The Customs, Excise and Service Tax Appellate Tribunal (CESTAT), New Delhi, has held that the goods component of a works contract cannot be subjected to service tax merely because the contractor did not pay Value Added Tax (VAT) on the materials used.

The Bench of Dr. Rachna Gupta, Officiating President, and P.V. Subba Rao, Member (Technical), ruled that the value of goods must be excluded, either on an actual or presumptive basis, while determining the service component of a works contract. Any failure to discharge an applicable VAT liability is a matter for the State Government and cannot expand the scope of service tax.

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The appellant/assessee is an individual service provider who was not registered with the service tax department, had undertaken civil work for KEC International Ltd., Power Grid Corporation of India Ltd. and EMC Ltd. during the financial year 2012–13.

Based on information received from the Income Tax Department through Form 26AS, the department issued a show cause notice dated April 26, 2018. It proposed service tax of ₹1,70,438 on gross receipts of ₹13,78,946, along with interest and penalties.

The demand was initially confirmed on May 10, 2019. On appeal, the Commissioner (Appeals) remanded the matter on June 25, 2020, directing verification of invoices, work orders and other records.

Following the remand, the Assistant Commissioner dropped ₹1,23,600 of the proposed demand but confirmed service tax of ₹46,838, together with interest. The authority also imposed an equivalent penalty under Section 78 of the Finance Act, 1994, and a further penalty of ₹10,000 under Section 77.

The Commissioner (Appeals) upheld this determination through an order dated March 30, 2022, leading to the appeal before CESTAT.

The appellant’s principal contention was that the civil works involved both services and materials. Consequently, the material component had to be excluded from the gross receipts before determining service tax liability.

He argued that this exclusion could be made either on the basis of the actual material value or through the applicable presumptive valuation method. According to his calculation, the service value would then remain below the ₹10 lakh threshold relied upon for exemption.

As an alternative calculation, the appellant adopted 70% of gross receipts as the service portion. For April–June 2012, this produced a service value of ₹3,32,220 against receipts of ₹4,74,600. For July 2012–March 2013, the claimed service value was ₹6,33,042 against receipts of ₹9,04,346.

On that basis, the appellant contended that the aggregate service value for the financial year remained below ₹10 lakh and no service tax was payable.

The Commissioner (Appeals) had rejected the appellant’s contention because he had not established payment of VAT on the materials used in executing the contracts.

The appellate authority examined the work order and noted that the service recipient was required to supply certain materials. It also acknowledged that the work could not be performed without additional materials.

The invoices separately reflected material costs and labour charges. However, the Commissioner (Appeals) observed that VAT had neither been charged nor had any VAT exemption been referenced in the invoices.

The appellant had claimed eligibility for the turnover-based exemption under the Rajasthan VAT provisions. The Commissioner (Appeals), however, considered the receipts to have exceeded the ₹10 lakh threshold and concluded that the appellant had failed to establish transfer of property in goods.

The Revenue supported this reasoning before the Tribunal.

CESTAT held that the undisputed factual position was that the appellant had rendered services under works contracts. Once that position was accepted, the value attributable to goods had to be excluded.

The Tribunal expressly observed: “Whether the VAT was paid or not paid on the goods is not relevant to determine the service component of a works contract.”

It explained that service tax could be levied only on the service component. The exclusion of goods value could not be denied merely because the contractor had not paid VAT.

If VAT was chargeable on the materials, the Tribunal said, it was for the State Government to recover it. Likewise, if tax was payable but had not been paid, the State Government could take the appropriate action.

That potential liability did not authorise the service tax department to tax the goods component of the transaction.

CESTAT allowed the appeal and set aside the impugned order.

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