The Customs, Excise and Service Tax Appellate Tribunal (CESTAT), Hyderabad, has set aside a service tax demand of ₹19.69 lakh holding that a composite works contract executed before June 1, 2007 could not be taxed under the category of “construction of residential complex service.”

The bench of  Angad Prasad (Judicial Member) and P.V. Subba Rao (Technical Member) has observed that works contracts constitute a separate class of contracts involving both the transfer of goods and the supply of services. Such contracts became taxable as “works contract service” only from June 1, 2007, when Section 65(105)(zzzza) was introduced in the Finance Act, 1994.

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The dispute concerned services provided by the appellant/assessee between March 13, 2006 and March 30, 2007. The Department classified the activity as “construction of residential complex service” under Section 65(105)(zzzh) of the Finance Act, 1994.

The Additional Commissioner had confirmed a service tax demand of ₹19,69,111 under Section 73 of the Finance Act. Interest was imposed under Section 75, while penalties were levied under Sections 77 and 78.

On February 18, 2014, the Commissioner (Appeals-II), Hyderabad, upheld the adjudication order dated September 28, 2012 and rejected the company’s appeal. The assessee subsequently approached the CESTAT.

The company’s construction contracts included the supply and use of materials. While confirming the demand, the authorities granted abatement under Notification No. 18/2005-ST dated April 7, 2005 and Notification No. 1/2006-ST dated March 1, 2006.

The central question before the Tribunal was whether a material-inclusive composite works contract executed before the introduction of the specific taxable category of “works contract service” could nevertheless be subjected to service tax under another category.

The Tribunal noted that “works contract service” was specifically introduced as a taxable service with effect from June 1, 2007 through Section 65(105)(zzzza) of the Finance Act.

The newly introduced provision covered contracts involving the transfer of property in goods and the execution of specified works, including the construction of a new residential complex, commercial or industrial construction, erection and installation, completion and finishing services, and turnkey projects.

Since the disputed services were rendered between March 2006 and March 2007, the entire period preceded the introduction of the works contract service levy.

The CESTAT relied on the Supreme Court’s ruling in Commissioner of Central Excise and Customs, Kerala v. Larsen & Toubro Ltd., reported in 2015 (39) STR 913 (SC).

In that decision, the Supreme Court held that works contracts are a distinct species of contract and cannot be treated as ordinary service contracts. The taxable service categories that existed before June 1, 2007 applied to service contracts simpliciter and not to composite contracts containing both goods and services.

The Supreme Court had explained that the Centre may tax only the service element in a composite works contract, while the States may tax the transfer of property in goods. A constitutionally valid levy therefore requires machinery to identify and separate the service component from the value of the goods.

Before June 1, 2007, the Finance Act did not contain the necessary charging and valuation mechanism for imposing service tax on indivisible composite works contracts. The scheme introduced in 2007, including the valuation rules and composition mechanism, provided this machinery for the first time.

The Supreme Court had also rejected the Revenue’s contention that the availability of abatements under exemption notifications permitted taxation of composite works contracts under earlier service categories. Where the charging provision itself did not cover the transaction, an exemption or abatement notification could not create the levy.

Applying the Supreme Court’s ruling, the Hyderabad Bench found that allowing abatement for the value of materials did not make the pre-June 2007 levy valid.

The contracts undertaken by assessee involved materials and were therefore works contracts rather than contracts for services alone. Such activities could be taxed only under the specific category of works contract service after that category came into force.

The Department could not bring the composite activity within the earlier category of construction of residential complex service merely by allowing abatement under the applicable notifications.

The Tribunal concluded that the service tax demand on the works contract services rendered by the company could not be sustained.

It accordingly allowed the appeal and set aside the Commissioner (Appeals)’ order. The company was also held entitled to consequential relief, if any. As the underlying demand was set aside, the associated interest and penalties could not survive.

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