introduced so that dealers get input credits for any GST levied on interstate transactions. Only this can avoid cascading effect in the real sense.

             (d)      GST model

                        There are four alternatives in this context:

  • GST at Central Government Level  (Option I)
  • GST at State Government Level (Option II)
  • GST at both, Central and State Government Levies (Option III)
  • On GST with allocation of dealers between Central and State (Option IV)

Canada has GST at Central level extending  to all goods and services covering all stage of value addition. In addition, there is tax at province (state) level in different forms which include VAT, Retail Sales tax and so on. European Union(EU) nations (each one is independent nation but, part of a Union and have agreed to adopt common principles for taxation of goods  and services) have adopted  “classic” VAT. If we consider EU as a country equivalent and member nations as state equivalent , EU has only State Level VAT with special rules for intra-community (inter-member state) transactions.

In Indian context, an additional dimension is added by the provisions of Constitution which specifically reserve power to impose tax on specific activities to specific level of government e.g. tax on import of goods can be imposed by Union government only whereas tax on sale of goods involving movement of goods within the state can be imposed by the State Governments only.

Presently, option III is being, recommended by JWG.

However, the experts’ expectation is Option IV, which will have following salient features:-

  • Instead of there being Central GST and State GST, there will one GST Act.
  • Administration and assessment is explained in detail in para A(d) above under the title “Single authority to deal with”  The advantage  of such arrangement has also been given.
  • It will be easy to operate, interpret and monitor one Act to the Advantage of both Government as well as dealers.

                        (e)       Motor Spirits, Naphtha & Natural Gas

It is recommended by JWG that no ITC will be available on purchase of petrol and diesel although sales tax rates on these products are as high as 26% (& 25%) on petrol and 28% (& 26%) on diesel in Maharashtra, 23% on petrol and 21% on diesel in Gujarat. In almost all States rates are very high and no ITC is available. For Trade and Industries if cost sheet is prepared for any product fuel and transportation cost direct and indirect costs will definitely form about 20% of the total cost. Trade and Industries strongly expect that rates should be rationalised or  input tax credit should be made available to avoid unnecessary burden to final consumers.

Similarly, on naphtha also there is high rate e.g. in Maharashtra -12.5%(with reduced input tax credit) and in Gujarat-16% + 2.5% = 18.5% (with no input tax credit), if used as fuel. If used as raw material, input tax credit is available but there will be accumulation of refund as end products are mostly taxable at 4%. Thus it is highly expected that rate of tax should be reduced to 4%.

Similarly, natural gas is taxable at 12.5% with the same issues as given in the case of naphtha. Hence, its rate should also be reduced to 4%.

If we look globally, in Australia GST rate is 10% on petroleum products and natural gas with availability of input tax credit when used for business operations.

In Canada, GST rate is 6% federal + 14% provincial with availability of input tax credit when used for business operations.

In Singapore, rate is 7% with availability of input tax credit when used for business operations.

In Sri Lanka, rate is 15% for petrol and input tax credit  is available when used for business operations, Surprisingly diesel, kerosene, LPG, Crude oil, ATF etc. are all exempt.

Thus it is believed that in India high rates of tax on petroleum products is one of the reasons for high cost of final product which is to be borne by common man i.e.    consumers.

It is possible to reduce rates and provide ITC under the GST regime because State Governments are going to get additional income by way of service tax which will duly compensate loss of revenue on petroleum products. Hence, Trade and Industry expect that rate on petroleum products must be rationalised and input tax credit must be made available.

c.         Expectations from Chartered Accountants

Introduction of GST is going to open up an entire new field of practice for all chartered accountants. Today, for expert advice on excise and service tax industry has to go to different experts and for VAT to different experts. When all Acts are going to be merged in one, it is high time that all chartered accountants also took up study of VAT, excise and service tax and become GST expert. Many Governments have opened single window where all queries pertaining to development of Trade and          Industries are answered. Similarly, if we have no single window, i.e. one GST expert answering all the queries, Trade and Industries will be very happy to take their services. Thus all chartered accountants also need to prepare for GST practice.

            Preparation of GST

  • Central & State Government  should be prepared to fulfil the expectations of Trade and Industries as listed above.
  • Even Trade and Industry need to prepare as they will have to reallocate and rearrange following activities.

