Centrally sponsored scheme grants and composite works contracts: service tax could not be sustained on the disputed transactions.

An implementing agency under a centrally sponsored scheme funded by central grant was not liable to service tax on amounts received for executing flood lighting work, because the grant was not consideration for a taxable service and the scheme framework treated the agency as a supervisor and implementer rather than a service provider. Composite subcontracted contracts involving both material supply and execution were held to be works contracts, not Erection, Commissioning or Installation Service, since the service and goods elements could not be artificially separated. Accordingly, tax raised under the wrong service category could not stand, and the connected penalty also failed.

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Issues: (i) Whether the principal appellant, acting as an implementing agency for a centrally sponsored scheme funded by central grant, was liable to service tax on the amounts received for execution of flood lighting work; (ii) whether the subcontracted, material-inclusive composite contracts for the remaining appellants were classifiable as Erection, Commissioning or Installation Service or as Works Contract Service.

Issue (i): Whether the principal appellant, acting as an implementing agency for a centrally sponsored scheme funded by central grant, was liable to service tax on the amounts received for execution of flood lighting work.

Analysis: The principal appellant executed the work on deposit basis as an implementing and supervisory agency under Memorandum of Understanding(s) with the Ministry of Home Affairs. The arrangement fell within the framework of a centrally sponsored scheme, and the central grant could not be treated as consideration for a taxable service. The circular on services provided by State governments or their agencies under centrally sponsored schemes was applied to hold that implementation of such schemes does not make the agency a service provider liable to tax.

Conclusion: The principal appellant was not liable to service tax.

Issue (ii): Whether the subcontracted, material-inclusive composite contracts for the remaining appellants were classifiable as Erection, Commissioning or Installation Service or as Works Contract Service.

Analysis: The contracts involved both supply of material and execution of the works, without a clear demarcation between the service and material components. Such composite contracts were held to be works contracts, following the settled principle that a composite contract involving transfer of property in goods and provision of services cannot be vivisected and taxed under Erection, Commissioning or Installation Service. Since the demand had been raised under the wrong service category, the levy could not survive, and the connected penalty also failed.

Conclusion: The demand was not sustainable under Erection, Commissioning or Installation Service, and the appellants were not liable to penalty.

Final Conclusion: The impugned order was set aside and all appeals were allowed, with the service tax demands and consequential penalties failing in full.

Ratio Decidendi: A composite contract involving both supply of materials and provision of services must be classified according to its true legal character as a works contract, and an agency implementing a centrally sponsored scheme against central grant is not liable to service tax on that grant as consideration for a taxable service.

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