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News and Press Release

Service Tax on Builders - An analysis and constitutional provisions:

March 7, 2010

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For Basic provisions related to civil construction - visit: SERVICE TAX ON BUILDERS - BASIC PROVISIONS

Just one year before, Board has issued a circular dated 29-1-2009 in which, board has said that builders are not the service providers and no service tax is leviable on there activity. The relevant portion of the circular is reproduced as under:

"3. The matter has been examined by the Board. Generally, the initial agreement between the promoters / builders / developers and the ultimate owner is in the nature of 'agreement to sell'. Such a case, as per the provisions of the Transfer of Property Act, does not by itself create any interest in or charge on such property. The property remains under the ownership of the seller (in the instant case, the promoters/builders/developers). It is only after the completion of the construction and full payment of the agreed sum that a sale deed is executed and only then the ownership of the property gets transferred to the ultimate owner. Therefore, any service provided by such seller in connection with the construction of residential complex till the execution of such sale deed would be in the nature of 'self-service' and consequently would not attract service tax. Further, if the ultimate owner enters into a contract for construction of a residential complex with a promoter / builder / developer, who himself provides service of design, planning and construction; and after such construction the ultimate owner receives such property for his personal use, then such activity would not be subjected to service tax, because this case would fall under the exclusion provided in the definition of 'residential complex'. ……..."

Now, after one year, the mind set of the government has changed and proposed the amendment in the statutory provisions to provide that, mere intention to sale before construction or during construction before completion of the project constitute a taxable service. The relevant explanations to be inserted are as under:

(ii) the following Explanation shall be inserted, namely:—

"Explanation.—For the purposes of this sub-clause, the construction of a new building which is intended for sale, wholly or partly, by a builder or any person authorised by the builder before, during or after construction (except in cases for which no sum is received from or on behalf of the prospective buyer by the builder or the person authorised by the builder before grant of completion certificate by the authority competent to issue such certificate under any law for the time being in force) shall be deemed to be service provided by the builder to the buyer;"

(e) in sub-clause (zzzh), the following Explanation shall be inserted, namely:—

"Explanation.—For the purposes of this sub-clause, construction of a complex which is intended for sale, wholly or partly, by a builder or any person authorised by the builder before, during or after construction (except in cases for which no sum is received from or on behalf of the prospective buyer by the builder or a person authorised by the builder before the grant of completion certificate by the authority competent to issue such certificate under any law for the time being in force) shall be deemed to be service provided by the builder to the buyer;"

==================

After reading the circular dated 29-1-2009, I was puzzled that what was there to prompt the legislature to change the mindset and amend the statutory provisions just against the views expressed in its own circular. In the absence of any authoritative statement from the legislature, it is not proper for me to guess that would lead to unwarranted situation but it is sure that at this point of time, that the government requires lot to funds. Since the real estate sector is a huge market and could be one of major source of revenue to the central government (apart from stamp duty and other local levies by the state government) on account of Indirect Taxes, the central government has chosen to levy service tax on builders on deemed service basis (presumptive concept of taxation applied to service tax)

Earlier, I remember the most controversial category of deemed services was the membership of club or association brought into service tax net under 65(105)(zzze) with effect from 16-6-2005. The argument against the levy was that club or associations are being operated on mutual concern basis and one can not provide service to himself. But, the legislature was determined to bring the service tax on this service and kept in force despite protest from the clubs or associations.

Therefore, what the legislature has proposed in the Finance Bill, 2010 that mere intention to sale the property before commencement of construction or at the time of commencement of construction or during the course of construction activity would lend the builder into service tax. To identify the intention and to make it free from doubt, legislatures has proposed that receipt of money wholly or partly before obtaining completion certificate shall be sufficient to prove that the builder is engaged in provided taxable service.

In this issue, the discussion would be incomplete without discussion the decision of the honorable Supreme Court [2006 -TMI - 493 - Supreme Court] upholding the decision of the Karnataka High Court in which it was decided by the Karnataka High Court that that the activity of the Builders are in the nature of  "Works Contract" for the purpose of sales tax. The relevant paragraph of the decision of the honorable Supreme Court is being reproduced as under:

"Thus the Appellants are undertaking to build as developers for the prospective purchaser. Such construction/development is to be on payment of a price in various installments set out in the Agreement. As the Appellants are not the owners they claim a "lien" on the property. Of course, under clause 7 they have right to terminate the Agreement and to dispose off the unit if a breach is committed by the purchaser. However, merely having such a clause does not mean that the agreement ceases to be a works contract within the meaning of the term in the said Act. All that this means is that if there is a termination and that particular unit is not resold but retained by the Appellants, there would be no works contract to that extent. But so long as there is no termination the construction is for and on behalf of purchaser. Therefore, it remains a works contract within the meaning of the term as defined under the said Act. It must be clarified that if the agreement is entered into after the flat or unit is already constructed, then there would be no works contract. But so long as the agreement is entered into before the construction is complete it would be a works contract."

But, despite the above decision of the Apex Court, the board has issued circular dated 29-1-2009, to extend the relief to the builders. Now after the proposed amendment and notification to be issued after enactment of the Finance Bill, 2010, all the developers would have the following choice:

1.                  If they are payment VAT under works contract category under the local levied, than they choose to pay service tax under the works contract category of service tax. The benefit of payment of service tax within the category of works contract 65(105)(zzzza) is that he can choose the option to pay composite service tax equal to 4% and avail the benefit of cenvat credit on input services and capital goods.

2.                  He may choose to avail the benefit of notification no. 12/2003 - which is if no impossible but next to impossible.

3.                  He may choose to avail the abatement and pay service tax only on 33% under notification 1/2006 if classifies his services under 65(105)(zzq) or 65(105)(zzzh)

Constitutional Validity

The issue of constitutional validity of the impugned service remains open.

But keeping in view of the decision of the honorable Supreme Court in the matter of K. RAHEJA DEVELOPMENT CORPORATION v. STATE OF KARNATAKA. [2006 -TMI - 493 - Supreme Court], and various other decisions in which honorable Supreme Court has upheld that power of the legislature to tax an activity on presumptive basis, a builder may choose to litigate the issue or to start deposit service tax as per the legislative intent.

If the builder chooses to litigate, he has to calculate his risk is how to recover the amount of service tax where the decision of the Apex Court goes in favor of revenue. On the contrary where the Apex court decides the matter in favor of Builder, the consequence of retrospective amendment since the intention of legislature is beyond any doubt.

 

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Acts Income Tax