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Karnataka High Court Upholds GST Exemption On Annuity Payments For Road Construction

The court stated that the 2021 clarification circular was contrary to the earlier GST council recommendations.

<div class="paragraphs"><p>A wooden gavel. (Photo: Unsplash)</p></div>
A wooden gavel. (Photo: Unsplash)

The Karnataka High Court upheld that annuity payment awarded by highway authorities to concessionaires is exempt from goods and services tax, a ruling that is a win for road contractors.

The argument rose in 2021 over a clarification circular issued by the government that stated annual deferred payments, called annuity, received by contractors for construction of roads and highway are taxable under the GST.

A writ petition was filed in the Karnataka High Court seeking exemption. And the court favoured the contractors in its recent judgment.

“The clarification issued [in 2021] is contrary to the notifications,” the Karnataka High Court said in its judgement. “(If the government) is desirous of altering the same, it has to issue fresh notifications amending its earlier notifications,” the court said.

Given the stakes involved, Hardik Gandhi, partner at Deloitte Haskins & Sells, said the matter is likely to end up in the Supreme Court. “The government had not mentioned any logical reasoning for changing its stand, before exacting a liability via the clarification circular."

A Change Of Law Or Confusion Over Language?

Road contractors receive payments for road construction services through annuity payments after the completion of a project, or through a right to collect toll charges from passengers that goes towards construction and maintenance.

“In some cases, contractors enter a hybrid annuity model with the highway authorities where part payment is given after the contract is awarded—usually 40%—and the rest is paid as annuity post construction,” Gandhi told BQ Prime.

In 2017, the 22nd GST Council recommended that toll charges collected by the contractors would be exempt from GST. It was also clarified that annuities paid for road construction instead of permitting toll collection should also be exempted from GST.

However, the circular that followed adopted a different wording to say exemption would be granted for annuity payments received for “access to roads and bridges”.

This created a disconnect in how the notification was understood. Though the intent was to exempt annuity received for construction, the language of the entry did not support it, said Ritesh Kanodia, partner at Economic Laws Practice. This resulted in tax liability on the annuity received for construction, he said.

The lack of clarity was followed by a clarification circular issued by the tax authorities on the behest of the GST Council in 2021, which stated that annuities paid towards road construction were not exempt.

Contractors’ Dilemma

An alternative by way of segregating activities and differentiating between cost of construction and access to highway for the GST purposes would increase the cost of operations and create chaos for previous periods, said SR Patnaik, partner and head of taxation at Cyril Amarchand Mangaldas.

"The increase in the GST rate from 12% to 18% w.e.f. July 18, 2022 for construction of road would also add to the increased cost of operation for contractors," he said.

The 47th GST Council approved a series of rate rationalisation measures that included raising the tax rate on work contracts for roads, bridges and railways.

The court judgment has only prompted new questions, Kanodia said. "The dilemma continues for contractors as the government’s interpretation signals a change in law, whereas the judgement has held the GST to be not applicable."

“The underlying concern for the industry is whether the GST will now be charged and collected under a change in law clause," he said. "And in such a case, will the contractor be able to claim input tax credit for the past, and whether should he continue to take credit?"

Input tax credit is claimed on the GST for the purchase of goods or services that are used in the production process.

According to Kanodia, "should the contractor now ask for reimbursement for the taxes and if not, what would be the way forward considering a possibility of challenge before Supreme Court or an amendment of law? And will such claim for reimbursement be net of credit considering the anti profiteering provisions?"

Patnaik said, "If such a view (change in law) is accepted, there is also a risk that even for any subsequent construction, repair work, which is frequent in such agreements, the department would always allege that later annuity payments pertain to construction."

The experts BQ Prime spoke with said the high court's ruling prompts a couple of questions that now come to the fore.

  • Will the law be amended to impose GST on annuity payments for road construction retrospectively?

  • How would that impact contracts entered pre-GST regime when road construction annuity payments were exempt from taxes?