CESTAT Chennai: Indivisible Works Contract Cannot Be Split to Deny CENVAT Credit; ₹2.83 Crore Demand on IL&FS Water Set Aside

April 30, 2026: The Chennai Bench of the Customs, Excise and Service Tax Appellate Tribunal has held that an indivisible works contract cannot be artificially split to classify the goods component as “trading” for the purpose of denying CENVAT credit, and has consequently set aside a service tax demand of ₹2.83 crore raised against IL&FS Water Ltd.

The Bench comprising Ajayan T.V. (Judicial Member) and M. Ajit Kumar (Technical Member) allowed the appeal and quashed the Order-in-Original passed by the adjudicating authority.

The dispute arose out of a water supply project executed for Indian Oil Corporation Ltd. at Paradip under a Build-Own-Operate-Transfer (BOOT) model. The Department alleged that the assessee had paid service tax only on the service portion of the works contract while excluding the value of goods on which VAT was discharged. It further contended that the material component constituted “trading,” an exempted service, thereby triggering the requirement to reverse proportionate input service credit under Rule 6 of the CENVAT Credit Rules, 2004.

The appellant, however, maintained that its primary activity was execution of a works contract and not trading in goods. It was argued that the transfer of property in goods occurred only in the course of executing the contract and did not amount to an independent commercial activity. The appellant also submitted that CENVAT credit was availed only on input services used for providing taxable output services and that separate records were maintained.

Upon examining the contract, the Tribunal noted that the BOOT agreement was a comprehensive, lump-sum arrangement involving design, engineering, procurement, construction, commissioning, and long-term operation and maintenance of a water transmission system. It found that there was no independent agreement for sale of goods and that the contract was a single, indivisible works contract.

The Tribunal held that the essence of the transaction was execution of work and labour, and not sale of goods as chattel. It rejected the Department’s attempt to treat the material component as “trading,” observing that transfer of property in goods during execution of a works contract is merely incidental and cannot be regarded as a separate activity. It further clarified that the constitutional concept of deemed sale cannot be extended to artificially classify such transactions as trading for the purposes of CENVAT credit reversal.

On the issue of reimbursements, the Tribunal observed that payments made towards materials were part of the overall contract price and did not constitute a distinct transaction. It also recorded that the appellant had maintained separate accounts for input services and that this factual position had not been disputed by the Department.

In these circumstances, the Tribunal held that there was no exempted service or trading activity involved and that Rule 6 of the CENVAT Credit Rules had no application. Consequently, the demand for reversal of credit along with interest and penalty was held to be unsustainable. The impugned order was set aside and the appeal was allowed with consequential relief.

Cause Title: IL & FS Water Ltd. v. Commissioner of GST & Central Excise, Chennai North
Case No.: Service Tax Appeal No. 40556 of 2017
Coram: Ajayan T.V. (Judicial Member) and M. Ajit Kumar (Technical Member)