Supreme Court settles service tax valuation in construction: Free materials excluded (19 February 2018)

Introduction

Date of the Judgment: 19 February 2018

Citation: (2018) INSC 123

Judges: A.K. Sikri, J., Ashok Bhushan, J.

When a construction company undertakes a project, they use both their services and materials. But what happens when the client provides some of the materials for free? Should the value of these free materials be included when calculating service tax? The Supreme Court of India addressed this important question in a batch of appeals concerning service tax on construction services.

The core issue was whether the value of goods/materials supplied free of cost by a service recipient should be included in the ‘gross amount charged’ by the service provider for the purpose of calculating service tax under Section 67 of the Finance Act, 1994.

The judgment was delivered by a two-judge bench comprising Justice A.K. Sikri and Justice Ashok Bhushan, with Justice A.K. Sikri authoring the opinion.

Case Background

The respondents in these appeals are construction companies that provide ‘Commercial or Industrial Construction Services,’ which are subject to service tax under Section 65(105)(zzq) of the Finance Act, 1994. The dispute arose over the valuation of these taxable services.

The construction companies were paying service tax on 33% of the gross amount charged from their clients, as per Notification No. 15/2004-ST. However, in many cases, the clients provided some materials like steel and cement for free. The tax department wanted the value of these free materials to be included in the ‘gross amount’ for calculating service tax.

The core dispute was whether the value of goods/material supplied or provided free of cost by a service recipient and used for providing the taxable service of construction or industrial complex, is to be included in computation of gross amount (charged by the service provider), for valuation of the taxable service, under Section 67 of the Act and for availing the benefits under Notification No. 15/2004-ST dated September 10, 2004 as amended by Notification No. 4/2005-ST dated March 01, 2005.

Timeline

Legal Framework

The core of the dispute revolves around the interpretation of Section 67 of the Finance Act, 1994, which deals with the valuation of taxable services.

Section 65(105)(zzq) of the Finance Act, 1994 defines ‘commercial or industrial construction service’ as a taxable service. Section 65(25b) further elaborates on what constitutes construction or industrial construction service, including construction of new buildings, pipelines, and finishing services.

Section 67 of the Finance Act, 1994, specifies that the value of taxable service shall be the ‘gross amount charged by the service provider for such service provided or to be provided by him.’ The explanation to this section clarifies that the gross amount includes payments made before, during, or after the service provision.

Notification No. 15/2004-ST, dated September 10, 2004, exempted a portion of the service tax, calculating it on 33% of the gross amount charged. This was amended by Notification No. 4/2005-ST, dated March 1, 2005, which added an explanation that the ‘gross amount charged’ includes the value of goods and materials supplied by the service provider.

The Supreme Court also referred to Notification No. 12/2003-ST, dated June 26, 2003, which exempted the value of goods and materials sold by a service provider to a recipient of service from the tax leviable thereon, subject to documentary proof specifically indicating the value of such goods and material.

The relevant provisions are:

• Section 65(105)(zzq) of the Finance Act, 1994: Taxable service of ‘commercial or industrial construction service’.
• Section 65(25b) of the Finance Act, 1994: Definition of ‘construction or industrial construction service’.
• Section 67 of the Finance Act, 1994: Valuation of taxable services.
  • “For the purposes of this Chapter, the value of any taxable service shall be the gross amount charged by the service provider for such service provided or to be provided by him.”
• Notification No. 15/2004-ST: Exemption for construction service, calculating service tax on 33% of the gross amount charged.
  • “In exercise of the powers conferred by sub-section (1) of section 93 of the Finance Act, 1994 (32 of 1994), the Central Government, being satisfied that it is necessary in the public interest so to do, hereby exempts the taxable service provided by a commercial concern to any person, in relation to construction service, from so much of the service tax leviable thereon under Section 66 of the said Act, as is in excess of the service tax calculated on a value which is equivalent to thirty-three per cent of the gross amount charged from any person by such commercial concern for providing the said taxable service”
• Notification No. 4/2005-ST: Amendment to Notification No. 15/2004-ST, defining ‘gross amount charged’.
  • “Explanation. – For the purposes of this notification, the “gross amount charged” shall include the value of goods and materials supplied or provided or used by the provider of the construction service for providing such service.”

