We get a clear indication of the change represented by GST by comparing the treatment of indivisible contracts by existing and proposed tax regimes. These contracts involve supply of goods and provision of services. Typical examples include EPC (engineering, procurement and construction) contracts for construction services and supply of building materials, which are generally known as works contracts. Their treatment is very convoluted under the existing tax regime.
VAT in works contract transactions is typically payable on the value of goods sold, which is determined by deducting labour and service charges, amounts paid to subcontractors and so on from the contract value. But some states do not provide a specific deduction for subcontractors, leading to uncertainties with respect to valuation for tax payment. State laws are not uniform on VAT rates for composition schemes, eligibility and quantum of input tax credit, and rates for deducting tax by contractee on payments made to contractors.
Similarly, service tax legislation also treats indivisible contracts ambiguously. ECI (erection, commissioning and installation) and CIC (commercial and industrial construction) service providers can pay 10.3% service tax or claim an abatement of 66.67% from the entire contract value for value of goods and materials supplied.
Under the abatement option, input tax credits are not available to the contractor. But in ?works contract services?, the contractor can pay 4% service tax on the entire contract value?under the composition scheme?and also opt to claim tax credit on input services and capital goods. Such disparities are leading to litigation on account of classification of services.
Budget 2009 has proposed an amendment of service tax law: for works contract services under the composition scheme, service tax would be payable on the amount including value of goods used, whether supplied for consideration or otherwise under any other contract. This has created uncertainty about service tax valuations of EPC contracts involving offshore and onshore supply of goods and services and onsite construction activities. Further, in the absence of any specific provision, there is no clarity on VAT levies on the service tax and service tax levies on VAT for indivisible works contracts.
Catering contracts involve supply of food and provision of services, telecom services involve SIM card sales. Double taxation on indivisible contracts?subject to VAT and service tax?constantly creates litigation concerning the rate, value and situs of sales. Hopefully, the GST will resolve such open-ended issues and create a logical framework for the levy of tax and claiming of input tax credits for indivisible contracts.
Another key issue the GST regime has to resolve concerns cross-border transactions. They typically comprise services exported out of India or services imported into India, and export and import of goods.
As per existing service tax laws, services that qualify as ?export? under the Export of Services Rules, 2005 are zero rated subject to specified conditions. There is a possibility this will continue under GST as well. But it is imperative that we have explicit rules to determine which services qualify as export, as the relevant rules have changed multiple times in recent years.
Import of services currently attracts service tax under the Import of Services rules and the service recipient is liable to pay tax under reverse charge mechanism. GST could be based on the principle of destination-based tax on consumption, which would actually be in line with current provisions. But it will be essential to lay down proper principles to determine the taxability of international transactions?like telecom services involving international roaming, international courier and traveling, oil and gas sector services performed on the high seas and so on.
Resolving ambiguities involving the taxability of cross-border transactions and credit of taxes in such cases would be key concerns while formulating the GST law.
The author is a tax partner, Ernst & Young, India