By S Sivakumar, FCA, FCS, MBA, ACSI, Advocate
THE very recent decision of the Delhi High Court in Suresh Kumar Bansal v Union of India 2016-TIOL-1077-HC-DEL-ST is bound to create a fresh set of controversies and confusion, insofar as the levy of service tax on the Realty Sector is concerned. Service tax on the construction of residential complexes that was introduced with effect from June 16, 2005 has continued to confuse the taxpayer and the taxman alike over the years and this decision would seem to add to this confusion.
In a case of the Builder entering into a single and composite agreement of sale of a flat to a prospective buyer, the Delhi High Court has held that, in the absence of a statutory provision or Rule to provide for the ascertaining of the value of the undivided portion of land which cannot be subjected to service tax, service tax cannot be levied. This decision has been rendered in the context of the service tax law that stood in 2011. The Court was not impressed with the argument of the Revenue that as per the abatement notification, an abatement of 75% of the entire consideration including the value of the undivided interest in land and consequently, provides for the levy of service tax only on 25% of the entire consideration. The Court has taken the view that, the in the absence of a machinery provision in the statute or in the Rules providing for a mechanism for deducting the value of the land, the very levy of service tax on the sale of an unfinished flat, in terms of a composite agreement, is invalid . The Court has referred to several decisions of the Supreme Court including the landmark decision rendered in Larsen & Toubro Ltd v State of Karnataka 2013-TIOL-46-SC-CT- LB rendered in September 2013.
Be that as it may…what are the possible implications arising out of this decision, on the Realty Sector. To my mind, this decision will apply only in cases of composite agreements involving also sale of land and not to composite works contracts, as is clear from Para 45 and other paras of the decision. Thus, this decision will not have a bearing on a large number of Builders who are following the practice of entering into two separate agreements, viz. one, for the sale of the undivided portion of the land and another, for rendering the construction services. The two agreement system, as we know, is followed by a very large portion of the Realty Sector and especially, in the South. The construction agreement is considered as a ‘works contract’ within the meaning of the VAT laws of the States and is consequently subjected to the levy of VAT. Many States allow the Builders to opt for what is known as the Composition Scheme allowing the Builders to pay VAT at a certain percentage of the construction value (like, in Karnataka) or, at a certain percentage of the total value including the value of the land (like, in Maharashtra). Levy of service tax in these cases of works contracts is largely governed by the provisions contained in Rule 2A of the Service Tax (Determination of Value) Rules, 2006 in terms of which, post 1-7-2012, service tax is levied on 40% of the construction value when the VAT on the value of the goods transferred in the course of execution of the works contract, i.e. the construction activity, is not paid on the actual value of such goods. It is clear that, in these cases, it cannot be said that the service tax rules do not provide for a machinery provision for determining the goods portion involved in the execution of the works contracts.
Taking this discussion further…many Builders who enter into two agreements, as stated above, have also opted to pay service tax on the basis of the abatement notification, in terms of which, they pay service tax on 25% / 30% of the total consideration including the value of the land. The relevant abatement notification does not specify that the option to pay service tax on 25% / 30% of the total consideration is applicable only when the Builder enters into a composite agreement and accordingly, both before 1-7-2012 and thereafter, many Builders have been paying service tax on the basis of the abatement notification, even when they enter into two separate agreements, viz. one, for the sale of the undivided interest in land and another, for rendering the construction services. In these cases also, this decision of the Delhi High Court would not apply, on facts, in my view.
It seems to me that the High Court has proceeded on the basis that a composite agreement for sale of an unfinished flat is not a works contract
In my view, even when a composite agreement of sale of an unfinished flat is entered into, it would be a case of a works contract from the VAT law point of view, as was held by the Apex Court in Larsen & Toubro Limited v State of Karnataka and this decision of the Supreme Court was, as a matter of fact, has been referred to in this decision, at several places. I am a bit surprised to note that the Delhi High Court has thought it fit not to consider the impact arising out of the binding precedent in Larsen & Toubro Limited v State of Karnataka, in this present decision, as is clear from Para 23 which is reproduced below.
23. Although such composite contracts for development of complex and sale of units therein would fall within the scope of works contract as held by the Supreme Court in Larsen and Toubro v. State of Karnataka (supra), we do not propose to examine whether services involved in construction of complexes is exigible to service tax as services in relation to execution of a works contract falling within the scope of Section 65(105)(zzzza) of the Act or under Section 65B (44) after the amendments brought about in the Act by virtue of Finance Act, 2012 – the said controversy is outside the scope of the present petitions and it would not be appropriate for us to examine it in these petitions [See Hindustan Polymers Co. Ltd. and Others v. Collector of Central Excise, Guntur: – 2002-TIOL-822-SC-CX.
It seems to me that, a composite agreement to sell a flat, when entered into before the completion of the flat, as are the facts that are applicable in this decision, would very much be a works contract, in terms of the decision of the Supreme Court in Larsen & Toubro v State of Karnataka and if this view had been accepted by the Delhi High Court, the decision could possibly have been different, inasmuch as, Rule 2A of the Service Tax (Determination of Value) Rules, 2006 would have become applicable, as the said Rule is applicable when VAT is paid or payable in terms of the VAT law, on a works contract. Once an agreement can be treated as a works contract under the VAT law, it should also be treated as a works contract under the service tax law. Therefore, in my view, the legal distinction between a composite agreement involving sale of an unfinished flat and a composite works contract involving development of and sale of a flat, is largely not that relevant, at least, insofar as the levy of VAT and service tax is concerned, in the light of the decision of the Supreme Court in Larsen & Toubro Ltd v State of Karnataka.
The impact of this decision would also be diluted in the post 1-7-2012 era inasmuch as the distinction between ‘construction of complex services’ and ‘works contract services’ has got blurred, due to the introduction of the negative list based service tax law. What can be subjected to tax is the ‘service element’ in the execution of a works contract, even when the benefit of the abatement notification No. 25/2012-ST dated 20-6-2012 is availed by the Builder.
Most national newspapers have carried reports that the Delhi High Court has struck down the service tax levy on sale of flats. The heat is already being faced by Developers/Builders as many flat buyers are asking for service tax not to be charged (or worse… for service tax already collected, to be refunded).
While allowing the writ petitions, the High Court has ordered the Department to examine whether the builder has collected any amount as service tax from the Petitioners for taxable service as defined in Section 65(105)(zzzh) of the Finance Act, 1994 (as it then existed) and has deposited the same with the respondent authorities and if so to refund to the Petitioners with interest at the rate of 6% from the date of deposit till the date of refund. I would wonder if the Builder had availed of cenvat credit and remitted the balance service tax liability, as is very likely to be the case. This decision could create a lot of difficulties in these situations.
The Centre is bound to take this decision to the Supreme Court and might also ask for a stay of this decision.
Even otherwise, if the laws that are being framed are held fragile, it would not be long before we once again have retrospective legislations becoming the order of the day!
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