Larger Bench Ruling on Valuation: Material Supplied by Receiver of Service, Whether Includible in Taxable Value

Relevant statutory provisions:
• Section 66 – Charging section

“There shall be levied a tax (hereinafter referred to as the service tax) at the rate of twelve per cent of the value of taxable services referred to in sub-clauses (a) to (zzzzw) of clause (105) of section 65 and collected in such manner as may be prescribed.” [emphasis supplied]

• Section 67 of the Finance Act, 1994 (the Act) deals with valuation of a taxable service for the charge of service tax. This section with effect from 18-04-2006 was substituted whereby its scope was expanded. Nevertheless, the basic mode and characteristic of valuation of a taxable service remained unaltered.

Prior to 18-04-2006, the said section 67 read as follows:

“For the purpose 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.

[emphasis supplied]

Explanation 1 ………… Explanation 2 ……….. Explanation 3 ………..”

(There were certain inclusions and exclusions provided in the above explanations which are not produced for the sake of brevity).

The substituted section 67 with effect from 18-04- 2006 reads as under:

“(1) Subject to the provisions of this Chapter, where service tax is chargeable on any taxable service with reference to its value, then such value shall, —

(i) in a case where the provision of service is for a consideration in money, be the gross amount charged by the service provider for such service provided or to be provided by him;

(ii) in a case where the provision of service is for a consideration not wholly or partly consisting of money, be such amount in money as, with the addition of service tax charged, is equivalent to the consideration;

(iii) in a case where the provision of service is for a consideration which is not ascertainable, be the amount as may be determined in the prescribed manner.

(2) Where the gross amount charged by a service provider, for the service provided or to be provided is inclusive of service tax payable, the value of such taxable service shall be such amount as, with the addition of tax payable, is equal to the gross amount charged.

(3) the gross amount charged for the taxable service shall include any amount received towards the taxable service before, during or after provision of such service.

(4) Subject to the provisions of sub-sections (1), (2) and (3), the value shall be determined in such manner as may be prescribed.

Explanation. — For the purposes of this section, —

(a) “consideration” includes any amount that is payable for the taxable services provided or to be provided;

(b) ………..

(c) “gross amount charged” includes payment by cheque, credit card, deduction from account …………………..” [emphasis supplied]

Commercial construction service was introduced in the service tax law with effect from 10th September, 2004 whereas residential construction service became taxable from 16th June, 2005. A variety of construction agreements are entered into by developers or builders with their contractors. Some contracts involve construction services with all the material to be supplied by their contractor/s and in some others, the owner/developer purchases critical materials like cement and steel on his own account. In order that the material supplied by a contractor in a composite contract would not have to suffer service tax, the Government issued Notification No.15/2004-ST and subsequently Notification No.18/2005-ST as regards residential construction on identical lines.

Notification No. 15/2004-Service Tax read as follows:

“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:

Provided that this exemption shall not apply in such cases where –

(i) the credit of duty paid on inputs or capital goods has been taken under the provisions of the CENVAT Credit Rules, 2004; or (

ii) the commercial concern has availed the benefit under the notification of the Government of India, in the Ministry of Finance, (Department of Revenue) No. 12/2003-Service Tax, dated the 20th June, 2003 [G.S.R. 503 (E), dated the 20th June, 2003.”

[emphasis supplied]

Consequent upon the introduction of the above service, Central Board of Excise & Customs (the Board) issued Circular No.80 dated 17-09-2004 wherein, inter alia, the reason for issue of Exemption Notification No.15/2004-ST was contained in para 13.5 as extracted below:

“13.5. The gross value charged by the building contractors include the material cost, namely, the cost of cement, steel, fittings and fixtures, tiles etc. Under the CENVAT Credit Rules, 2004, the service provider can take credit of excise duty paid on such inputs. However, it has been pointed out that these materials are normally procured from the market and are not covered under the duty paying documents. Further, a general exemption is available to goods sold during the course of providing service (Notification No. 12/2003-ST) but the exemption is subject to the condition of availability of documentary proof specially indicating the value of the goods sold. In case of a composite contract, bifurcation of value of goods sold is often difficult. Considering these facts, an abatement of 67% has been provided in case of composite contracts where the gross amount charged includes the value of material cost. (refer notification No.15/04-ST, dated 10-09-2004) This would, however, be optional subject to the condition that no credit of input goods, capital goods and no benefit (under notification no. 12/2003-ST) of exemption towards cost of goods are availed.”

