Service Tax Aspects for Builders and Real Estate Developers

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Service Tax Aspects for Builders and Real Estate Developers
Monday, 11 July 2011 14:35 sandesh mundra


Service Tax Aspects for Builders and Real Estate Developers

I – Government and its style of functioning

Government in a bid to resurrect its fiscal position needs tax revenues. Now the manner in which it goes on to earn the revenue is very simple. Identify a particular business class enjoying incomes higher as compared to others. Start taxing them under any of the existing statues because its cumbersome to come out with a new statue every time. This is precisely the reason that the government hastily included the class of builders and developers under the service tax regime by way of a deeming provision, which till date most of us find difficult to digest.

But as citizen one has to abide by the law of the land whether one likes it or not, though the constitution has given its citizen right to make representations and also approach court for any issues which one feels are not fitting in the basic framework of the constitution. So the fight for builders community shall continue for times to come, but in the meanwhile let us try and understand the basics involved in the charge of service tax on real estate transactions.



II – How did it all begin (Background)

Well, it all began with verdict of Hon' Karnataka High Court in the matter of K Raheja Corporation wherein the facts were as follows:-

Builder entered into two separate agreements with the customers, one for construction and the other for sale of undivided share of land.

This was probably done with a view to save stamp duty on the value of construction transferred.

The words used in the Agreement for Construction were that the agreement is for construction as a developer on behalf of the allottee.

Section 2(1)(v-i) of Karnataka Sales Tax Act stated that 'works contract' includes any agreement for ………….carrying out the building, construction……of any movable or immovable property.

It was thus interpreted by court that the property in the goods passed by accession during the construction. Hence it was held as "Works Contract" and not a contract of sale. It may be noted that under a Contract of sale the property is transferred after the construction.

Although the above judgement was issued under the VAT law, but even the service tax department picked up the words "Works Contract" and started issuing show-cause notices to the builders.

What followed was that notices were sent to various builders across the country who were viewed similar to K Raheja, despite having different facts. By different facts we mean that in several cases only single agreements were being entered with the customer for the complete property unlike that of K Raheja, where separate agreement was entered for the construction of property. The department on the basis of Hon’ Supreme Court’s judgement has started interpreting that if the Agreement to sale is entered prior to completion of construction, it results in the contract being a Works Contract subject to both VAT and Service Tax.

The law laid down by the Hon’ble Supreme Court in K. Rahejas’ case (141 STC 298) was a subject matter of challenge before the Hon’ble Supreme Court in the case of Larsen and Toubro Limited & Another vs. State of Karnataka & Another (2008-VIL-29-SC). The Hon’ble Supreme Court while delivering the judgment on 19-8-2008 in the Larsen and Toubro’s case observed and questioned whether the ratio of the judgment of the Division Bench in the case of Raheja Development Corporation (supra) is correct. The statutory authorities have relied upon the judgment of Raheja Development Corporation (supra) case as it favours the revenue. And the Court also mentioned that if the ratio of Raheja Development case is to be accepted then there would be no difference between works contract and a contract for sale.

Based on the above finding the Hon’ble Supreme Court placed the matter before the Honourable Chief Justice of India for re-consideration of the K Rahejas’ case by a larger bench which is still pending before the court.

Surprising that in India, certain judgements of Bollywood stars and politicians are delivered at a very fast pace and certain matters of immense importance like above take a back seat. For the country to prosper the legal system needs to take a heavy dose of steroids.


However things came to some halt with the judgement of

Assotech Realty Pvt Ltd vs. State of Up and Another vide Writ Petition No.1238 of 2006 (reported in 2007-TIOL-297-HC-ALL-CT) in the favour of builders.

Comments in the background of the judgment of the Assotechs’ case cited above:

1. Hon’ble Allahabad High Court clearly distinguished the facts with K Raheja's case while delivering the judgment by stating that in the K. Rahejas’ case the appellants were constructing the unit for and on behalf of the person who had agreed to purchase the flats”. Whereas in the Assotech’s case the petitioner is constructing the flats/apartments not for and on behalf of the prospective allottees but otherwise. And any activity for self can-not result In charge of service tax.

2. Agreements wherein the land and building are conveyed to the purchaser (assuming stamp duty is paid on such conveyance) are deemed to be transfer of immovable properties and not liable to tax under the VAT/Service Tax laws.

Although the readers would be aware that the above judgement was set aside by the Honourable Supreme Court on grounds other than legal:-

That the appellant ought to have filed a First Appeal, since a writ petition against an order of assessment was not maintainable.

That the nature of right conferred on the allottees of flats/consideration for payments of installments/whether construction was on its account or on behalf of the allottees were not matters to be decided in a writ.

Thus the matter will now take a longer time to get resolved.

The Advance ruling in the case of Hare Krishna Developers took another "U" turn with the ruling going in favour of the department.

Finally to settle things department itself came out with the circular No. 108/02/2009-ST dated 29-1-2009, where it is clarified that at the time of execution of agreement to sale, property does not pass to the buyer and hence no service tax is applicable.










