GST and Works Contracts: Understanding the Impact on Construction and Services

Bio

An Alumnus of IIM and DU with almost a decade of experience in the banking and finance sectors. I had the opportunity to work with all types of institutions in BFSI ecosystem like Bank, NBFC, Fintech, Consulting and Auditor. I started my professional journey at KPMG and subsequently worked in leading names of the BFSI sector including Ujjivan Bank, Vistaar Finance. Currently building a fintech startup ( PICE) by handling alliances, compliance and creation of GTM strategy for payments and credit product.

11 Aug 24
9 mins

Saurabh Agrawal

08 Mins
11-08-24

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Table of Contents

Works Contracts Before the Introduction of GST
Understanding the Composition Scheme for Service Providers
Service tax rate on works contract composition scheme
How Service Providers Can Register for the Composition Levy?
Eligibility Criteria for the Composition Scheme
Exclusions: Service Providers Ineligible for the Composition Scheme
Analyzing the Differences: Standard vs. Composition Scheme

The GST unified tax rates for works contracts, simplifying the complex dual taxation system of VAT and Service Tax that existed pre-GST.
The Composition Scheme under GST offers small taxpayers, including service providers for works contracts, a simplified compliance and tax payment process at a reduced rate.
Composition taxpayers cannot claim the credit of input tax, emphasizing the need to weigh the benefits of simplified tax compliance against potential financial advantages.
Eligibility for the Composition Scheme is determined by specific criteria, including annual turnover limits and restrictions on interstate supplies and certain types of sales.
The introduction of GST and the Composition Scheme has streamlined business compliances and tax payments for works contracts, benefiting both service providers and consumers.

Works Contracts Before the Introduction of GST

Before the implementation of the Goods and Services Tax (GST) in India, works contracts were enveloped in a complex tax environment. A works contract, essentially a contract for both services and goods in projects such as construction, repair, or installation, was taxed under both the Value Added Tax (VAT) system administered by states for the supply of goods and the Service Tax regulated by the central government for services. This dual taxation often led to a cascading effect of taxes, where tax was levied on a value inclusive of taxes already paid. This system not only made compliance cumbersome for businesses involved in works contracts but also increased the overall tax burden on the end consumer, leading to higher costs in the construction and infrastructure sector.

Understanding the Composition Scheme for Service Providers

With the advent of GST, the Composition Scheme emerged as a boon for small taxpayers, including service providers. Specifically tailored to simplify GST compliance and reduce the tax burden, this scheme allows eligible service providers to pay GST at a fixed rate of their turnover instead of the standard GST rates. This rate is significantly lower and is intended to simplify the tax filing process, making it an attractive option for small businesses and startups.

For service providers, including those engaged in works contracts, opting into the Composition Scheme can mean less time spent on bookkeeping and tax filings, and more on business operations. However, it's important to note that service providers opting for this scheme are subject to certain restrictions, such as a cap on annual turnover and limitations on interstate supplies, emphasizing the need for businesses to carefully assess their eligibility and the scheme's suitability for their operations.

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Service tax rate on works contract composition scheme

For works contracts, which encompass both goods and services within the construction sector, the GST regime has streamlined taxation by imposing a unified rate. Generally, these contracts are taxed at an 18% rate under GST, encompassing a broad range of construction and related services. This consolidation under a single tax rate significantly simplifies the earlier complex tax structure, making it easier for businesses to comply and reducing the overall tax burden by eliminating the cascading effect of taxes. The uniform rate aims to bring transparency and efficiency to the sector, benefiting both service providers and consumers.

How Service Providers Can Register for the Composition Levy?

Service providers interested in availing of the benefits offered by the GST Composition Scheme need to follow a structured process for registration. Firstly, they must ensure their eligibility, which primarily involves having an annual turnover below a specific threshold, currently set at Rs. 50 lakhs for service providers.

To register, service providers should log on to the GST portal and opt for the GST Composition Scheme during their initial GST registration process or through a subsequent amendment to their existing GST registration. The process involves filling out the necessary forms and providing accurate business details. Once registered under the scheme, service providers are subject to the scheme's rules and limitations, such as not engaging in interstate supplies and adhering to the turnover cap, while benefiting from a lower tax rate and simplified compliance requirements.

Aspect	Standard GST Scheme	Composition Scheme
Composition Tax Rates	Ranges from 5% to 28% based on goods and services	Fixed lower rate: 1% for manufacturers and traders, 5% for restaurants, 6% for other eligible service providers
Compliance Requirements	Detailed tax invoice-wise data reporting, monthly return filings	Simplified record-keeping, quarterly return filings
Eligibility	All businesses subject to GST	Normal taxpayers with turnover up to Rs. 1.5 crores for goods, Rs. 50 lakhs for services
Input Tax Credit	Available	Not available
Inter-state Supply	Allowed	Not allowed
Applicable to	All taxable goods and services	Specific small taxpayers, excluding certain service providers like those engaged in interstate supplies

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Eligibility Criteria for the Composition Scheme

The Composition Scheme under GST is designed for regular taxpayers seeking to simplify their tax obligations. To be eligible, businesses must meet specific criteria: their annual turnover must not exceed Rs. 1.5 crores for goods providers or Rs. 50 lakhs for service providers, including works contract services. Additionally, they must not be engaged in making any interstate supplies, non-taxable supplies, or supplying through e-commerce platforms that require tax collection at source. Importantly, the scheme is voluntary, offering a simplified tax rate but requiring compliance with its restrictions.

