The issue of tripartite agreement in the works contract under VAT is equally important in service tax matters. On the basis of K Raheja Development decision, service tax department is raising demand of service tax on developers of flats under tripartite agreements.

In the matter of M/s RAHEJA DEVELOPMENT CORPORATION v. STATE OF KARNATAKA (reported in 2006 -TMI - 493 - Supreme Court) division bench of Supreme Court has observed that,

"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."

The impugned matter was initially raised by the sales tax department of Karnataka. In this matter the appellant took the case upto Supreme Court but the luck was with the department and the developer lost the case in favor of revenue.

Now, department has raised the similar issue in case of LARSEN & TOUBRO LIMITED. L&T filed SLP before the honorable Supreme Court .

Two member bench of the Supreme Court in this matter (reported in 2008 -TMI - 30664 - SUPREME COURT) has observed that:

"……However, we are of the view 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 of chattel as a chattel. Lastly, could it be said that petitioner ­ Company was the contractor for prospective flat purchaser. Under the definition of the term "works contract" as quoted above the contractor must have undertaken the work of construction for and on behalf of the contractor for cash, deferred or any other valuable consideration. According to the Department, Development Agreement is not works contract but the Tripartite Agreement is works contract which, prima facie, appears to be fallacious. There is no allegation that the Tripartite Agreement is sham or bogus."

Therefore, the matter has been referred to larger bench for re-consideration of Raheja Development's Case

Works contract classification of tripartite developer agreements challenged, prompting reconsideration of Raheja Development precedent by larger bench. The central question is whether tripartite agreements qualify as works contract: Raheja held that agreements entered before completion, where construction is carried out for and on behalf of the purchaser, remain works contracts despite developer lien or termination rights; if the unit is retained on termination or the agreement is post construction, works contract character ceases. A later bench questioned Raheja's breadth, found classifying tripartite agreements as works contracts prima facie problematic and referred the matter to a larger bench.