With effect from 01-03-2005, vide Notification No.4/2005-ST, an explanation was inserted in the above Notification viz. “For the purpose of the Notification, the gross amount charged shall include the value of goods and materials supplied or provided or used for providing the said taxable service provided by the said service provider.”

In terms of this explanation, the revenue contended that when cement or steel is supplied by the builder/developer/owner, the same should form part of the value for determining 67% abatement. Widespread litigation occurred on this issue across the country. The Madras High Court provided an interim relief in a writ filed by Larsen & Toubro Ltd. 2007 (7) STR 123 (Mad) holding that:

“On a reading of the explanation, this court is prima facie of the view that such an insistence is not in accordance with the explanation. To that extent there will be an interim order as prayed for.”

Based on the above interim order, the Delhi High Court in Era Infra Engineering Ltd. 2008 (11) STR 3 (Del) also provided interim relief to the appellant.

Conflicting decisions by two co-ordinate Benches of Tribunal:

Subsequently, the Bangalore Tribunal in Cemex Engineers vs. CST Cochin 2010 (17) STR 534, relying on the observation of the Madras High Court in Larsen & Toubro (supra), held that the value of goods supplied and provided by the client cannot be included for calculating service tax and that such inclusion would be contrary to the provisions of section 67 of the Act which specifies that the value of taxable service shall be the gross amount charged by the service provider for such service. As against this, in Jaihind Projects Ltd. vs. CST, Ahmedabad 2010 (18) 650 (Tri.-Ahmd), the Appellant engaged in laying pipelines provided commercial or industrial construction service to companies such as ONGC, GAIL, Essar Projects Ltd. etc. In all cases, pipes were supplied by the receiver of service to the Appellant. The department raised a dispute contending that the value of pipes supplied by receiver ought to have been included in the value for determining taxable value of 33% while availing the benefit of Notification No.15/2004-ST. The Tribunal held that even under section 67 of the Act read with Rule 3 of the Service Tax (Determination of Value) Rules, 2006, the pipes being essential component of providing pipeline service, it must be treated as consideration other than money and therefore the value of such pipes must be included in the gross value to be offered for service tax payment. As regards Explanation to Notification No.15/2004-ST, the Tribunal held that the ‘Explanation’ has explained the meaning of “gross amount charged” and since the assessee has opted to avail the abatement under the Notification, he must include the value of goods supplied for the purpose of determining taxable value. The Tribunal further noted that if the value of the pipes used is not included, the Appellant would not be eligible to claim abatement under Notification No.15/04-ST as amended. The Tribunal also recorded that discriminatory results would ensue between two pipeline service providers if one uses pipes provided by him and the other uses one provided by the receiver client. Therefore, when the receiver supplies the material, the expression ‘used’ in the Explanation comes into play as the objective of the Explanation and the proviso is to ensure uniformity in different situations. Further, reliance on Circular No.80/10/2004-ST dated 17-09-2004 by the Appellant was negated by holding that the Explanation brought about from 01-03-2005 did not exist at the time of issue of the circular.

The above conflicting decisions led the Division Bench of the Delhi Tribunal to make a reference to the Larger Bench wherein 23 appeals got bunched together. The decision dated 6th September, 2013 is discussed below:

M/s. Bhayana Builders (P) Ltd. & 22 Others 2013-TIOL-1331-CESTAT-DEL-LB:

The question before the Larger Bench (the Bench or LB) was whether the value of the material supplied by the recipient of the taxable service free of cost to the provider of service should also be included for availing tax benefit under Notification No.15/2004-ST dated 10-09-2004 as amended by Notification No.4/2005-ST dated 01-03-2005. The above Notification as well as Notification 18/2005-ST issued in respect of residential construction service along with all other abatement Notifications later got merged into a single one viz. Notification No.1/2006 -ST dated 01-03- 2006 without any change in the notification per se. Although the issue relates to the construction industry and a vast number of contractors providing construction services, the decision assumes greater importance as the scope of provision of valuation contained in section 67 of the Act is examined and dealt with at a great length.

