Make service tax on turnkey project leviable

EXPERT EYE

The service tax on consulting engineer has been subject to immense litigation since its inception on July 7, 1997. The commissioning and installation service (erection later included) has been also taxed since July 1, 2003.

All along there has been litigation about their chargeability in the case of composite work contracts for projects for erection and installation of plants on turnkey basis.

The revenue department feels that the turnkey project has an element of service namely consultancy by engineers when they erect and install a plant. That element is to be charged to the service tax under this head.

Many cases moved up to the tribunal. The Daelim Industrial Co Ltd vs Commissioner of Central Excise case, 2003 (155) 457 (T), is a leading one. In this case, a desulphurisation plant for IndianOil Company was set up by Daelim for reducing sulphur in diesel. There was no outside consultancy service employed and the project was set up by the company's employees including engineers.

The contract involved residual process design, detailed engineering, procurement, supply, construction, fabrication, erection, installation, testing, commissioning and mechanical guarantee.

The revenue department held that the service tax was chargeable for consulting engineers on residual process design, detailed engineering and commissioning of plant.

The tribunal held that it was a case of complete works contract. It was basically for supply of materials and erection of the plant all combined together on a turnkey basis and not for consultancy as such.

This judgment has been followed by in the L&T vs Commissioner of Central Excise case, Cochin, 2004 (174) ELT 322 (T), the Ishikawajima-Harima Ltd case, 2005 (182) ELT 281(Comm APP), the L&T case, 2005 (187) ELT 138 9(Comm.Appl) and all subsequent judgments. Their logic is based on:

The Supreme Court has said the primary objective of the contract will determine the issue in the State of Punjab vs Associated Hotels India Ltd case, (1972) 1 SCC 472. It is concluded from the judgment that since the main objective of the contract is to construct the plant, the contract cannot be vivisected.

The Supreme Court has refused to accept appeal filed in the Daelim Industrial Co case, 2004(170) ELT at A 181.

It now leads to a piquant situation. If the company is only doing consultancy for installation and commission, then it has to pay the service tax on consultancy services.

But if it undertakes complete works contract for a plant on turnkey basis, and even if the heart and soul of this is engineering consultancy, it still does not have to pay any service tax on the basis of the thesis that a works contract cannot be vivisected.

Thus companies who do only consultancy are taxed more than those who do consultancy as part of a total integrated works contract. So it favours integration. Thus it is not a neutral tax as it is biased against the stand-alone consultancy firms. A tax is best when it is neutral. (The Government of Canada""Report of the Royal Commission, 1966, Volume II, page 11).

This is an accepted canon of tax. A tax is truly neutral when all economic decisions are unaffected by considerations of tax (Richard W Lindholm--Value Added Tax, page 38) such that it does not favour vertical integration of factories or services against horizontal.

Thus the law should be amended in the next Budget to provide for vivisection of the engineering consultancy element from the total invoice value of the works contract.

Once the definition of the tax on consultancy is so amended, the legality will be without question. This will also be possible since the Supreme Court lately admitted an appeal from the revenue department on the issue (The Commissioner vs L&T case, 2005 (182)ELT. A 149)

The point is: if there is an element of consultancy in a contract, the consultancy part has to pay the service tax as much as a stand-alone consultancy does. That will be truly neutral tax.

The author is a former member of the Central Board of Excise &Customs smukher2000@yahoo.com