Institute of Cost Accountants of India
WIRC Bulletin-August 2018

Concept Note: Free issue of Materials to Contractors : CMA Subhasish Paul

Before we start: Company X has been awarded a contract by Maharashtra State Road Development Corporation Limited (MSRDC) for construction of ‘Versova Bandra Sea Link (VBSL)’ on ‘Turn Key’ (EPC) basis. As an EPC contractor, X is required to procure materials and services and execute all such works for completion of projects as per the design specified. X to raise bill on MSRDC as per agreed Billing Break-Up (BBU) on ‘Works Contract’ basis. X is the Principal Contractor for the project.

Issue to address: In executing the contract, X has to appoint various sub-contractors who will execute the works under the supervision of principal contractor. While executing such work, two situations may arise.

a) Required materials for executing the work will be in the scope of the sub contractor and/or
b) Materials will be supplied by the principal Contractor to sub contractors.

The second aspect is addressed as ‘Free Issue of Materials’(FIM). We have to address the GST provisions in such cases.

Understanding GST Provisions: Our Billing to Customer will be on ‘Work Contract Basis’. Similarly, our subcontractors will also bill us on ‘Work Contract basis’. So firstly, we need to understand the concept of ‘work contract’ service under GST Law.
As per section 2(119) “works contract” means a contract for building, construction, fabrication, completion, erection, installation, fitting out, improvement, modification, repair, maintenance, renovation, alteration or commissioning of any immovable property herein transfer of property in goods (whether as goods or in some other form) is involved in the execution of such contract;
From the above definition, it is clear that this contract fulfills the conditions of ‘Work Contract’.

Now we need to understand the taxability aspects of ‘Work Contract.

Charging Section: Section 9 of CGST Act is the charging section. As per Section 9(1) ‘there shall be levied a tax called the central goods and services tax on all intra-State supplies of goods or services or both………………..and collected in such manner as may be prescribed and shall be paid by the taxable person.’

So, in GST ‘Supply’ is the charging point of tax.

Now we need to understand the ‘scope of supply’ as specified in Section 7 and schedules I (Transfer without consideration)

As per section 7 ‘Supply’ includes ‘all forms of supply of goods or services or both such as sale, transfer, barter, exchange, license, rental, lease or disposal made or agreed to be made for a consideration by a person in the course or furtherance of business;’
Analyzing the above provisions it is clear that two conditions are required to be fulfilled for charging GST.
a) There must be a consideration for such supply and
b) Such supply shall be made in the course or furtherance of business.

There is one exception where Tax will be charged even if supply is made without consideration. As per Schedule I of Section 7 of CGST Act, Supply of goods or services or both between ‘related persons’ or between ‘distinct persons’ as specified in section 25, when made in the course or furtherance of business is subject to tax liability.
So, combined reading of the above provisions, it is clear that three conditions to full fill for charging GST
a) Supply to be made or agreed to be made for consideration.
b) Such supply should be in the course or furtherance of business.
c) Supply without consideration will be considered as supply provided it is occurred between ‘related person’ or between ‘distinct persons.
In this Contract, though the FIM is in the course or furtherance of business, principal contractor and subcontractors are neither related person nor distinct person.

Whether the FIM will be made or agreed to be made for a consideration will depend upon the conditions of contract. There can be two situations for FIM.
A) It is provided without considerations ( FOC basis) [ Contract has to specify that FIM will be on FOC basis] and
B) It is provided on deemed consideration [ when contract does not specifically mention the provision of material on FOC basis ]

A. It is provided without considerations ( FOC basis): As the material is given to a distinct / unrelated person with out consideration, GST will not be applicable on such FOC materials. Value of such FOC material shall not be included in the Invoice Value raised by the Sub-Contractor.
B. It is provided on deemed consideration: If there is no upfront agreement with the subcontractors regarding such FIM supply, same may be considered as payment of consideration. Valuation will of such FIM will have to be made as per Section 15 of CGST Act. Such value will form part of the invoice value raised by sub-contractors. Subcontractor will charge GST on full value including FIM. Principal Contractor is entitled to avail Input credit of GST paid on purchase of such materials.

Treatment and GST on FIM : Let us understand the above concept with an Example. MSRDC is the Customer for the project. X is the principal contractor and X is one of the sub contractor.

A. Situation 1: Contract specifies that Supply of Cement for say Rs 1,00,000 will be given as FOC basis to X by X without consideration. X has acquired such Cement by paying GST of Rs 21,875/- (Basic Value Rs 78,125 + GST Rs 21875). For such FOC Materials, X will not change anything. Now billing pattern and GST implication will as follows.
1) X not to charge anything for such FOC to X. No invoice is required to be raised.
2) X will not add value of such FOC while billing on X.
3) X will bill to MSRDC as per the BBU between MSRDC and X.
4) X will claim Input credit of such GST paid on purchase of Cement. Input credit of GST paid on the invoices raised by X will also available.

B. Situation 2: Contract does not specify that supply will be on FOC Basis. In that case value (determined as per Section 15) of such supply will be included in the invoice value raised by subcontractor. Now billing pattern and GST implication will be as follows.
1. X needs to raise an invoice on X for such FOC say for Rs 1,00,000 ( assuming no Margin added)
2. X will have output GST liability of Rs 21,875/- and can avail Input credit of Rs 21,875/-.
3. X will add such value in their invoices and GST will be charged by GST on entire Invoice Value.
4. X will bill to MSRDC as per the BBU between MSRDC and RAX.
5. Input credit of GST paid on the invoices raised by X will also available to X.

C. Situation 3: Equipment or Materials given on returnable basis.
In some cases, equipments or materials are given to the contractor on returnable basis. No consideration is charged for them. If the materials/equipments are replenished/returned by the contractor, no GST is leviable on the transaction as supply without consideration between unrelated persons are not taxable supply (Sect 7 of CGST Act).
But if consideration for the same is charged from the contractor by way of deduction from the bill of the contractor, it will be considered as taxable supply. Consideration in the form of deduction form invoice will be considered as value of such taxable supply and GST will be charged.

Conclusion:
1. Transaction without consideration between Principal Contractor and subcontractors does not come under the ambit of GST as this is between unrelated/distinct persons.
2. If Contract specifies that FIM will be on FOC basis no GST will be applicable.
3. If contract remains silent, it will be considered as deemed supply and GST will be applicable on such supply. Valuation will be done on the basis of Section 15 of CGST Act.

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