(i) If separate departments are existing in the companies to monitor excise, service tax and VAT, they will have to be merged in an amicable manner.
(ii) Record keeping will have to be changed and IT software will have to be updated in order to comply with GST provisions.
(iii) Teachings and training will be required at all levels.
(iv) Trade and Industries will have to rethink about their  market strategies, stock transfer policies and godown keeping policies in different States depending on GST provisions.

Global Experience
Globally GST is not a new concept. Today it is in operation in more than 150 countries. Brazil introduced federal VAT replacing wholesale tax and the State VAT replacing, the State turnover tax in 1967. The tax base for the federal VAT is industrial production. The tax for the State VAT includes all goods with the exception of some industrial products, imports, agricultural inputs, food products and services. Agriculture, minerals and services are excluded from tax.

Mexico implemented VAT regime in 1980 to replace 30 federal excise taxes and 400 municipal and state taxes. The tax base covers businesses  connected with the sale of goods and services. Mexico has uniform VAT rate and bases across the States and it follows the destination principle. The tax may be regarded as a unified national VAT with revenue sharing.

The European Union (EU) has fully harmonised  VAT since 1993. Initially, it was achieved through the “approximation” of rates i.e. by fixing a specified range within which VAT rates could vary.

Dr. Vijay Kelkar’s Views on GST

It is worth quoting some of the views of the chairman of 13th Finance Commission. Dr. Vijay Kelkar who has always pitched for he introduction of GST, He elaborates that:

  • A well designed destination-based GST on all goods and services should be the most elegant method of eliminating distortions and taxing consumption.
  • Under this structure, all different stages of production and distribution should be interpreted as a mere tax pass-through, and the tax essentially `sticks’ on the final consumption within the taxing jurisdiction.
  • The introduction of GST should also bring about a macroeconomic dividend, as it reduces the overall incidence of indirect taxation and therefore, the overall tax burden by removing many adverse features of the present sales tax system.
  • The effective revenue neutral rate at which GST can be implemented should be far lower than 30% indicating a significant reduction in the effective tax burden on our economic agents.
  • The comprehensive GST should fully eliminate the export of taxes and improve international competition. This in turn, should help in increasing the production and exports of labour intensive manufacturers and also, boost employment in our  economy.
  • Considering the high level of distortions in the indirect tax system, one can argue that the real output effect of a well implemented GST in India would be at least 1.4%  of the GDP in Canada. This amounts  to $ 15 billion annually, implying that the economic value of GST reforms would, at a modest 3% discount rate, be close to half a trillion dollars or 50% of the country’s present GSP;
  • More importantly, this means  potentially creating an additional productive employment for as many as 4 to 5 million. The introduction of GST would also be a reform measure whose economic impact will rival that of the elimination of licensing in 1991.
  • The existing tax system introduces myriad distortions which favour some goods and services at the expense of others. Such distortions in our tax system are also adversely affecting the growth for manufacturers, particularly labour intensive manufacturers, who are extremely important  in meeting the challenge of providing productive employment. This should be achieved by the introduction of GST.

It is also worth quoting his views and concerns relating to GST expressed at the speech delivered by him recently at ASSOCHAM 3rd National Conference on “GST for Accelerated Economic Growth and Competitiveness”.

While discussing on design issues, on the issue of rate structure and value he said: “The primary concern of all State Governments is protection as well as enhancement of existing  revenue streams. There are three parameters which need to be balanced here – one is the rage of taxes presently being levied which will be subsumed into the GST. This will determine the tax base of the GST. The other two  parameters are the number of rates and the numerical value of these rates which will be applied to this base”.

On interstate sales and Central Sales Tax(CST) he has said.

“While CST will be abolished in the GST regime, the treatment of interstate sales will need to be carefully thought through. It would be necessary to guard against tax   arbitrage where local sales which will be taxed could be shown as interstate sales”.

While deliberating on operational issues he has advised all States and Centre to have a common approach relating to legislation, various assessment  procedures, exemptions, thresholds and composition.

To avoid any tax evasion under GST regime, he has emphasised on sharing of information amongst Centre and States, introduction of practical IT infrastructure, continuation of check-post for some more time.

He has also suggested two more sectors to be included under the GST regime which are not part of the present discussion on the GST configuration – first is taxation of real estate sector (this issue was raised in 2003 FRBM Task Force report) and second is taxation is rail sector. He wants to include these two sectors in the GST tax base either immediately or during the subsequent phase. This is highly a debatable issue itself having lot of pros and cons for the same.

In the end, I will conclude that if coming GST will fulfil our expectations as listed above it will turn out to be good and serving tax.