Arguments

The tax department argued that the value of free goods/materials should be included in the gross amount charged for service tax calculation. They contended that Notification No. 15/2004-ST, which allows service tax to be calculated on 33% of the gross amount, was based on the understanding that the total cost of construction is divided into 67% for materials and 33% for services. Therefore, if the value of free materials is not included, it would disrupt this ratio.

The tax department also relied on Explanation (c) to Section 67, which defines ‘gross amount charged’ to include payments in any form, including book adjustments and amounts credited or debited in the books of accounts. They argued that the value of free materials is a form of payment and thus should be included.

The construction companies argued that the ‘gross amount charged’ should only include the amount they actually billed to their clients for their services. They contended that the value of materials supplied free of cost by the service recipient cannot be considered as an amount charged by the service provider. They also argued that the explanation added to Notification No. 15/2004-ST only includes the value of goods and materials supplied by the service provider, not by the service recipient.

The construction companies argued that the value of goods/materials supplied free of cost by the service recipient is not an amount “charged” by the service provider. They further argued that it cannot be regarded as a consideration for the service provided by the service provider, and has no nexus with the taxable services.

The construction companies also argued that the definition of “gross amount charged” in Explanation (c) to Section 67 only provides for the modes of payment and does not expand the meaning of the term to include the value of free supply goods.

The arguments can be summarized as follows:

Issues Framed by the Supreme Court

The Supreme Court framed the following issue for consideration:

1. Whether the value of goods/material supplied or provided free of cost by a service recipient and used for providing the taxable service of construction or industrial complex, is to be included in computation of gross amount (charged by the service provider), for valuation of the taxable service, under Section 67 of the Act and for availing the benefits under Notification No. 15/2004-ST dated September 10, 2004 as amended by Notification No. 4/2005-ST dated March 01, 2005.

Treatment of the Issue by the Court

The following table demonstrates as to how the Court decided the issues:

Authorities

The Supreme Court considered the following authorities:

Judgment

The Supreme Court upheld the decision of the Customs, Excise and Service Tax Appellate Tribunal (CESTAT) and ruled in favour of the construction companies. The court held that the value of goods/materials supplied free of cost by a service recipient should not be included in the ‘gross amount charged’ for calculating service tax.

The Court reasoned that the ‘gross amount charged’ refers only to the amount billed by the service provider to the service recipient. The value of free materials provided by the service recipient is not an amount charged by the service provider and therefore cannot be included in the calculation of service tax.

The Court also noted that Explanation (c) to Section 67, which defines ‘gross amount charged’ to include various modes of payment, does not expand the meaning of the term to include the value of free supply goods.

The Court further clarified that the explanation added to Notification No. 15/2004-ST only includes the value of goods and materials supplied by the service provider, not by the service recipient.

The court also held that the service tax is to be levied in respect of ‘taxable services’ and for the purpose of arriving at 33% of the gross amount charged, unless value of some goods/materials is specifically included by the Legislature, that cannot be added.

The Court also noted that the notifications in question are exemption notifications issued under Section 93 of the Act, which empowers the Central Government to grant exemptions from service tax.

The Court also held that the appeal in the case of Gurmehar Construction had abated due to the death of the sole proprietor.

The following table demonstrates how each submission made by the parties was treated by the Court:

The following table shows how each authority was viewed by the Court:

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily influenced by a literal interpretation of the term ‘gross amount charged’ in Section 67 of the Finance Act, 1994, and the specific language used in the exemption notifications. The Court emphasized that the amount charged should be directly linked to the service provided and that the value of free materials does not fall under this definition. The Court also highlighted that the explanation to Notification No. 15/2004-ST only includes the value of materials supplied by the service provider, not the service recipient.

The Court also noted that the definition of “gross amount charged” given in Explanation (c) to Section 67 only provides for the modes of the payment or book adjustments by which the consideration can be discharged by the service recipient to the service provider.

