Vat on free supply of material to contractors

The issues in Value Added Tax (VAT) for free supply of material to contractors and how to avoid such effects

1. By CA. Abdur Rahman Musba
[email protected]
Case study on issue of Sale Tax on
free supply of material to contractor

2. Scope
This presentation covers a very specific issue of free supply of
Cement and Steel to Builders/Project Owners to their
contractors and the taxable implication under VAT/Sale tax

3. Commercial Practice
The builder usually enter an contract with the contractor for
construction of Building
In construction contract, a BOQ (Bill of Quantity) will be
available.
The BOQ will contain detailed description of the item, the
Unit of measurement, the rate, the total value for each item
The total of the each value shall give the contract value

4. BOQ
A sample description is given above. On carefully reading
the description, you will find that the item contains various
material like Steel, Cement, Gravel (jelly), sand; and labour
component.
The unit of measurement of above description is in Cubic
Meter
Providing and laying reinforced cement concrete M-20 mix using 20 mm and down size
granite jelly and clean sieved approved sand, including mixing, mechanically vibrating with
needle vibrator, providing and removing centering, shuttering, including cost of all material,
labour, hire charges of machinery, loading, unloading, mixing, laying, tamping, curing and
finishing the exposed faces with C.M.1:4 proportion etc., complete with all leads and lifts
(excluding the cost of reinforcement) and as per detailed tender specification and as directed
by the Engineer.etc.,complete.

5. BOQ
The unit of measurement can be square meter (for painting),
Metric Tonnes(for supply of reinforce steel), number for
specific jobs.
These description and rate for each item is available either
from public domain (like Public Work Department or
National Highway) or own sources (like previous contracts)
The BOQ rate is used to analyseand control the contract
cost
In the description given, it is difficult to segregate the value
of steel and cement from the BOQ

6. Free Supply of Material
For various reasons like for quality purpose, to ensure that
contractor do not suffer price escalation, for commercial
relationship with Supplier (to get discount on cement, in case
builder buys for multiple projects);
the Builder may buy the steel and cement directly from
manufacturers/dealer
And supply the same, free of cost to the contractor

7. Inter-State Purchase
Sometimes, the builder may buy these goods from outside
the state, by issuing Form C
The builder add in the CST Registration, cement and steel in
the default category. In case of construction of Plant and
Machinery, the buyers puts steel and cement for use in
Manufacture/Processing
(Under CST, goods purchase from outside the state should be
mentioned in the Registration Certificate under various
category like use in (i) Manufacture, (ii) generation and
distribution of power, (iii) mining, (iv) Re-sale etc)

8. Bill of Contractor
The Purchase Order for steel and cement is issued by the Builder
and the same are received by the contractor.
The contractor does the construction, prepares the measurement
sheets. The measurement sheets are verified by the Builder. The RA
(Running Account) Bill is generated by the contractor at the
contract (BOQ) rates.
The amount of cement and steel consumed is deducted from the
RA bill.
VAT invoice and Service Tax invoice is raised on value after
deduction of cement and steel.
Sometimes, the contractors is registered under composition
scheme. In that case, he may not charge separately for VAT

9. Tax impact on builder
In case of civil works, the input tax credit under VAT and
Service Tax is restricted. (In case, the contractor is under
composition scheme, VAT credit cannot be taken),
In case of resale, input tax credit can be taken, provided the
builder is not under composition scheme
The contractor pays its taxes properly (VAT and Service Tax
on the net amount)
The builder needs not pay tax (unless a real estate developer
who sells building)
But wait…….. Is everyone is correct???

10. Twist in the Tale
Here is a twist in the tale and that too a bad twist.
It is more painful because the construction of building is
expensive and the tax rates are really high
The above treatment is not correct
Let analysis how the VAT department treat the above
transactions

11. Tax Treatment
For the above transactions, the VAT department considers
there is three sales
First, from the cement/steel supplier to the builder
Second, from the Builder to the contractor
Third from the contractors as works contract back to the
builder
They rely on N M Goel& Co. vs. Sales Tax Officer 72 STC
368 (SC)

12. Implication of above tax treatment
The VAT officer will do a best judgment assessment, cost of
cement/steel + Gross Profit (or the amount deducted from
contractors bill) and apply VAT rate on the builder
For the contractor, VAT officer shall apply the
BOQ/Contract rate with Standard Deduction or best
judgment assessment
In case, the VAT amount is for prior period, input tax credit
cannot be taken beyond 6 months
In case of composition dealers, VAT credit cannot be taken.
Hence, double VAT is payable, when no VAT should be
payable at all
Over and above this, interest and penalty will be levied.

13. Interstate Purchase -Further Damage
There can be further damage (in case of Interstate Purchase)
In case of inter-state Purchase, Form C was issued to the
supplier
In case the category for Purchase was for
Manufacturing/Processing, then the Form C issued is wrong
The builder has sold the cement/steel to supplier, and the
CST registration should contain Cement/steel in Resale
Category

14. Step to safeguard
There is two options to safeguard
First Option
The builder should charge VAT in each supply of cement and steel to
the contractor
The Builder’s CST registration should contain cement/steel in resale
category
The Builder should be under Regular Registration to take input credit
and let the contractor take input credit
Similarly, the contractor should be under Regular Registration to take
input credit and pass on VAT credit
In case the builder sells the building, he can charge VAT to his buyers.
In other cases, Input Credit may not be available, (egNon-Plant
building would be restricted under Schedule V)
SEZ unit would able to get refund

15. Second Option
The builder and contractor should taken various precautions
The Item Rate should be without cement and steel cost
The contract value should be without steel and cement cost
The Contract should mentioned that the goods shall be given on
bailment basis
The Builder should receive the goods from the supplier
The contractor should request for the goods by raising a
requisition
After receiving the goods, the goods should be supplied on
bailment basis
The contractor should acknowledge the goods received
The contractor should not deduct the value of cement and steel
from his RA bill

16. Service Tax
Though this presentation does not cover Service Tax, Service
Tax issues should also be looked into
For Example, in case the contractor charge Service Tax on
composition scheme of Service Tax, cost of Free Supplies of
cement and steel should also be added to cost of Taxable
Value for purpose of Service Tax.

17. Thank You