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Free of cost material (FOC) not to form part of value of service

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Free of cost material (FOC) not to form part of value of service
By: DEV KUMAR KOTHARI
March 5, 2018
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Recent judgment:

Commissioner of Service Tax Etc. Versus M/s. Bhayana Builders (P) Ltd. Etc. 2018 (2)  TMI 1325 - SUPREME COURT OF INDIA

Judgments referred to in above:

  1. Commissioner, Central Excise & Customs Versus M/s Larsen & Toubro Ltd. and others - 2015 (8) TMI 749 - SUPREME COURT
  2. Shabina Abraham And Others Versus Collector of Central Excise & Customs - 2015 (7) TMI 1036 - SUPREME COURT
  3. M/s Bhayana Builders (P) Ltd. & Others Versus CST, Delhi & Others. - 2013 (9) TMI 294 - CESTAT NEW DELHI (LB)

Article by  Dr. Sanjiv Agarwal titled “APEX COURT ON TAXABILITY OF FREE SUPPLIES” for related history of provisions and judgments to some extent found therein.

Use full relevant concepts:

works contract/ mixed contract, free of cost (FOC) supply of material or facilities for working,  value addition, and service rendered.

Contract for services and free of cost material and facilities:

Contract for services involve use of manpower, technical and professional  knowledge and experience, infrastructure and also material, tools, equipment and facilities.

Some of material may be provided by the service receiver to the service provider to use in the work of service receiver and return extra / unused quantity. Likewise service receiver can also provide some facilities, equipment, tools etc. to the service provider for use in execution of the contract. These may be provided free of cost or at some charge. When FOC supply is made, the service provider also do not charge for such material in charges for service. However, if the service receiver charges to the service provider any charges, then service provider will have to charge for the same, though it may be included in agreed charges.

For control purposes memorandum entries may be made for material given or facilities provided which are reversed when service provider complete work and return surplus material. Such memorandum entries are made not for sale of goods but for material provided which is to be returned in form of execution of contract. Therefore, in such situation also there is FOC supply, and there is no sale of goods.  

While working out consideration payable for services, such free of cost (FOC) items are considered in negotiation process. Some material are used as such without any changes like components to be assembled. Some may have to undergo some processes undertaken by the service provider. For example, in case of shirt making inner components / fittings for collars and, cuffs thread and buttons are used as such in shirt as components whereas fabric provided will be processed according to requirements. A process of measuring, marking and cutting of cloth will be involved. 

Ownership of items provided free of cost (FOC), for use in a works contract (or mixed contract for work and material) remains with the service receiver. The service provider use them in execution of agreed work.

Service tax is a tax on service provided which is in nature of value addition by way of providing service. Service can be without material or with material. Material can be provided by service receiver and /or service provider. Even if service provider provide some material it may  be supply of goods and not service.

Therefore, when FOC goods are provided for use of them in execution of work, there is no service addition by use of material in execution of contract.

However, in some circumstances supply of material being part of service can be a service. It can depends on overall nature of work and content of material. For example, in case of professional services, some use of  paper, pencils, pen, ink and also equipment will be part of service and not supply of goods.

The above discussion is based on general concepts, however, one has to look at particular provision and schemes introduced by Government and options availed by assesse. Therefore one need to consider applicable provisions.

Controversy settled by the Supreme Court:

Earlier There have been cases on this aspect. In recent case of Bhayana Builders (supra.) the honourable Supreme Court has considered matter in view of specific provisions and settled that material supplied by service receiver to service provider for use in execution of contract will not be part of service or value of service provided by service provider. The case related to works contract for construction activity. However, the principal is applicable to all cases wherein service receiver provide some material to the service provider, FOC and for use in work of service receiver. For example, in case of contract for shirt making, as discussed in preamble of article  also this principal will apply.

Honourable Supreme Court considered provision related to valuation of taxable service, as per Section 67 of the Act which enumerates that it would be ‘the gross amount charged by the service provider for such service provided or to be provided by him’.

The question involved was whether, the value of materials/goods supplied free of cost by the service recipient to the service provider/assessee is to be included to arrive at the ‘gross amount’, or not.

The Court noted that on this aspect, there is no difference in amended Section 67 from unamended Section 67 of the Act and the parties were at ad idem to this extent and on this there is no dispute.

The Explanation 3 to subsection (1) of Section 67 had remove any doubt by clarifying that the gross amount charged for the taxable service shall include the amount received towards the taxable service before, during or after provision of such service, implying thereby that where no amount is charged that has not to be included in respect of such materials/goods which are supplied by the service recipient.

No amount is received by the service provider/assesse.

Though, sub-section (4) of Section 67 states that the value shall be determined in such manner as may be prescribed, however, it is subject to the provisions of sub-sections (1), (2) and (3).

No such manner is prescribed which includes the value of free goods/material supplied by the service recipient for determination of the gross value.

In the related cases the service tax is to be levied in respect of ‘taxable services’ and for the purpose of arriving at 33% of the gross amount charged, unless value of some goods/materials is specifically included by the Legislature, that cannot be added.

Exemption under Section 93 can only be granted in respect of those activities which the Parliament is competent to levy service tax and covered by sub-clause (zzq) of clause (105) and sub-clause (zzzh) of clause (105) of Section 65 of Chapter V of the Act under which such notifications were issued.

The value of the goods/materials cannot be added for the purpose of aforesaid notification dated September 10, 2004, as amended by notification dated March 01, 2005.

Therefore, appeal was dismissed and matter was decided against Revenue.

Authors views:

As per author, this litigation by revenue was un-necessary. The legal provisions must not be contrary to natural aspects of any business. Some fictions can be made, however any fiction should not take away natural and commercial meanings. Deeming provisions which have impact of changing natural meanings are not good. The revenue authorities must consider commercial and business aspects about such matters and should not try to impose irrational provisions by introducing artificial meanings, definitions which goes totally against natural aspects of any activity or matter. Under provisions of GST such supplies are also considered taxable, which goes against ground realities and common sense approach. This is likely to cause unnatural information about tax collection, besides difficulties in business  and may involve  litigation in due course.  

 For detailed discussions on related provisions during  service tax regime, and history of provisions and judgments ,  disputes on related issues readers may also refer to article by  Dr. Sanjiv Agarwal titled “APEX COURT ON TAXABILITY OF FREE SUPPLIES” webhosted on28-02-2018

 


 

By: DEV KUMAR KOTHARI - March 5, 2018

 

 

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