The Court also considered the fact that the service tax is to be levied in respect of ‘taxable services’ and for the purpose of arriving at 33% of the gross amount charged, unless value of some goods/materials is specifically included by the Legislature, that cannot be added.

The Court also noted that the notifications in question are exemption notifications issued under Section 93 of the Act, which empowers the Central Government to grant exemptions from service tax.

The sentiment analysis of the reasons given by the Supreme Court can be ranked as follows:

The ratio of fact to law that influenced the court’s decision can be represented as follows:

The Court’s logical reasoning can be illustrated as follows:

The Court considered the argument that the 33% calculation was based on a 67:33 material-to-service ratio but rejected it due to lack of evidence. The Court also rejected the argument that Explanation (c) to Section 67 includes all forms of payment, clarifying that it only includes modes of payment and book adjustments, not free materials.

The Court’s decision was based on a plain reading of the law and the notifications, emphasizing that only amounts charged by the service provider can be included in the ‘gross amount’ for service tax calculation.

The Court’s decision was unanimous, with both judges agreeing on the interpretation of the law and the facts.

The Court’s decision clarifies that the value of free materials provided by service recipients should not be included in the ‘gross amount charged’ for calculating service tax. This decision has significant implications for the construction industry, as it provides clarity on how service tax should be calculated in cases where clients provide some of the materials for free.

The Court also emphasized that the service tax is to be levied in respect of ‘taxable services’ and for the purpose of arriving at 33% of the gross amount charged, unless value of some goods/materials is specifically included by the Legislature, that cannot be added.

The Court also noted that the notifications in question are exemption notifications issued under Section 93 of the Act, which empowers the Central Government to grant exemptions from service tax.

The Court cited the following from the judgment:

• “A plain meaning of the expression ‘the gross amount charged by the service provider for such service provided or to be provided by him’ would lead to the obvious conclusion that the value of goods/material that is provided by the service recipient free of charge is not to be included while arriving at the ‘gross amount’ simply, because of the reason that no price is charged by the assessee/service provider from the service recipient in respect of such goods/materials.”
• “In fact, the definition of “gross amount charged” given in Explanation (c) to Section 67 only provides for the modes of the payment or book adjustments by which the consideration can be discharged by the service recipient to the service provider. It does not expand the meaning of the term “gross amount charged” to enable the Department to ignore the contract value or the amount actually charged by the service provider to the service recipient for the service rendered.”
• “It is clear from the above that the service tax is to be levied in respect of ‘taxable services’ and for the purpose of arriving at 33% of the gross amount charged, unless value of some goods/materials is specifically included by the Legislature, that cannot be added.”

Key Takeaways

• The value of goods/materials supplied free of cost by a service recipient should not be included in the ‘gross amount charged’ for calculating service tax.
• Service tax should only be calculated on the amount actually billed by the service provider for their services.
• The decision provides clarity for the construction industry on how to calculate service tax in cases where clients provide free materials.
• The judgment reinforces the principle that service tax is levied on ‘taxable services’ and that the value of free goods/materials cannot be included unless specifically provided by the legislature.

Conclusion

The Supreme Court’s judgment in Commissioner of Service Tax vs. M/S. Bhayana Builders (P) Ltd. is a significant ruling that clarifies the valuation of taxable services in the construction sector. The court’s decision provides much-needed clarity on the treatment of free materials supplied by service recipients, ensuring that service tax is only calculated on the amount actually charged by the service provider.

This judgment has important implications for construction companies and service providers, as it reduces the tax burden by excluding the value of free materials from the gross amount charged. It also reinforces the principle that service tax is levied on ‘taxable services’ and that the value of free goods/materials cannot be included unless specifically provided by the legislature.

The judgment emphasizes the importance of a literal interpretation of the law and the specific language used in notifications, providing a clear guideline for the valuation of taxable services.

The judgment also highlights the importance of legislative clarity in tax matters, underscoring the need for clear and precise language in tax laws and notifications to avoid ambiguity and disputes.

This decision is a significant win for the construction industry, providing a clear and consistent approach to service tax calculations in cases where clients provide free materials. It also serves as a reminder of the importance of adhering to the plain language of the law and the notifications issued thereunder.