Accepting turnkey responsibility is onerous. It requires razor sharp estimation skill for man and material. Appetite for indirect tax risk is far and few among most contractors and they desire full pass-through of these taxes to the project owner. On the other hand, the project owner needs a fixed price for the capital expenditure and among the many contractors that aspire to sign on the dotted line; he wants to shake hands with the lowest of them all.

In this tug of war of competing interests between the contractor and the project owner (PO), the contractor often makes compromises. The contractor has little choice but to accept a fixed price and, therefore, indirect taxes are not extra and pass through, instead these need to be rolled into the contact price upfront.

As a result, if the contractor has not budgeted or even estimated a given tax in his price bid (for any reason) and the tax is imposed during the course of the project, it is a strait hit to his bottom line! Even if the contractor was successful in negotiating a tax extra contract, it still has to convince PO if a certain tax that it desires to claim as reimbursement is indeed leviable. To the contractors chagrin, it is mostly POs interpretation that governs in such cases.

The contractor, therefore, is forced to convince PO that the tax is payable and ought to be reimbursed by the the latter. Clearly, from a contactors perspective, certainty of tax law is crucial in this context. Levy of service tax on turnkey contracts and taxation of oil field operations are two good examples of the directionless policy making. In 1997, the Finance Act, 1994, was amended to introduce service tax on consulting engineers.

While it had a defined meaning ascribed to the phrase consulting engineering services, what was meant to cover engineering consultants alone, the revenue department however thought otherwise. Suddenly, in the eyes of the revenue, almost everybody was consulting engineer, regardless of what they did and the list included turnkey contractors and others that were merely executing a scope of work.

Show cause notices were issued dime a dozen and contractors argued fiercely. They argued that even though turnkey contracts may involve some level of engineering but that part could not be dissected from the contract, as the deliverable was never the engineering but a constructed facility. The judiciary later delivered justice. The revenue has no case to proceed against contractors in levying service tax under consulting engineering services, where they were executing a turnkey scope of work.
 
In the intervening period, the revenue in its wisdom introduced service tax on all other components of a turnkey contract, leaving material supply as the only aspect on which service tax was not levied. Consequently, it appeared that the hop and skip method of adding taxable categories year on year to cover one or more aspects of a turnkey contract was a conscious attempt to tax contractors one way or the other. It seems the net is now wide enough to cover every turnkey contractor.

Just as one thought stability and certainty was achieved on this aspect, the Finance Bill, 2007, has left all in a quandary. It has introduced a separate taxable category which aims to impose service tax on services involved in the execution of a work contracts. This new taxable category would co-exist with other existing taxable category such as installation of plant and machinery as well as construction services, leading to overlap and some more confusion. To elaborate:

* Since service tax on the new taxable category is leviable only where transfer of property in goods takes place, pure service contracts or a split contract for services can never be taxed under this new category. Nevertheless, the revenue might point at the existing taxable category of installation of plant and machinery and justify its intention to impose tax.
* The new taxable category seeks to cover exactly the same activities viz erection, commissioning or installation of plant, machinery, construction of buildings, etc, completion and finishing services, for each of which there exists separate taxable category any ways. Under these situations, where must a tax payer classify itself?
* While an option of paying service tax on 33% of the contract value at the merit rate of service tax has been provided for the existing taxable categories, the new category may have an option of payment of service tax at 2% on the entire contract value. Comparatively the service tax liability under the 2% method is likely to be half of the tax liability that would arise if one uses the 33% method. Does that mean, contractors would be forced to migrate from the existing taxable category to the new category?
* Under the existing taxable category of construction of complex, service tax is leviable only where the residential complex has more than 12 units, however, there does not appear to be any such limit under the new taxable category.
* The fact that a specific category seeking to levy service tax on turnkey contracts have now been introduced, does that mean that such contracts were never taxable in the past, even if there existed categories such as installation of plant and machinery, construction services, etc?

Clearly, there are many questions that need clarity and resolution, failing which contractors would continue to walk the tight rope of uncertainty for the past period as well as the future. Coupled with this, the reluctance of some POs to bear tax liability that has some level of uncertainty and the zeal of the revenue to issue notices and demands may make the situation worse for them.

Just as the contractors are trying to unravel the mystery, oil field service providers are no exception as well. There has been considerable debate on whether drilling is liable to service tax. While litigation is being perused on this issue, the government has given food for some more debate with the introduction of a new taxable category ie., any services in relation to mining of mineral oil or gas, without defining the key word mining.

In the absence of a clear definition, the term mining can be interpreted in many ways. While the revenue may impart a very wide meaning, the exploration and production (E&P) companies may reject it on the basis that mining companies are distinct and different from them and they/their contractors are engaged in exploration and productions and not mining. The drilling contractors would now have to figure out, if they are miners as well.

The time is indeed ripe to revisit the overall service tax policy. A comprehensive service tax code, which taxes all services and exempts few, is better than taxing some and exempting few. Such a policy shift can eliminate debate on taxability and definitions impart certainty of taxes and reduce the hardship of value creators.

SUJIT GHOSH
(The author is executive director, BMR &Associates)