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Service tax on construction and sale of residential property

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The issue of the imposition of service tax on construction and sale of residential property has been a matter of concern for the real estate and construction industry as well as buyers of residential property. The Central Board of Excise and Customs (CBEC) has recently issued a Circular (No. 108/02-ST dated January 29, 2009) clarifying the Board’s view on the matter. While the Circular is welcome, in that it provides for relief from service tax in specified circumstances, it remains to be seen as to how it would be understood and implemented on the ground.

However, before coming to the matters that have been clarified in the Circular, it would be worthwhile to look at the manner in which the service tax authorities have sought to tax the activities construction of residential property. It must be mentioned at the outset that since the activity of construction is in many instances in the nature of a works contract, the charge of sale tax or VAT has typically applied as well. Indeed, the genesis of the dispute in relation to service taxation of the activities of construction and sale of residential property is the decision of the Supreme Court in the case of Vs State of Karnataka [2005] 2 STT 178 (SC), which was qua the provisions of the Karnataka Sales Tax Act, 1957.

Based on a particular understanding of this decision, the Director General of Service Taxes issued a Circular in February 2006 holding simply that construction and sale of residential property in all situations were taxable as works contracts and since such contracs, inter alia, comprised of provision of services, service taxes would apply under the heading of residential complex construction service.

This Circular essentially meant that in all situations where the developer or builder engaged in the above activities, regardless of when the sale of immovable property took place, service tax would inevitably apply. This Circular led to significant litigation and was the subject matter of a petition in the Mumbai High Court.

Meanwhile, the CBEC issued a clarification in August 2007, holding that in a situation of construction of residential property, a contractor who was engaged in construction activity on behalf of a builder who ultimately sold the built up residential property to the various buyers was alone liable to discharge service tax in relation to the construction activity.

The Circular implied that if such a contractor had discharged the tax, there was no further liability on the part of the builder to charge service tax on the consideration received from the byers who purchased the residential property from the builder. The Circular also stated that if the builder himself undertook the construction activity and sold only the completed flats to the buyers, no service tax was at all payable.

It must be mentioned here that in addition to the aforesaid heading of construction of residential complex, the government also brought within the ambit of the service tax, the category of ‘works contract service’ with effect from June 1, 2007. This category included within its purview works contracts relating to residential complexes as well. The Department has further clarified that contracts for carrying out any works would be covered under the aforesaid heading even if they were to be possibly categorised under any other heading. Consequently, the position is that in case a contract is in the nature of a works contract, it would become liable to both the sales tax or VAT as well as the service tax.

The point however is whether or not the construction and sale of residential property is a works contract in all situations or whether it could only be so construed, based on the intent of the contracting parties, as discerned from under the contractual agreement.

In a decision of dubious quality, the Authority for Advance Ruling in the case of Harekrishna Developers [2008-TIOL-03-ARA-ST] held that the definition of construction of residential complex covered within its ambit incidental and allied activities thereto as well.

Further, it also relied upon the words ‘in relation thereto’ occurring thereunder in order to hold that an agreement to sell yet to be built residential units would attract service tax and consequently a developer or a builder who charged periodic payments from parties and thereupon constructed residential units prior to their ultimate sale was indeed a service provider and liable to pay service tax under the relevant heading.

The CBEC Circular of August 2007 was brought to the attention of the AAR but it curiously held that the Circular lacked clarity and could not, in any event, be relied upon to argue that developers were not required to discharge service tax in such situations.

Again, the Guwahati High Court in the case of Magus Construction Pvt Ltd Vs Union of India [2008-TIOL-321-HC-GUW-ST], held that an agreement to purchase a fully constructed unit, which envisaged instalment payments of the purchase price during the period of construction was not a works contract since the intention of the parties was always to transact in sale/purchase of a fully constructed immovable property.

Notwithstanding the aforesaid position in law, litigation on the matter was rampant and the authorities were continuously seeking to impose tax on the typical activities undertaken by builders/developers. As a result of the several representations that were consequently received by the CBEC, the recent clarificatory Circular has been issued. It sets out the underlying issue as also the possible two views in regard to the service tax.

Thereupon, the Board has opined that an agreement to sell immovable property does not by itself create any interest in or charge on such a property, as per the Transfer of Property Act, 1884. It was only after the completion of the construction and the payment of the full consideration by the buyer to the developer/builder that the proper sale deed was executed and ownership/title in property was transferred.

The Circular consequently clarifies that the activities carried out by the builders/developers prior to the point of sale of property were not services rendered to customers. Consequently, no service tax would be chargeable with regard to the construction activities carried out by the builders/promoters.

While the Circular does not explicitly say so, it is also implied and indeed it is implicit therein that since the agreement for sale does not transfer title and indeed the parties only intend to buy and sell immovable property, there could also not be a service tax on such activities under the heading of ‘works contracts’. The Circular also reiterates what was clarified through the earlier Circular of August 2007 that if the services of a third party such as the contractor or a designer was procured by the builder/promoter, such services would be chargeable to tax.

The Circular concludes by holding that any decision of the Advance Ruling Authority which is contrary to the foregoing view could only impliedly be based on different facts and would hence have applicability to that case only. It is hoped that in line with the principles enunciated in the aforesaid Circular, due relief from the service tax would be granted to the construction industry and to the buyers of immovable property.

It is also hoped that the benefits of this Circular, which were until very recently understood to be binding on the authorities, will effectively accrue to those for whom it is intended and that the matter will no longer be pursued by the tax authorities.

The author is Leader, Indirect Tax Practice, PricewaterhouseCoopers
pwctls.nd@in.pwc.com  

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