In a significant change in taxation of transactions for sale of property before construction is completed, the Finance Bill 2010 proposes to levy service tax deeming such transactions as ??services??.
Service tax already applies on services provided by a construction company to a developer, whether the property is for commercial use or residential use (however, there are some exclusions: Residential construction less than 12 dwelling units is not liable). By way of an explanation, this is proposed to be extended to cover transactions between the ??builder?? (read developer) and buyer of the property or a unit in the property. The test laid down to determine what gets taxed under this explanation it has been provided that all cases where the whole or part of the payment is made by the buyer to the developer before a completion certificate is received from the local authority (say, municipal corporation), the transaction between the two would partake the nature of a service of ??construction?? being provided by the developer to the buyer.
The genesis of this appears to be in the view expressed by the Supreme Court in the case of K Raheja, which has been referred to the larger bench of the SC. The principle possibly being applied is that if the construction activity is performed after the underlying land or interest in underlying land is transferred to the prospective buyer, such construction would be a service to meet the obligation of providing a constructed building on the land so transferred. In other words, the prospective buyer first become owner or co-owner of the land; post which the construction (or part thereof) is carried out. In such case, work is being done by the developer on a property belonging to the buyer, and thus a works contract?ie supply of goods in the course of provision of services.
A clarification issued by the Revenue suggests that the above types of transactions would be covered by the explanation. It may be a matter of debate on whether the explanation is at all necessary to cover the above case, as the current definitions are fairly wide to address ??construction?? services.
The explanation could have wider implications. It may also cover cases where the above two step contract structure is not followed. For example, there may be only a single ??agreement to sell?? between the developer and the buyer, where the buyer would be granted possession of the property after the building is constructed and completion certificate is received. It is possible that in such cases, the buyer never gets any title to the land directly. The land is transferred to a co-operative housing society after possession is granted to various buyers and they come together and create a housing society. Such cases are distinguishable from the previous example. It has been held by the Allahabad High Court in the Assotech Realty case that such arrangements are not agreement for construction services and therefore not works contracts.
If we examine the fiction that is intended to be addressed by this Explanation, the Revenue clarification states that there are several models of transactions between the developer and buyer for under construction property which have lead to differing practices and disputes on what is liable to service tax and what is not. To bring ??parity in tax treatment??, a sweeping Explanation is being added with a deeming fiction. It suggests that the legislative intent is being given due effect. By this reasoning, it appears that the intention is to tax all transactions relation to under-construction properties, whether or not a service is involved. Whether this would stand the test of judicial scrutiny remains to be seen.
There is no discussion on deduction for value of land. In cases where land or interest in land is not being transferred through a separate agreement, it is possible that the value of land in the price of the property would also suffer service tax.
This may be challenged as the Centre does not have power to levy tax on sale of land. The provisions may be amended to provide for a method to ascertain the value of land, which can then be deducted before arriving at the value liable to service tax.
Overall, it appears that realm of service tax is being extended to cover transactions that were typically viewed as transactions in immovable property. This is likely to be intensely debated.
(The writer is Partner and Leader of Indirect Tax, BMR Advisors. With inputs from Divyesh Lapsiwala, Director. Views are personal.)