In a move to sustain India’s 7 per cent growth in the country, the Government is focusing on increased investments in infrastructure such as Rs 8.5 lakh crore in Railways and Rs 8 lakh crore under the Sagarmala project and, the recently announced Rs 7 lakh crore in Bharatmala projects.
Currently, almost all these projects are being executed by either private players or Government corporations. In the pre-GST era most of these contracts were categorised as ‘works contracts’ which were overlapping between supply of services and supply of goods, and a combination of service tax and value added taxes (VATs) were applicable. Hence, there was a dichotomy in the applicable indirect tax regime relevant to infrastructure.
While the Central Government laws provided exemptions and concessions, state VAT and entry tax laws were applicable to goods procured. In addition, the cascading effect of Central and State indirect taxes were a concern, due to a high base for levy of respective taxes and a restrictive credit mechanism. There was also litigation at the Central and State levels on classification of contracts, valuation, and jurisdiction of state on inter-state works contracts among other issues.
As per the new Goods and Services Tax (GST) rates, today, the composite supply of ‘works contracts’ comes under the 18 per cent GST rate with full input tax credit (ITC). At a first glance, the GST rate does appear higher than the Pre-GST taxation regime, in which majority of construction contracts fall under the nature of work contracts. The service tax applicable for construction companies is generally 6 per cent (assuming 40 per cent services portion of the contract). The VAT payable varies across states ranges between 1 and 15 per cent and is applicable to the supply of goods area of the contract.
Thus, the effective tax incidence for an average construction contract in the pre-GST era was typically in the range of 11-18 per cent, which is lower in comparison to the announced GST rate of 18 per cent. However, despite higher rates, the sector is likely to benefit under GST regime from the availability of input tax credit.
Under the Pre-GST tax regime, the benefit of input tax paid was not fully available to the companies. The benefits arising out of input tax credit on the raw-materials available under the GST regime should result in an overall neutral tax incidence for construction services. The introduction of GST, therefore, seems to be a mixed bag for the infra sector – predictability and efficiency being advantageous, while non-inclusion of sub-sectors, higher rate and certain restrictions are limitations.
As far compliance costs are concerned, GST will also make compliance easier by eliminating multiple indirect taxes. However, EPC contracts spread across multiple states will require contractors to register at multiple states including their site offices owing to the ‘place of supply’ concept. Also, the site offices will have to incur the costs of upgrading their IT systems, as input credit would be available only after an online reconciliation of tax invoices.
In the Pre-GST era, the total incidence of taxes on construction equipment depended from where it was purchased and type of classification of the equipment. The three important categories of construction equipment are excavators, backhoe loaders and wheel loaders where the last two types are registrable equipment. For the registrable equipment, the total tax incidence in some of the states is close to 28 per cent – the rate of GST applicable to construction equipment. However, in case of excavators, customers in a large majority of states have seen costs increase to the extent of 10 per cent. Such a massive tax increase will have an adverse impact on the sale of this equipment category.
In case of GST registered contractors as well as construction companies, the GST is a pass through tax as this will be available as input tax credit to be offset against final tax liability and hence is neutral to positive in impact. However a large majority of customers are hirers or sub-contractors of large construction companies and are largely unorganised. It is for this segment of customers that GST has had a major impact. Majority of these firms are still grappling to understand the nuances of how the system works and the impact it has had on their business. They have therefore deferred purchases of equipment and this has impacted sales of equipment in the short-term.
On a whole, the impact of GST on the construction and infrastructure sector has been a mixed bag for construction equipment customers. In the biggest GST rejig yet, this November, tax rates on over 200 items, were reduced to provide relief to consumers and businesses. This reduction of rates will substantially reduce the prices of a number of commodities and is a welcome move for industries in the mass consumption space.