III – Amendment in the Service Tax law

Now as we have seen in the Indian Mythology that when all weapons fail, the warrior uses "Pashupatastra". So finally we had the pashupatastra from the Central Government

In the Finance Act, 2010, an Explanation has been added w.e.f. 1-7-2010, which meant that any construction of a complex by a builder during or after construction shall be deemed to be service taxable under the act. This came with an exception that if no sum is received from the prospective buyer before the grant of completion certificate by the authority, then it would not be service taxable under the act.

Thus practically speaking almost all cases were brought within the ambit of service tax.

Thus, by a ‘deeming provision’, an activity which is not ‘service’ as per Court decisions and CBE&C’s own earlier circulars will be a ‘deemed service’ for the purpose of levy of service tax.

This amendment did not take the form of a retrospective amendment, but going by the logic it was always going to be prospective w.e.f 1-7-2010.

IV – Transitional Provisions on 1-7-2010

Date of booking is not relevant. Date of provision of service is relevant as provision of service is the taxable event. Hence, if construction service is provided after 1-7-2010, service tax will be payable.

If construction is complete before 1-7-2010 even if completion certificate is not received, no tax is payable, as service tax is on provision of service, provided the facts can be made clear from books of accounts.

In case of payments received prior to 1-7-2010, as per Notification No. 36/2010-ST dated 28-6-2010, if any advance payment was received prior to 1-7-2010, for service to be provided after 1-7-2010, service tax was made fully exempt.


V - Options available for discharge of service tax liability

(Without the impact of Education cess (3%) for the sake of simplicity)

S.No.


Rate


Market Value of Land on the date of sale


Value of Free Issue Material


Value of own Material


Cenvat Credit

1


10%


To be reduced from total value


Not to be added to total value


To be Reduced from Total Value


Available for Services and Capital Goods

2


4% (Works Contract)


To be reduced from total value


To be added to total value


Not to be reduced from total value


Available for Services and Capital Goods

3


3.33%


To be reduced from total value


To be added to total value


Not to be reduced from total value


Not available

4


2.5%


Not to be reduced from Total Value


To be added to total value


Not to be reduced from total value


Not available



Illustrations on 75% Abatement Scheme –

Agreement to Sell Value (Including Land Value) – Rs. 50,00,000/-. The value for the purpose of computing service tax will be 12,50,000 (25% of 50,00,000). The service tax amount will be Rs. 1,28,750/- i.e. 10.30% on Rs. 12,50,000/-. The 75% abatement is available effective 1st July 2010.

If however free issue material of Rs. 10,00,000 have been supplied in addition by the customer, then the same would be added to arrive at Gross value of Rs. 60,00,000/- (Rs. 50 Lacs as Agreement Value+ Rs. 10 Lacs as Free Issue). The value after taking the 75% abatement would be Rs. 15,00,000 on which service tax would have to be paid as Rs. 1,54,500/- (10.30% on Rs. 15 Lacs).

Illustration on a Regular 10.3% Scheme

From the sale value of Rs. 50 Lacs, one may reduce the cost of own materials (not Free Issue) say Rs. 25 Lacs and value of land say Rs. 15 Lacs. Then service tax has to be paid at 10.30% on the balance of Rs. 10 Lacs as Rs. 1.03 Lacs.

VI – Settlement of consideration by sale of undivided share in Land

If Developer has received the land from the land owner and has entered into an agreement with the landowner to give him some residential flats as consideration for purchase of undivided share of land, then computation of service tax can be tricky. As per the service tax laws ‘consideration’ need not be in the form of money alone.

So as and when the builder/developer gets possession of land from land owner, it would be ‘advance received’ and service tax will be payable on the market value of the land normally the Jantri rates.

Even the landowner may be asked to pay service tax if he is selling the flat before obtaining the completion certificate. He may choose to argue, but it might be a futile exercise in the end.



VII – Impact of Point of Taxation Rules w.e.f 1-7-2011

Till 1-7-2011, we had a system of payment of service tax upon receipt of money from the client. But w.e.f this date, things are set to change and now the point of taxation has been redefined under the Point of Taxation Rules, 2011 (POT).

Under the POT Rules, a concept of continuous Supply of service (CsoS) prevails which means any service which is provided, or to be provided continuously, under a contract, for a period exceeding three months, or where the Central Government, by a notification in the Official Gazette, prescribes provision of a particular service to be a continuous supply of service, whether or not subject to any condition;

On 1-4-2011 CBEC declared following services as CSoS.

Commercial or industrial construction service

Construction of complex;

Telecommunication service;

Internet telecommunication service and

Works contract service.

Thus even builders would be covered under the concept of CSOS implying that the milestones for payment as decided in the Agreement to sale would become Point of Taxation for the builders. Utmost care is thus required that the payments are actually received as per the pre-decided milestones.

With the service tax returns set to be revised, and lot of interpretations coming for the POT rules, it becomes very important for the parties to understand the manner in which the agreements need to be framed, to ensure

proper compliance

hardship of making service tax payments without receiving the same is avoided


This has to be done by defining the events in such a way that the time difference between the arising of tax liability and receipt of payment are reduced to shortest period.

