Free Materials In Works Contracts Pre-July 2009 Excludible From Service Tax: CESTAT Ahmedabad

On 15 January, the Ahmedabad Bench of the Customs, Excise and Service Tax Appellate Tribunal (CESTAT) held that the value of free materials provided under an indivisible Works Contract cannot be included in taxable value for service tax purposes for contracts executed before 7 July 2009.

A Bench comprising Judicial Member Dr. Ajaya Krishna Vishvesha and Technical Member Mr. Satendra Vikram Singh set aside the portion of the service tax demand calculated on 933.355 MT of steel, valued at Rs. 2.56 crore, against the appellant construction company, and remitted the matter to the Adjudicating Authority to redetermine the service tax liability and penalties.

The Tribunal noted that Works Contract Service became taxable only from 1 June 2007, and that, for contracts executed prior to 7 July 2009, free supplies cannot be included in taxable value. The Bench also upheld a Rs. 5,000 penalty for late filing of half-yearly service tax (ST-3) returns.

The appellant, a construction company, had executed a works contract to construct a shopping mall at a cost of about Rs. 6.5 crore. The Service Tax Department alleged non-payment of service tax and non-registration under Commercial or Industrial Construction Service for 2008–09. In March 2012, a Show Cause Notice was issued demanding service tax of Rs. 35.93 lakh, along with interest and penalties under Sections 76 (failure to pay tax), 77 (failure to comply with notices/returns), and 78 (wilful misstatement/suppression) of the Finance Act, 1994.

The appellant contended that it had paid all indirect and direct costs from December 2006 to 2008–09 and was registered under VAT, with substantial sales tax paid on construction materials, supported by documentation.

The CESTAT noted that under the Works Contract (Composition Scheme for Payment of Service Tax) Rules, 2007, effective 7 July 2009, the inclusion of free-of-cost supplies in the gross amount is prospective in nature. Citing a CBIC circular, the Bench observed:

“Rule 3(1)… explanation inserted w.e.f. 07.07.2009… is clarificatory and prospective in nature. Inclusion of value of free of cost supplies of goods and services in or in relation to the execution of Works Contract in the gross amount for the purpose of payment of service tax on Works Contract in the Composition Scheme is a legal requirement only w.e.f. 07.07.2009 when the explanation became part of Rule 3(1).”

On the extended period of limitation, the Tribunal clarified that the proviso to Section 73(1) was correctly invoked, as the appellant had failed to register and file returns until an investigation was initiated, demonstrating intent to evade tax.

Citing precedents, including the 2015 Supreme Court decision in Larsen & Toubro, the Bench directed the Adjudicating Authority to recalculate the service tax and penalties from 1 June 2007 onwards, taking into account the exclusion of free steel from taxable value.