Understanding Goods and Services Tax Implications for Works Contracts

Works contracts combine the supply of goods with service execution, encompassing activities like building construction or machinery installation. This article provides a detailed analysis of how the Goods and Services Tax (GST) applies to works contracts.

Works Contract Under Pre-GST Regime

Before the implementation of GST, works contracts were subject to a complex taxation framework. The supply of goods within a contract was taxed under Value Added Tax (VAT), while services were subject to service tax. Additionally, if the execution of a works contract resulted in the creation of a new product, Central Excise duty was levied. This multi-layered taxation led to significant confusion regarding tax treatment and frequent legal disputes. GST was introduced to simplify this intricate system and bring clarity to the legislative landscape.

Taxability of Works Contract Under GST

Unlike the previous VAT and Service Tax regulations, the term “Works Contract” under GST is specifically confined to work performed on “Immovable Property.” Former laws, in contrast, also covered contracts related to movable property. Under GST, a works contract is defined as a composite supply that involves the construction, fabrication, completion, erection, installation, fitting out, improvement, modification, repair, maintenance, renovation, alteration, or commissioning of any immovable property, where the transfer of property in goods (either as goods or in another form) is part of the contract’s execution. Importantly, composite supplies involving movable items, such as a vehicle's paint job, are not considered works contracts for GST purposes. GST Schedule II clearly states that the construction of a complex, building, civil structure, or a portion thereof (including those intended for sale), and works contracts involving the transfer of property in goods, are classified as a supply of service. This categorization eliminates the prior confusion about tax treatment, establishing that works contracts are to be treated as services, with tax applied accordingly. This unified approach simplifies tax calculations significantly compared to the diverse VAT schemes and complex service tax abatements of the earlier regime.

Input Tax Credit (ITC) Not Available on Some Works Contracts

GST law specifies restrictions on claiming Input Tax Credit (ITC) for certain works contract services. ITC is generally not available for works contract services when they are supplied for the construction of immovable property, excluding plant and machinery. An exception exists if these services are utilized as an input for the further supply of works contract services. Furthermore, ITC cannot be claimed on goods or services received by a taxable person for constructing an immovable property on their own account, even if it is for business use, again with the exception of plant and machinery. For example, a building developer who subcontracts a portion of a project can claim ITC on the subcontractor's tax invoice, as the developer's output also constitutes a works contract service. However, if a company in the IT sector receives a works contract service (not involving plant and machinery), it will not be eligible to claim ITC on the GST paid.

Abatement Is Not Provided Under GST

Under GST, no abatement is prescribed for works contract services. In the previous tax regime, VAT was applicable to works contracts, and service tax was paid at 15% with abatements of either 40% (for new work) or 70% (for repair and maintenance work). The absence of such abatements or composition schemes under GST has resulted in a notable increase in the tax burden, particularly since works contracts are generally taxed at the standard GST rate of 18%, or occasionally a lower rate of 12%.

GST Rate on Works Contract

The Goods and Services Tax rates applicable to various types of works contracts are categorized as follows:

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