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Exclusions: Service Providers Ineligible for the Composition Scheme

Certain service providers are explicitly excluded from opting into the Composition Scheme due to the nature of their business activities. These exclusions include service providers engaged in interstate supplies, supplying non-taxable goods or services, e-commerce operators involved in supplies requiring tax collection at source, and those providing services not permissible under the scheme such as restaurant services that serve alcohol. This ensures the scheme remains targeted toward small and medium-sized enterprises (SMEs) with relatively simpler business models.

Analyzing the Differences: Standard vs. Composition Scheme

The key difference between the standard GST scheme and the Composition Scheme lies in tax rates, compliance requirements, and eligibility. The standard scheme subjects businesses to regular GST rates (ranging from 5% to 28% based on goods and services) and requires detailed invoice-wise data reporting, allowing for input tax credit claims. In contrast, the Composition Scheme offers a significantly lower tax rate (1% for manufacturers and traders, 5% for restaurants, and 6% for other eligible service providers), but restricts businesses from claiming input tax credits and engaging in interstate supplies. Additionally, while the standard scheme requires monthly return filings, the Composition Scheme reduces this burden to quarterly filings, simplifying compliance for eligible small businesses.

FAQs

What were works contracts taxed under before GST?

Before the introduction of GST, works contracts were subject to a complex taxation structure that included both VAT (administered by states for the supply of goods) and Service Tax (regulated by the central government for services). This dual taxation system often resulted in a cascading effect, increasing the overall tax burden on the end consumer. Taxable persons involved in works contracts faced cumbersome compliance requirements, leading to higher costs in the construction and infrastructure sector.

How does the Composition Scheme benefit service providers in works contracts?

The Composition Scheme under GST simplifies tax compliance for small taxpayers by allowing them to pay taxes at a fixed rate on their turnover, instead of adhering to standard GST rates. This scheme significantly reduces the tax burden on composition taxpayers, especially those involved in works contracts, by simplifying business compliances. However, it's important to note that opting for this scheme restricts taxpayers from claiming the credit of input tax. The scheme's simplified process means less time spent on bookkeeping and tax filings, focusing more on business operations.

What is the GST rate applicable to works contracts?

Under GST, works contracts, which include both goods and services in the construction sector, are generally taxed at a unified rate of 18%. This standardization of the tax rate under GST brings transparency and efficiency to the sector, benefiting both service providers and consumers. The consolidation under a single tax rate significantly simplifies the earlier complex tax structure, thereby easing the payment of taxes and reducing the overall tax burden.

How can service providers register for the Composition Levy?

Service providers can register for the Composition Levy by ensuring their eligibility, primarily based on having an annual turnover below the specified threshold, and then opting for the Composition Scheme during their initial GST registration or through a subsequent amendment. The registration process involves filling out necessary forms on the GST portal and adhering to the GST composition scheme rules. Once registered, they must comply with the scheme's limitations, including a ban on interstate supplies and the adherence to simplified compliance requirements. This registration enables them to benefit from lower tax rates and reduced compliance burdens.

What are the eligibility criteria for opting into the Composition Scheme?

To be eligible for the Composition Scheme, businesses must ensure their annual turnover does not exceed Rs. 1.5 crores for goods or Rs. 50 lakhs for service providers, including those offering works contract services. Eligible businesses, known as composition taxpayers, must also avoid making any interstate supplies, non-taxable supplies, or supplies through e-commerce platforms that necessitate the collection of tax at source. These criteria are designed to simplify tax compliance for small to medium-sized businesses by offering them a streamlined process for the payment of taxes.

Who cannot opt for the Composition Scheme under GST?

Certain service providers are barred from opting into the Composition Scheme due to the nature of their business activities. These include providers engaged in interstate supplies, supplying non-taxable goods or services, operating through e-commerce platforms that require tax collection at source, and those offering services not permissible under the scheme, such as restaurant services that serve alcohol. The exclusions ensure that the scheme remains focused on simplifying business compliances for small and medium-sized enterprises with relatively straightforward business operations.

How do the standard GST scheme and the Composition Scheme differ?

The standard GST scheme and the Composition Scheme differ primarily in tax rates, compliance requirements, and eligibility. Under the standard scheme, taxable persons are subject to regular GST rates and must report detailed invoice-wise data, but they can claim the credit of input tax, enhancing tax efficiency. In contrast, the Composition Scheme offers a lower, fixed tax rate and simplified compliance requirements, such as quarterly filings, but prohibits composition taxpayers from claiming input tax credit and conducting interstate supplies. These differences highlight the trade-offs between simplifying business compliances and the flexibility in tax credits and operations.