Revenue’s contention in brief:

The Revenue discussed various alternative schemes available under the service tax provisions for valu-ation of construction service as follows:

•    CENVAT credit of material including cement and TMT bars used while providing construction service and remitting full value of the service.

•    Benefit under Notification 12/2003-ST of exemp-tion to the extent of value of goods sold during the course of providing service.

•    Benefit under Notification 15/2004-ST wherein a generic abatement of 67% of the “gross amount charged” in case of composite contracts when the gross amount charged includes value of material used upon condition of non-availment of credit on inputs and capital goods and the benefit under the above referred Notification
12/2003-ST.

•    In case of works contracts under a scheme, service tax at a very low rate on the gross amount wherein value of goods or abatement is not deducted.

In the above background, it was contended that Explanation to Notification 15/2004-ST as amended provided that where an assessee opts for the benefit of abatement of 67%, the value of all the goods must be included for determining the value of the contract without availing CENVAT credit of inputs or capital goods or the benefit of exclusion of goods sold under Notification No.12/2003-ST.

The word ‘used’ in the explanation clearly means irrespective of the source of supplies. If the material/ goods were used in the construction service, the value of such goods ought to be included to avail abatement of 67%. Further, even u/s. 67 of the Act, the value of goods whether supplied by the provider or the receiver, if used for providing taxable service, constitute the “gross amount charged” for providing taxable service and lastly, in terms of the contract between the parties, free supplies constitute the consideration by the receiver to the provider of construction service and this value is accordingly taxable u/s. 67 and therefore, it must be declared and offered for tax if 67% abatement benefit is availed. The Revenue interalia relied on N M Goel & Co. vs. Sales Tax Officer (1989) 1 SCC 335 wherein steel and cement supplied by PWD to the assessee were to be deducted from the bills payable by PWD and thus PWD sold these goods to the assessee, though the goods were used for construction for the benefit of PWD. The Bench, in this frame of reference, observed that as against the above case of N. M. Goel & Co. (supra), in the instant case of free supply by the receiver, the agreements between the parties do not provide for recovery of cost of free materials by the recipient from the service provider and the case does not help achieve resolution of the referred issue. The Bench further observed that it did not dispute the fact of integral nexus between free supplies with the construction activity. However, essentially whether such free supplies by the recipient would constitute consideration accruing to the service provider so as to be includible in the “gross amount charged” for the purpose of computation of the taxable value u/s. 67 or to be included in the “gross amount charged” for availing benefit under the abatement Notification as comprehended within the meaning of the word ‘used’ in the Explanation.

Discussion & Analysis contained in the Decision:

Contentions presented by the Appellants were referred to the order of the Hon‘ble Bench in the analysis that follows:

•    Section 67 deals with valuation of taxable services and intends to define what constitutes the value received by the service provider as consideration from the recipient for the service provided. Implicitly, the consideration— monetary or otherwise—must flow from the receiver to the provider of service and should accrue to the benefit of the latter. For interpreting the term ‘consideration’, reliance was placed on the Supreme Court decision in Ku. Sonia Bhatia vs. State of UP & Others AIR 1981 SC 1274 wherein it was held that “consider-ation means a reasonable equivalent for other valuable benefits passed on by the promisor to the promisee or by the transferor to the transferee.” The Bench, thus observed that even on an extravagant inference, free supply of cement and steel would not constitute a non-monetary consideration by the recipient to the provider particularly because material supplied is retained by the service recipient (misprinted as provider in the order). The Bench also relied on the recent decision of the Delhi High Court in Intercontinental Consultants & Technocrats P. Ltd. vs. Union of India 2013 (29) STR-DEL and observed that the High Court considered the challenge of constitutionality of Rule 5 of the Service Tax (Determination of Value) Rules, 2006 to the extent it includes reimbursement of expenses in the value of taxable service and also that the said Rule is ultra vires sections 66 and 67 of the Act. The High Court held that section 66, the charging section, levies tax only on the taxable services and this inbuilt mechanism ensures that only taxable services shall be evaluated u/s. 67. On construing provision of section 66 and section 67(1)(i) together and harmoniously, the value of taxable service shall be the gross amount charged by the service provider and nothing more and nothing less than consideration paid as quid pro quo for the service can be brought to charge. The Bench thus observed that the legislative text of sections 66 and 67 being clear and unambiguous and in the light of the judgment in Intercontinental Consultants & Technocrats P. Ltd. (supra) “the conclusion is compelling and inviolable that value of free supplies by a construction service recipient would not constitute non- monetary consideration to the service provider nor form part of the gross amount charged for the service provided” and consequently could not constitute value of tax-able service. As per this analysis, the Bench held that the conclusions in Jaihind Projects Ltd. proceeded on a flawed interpretation of section 67. Further, on bringing uniformity of incidence as discussed in this decision, the Bench relying on Union of India & Others vs. Bombay Tyre International Ltd. & Others 1983 (14) ELT 198 (6) (SC) and UOI vs. Nitdip Textile Processors P. Ltd. 2011 (273) ELT 321 (SC) observed that advantages or disadvantages to individual assessees are accidental, inevitable and inherent in every taxing statute. Further, referring and relying on Moriroku UT India (P) Ltd. vs. State Of U.P. 2008 (224) ELT 365 (SC), the Bench observed as follows:

