The issue of the imposition of service tax on construction and sale of residential property has long been a matter of concern for the real estate and construction industry as well as for buyers of such residential property. Before coming to the Budget 2010 proposals in this regard, it would be worthwhile to briefly understand the background in relation to the levy of service tax on such activities. 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 sales tax or VAT has typically applied as well. Hence, the issue has been problematic even in that regard. The genesis of the dispute in relation to service taxation of such activities was the decision of the Supreme Court in the case of K Raheja Development Corporation vs. State of Karnataka (2005) 2 STT 178 (SC), which had, based on the facts of the case, upheld the charge of the VAT, or the goods tax, on a contract for building and subsequent sale of immovable property.
Thereafter, there was a circular issued by the Central Board of Excise & Customs (CBEC). An earlier article in this column had addressed the issue, post the issuance of this Circular. It was hoped then 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 was also hoped that the benefits of the Circular, which were understood to be binding on the authorities, would effectively accrue to those for whom they were intended and that the matter would no longer be pursued by the tax authorities.
Considering the above, no new proposals in this reg-ard were anticipated in the Budget. However, Budget 2010 contains a very significant proposal seeking to bring such construction activities under the tax net. Accordingly, an explanation has been inserted in the definition of ‘construction of complex services’. The explanation reads:
“For the purpose 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.”
The Department of Revenue, Ministry of Finance, has issued clarifications on the matter referring to the varying patterns of execution of agreements to sell / sale deeds as also sales of undivided portions of land / construction agreements which have led to confusion and litigation in terms of the levy of service tax and accordingly the aforesaid explanation is proposed to be inserted to bring in parity in tax treatment of the sale of residential properties with that perhaps of the VAT. This proposed amendment will come into force from a future date, post the enactment of the Finance Bill 2010. Consequently, installment purchases of immovable property will become chargeable to the service tax. This does of course add to the cost of purchase of property. It appears that the authorities wish to treat such agreements as constituting “bundled supplies” of goods and services and thus chargeable to service tax on the services portion.
However, there seems to be a misunderstanding that the Budget proposal would lead to levy of service tax on the entire value of the consideration which is paid to the builder / developer. This is incorrect. The developer / builder is required to pay service tax, and perhaps recover it from the buyers, only on the labour or services portion and not on the material portion of the sale consideration, since VAT in the form of the works contract tax is already applicable on that portion. Indeed, there is an abatement scheme in vogue whereby service tax is charged on 33 per cent of the gross amount charged. This is but one option and there are others whereby the tax is paid on the identified services portion of the contract. Should this option be chosen, the service tax impact of the proposed change in law works out to 3.40 per cent (being 10.30 per cent of 33 per cent of the overall value). Of course, the sales of residential property post the issuance of the completion certificate by the relevant authorities would not attract the levy. This is also obviously true for second or subsequent sales of such property. It must also be understood that similar to the VAT, input tax credits could be available to offset these service taxes and hence the net effect of the tax could be lesser than the 3.40 per cent indicated above.
These are early days and we will need to wait and watch as to how these proposals will be enacted and implemen-ted in practice and what effect they will have on the real estate sector.
The author is Leader, Indirect Tax Practice, PricewaterhouseCoopers
(Supported by Rahul Renavikar)
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