Budget 2010 has significant service tax related proposals in store for the real estate sector. In the previous article, the service tax proposals on property construction activities were discussed. The article addresses the amendments concerning the renting of immovable property. Before that it is imperative to set out first the background relating to the issue.
The service in respect of renting of immovable property has been defined under Section 65(105) (zzzz) of the Finance Act, 1994 (‘The Act’) and was introduced w.e.f. June 1, 2007. The relevant portion of the definition reads as follows:
“Taxable service” means any service provided, or to be provided to any person, by any other person in relation to renting of immovable property for use in the course or furtherance of business or commerce and the term "service provider" shall be construed accordingly.
At the outset, it must be noted that tax applies only on the renting of commercial property and not on residential property.
Following the introduction of this taxable service, several writ petitions challenging the levy were filed in various courts. In April 2009, the Delhi High Court, in the case of Home Solution Retail India Ltd & Others vs. UOI & Others (2009 (237) ELT-209), held that the taxable service in respect of renting of immovable property, as defined under the relevant sections of the Finance Act 1994, was with regard to any service in relation to renting of property and was not on the renting of immovable property as such.
Consequently, the High Court held that the levy of service tax on the renting of immovable property itself, in terms of the relevant notification issued consequent to the introduction of the taxable service, was ultra vires the provisions of the Act. In arriving at its decision, the court relied on the wordings of the definition to hold that since the activity of renting of immovable property was itself not a service, the expression ‘service in relation to renting of immovable property’, could only extend to services which are provided in relation to the renting of immovable property.
With regards to the nature of the service tax itself, the High Court had held that it is a value added tax and the tax is a tax on value addition done by the service provider and it must have a connection with the service. Consequently, since the mere renting of immovable property did not entail any value addition, it could not be regard ed as a service for that reason as well.
While upholding the arguments contained in the writ petitions in regard to the above points, the High Court did not examine the alternate argument that the relevant definition, should it be construed as applicable to the activity of renting of immovable property as well, would be violative of the Constitution of India in that the Central Government could not, in terms thereof, impose a tax on land, as it was a State subject.
Coming back to Budget 2010, the proposal is to amend the definition of renting of immovable property services, to provide that the activity of “renting” is itself a taxable service. This amendment is proposed to be made with retrospective effect from June 1, 2007. The amendment also now extends the service tax to rent of vacant land where there is an agreement or a contract between the lessor and lessee for undertaking the construction of a building or structures thereon for the purpose of business or commerce. These amendments will come into force from a date to be notified after the enactment of the Finance Bill 2010.
Once that happens, the tax will become payable for the period from 1st June 2007 and beyond.
Now, there could be constitutional challenges to the above amendment on the following possible grounds:
# the retrospectivity of the amendment itself;
# whether, in the absence of specific enabling provisions, the Government could simply deem something to be a service: and.
# whether the Central Government can at all tax property related transactions, as they form part of the State List of the Constitution.
Assuming that the retrospective amendment is constitutionally valid, the point is that the tax becomes payable on and from 1st June 2007. Some key questions need to be answered in this regard. One such question is whether such a tax is chargeable and payable prior to the retrospective amendment coming into force. The legal position is that the tax is not chargeable or payable before this date. This would mean that landlords need to enter into a dialogue with their tenants as to how such back taxes are to be charged for the taxable periods in question and how they would be reimbursed by the tenants, as per contractual terms.
Another question is regarding interest on such back taxes. Now, Clause 76 of the Finance Bill 2010 saves actions taken between June 2007 until the date of the retrospective amendments coming into effect on any proceedings for recovery of service tax, interest, penalty, fine or charges related to the renting of immovable property. This could be interpreted to mean that should there be demands from the department to this effect, such demands will continue to have force.
However, should there not be a proceeding at all, and therefore no demand or an order related to the service tax on renting is or was in force, no interest can apply in the matter. In other words, the interpretation is that the savings provisions do not authorise the computation of interest, where no order for interest had earlier been passed. An entirely similar argument could be made with regard to penalty as well.
Independent of the above position in law, and to avoid prolonged and vexatious litigation on the point, the Government should seriously consider issuing a clarification that no interest or penalty will be required to be paid, if the service tax were to be paid immediately upon the date of coming into force of the amended provisions. Indeed, this is the only reasonable course to adopt, given that the service tax on renting per se was held not payable by the Delhi High Court and taxpayers had legitimately followed this decision and it is only now that the Government is seeking to undo the decision through the retrospective amendment in question. In such a situation, imposition of interest and/or penalty will be highly inappropriate.
In conclusion, the retrospective imposition of service tax on property rentals will have significant implications, especially where no offset of such taxes is possible, such as in retail sector. The Government needs to be sensitive to this point. It is the expectation in the forthcoming GST, such inability to offset input taxes will be addressed. Until such time however, this matter will continue to pose significant challenges.
The author is Leader, Indirect Tax Practice, PricewaterhouseCoopers
Supported by Rahul Renavikar