Liability of Builders — “K. Raheja” explained

It is well understood that sales tax (VAT) may be levied on
sale of goods and not on sale of immovable properties, and the transactions of
sale of flats, offices, etc. are in the nature of sale of immovable properties,
hence the same are outside the purview of sales tax laws. However, there may be
a situation where the builder or developer may commence construction activity
for building, etc. and while the construction is on, the builder may enter into
an agreement with the prospective buyer for sale of premises. These are normally
referred to as ‘Under-Construction Contracts’. The controversy is about the
above transactions. The Revenue Department is of the opinion that the work
carried on by the builder/developer, after entering into such Under-Construction
Contract, is liable to sales tax as works contract. The argument is that since
there is an agreement for sale of premises and the work, using the property of
the builder, is done after such agreement, the property used in such work can be
said to have been transferred in the execution of works contract and hence the
liability will accrue. In fact this was the issue taken up by the Sales Tax
Department in Karnataka in case of K. Raheja. The matter went to the Supreme
Court.

The Supreme Court delivered its judgment in 2005 in the case
of K. Rehaja Construction, which is reported in 141 STC 298. Based on this
judgment, the Department is taking a view that all under-construction agreements
are liable to sales tax as works contracts. A similar view is also tried to be
adopted by the Sales Tax Department of Maharashtra as is evident from Circular
issued by the Commissioner of Sales Tax bearing No. 12T of 2007, dated 7-2-2007.
In the ‘Sales Tax Corner’ of BCAJ (March, 2007), we have analysed the position
and observed that in spite of the judgment in the case of K. Raheja, all the
under-construction agreements cannot be liable to sales tax. The distinguishing
features in K. Raheja were also highlighted. In the case of K. Raheja, there
were in fact two separate agreements, one for sale of land and other for
construction, though embodied in one agreement. It is under these circumstances,
the Supreme Court observed that there is a separate sale of land and a separate
contract for construction. Therefore it was held by the Court that it is a works
contract liable to sales tax. In light of the above observations of the Supreme
Court it was pointed out that if in the under-construction contract the price of
land is not mentioned separately, then the judgment in the case of K. Raheja
cannot apply.

Recently the Gauhati High Court had an occasion to deal with
similar controversy in the case of Magus Construction Pvt. Ltd. and Others v.
Union of India, (15 VST 17). The issue was in relation to service tax on
builders. While deciding the issue, the High Court has dealt with the effect of
the judgment of K. Raheja. A gist of the judgment is as under :

The petitioner was involved in development and sale of
immovable properties like, flats, etc. They entered into ‘flat purchase
agreements’ with various purchasers, wherein the petitioner-company allotted and
sold flats to the purchasers. The petitioner-company entered into an agreement
for sale of flat, which was registered. The Service Tax Department issued notice
on the ground that the petitioner- company is providing ‘Commercial or
Industrial Construction Service/Construction of Complex Service’. The
petitioner-company filed writ petition before the High Court and contended that
the transaction between the petitioner and the flat purchaser was purely a
transaction of sale of flat (i.e., sale of immovable property) and not a
contract for rendering of service of any nature whatsoever.

The High Court observed that in the case of
petitioner-company, the petitioner was not shown to have undertaken any
construction work for and on behalf of proposed customer and the title in the
flat passed to the customer only on execution of sale deed and registration
thereof. Until the time the sale deed was executed, the title and interest
including the ownership and possession in the construction made remained with
the petitioner. The construction activities which the petitioner had been
undertaking were in respect of the petitioner’s own work and it was only the
constructed work which was sold by the petitioner-company to the buyer, who
might have entered into agreement for sale before construction had actually
started or during the progress of construction activity. Any advance made by a
prospective buyer was against the consideration for sale of flat to the
prospective buyer and not for the purpose of obtaining services from the
petitioner. Under the above circumstances, the Gauhati High Court held that the
transaction cannot be liable to service tax.

The same principle will apply even for deciding the liability
under sales tax laws. As there is no element of rendering services while
selling the flat, similarly there cannot be sale of material, as ultimately in
such an agreement the flat, an immovable property is sold.

Amongst others, in relation to the judgment of K. Raheja, the
High Court observed as under :

35. Further, in K. Raheja Development Corporation (2005) 141 STC 298 (SC); (2005) 5 RC 105; (2005) 5 SCC 162, the Apex Court was considering the issue relating to ‘sales tax’ and the issue therein was not at all related to ‘service tax’. While interpreting the provisions of ‘sales tax’ under the Karnataka Sales Tax Act, 1957, the Apex Court held in K. Raheja Development Corporation (2005) 141 STC 298 (SC); (2005) 5 RC 105; (2005) -I 5 SCC 162, that the definition of ‘works contract’ given under the Finance Act, 1994 is very wide and is not restricted to the ‘works contract’ as commonly understood, i.e., a contract to do some work on behalf of someone else. The Apex Court, therefore, held as under (at page 302 of STC) :

“…..The definition would  therefore  take within its ambit any type of agreement wherein construction of a building takes place either for cash or deferred payment, or valuable consideration. To be also noted that the definition does not lay down that the construction must be on behalf of an owner of the property or that the construction cannot be by the owner of the property. Thus even if an owner of property enters into an agreement to construct for cash, deferred payment or valuable consideration a building or flats on behalf of anybody else it would be a works contract within the meaning of the term as used under the Finance Act, 1994./1

36. In K. Raheja Development  Corporation  (2005) STC 298 (SC); 2005 5 RC 105; (2005) 5 SCC 162, the agreement provided that K. Raheja Development Corporation, as developers, on its own behalf, and also as developer for those persons, who would eventually purchase the flats, do the construction works. Thus, K. Raheja Development Corporation was not only undertaking construction work on its own behalf, but also on behalf of others who were prospective buyers. It is, in such circumstances, that K. Raheja Development Corporation was treated to have been doing the ‘works contract’. In the present case there is no material to show that the petitioner-company constructs the flat/ apartments on behalf of the prospective allottees and, hence, it cannot be said that the constructions done by the petitioner-company are the constructions undertaken by the petitioner-company for and on behalf of their prospective buyers/allottees. Thus, there is no ‘service’ rendered by the petitioner-company to the prospective allottees. Similar view has been taken by the Allahabad High Court in Assotech Realty Private Limited v. State of Uttar Pradesh, (2007) 8 VST 738, wherein the Court has held as under (atpage  759):

“……In the present case, we find that  the petitioner is constructing the flats/ apartments not for and on behalf of the prospective allottees but otherwise. The payment schedule would not alter the transaction. The right, title and interest in the construction continue to remain with the petitioner. It cannot be said that the constructions were undertaken for and on behalf of the prospective allottees and, therefore, the constructions in question undertaken by the petitioner would not fall under clause (m) of S. 2 read with S. 3F of the Act and are outside the purview of the provisions of the Act. In other words, they cannot be subjected to tax under the Act and the action, in imposing tax on such constructions treating them to be works contract, is wholly without jurisdiction ….