“Sales-tax or trade-tax under the 1948 Act is leviable on sale, whether actual or deemed, and for every sale there has to be a consideration. On the other hand, excise duty is a levy on a taxable event of ‘manufacture’ and it is calculated on the ‘value’ of manufactured goods. Excise duty is not concerned with ownership or sale. The liability under the excise law is event-based and irrespective of whether the goods are sold or captively consumed. Under the excise law, the liability is there even when the manufacturer is not the owner of raw material or finished goods (as in the case of job workers). For sales-tax purposes, what has to be taken into account is the consideration for transfer of property in goods from the seller to the buyer. For this purpose, tax is to be levied on the agreed consideration for transfer of property in the goods and in such a case cost of manufacture is irrelevant. The provisions relating to measure (section 4 of 1944 Act read with Excise Valuation Rules, 2000) aim at taking into consideration all items of costs of manufacture and all expenses which lead to value addition to be taken into account and for that purpose Rule 6 makes a deeming provision by providing for notional additions. Such deeming fictions and notional additions in excise law are totally irrelevant for sales-tax purposes.” [emphasis supplied].

Based on the observations in Moriroku UT India (P)    Ltd. (supra), the Bench concluded that a clear principle emerged therefrom that consideration for the transfer of property in goods from the seller to the buyer is only to be held as consideration for the levy of tax unlike event-based excise duty and this principle would equally apply to the levy of service tax and particularly in the context of specific language of section 67 of the Act.

•    For the next issue of the Explanation inserted in Notification No.15/2004, the Bench observed that the Explanation purports to define “gross amount charged” and the abatement of 67% is in respect of the “gross amount charged” by the service provider to the recipient, the identical expression employed in section 67(1)(i). The question, therefore, requiring examination is whether the Notification No. 04/2005-ST amending Notification No. 15/2004-ST enlarged the contents of the said expression. The Bench while considering various contentions advanced for the Appellants observed that the nuance of the substantial contention of the Appellants was that goods used by the provider of the construction service for providing such service in the Explanation to the Notification No.15/2004-ST must connote those goods as are charged to the service recipient. However, the revenue contested that the literal meaning of the word ‘used’ be given its full effect and ought not to be restricted to the other two expressions ‘supplied’ and ‘provided’ with reference only to the “gross amount charged”. On behalf of the assessees, contention was made to employ interpretative principle of “Noscitur A Sociis” or the analogy of the “ejusdem generis” to hold that goods and material used for providing the construction service, the value of which is charged to the service recipient. Considering the term ‘used’ problematic, examination and analysing of the said principle of noscitur was found imperative and a number of judgments and quotes on the subject matter were referred to in aid thereof which inter alia included;

•    Rohit Pulp and Paper Mills Ltd. vs. Collector of Central Excise AIR 1991 SC 151

•    Paradeep Agarbatti, Ludhiana vs. State of Punjab AIR 1998 SC 171

•    Hariprasad Shivshankar Shukla and Another vs. A. D. Divelkar and Others 2002-TIOL-447-SC-MISC-CB

