Two types of Sub-Contracting under Construction Business and its GST implications.

Construction projects involve multiple companies collaborating to complete a contract. Typically, one company oversees the project and hires sub-contractors to handle specialized tasks. This structure applies to the relationship between general contractors, who manage the overall project, and various specialty contractors, who focus on specific aspects within the main job.

The term "contractor" refers to anyone involved in a construction project, but there are key distinctions between the various types. This article explores those differences in detail, including an overview of different subcontractor roles and the tasks they handle, to clear up any confusion.

Who is a Main Contractor?

A Main Contractor is directly hired by the project owner/client to execute the construction work.

GST Perspective:

The main contractor raises invoices directly to the client.
GST is charged at 18% (depending on the type of construction and whether material is included).
The main contractor is eligible to claim ITC (Input Tax Credit) on purchases and services used for the project

Who is a Subcontractor? (Type-1)

A Subcontractor is hired by the main contractor to carry out a portion of the construction work (e.g., electrical, plumbing, painting).

GST Perspective:

The subcontractor raises invoice to the main contractor, not to the client.
GST is charged at the same applicable rate (usually 18%).
Subcontractors can also claim ITC on their purchases.
Main contractor shall claim ITC on GST charged by the subcontractors.

Who is Employee Under Main Contractor? (Type-2)

An employee is hired by the main contractor to handle specific construction tasks, such as project planning and design, site preparation, and structural work.

GST Perspective:

The employee never raises invoices to the main contractor rather the part of profit is given to him in terms of salary.
The main contractor is eligible to claim ITC on purchases and services used for the project.

Let’s take an example to understand it better.

Client: PWD Department

Main Contractor: M/s ABC Infra Ltd

Employee: Mr. Asif Hussain

Subcontractor: M/s XYZ Constructions

Project Work:

Construction of a government school building worth ₹1 crore.
ABC Infra hires XYZ Constructions to do electrical work worth ₹10 lakhs.
ABC Infra employees Asif Hussain to do Structural Work worth ₹5 lakhs.

Billing Flow:

Subcontractor to Main Contractor:

Invoice by XYZ Contractors:
- Work Value: ₹10,00,000
- GST @18%: ₹1,80,000
- Total: ₹11,80,000
XYZ charges 18% GST since they're working for a contractor, not directly for government.
ABC Infra can claim ITC of ₹1.80 lakhs.
All the purchases made for executing this work, input shall be taken by Sub-contractor, as all the payment shall be made from sub-contractor’s bank account.
What ever is spent and earned by XYZ Contractors is its profit.

Employee to Main Contractor:

Invoice by Asif Hussain:
- Work Value: ₹5,00,000
- All the purchases made for executing this work, input shall be taken by main-contractor, as all the payment shall be made from main-contractor’s bank account.
- Let’s say Asif spends Rs. 1,00,000+ 18%= 1,18,000/- for purchasing one GST item and Rs. 3,50,000/- for purchasing one non-GST item, hence Asif gets his share of profit on work is- 5,00,000/- less 3,50,000+1,00,000= 50,000/- (note: not 1,18,000/- as main contractor claims input of the same).

Main Contractor to Government

Invoice by ABC Infra Ltd:
- Work Value: ₹1,00,00,000
- GST @18%: ₹18,00,000
- Total: ₹1,18,00,000

Government pays ₹1.18 crore (ignoring TDS, Labour cess, forest royality etc).
ABC Infra utilizes the ITC of ₹1.80 lakh (from XYZ's invoice) and purchases made from its employee Asif to reduce its net GST liability.

So, when which option is chosen?

Option for sub-contracting is chosen when the main contactor doesn’t have much resource to complete the project.
Option of employee route is chosen:

o When main contract has resources but doesn’t want to be fully occupied with the day-to-day management and hires an internal employee to complete it and assigns a target cost to him, rest any money saved shall be his profit.

o When sub-contractor doesn’t have GST number.

o When work is allocated to one contractor but is jointly executed by its informal partner.

Here we have not considered the income tax angle and its implication on TDS etc.

We hope the above blog was helpful in enhancing your knowledge on the matter. In case of any queries feel free to get in touch with our team of experts.