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-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 OptionA-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.
(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.
( 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 .