The Bench finally concurred with the contention advanced on behalf of the Appellants while elaborating on the noscitur a sociis principle that when the Notification exempts service tax to the extent of 67% of the “gross amount charged” in relation to construction service, section 67 enacts that the value of taxable service shall be the “gross amount charged” which would not include the value of free supplies, as any value to constitute consideration, monetary or otherwise should flow from a recipient to the provider of service and this being the pre-condition u/s. 67, the expression “gross amount charged” in the Explanation could not be construed as expanding the scope of the said expression. Likewise, the reliance placed by the Appellants inter alia on CIT, Bangalore vs. B. C. Srinivasa Setty (1981) 2 SCC 460 was noted and the Bench observed the principle laid therein to the effect that when four important components of concept of a tax system (viz. the nature of the imposition of a tax which prescribes the taxable event, the person on whom the levy is imposed, the rate of tax and the measure or value to which the rate is applied), are not clearly and definitely ascertainable, it is difficult to say that the levy exists in point of law and any uncertainty and vagueness in the legislative scheme defining any of those components of the levy will be fatal to its validity. Considering this principle analogous to the principle that liability to tax could not be inferred on a doubtful or ambiguous provision and the benefit of ambiguity must be resolved in favour of the assessee, the Hon‘ble Bench concluded that the expression ‘used’ in the Explanation to Notification No.15/2004-ST is inherently ambiguous and more so in the context of other expressions therein i.e., supplied or provided, the noscitur principle must be applied to conclude that only such goods/materials which are ‘supplied’ by the service provider or ‘provided’ by the service provider or ‘used’ when supplied or provided by the service provider i.e. goods and material whether supplied, provided or used in the construction and charged on the service recipient and value where-of is received by the service provider towards a consideration that accrues to the provider’s benefit would alone comprise the “gross value charged” by the construction service provider within the meaning of section 67 and for availing benefit of Notification 15/2004- ST. Alternatively, it can also be stated that since the free supplies i.e. incapable of computation provision of section 67(1)(iii) would not apply as free supply would not fall within section 67, the computation provisions fail and consequently restriction on availability of benefit of exemption would be nugatory. Based on the above, the reference was answered in the following words in para 16 of the order:

“Para 16:

(b)    Value of free supplies by service recipient do not comprise the gross amount charged under Notification No. 15/2004-ST, including the Explanation thereto as introduced by Notification No. 4/2005-ST.”

Conclusion:

Despite the above, the observation of the Bench concluded in para 15 is important. “This is not to say that an exemption Notification cannot enjoin a condition that the value of free supplies must also go into the gross amount charged for valuation of the taxable service. If such intention is to be effected, the phraseology must be specific and denuded of ambiguity.” The question now arises is whether the effect of above ruling would be extended to the composition scheme under the works contract service or the works contracts under the negative list based taxation.

Under the Works Contract (Composition Scheme for Payment of Service Tax) Rules, 2007, service tax @2% or 4% during application period was payable on the gross amount charged. An Explanation was inserted with effect from 07 -07 -2009 to include “the value of all goods used in or in relation to the execution of the works contract, whether supplied under any other contract for a consideration or otherwise.”

Further, the above Rule 3(1) contained “notwith-standing anything contained in section 67 of the Act and Rule 2A of the Service Tax (Determination of Value) Rules, 2006………”, means a non-obstante provision. However, determination of value of services involved in the execution of works contract under Rule 2A of the Service Tax (Determination of Value) Rules, 2006 (Valuation Rules) was subject to the provisions of section 67.

Similarly, in the post-negative list period, service tax is to be paid on a specific percentage of the total amount charged for the works contract in accordance with the substituted Rule 2A of the Valuation Rules. The term “total amount” is defined to include the fair market value of all goods and services supplied in or in relation to the execution of the works contract. As per the substituted Rule 2A also, the value of service portion in the execution of a works contract is to be determined subject to provisions of section 67.

Thus, in both the cases, the question remains as to whether the Explanation and its phraseology is unambiguous enough to expand the scope of the term “gross amount charged” to include the value of free supplies is again a matter of interpretation. However, the treatise of the above landmark decision would serve as a guidance to resolve many vexed issues on the subject of valuation. However, the finality on this issue of valuation is unlikely in the near future.