TAX EFFECTS TO DEVELOPER ON SUPPLIES TO TURNKEY CONTRACTOR

TAX EFFECTS TO DEVELOPER ON SUPPLIES TO TURNKEY CONTRACTOR

CA NISHANT MUNDADA

INTRODUCTION

There is a lot of ambiguity regarding taxation of turnkey construction contracts in India. It starts from the fact that a turnkey construction contract involves both labour and material therefore, both Service tax and Value Added tax is levied on the same transaction. The process becomes complex depending upon the various factors such as the Scope of work, the nature of the contract, whether the contract includes any further sub – contracting, whether individual prices have been specified for different tasks , whether the contract involves off –shore and on – shore activities, etc.

TURNKEY CONTRACT

A turnkey contract is a business arrangement in which a project is delivered in a completed state. Rather than contracting with an owner to develop a project in stages, the developer is hired to finish the entire project without owner input. The builder or developer is separate from the final owner or operator, and the project is turned over only when it is fully operational. In effect, the developer is finishing the project and “turning the key” over to the new owner.

Turnkey contracts offer several advantages over traditional construction contracts. The developer still owns the building until the project is complete so he has financial motivation to get the job completed as quickly and efficiently as possible. A turnkey contract also provides more time for the developer to search for interested investors before he is required to pay for the completed project. These agreements also save inexperienced owners from making difficult construction decisions, leaving these decisions in the hands of the builder.

The primary drawback of this contract is the lack of control the owner maintains over the design and construction decisions. For some owners, this may mean the project is not perfectly suited to their needs once it is complete. For others, this drawback may be cancelled out by the potential for cost savings and shorter construction schedules.

CONSTRUCTION TURNKEY CONTRACT

A Turnkey Construction Contract is a type of construction contract under which the construction firm is obligated to complete a project according to proposed criteria for a price that is fixed at the time when the contract is signed. 

The Tunkey Contract arrangement is now a common thing, used for construction projects ranging from single building to large - scale developments. Under a traditional lump - sum Turnkey contract, the owner agrees to pay the developer a fixed sum of consideration to complete a project that is built to the owner's specifications. The owner is given many opportunities to make decisions throughout the project, and to make changes as needed. In a turnkey contract, the owner is generally left out of the building process entirely as the builder handles all decisions and challenges related to construction.

In Turnkey construction contract, the owner agrees to pay to the contractor the contract price in consideration of the performance of Work by the Contractor of its obligations under the Contract, as detailed in the contract and as per the Bill of Quantities.

WORK ORDER ESSENTIALS

The Work Order for execution of work between Turnkey Contractor and owner generally specifies all the details which are essential for the Turnkey construction contact. A typical Construction Turnkey Contract has the following key points:

·         Scope of Work

·         Contract Price which owner agrees to pay

·         Terms of Payments

·         Duration of the Contract

·         Special Condition of the Contract for Supply and Delivery of Material by the contractor

·         Condition for Price adjustment for contractor

·         Terms and Condition in respect of Inventory to be maintained And

SUPPLY OF MATERIAL

In turnkey construction contract, the owner may supply certain material like Cement, Steel, Ready Mix Concrete etc. to the turnkey contractor for executing the work. Other than this, the owner also provides General Electricity and Water to the Turnkey construction contractor to execute the work. The cost of all the supplies provided by the owner is adjusted in the payments to be made to the turnkey construction contractor at agreed prices as per the contract.

TAX IMPLICATIONS ON TURNKEY CONSTRUCTION CONTRACTS

A.      VALUE ADDED TAX

The work agreed by the owner and the turnkey construction contractor would be considered as a Works Contract under Sec 2(24) of the Maharashtra Value Added Tax, 2002. Thus, the turnkey contractor will charge Value Added Tax (VAT) on the amount of Work done including price adjustments of Material, Electricity, Water and Material testing provided by the owner at the rates specified in the rate schedules.

The owner will also be liable for payment of Value Added Tax (VAT). The Material like Cement, Steel, Ready Mix Concrete etc. supplied by the owner to the turnkey construction contractor would be considered as a “Deemed Sale” under Sec 2(24) of the MVAT Act, 2002 and owner will have to pay Value Added Tax (VAT) on the specified rates.  The Input Credit in respect of VAT paid by the turnkey construction contractor will be available provided production of information as requisite under Section 48 read with Rule 52 of the Maharashtra Value Added Tax.

B.      SERVICE TAX

The work agreed by the owner and the turnkey construction contractor will be regarded as a Works Contract. Thus, the turnkey contractor will charge the Service Tax (VAT) on the amount of Work done including material price adjustments and Material, Electricity, Water and Material testing provided by the owner at the rate specified by the Finance Act.

The Owner will also be liable for the payment of Service Tax under Finance Act. The Material testing and other service provided by the owner on the behalf of Turnkey Construction Contractor will be regarded as a Taxable Service and will be liable for Service Tax. 

C.      CENVAT CREDIT

The owner being developer is liable for payment of service tax on various services provided such as “Construction of Residential Complex” or “Construction of Commercial Complex” etc.  Post 01.07.2012, the developer being eligible for CENVAT Credit can avail the CENVAT Credit of all input services.

However, the sale of goods being “trading”, will be an exempt services and hence CENVAT Credit to that extent may be required to be reversed applying Rule 6 of the CENVAT Credit Rules, 2004.

The owner can avail the Cenvat Credit in respect of Service Tax charged by the turnkey construction contractor subject to the provision of Rule 6 sub clause 3 of Finance Act. As per the provision of Rule 6 (3), the owner needs to reverse the Cenvat Credit taken in respect of exempted services. There are three options for owner:

                    i.            pay an amount equal to [six per cent.] of value of the exempted goods and exempted services,

                  ii.            Maintain separate accounts for the receipt, consumption and inventory of inputs and take the CENVAT credit only on inputs and need to pay the amount attributable to Exempted goods.

                iii.            If separate books of accounts are not maintained then owner has to pay amount specified under Rule 6 (3A).

Special Points to be noted: -

1.       Value of exempted goods shall be the difference between the value at which Material, Water and Electricity supplied by the owner to the Turnkey construction Contractor and the cost of goods sold of the Material, Water and Electricity provided or 10% of the cost of goods sold of the Material, Water and Electricity provided whichever is higher.

2.       The Owner has to intimate in writing to the Superintendent of Central Excise in respect of payment made by the owner for CENVAT Credit taken on exempted goods and the method adopted for payment of tax on reversal of such CENVAT Credit as attributable to the exempted services.

Email : nishant@ghoshnpande.com