A previous article in this series had discussed an important recent judgment of the Mumbai High Court on the vires of the recently introduced Explanation to the relevant definitions contained in service tax law on construction services. The Explanation had deemed the construction of a building by a builder etc. as a service to the buyer of the building, if it was intended for sale, wholly or partly, before during or after construction. The only exception was an outright sale of immovable property where no sum was received from the buyer or on his behalf by the builder etc prior to the grant of a completion certificate relating to the building. The Court had held that the Explanation was legally valid. Subsequent to this judgment, the Central of Excise & Customs (CBEC) has issued Circular No. 151/2/2012-ST dated 10.2.2012 (Circular) clarifying the service tax applicability on the various operating models prevalent in the construction industry. The contents of this important Circular are discussed below.
The first such one relates to the tripartite business model wherein the landowner transfers the development rights over the plot to the builder and the builder develops the property through the contractor for onward allotment to the landowner and other buyers. The Circular clarifies that the services provided by the builder prior to the date of insertion of the above Explanation on 1st July 2010 will not be subject to service tax, in the light of an earlier Circular on the subject dated 29.1.2009, which was the subject matter of a previous article in this column. However, for the subsequent period the services provided by the builder to both the landowner and other buyers will be subject to service tax on a value to be ascertained in accordance with the relevant valuation rules under service tax law. Specific reference has been made to these rules because the transfer of development rights by the landowner to the builder, which is treated in the Circular as consideration for the transfer of the built up property by the builder to the landowner, is evidently not in monetary terms and hence its value needs to be determined appropriately. This contentious point is more fully discussed subsequently in this article.
The second model pertains to the redevelopment or reconstruction of apartments by housing societies. The Circular considers a scenario wherein the society or its members give no objection certificates to the builder to reconstruct their apartments as also build and sell additional apartments to others. In these circumstances, the Circular clarifies that the apartments so reconstructed for the members will not be subject to service tax as they are meant for their personal use. However, post 1.7.2010, vis-à-vis the other buyers, a service tax will be charged if part or full consideration is received prior to issuance of the completion certificate.
The third model considered in the Circular is the investment model wherein a specified area is earmarked for an investor in the project and the builder undertakes construction activities subsequent to such earmarking. The Circular clarifies that post the introduction of the Explanation, the amount invested will be deemed as advance paid by investor for construction services to be provided by the builder and will hence be subject to service tax. The Circular further clarifies that the builder will be allowed to adjust the service tax so paid, in case the investor surrenders the flat allotted to him, in terms of the right of exit granted to him, provided the service tax is also refunded by the builder to the investor.
Apart from the above, the Circular discusses the service tax applicability on Built Operate and Transfer (‘BOT’) and Build, Own, Operate and Transfer (‘BOOT’) models for construction projects. It clarifies that between the Government and the concessionaire, service tax will be chargeable, as renting of immovable property services, on the rentals received by the Government relating to the transfer of the right to use/develop the vacant land on which the concessionaire constructs a building. At the second level, the contractor who constructs the building for the concessionaire, if any, will be liable to discharge service tax under the appropriate taxable category on the services provided by him. Finally, the concessionaire will need to discharge tax on the various services provided by him to the various users of the built up project.
Finally, the Circular considers the taxability of the typically prevalent model of the joint development agreements wherein the landowners and builders contract to jointly develop a piece of land with mutuality of interest and sharing of underlying profits and losses.
The Circular clarifies that the service tax implications between the landowners and builders on the one side and the resulting entity on the other will be determined in terms of the earlier Circular No. 148/17/2011-ST dated 13/12/2011 and on whether or not there comes into existence a separate entity, incorporated or otherwise.
This earlier Circular, which was issued in relation to other taxable services, is in itself a contentious one and has been discussed in this column. Further, insofar as the period prior to 1.7.2010 is concerned, the earliest Circular on the matter No. 108/02/2009-ST dated 29.1.2009 has been referred and it is clarified no service tax will apply.
However, the tax is stated to apply post the introduction of the Explanation. Now, the Circular of 2009 had stated that no service tax was applicable where the builder and the buyer had entered into an ‘agreement to sell’ before construction and subsequently executed a sale agreement after the construction was complete.
The basic premise for non-applicability of service tax was that the ‘agreement to sell’ did not create an interest or charge on such property and hence the construction of the building by the builder was nothing but construction on his own account.
The present Circular negates this position in the light of the Explanation inserted in the relevant definition of construction services.
It has however not explained as to how, consequently, a service provider/service recipient relationship is created between the builder and the buyer, in the light of the fact pattern described above. Interestingly, the Circular appears to be contradictory in treating the BOT model and the joint development agreement differently.
The key question is whether despite the Mumbai High Court upholding the Constitutional validity of the insertion of the Explanation to the taxable services in question, the tax will apply in the absence of any service by the builders to the landowners, in the facts of the joint development model whereby the landowners continue to remain the owners of the land under the ‘agreement to sell’ contract and the ownership is only transferred subsequent to the sale of the built up immoveable property.
It does not appear that the deeming provisions of the Explanation will automatically address this point since it could be argued that the Explanation will only apply where the builder has acquired title to the immoveable property and has contracted to provide construction services prior to transfer of title to buyers of the completed property.
The fact pattern in such a situation is quite different from those of the joint development discussed above.
We have surely not seen the last of the litigation on this critical aspect of service taxation.
The author is executive director, PricewaterhouseCoopers Pvt. Ltd