Further a situation may arise when the customer surrenders the flat and the amount paid during the initial phase is refunded back to him.

In such a scenario as per Rule 6(3) of the Service Tax Rules if excess tax is paid in respect of service which is not provided, the excess service tax can be adjusted against the liability of the subsequent period.

It is crucial to note that there Is no regard to bad debts under the Point of Taxation Rules, hence any unilateral action would not result in future adjustment of service tax as per the current rules. Thus for any rate adjustments, it is advisable to raise credit notes with proper confirmation from the customers.


VIII – Other Issues

Centralised Registration

A builder is advised to take a centralized registration if the invoices are received containing the site address, if he wishes to take cenvat credit.

Extra items


The extra items on which service tax is payable include:-

prime/preferential location charges for allotting a flat/commercial space according to the choice of the buyer

internal or external development charges which are collected for developing/maintaining parks, laying of sewerage and water pipelines, providing access roads and common lighting etc;

fire-fighting installation charges; and

power back up charges etc.


Exemptions on which service tax is not payable:-

Charges for providing parking space have been specifically excluded from the scope of this service.

Development charges, to the extent they are paid to State Government or local bodies, will be excluded from the taxable value levy.

Further, any service provided by Resident Welfare Associations or Cooperative Group Housing Societies consisting of residents/owners as their members would not be taxable under this service.


Different valuation methods for different contracts

Each contract can be treated as separate contract and valued differently.

Construction of Individual Flats


As per section 65(91a) of Finance Act, 1994, “residential complex” does not include a complex which is constructed by a person directly engaging any other person for designing or planning of the layout, and the construction of such complex is intended for personal use as residence by such person

How do we ascertain if a Residential Unit is completed?


If a completion certificate is obtained from any of the following authorities, powered under any law it will be treated to be completed.

i. Any Government authority

ii. Architect registered with the Council of Architecture constituted under the Architects Act, 1972( 20 of 1972); or

iii. Chartered engineer registered with the Institution of Engineers (India); or

iv. Licensed surveyor of the respective local body of the city or town or village or development or planning authority;

Transactions involving resale of properties


Resale Properties – No service tax is applicable on resale of immovable properties as they would have already obtained the completion certificate as required under the law.

Raising Invoices


Most of the builders, find it difficult to digest when they are asked to raise Invoices. For the sake of clarity and to ensure proper charge of service tax, it is highly advisable for the builders to raise invoices on their customers as per the milestones decided in the Agreements entered into with them. In raising the same, the basic requirements of the service tax rules need to be complied with.

IX – Challenging the constitutional Validity

The amendment in Finance Act, 2010 which brought the deeming fiction with regard to service tax on construction of residential complex was stayed by the high court of Mumbai in case of Maharashtra Chamber of Housing Industry. An interim stay was granted on the grounds of constitutional validity. The judges ruled that “ No coercive steps will be taken against the developers for recovery of service tax in relation to the provisions in question”.

Similar order were passed in writ petetions filed by DB Reality Ltd vs UOI (2011) 30 STT 110 (Bom HC DB) / Mighty Construction vs UOI and May fair Housing. It may be noted that the stay is limited only for the coercive action for recovery.

However in GS Promoters v. UOI (2011) 8 taxmann.com 271 = 30 STT 268 = 37 VST 272 (P&H HC DB), validity of the amendment has been upheld.

Due to the stay as above, the following options have been opened up for the assesses to choose from namely – Builder Model and the Developer Model as below:-

Particulars


Builder Model


Developer Model

Definition


Under this model, the agreements are for the purpose of sale of the completed building. Right in the property accrues to the owner only on execution of sale deed and not otherwise. It is thus believed that the construction undertaken is for self and various decisions have been rendered by the tribunals which state that there is no levy of service tax in the absence of service provider service receiver relationship.


Under this model, developer enters into an agreement with the prospective buyer. The owner of land directly transfers the entire land to society or owner of apartment. After entering into such agreement no separate sale deed is executed between developer and purchaser, therefore as and when builder/developer deploys the material on the land for construction , such material would get transferred in accession to the prospective buyer.

Stand on Service Tax


Not to be charged


Required to be charged

Case Laws in support of the stand


Allahabad High court in case of Assotech Reality P. Ltd., Vs. State of UP 2007 (007) STR 0129 (All.)

Honorable Gauhati High Court in case of Magus Construction Pvt. Ltd. and another Vs. UOI 2008 (11) STR 225,


K. Raheja Development Corporation v. State of Karnataka 2006 (3) STR 337 (S.C.))

AAR ruling AIT-2008-127-AAR dated 7th April 2008 in case of Hare Krishna Developers ; Authority for Advance Rulings



Conclusion

Despite the stay as we read above and the two models proposed in the article, it would be wise to collect and pay the taxes. Not much can be read in the stay order, as the courts have clearly stated that the assessments can continue, which means assessee has to register with service tax. Hence to avoid litigations it would be in the interests of the builders to pay service tax suo moto because at the end of the day –

“Time Is precious than money”.

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