“Difficult roads lead to beautiful destinations.” -Anonymous.
The new tax reform will pose several challenges for the infrastructure sector such as treating of works contracts as service contracts, the imposition of new tax rates on ongoing projects, and change in the costs of construction materials. However, the advent of GST is also expected to boost the infrastructure sector with the elimination of ´tax on tax’ and the introduction of input tax credit (ITC).
Under the previous tax regime, it was a litigious issue of whether infrastructure contracts have to be treated as ‘supply of goods’ or ‘provision of service’ contracts, or as a composite works contract involving the supply of both goods and services. While Value-added Tax (VAT), a state tax, was applicable to the ‘supply of goods’, a service tax, a central tax, was applicable to ‘provision of service’. With the implementation of GST, these litigations will come to an end. The Central GST Act, 2017 (GST Act), specifically provides that ‘works contract’ as well as ‘construction of a complex or a building, civil structure or a part thereof’ shall be treated as the supply of services. Even though this provision will provide clarity to a great extent, it may not be able to eliminate ambiguity completely. Contracts in the infrastructure sector can be quite complex, and determining the nature of these contracts would be difficult.
Under the previous regime, a majority of construction contracts, being work contracts, were subject to a combination of both service tax and VAT. A service tax of around 4.5% (assuming taxable component of the service contract is 30%) and VAT ranging from 1-15%, depending upon the state, was applicable to construction contracts. Thus, under the earlier regime, the effective tax incidence for an average construction contract, ranged from 11-18%. Moreover, there were several construction activities, such as the construction of roads, dams, irrigation, that were exempt from service tax.
With the rollout of GST, the rate of 18% for works contracts is higher, and the difference is more prominent for construction activities falling under the service tax exemption category. However, this higher GST rate could be set off by the benefit of input tax paid and ITC on the raw materials. On the other hand, a higher GST rate could also result in higher costs, if there is limited scope for renegotiating construction contracts, and contracts that do not account for contingency factors.
The cost of construction services will also be impacted due to credit restrictions provided under Section 17(5) of the GST Act. According to the aforesaid section, a contractor will not get ITC for the supply of works contract service for construction of an immovable property but can avail the benefit of ITC on construction services availed from the sub-contractor. Furthermore, the aforesaid section also provides that ITC shall not be available for goods or services or both received by a taxable person for construction of an immovable property (other than plant or machinery) on his own account, used in the course or furtherance of business. Thus, these provisions are complicated and contradictory.
We can see that implementation of the above-mentioned credit restrictions can have an adverse impact on the infrastructure sector. However, this does not seem to be the intent of the lawmakers, as seen from the ‘Schedule of GST Rates’, which clearly provides that full ITC will be available for the composite supply of works contracts. Thus, we cannot conclude that higher GST rate on works contracts will be neutralised by ITC until explanation and clarity are sought with respect to the aforesaid credit restrictions.
GST would also make compliance easier by eliminating multiple indirect taxes. However, it would require contractors to register in multiple states owing to the requirement of registering at the place of supply of service. Contractors would also have to compulsorily register in a state where it supplies services but has no fixed place of business, owing to the concept of “casual taxable person”. These provisions will increase the compliance costs for construction companies. Furthermore, companies will have to incur the costs of upgrading their IT systems, as input credit would be available only after an online reconciliation of tax invoices.
With the advent of GST, there will also be a change in the cost of construction materials. For example, a higher GST rate of 28% imposed upon cement would adversely impact construction cost. Similarly, electricity is not within the ambit of GST and input tax will be an additional burden for the infrastructure industry.
We cannot conclusively comment on the impact of higher GST rate on the infrastructure sector, as there is still ambiguity with respect to credit restrictions. GST will boost the sector by eliminating multiple taxes and simplifying the law, but it will also impact the cost of goods and services used in construction and increase compliance costs. It is still very early to make a judgment on the new tax reform. We should wait till it concretises.
By- Krrishan Singhania & Srishti Singhania