Works Contract (Composition Scheme for payment of Service Tax), Rules, 2007

After much controversy and following the ratio of decision in
the case of Daelim Industrial Co. Ltd. v. Commissioner, 2006 (3) STR 124
(Trib.-Del) in a catena of Tribunal decisions, it was held that transactions of
works contract could not be vivisected to levy service tax only on the portion
of a composite contract. Consequently, works contract service was notified to
levy service tax on the component other than that chargeable to VAT/sales tax.
Considering that valuing service component in accordance with the method
prescribed in Rule 2A of the Valuation Rules is not only lengthy, but also
questionable at any point of time, exercising option of the Composition Scheme
was advantageous on all counts including presumptive tax rate of 2%, wherein
liability would further get reduced as persons paying under the Scheme are
eligible for CENVAT credit of service tax paid on input services.

However, the Government vide its Circular No. 98/2007-ST,
dated 4-1-2008 clarified that works contracts in process as on June 01, 2007
were not eligible to register under the new category of services, as works
contracts cannot be vivisected.

This gave rise to a controversy as to whether the contracts
in process were liable for service tax at all in terms of decisions in cases of
Daelim Industrial Company (supra) and Larsen & Toubro, 2006 (3) STR 223
(Tri.-Del) or they were liable under their respective categories like
construction services or erection, commissioning and installation services.
Works contractors who had registered under the relevant category and paid
service tax after claiming abatement @67% of the gross value charged, faced a
dilemma unless they decided to terminate the ongoing contract pending
completion. The Circular issued by the Board being binding on the subordinate
authorities of the Department, if contractors opted to pay service tax @2% under
the Composition Scheme after registering under the works contract category,
litigation would be inevitable. Approach of the Board meant dual standards. When
a category like commercial construction service or erection, commissioning or
installation was introduced, the Government did not mean to exclude the ongoing
contracts from the purview of service tax, and accordingly, value of pending
contract on the date of introduction of the relevant category was required to be
offered for taxation. This indeed was independent of the questionability of
coverage of works contract under the service tax law prior to introduction of
category of works contract with effect from June 01, 2007.

Given the above scenario, only the contracts executed post
June 01, 2007 had the option of the Composition Scheme and the 2% rate of tax. A
majority of works contracts of construction or commissioning or installation
would involve a period longer than a year and in a number of cases even over two
years. Therefore, within a period of nine months, insignificant number of works
contracts undertaken after June 1, 2007 might have reached completion stage.
From March 01, 2008, now vide Notification No. 77/2008-ST, the rate is increased
to 4%.

The increase in rate adversely affects all contractors who
opted for the Composition Scheme, as the increase essentially means a dent on
their margin. There is a view held by some professionals that doctrine of
promissory estoppel should apply in this case. The poser is, whether legally
does the increase in rate involve principle of promissory estoppel ? Rule 3(3)
of the Works Contract (Composition Scheme for payment of Service Tax) Rules,
2007 provides that option of paying service tax under these rules once exercised
is not allowed to be withdrawn until the completion of a contract. Given the law
that a person is not allowed to withdraw the option until the completion of the
relevant works contract, how much weightage can be given to the Board’s Circular
viz. DOF 334/1/2007-TPU of February 28, 2007, which inter alia
stated :

“Under Composition Scheme, the assessee is required to pay
2% of the total value of the works contract as service tax“. As
against this, the scheme prescribed payment of “service tax equivalent to 2% on
the gross amount charged for the works contract”. (emphasis supplied). The
Circular being more of a clarificatory nature, cannot be beyond the scheme of
the law, it appears doubtful to apply doctrine of promissory estoppel on the
basis of a decision of the Hon. Supreme Court in the case of CC Calcutta v.
Indian Oil Corporation, 2004 3 SCC-488 wherein it was held that departmental
Circulars or Clarifications issued u/s.37B of the Central Excise Act, 1944 would
be covered by the doctrine of ‘promissory estoppel’. The above Circular not
being one u/s.37B, and more in the nature of issue of guidance note on
introduction of new provision, challengeability of the increased rate on the
above ground appears doubtful, although it is undoubtedly unfair on the part of
the Government to double the rate of tax within nine months of its introduction.