Karnataka High Court Orders Reimbursement of GST Differential for Pre-GST Works Contracts

Background and Context

The Karnataka High Court, through a common order dated 11 April 2023, addressed a batch of writ petitions filed under Article 226 of the Constitution of India by class-I contractors. The central grievance in all these petitions was the additional tax burden that arose when works contracts — originally entered into under the pre-GST regime — continued into or were paid for during the GST era. Since common questions of law and fact were involved, the Court took up all petitions together and issued a unified order.

The petitioning contractors had originally entered into works contracts with various State Government agencies at a time when the Karnataka Value Added Tax Act, 2003 (KVAT Act) and the Finance Act, 1994 were operative. Most of these contractors were enrolled under the composition scheme (COT scheme) governed by Section 15 read with Rule 135 of the KVAT Act, with a smaller group operating under regular VAT assessment. Under the composition scheme, tax was levied at 4% on the transaction value. Under regular VAT assessment, the applicable rate was either 5% or 12%, depending on the nature of the contract. Importantly, service tax was entirely exempted on works contracts rendered to Government and statutory agencies, meaning these contractors bore no service tax liability on such work.

The Core Problem: Tax Burden After GST Implementation

When GST came into force on 01.07.2017, works contracts were reclassified as "deemed services." As a direct consequence, these contractors became liable to pay GST at 18% for the period from 01.07.2017 to 21.08.2017, and at 12% from 22.08.2017 onwards. This sudden jump in the applicable tax rate created a significant differential burden that was entirely unforeseen at the time the original contracts were executed.

The specific categories of contracts affected included:

  • Works completed before 01.07.2017 but where inspections, invoices, or payments were still pending after that date
  • Works partly executed before GST and partly thereafter
  • Contracts entered before 01.07.2017 but completed or paid under the GST regime
  • Tenders floated during the KVAT era but finalized under GST using the old Schedule of Rates (SR)

The petitioners argued that since the tax component in a contract is not profit retained by the contractor but a statutory payment passed through to the Government, the employer-agencies were legally and equitably obligated to absorb the differential tax burden created by the legislative change.

Positions of the Parties

Petitioners' Stand

The contractors contended that:

  • The shift from VAT to GST was a legislative development entirely outside their control.
  • The tax component is always an independent element of the contract price — distinct from cost and profit — and must be borne by the recipient of services, i.e., the Government employer.
  • Other states including Maharashtra, Odisha, Andhra Pradesh, and Telangana had already directed reimbursement of such differential tax to contractors, and Karnataka's contractors were entitled to parity of treatment.
  • The Central Government's Department of Railways had itself adopted a GST neutralization mechanism for pre-GST contracts, which demonstrated that absorption of differential tax by the employer was the correct approach.

During the hearing, senior counsel for the petitioners clarified on instructions that the constitutional challenge to the validity of the GST Act was not being pressed. The petitioners indicated they would be satisfied if the respondents acted upon their representations and absorbed the differential tax burden.

The petitioners placed reliance on State Government Circulars dated 03.01.2020 and 14.12.2020, as well as on the following judicial decisions: