REAL ESTATE DEVELOPMENT – A ‘REAL’ CONUNDRUM

GST law has recently overhauled the entire taxation scheme of
real estate development activities. Amidst discussions over inclusion of real
estate in the GST fold, the 33rd GST Council made the following broad
announcements on real estate development activities:

a)   GST to be levied at 5% on regular and 1% on
affordable housing (‘final taxes’), without any input tax credit (ITC).
Apartments up to 90 / 60 square metres in non-metro / metro cities having gross
sale value below Rs. 45,00,000 are considered as ‘affordable residential apartments’;

b)   Tax on
development rights / TDR / JDA, lease premium, FSI (‘intermediate taxes’) are
to be exempted for apartments sold pre-completion, and taxable where apartments
are sold after completion, in other words, intermediate taxes would be payable
if final taxes are not applicable.

The
philosophy behind the recommendations was stated as follows:

“i. The
buyer of house gets a fair price and affordable housing gets very attractive
with GST @ 1%;

ii. Interest of the buyer / consumer gets
protected; ITC benefits not being passed to them shall become a non-issue;

iii.
Cash flow problem for the sector is addressed by exemption of GST on
development rights, long-term lease (premium), FSI, etc.;

iv.
Unutilised ITC, which used to become cost at the end of the project, gets
removed and should lead to better pricing;

v. Tax
structure and tax compliance becomes simpler for builders.”

In view of limitations in bringing
the said amendments through primary enactments, the 34^th GST Council
adopted the route of issuing notifications to give effect to the said
decisions. The modalities of the scheme were carried out by rate notifications
and other procedural amendments. The rate notifications are the subject matter
of discussion in this article:

Notification 3/2019 – CT(R): Beneficial rates for pure
and mixed residential real estate

____________________________________________________

1    These rates are aggregate GST rates after
considering the ad hoc land deduction of 33.33%

2    RREP represents a real estate project where
carpet area of commercial apartment is not more than 15%. An REP represents all
the other real estate projects as covered by the RERA law

3    Ongoing projects
represent those cases where commencement certificate has been issued prior to
01-04-2019, actual construction has commenced, the project has not received its
completion / occupancy certificate and at least one apartment has been booked
in such a project. New projects are those which commence after 01-04-2019

Note 1: Cumulative
conditions for the beneficial rate of 1% / 5%

i.    The
taxes should only be paid in cash and not by ITC;

ii.    ITC on goods and services has not been
availed except to the extent of the completed construction activity / supply as
specified in Annexure I / II of the notification. Adverse variance between
computed and availed ITC should be paid either by credit / cash. Favourable
variance permits the developer to take additional ITC to meet the shortfall;

iii.   Landowner’s
area share⁴ – Developer to pay the tax on constructed area and the
landowner would be entitled to ITC only against taxable supplies (i.e.,
pre-completion supplies);

___________________________________________________

4    Landowner
promoter is the person who transfers land / development rights / FSI to a
developer promoter against area share in the project

iv.   80/20
rule – 80% of input / input services (other than grant of development rights /
lease premium, FSI, etc., electricity, diesel / petrol, etc.) are from
registered persons. Shortfall is liable to tax @ 18% on reverse charge basis
(RCM). In case of cement, it is expected that the entire material is purchased
from registered persons and any shortfall on this front would be liable to tax
@ 28%. The tax liability on account of the shortfall of RCM would have to be
paid by the end of the quarter following the financial year. In case of cement,
the tax would have to be paid in the same month itself;

v.   Project-wise
computations and accounts to be maintained to justify compliance of above
conditions. ITC not availed is required to be reported in the specified column
of GSTR-3B as being ineligible ITC.

Note 2: Conditions
for continuing with the regular rate of 8% / 12% for ongoing projects

i.    It
is mandatory to exercise the option of continuing in old scheme within the
specified time limit of 10^th May, 2019 (extended up to 20^th
May, 2019). Where the option is not exercised, the new rates / conditions would
automatically be considered as applicable.

Note 3: Conditions
to be satisfied by works contractor

i.    Aggregate
carpet area of affordable residential apartments is more than 50% of the total
carpet area of all apartments.

ii.    In
cases where the above threshold drops below 50%, the beneficial rate would be
denied and developer would have to repay the differential tax on reverse charge
basis

Notifications
4/2019 –CT(R): Exemption to intermediate taxes subject to RCM

Note 4: Cumulative
Conditions for the exemption

i.    Exemption
would be limited to the proportionate residential carpet area of the project;

ii.    Developer
would be liable to repay the tax under reverse charge on the proportionate
value of flats remaining unbooked as on date of issuance of completion
certificate. The tax payable is limited to 1% of value of unbooked affordable
and 5% of booked regular residential apartments, i.e., extent of final taxes
otherwise applicable prior to completion;

iii.   The
above liability would be payable on the date of completion / first occupation
of the project, whichever
is earlier;

iv.   Value
of the above services would be the fair market value of residential /
commercial area allotted to the transferor of development rights / FSI nearest
to date of allotment.

Notifications
5/2019 – CT(R): RCM of
intermediate taxes

Notifications 6/2019 – CT(R):
Special procedures for developers (Section 148): Developers receiving
development rights / long-term lease of land on or after 1^st April,
2019 would be granted ‘deferment’ of payment of RCM taxes up to issuance of
completion certificate or first occupation, whichever is earlier.

Notifications 7/2019 and 8/2019 –
CT(R) (Section 9(4), 15(5)): Enabling notifications for payment of RCM on
procurements from unregistered persons beyond the 80/20 rule. The notifications
also provide for RCM on procurement of all capital goods from unregistered
persons and such goods do not form part of the
80/20 rule.

KEY CONCEPTUAL CHALLENGES UNDER NEW SCHEME

Without going into the
constitutionality and / or the vires of the statute to tax real estate
transactions, including development rights / TDRs, FSI, lease premium, etc.,
the key conceptual issues under the new scheme have been discussed herein:

Issue 1 – Whether the real
estate notification(s) is a rate notification / exemption notification? If it
is a rate notification, is it permissible to place conditions in rate
notifications?

Unlike VAT / Excise / Service tax
laws where the base rates are statutorily fixed with exemption powers being
delegated to the Government, the GST law has delegated both the rate fixation
(u/s 9[1]) and exemption powers (u/s 11[1]) to the Government(s) which gives
rise to the confusion over the powers which are being invoked while prescribing
tax rates.

Rate fixation (commonly termed as
tariff / scheduled rate) is an absolute power u/s 9(1). The section requires
the Government to notify tax rates on all supplies with a cap of 40%. Once the
tariff rates are fixed, tax payers are bound by it with absolutely no
flexibility. Section 11(1) then permits the Government to grant exemptions (a)
wholly or partly; (b) in public interest; and (c) with or without conditions.
An exemption always presupposes a fixed base rate. Notifications under both
these sections have to be backed by recommendations from the GST Council.

In this context, the Supreme Court in
Associated Cement Company vs. State of India & others (2004) 7 SCC
642 had stated as follows:

The question of exemption arises
only when there is a liability. Exigibility to tax is not the same as liability
to pay tax. The former depends on charge created by the Statute and latter on
computation in accordance with the provisions of the Statute and rules framed
thereunder if any. It is to be noted that liability to pay tax chargeable under
Section 3 of the Act is different from quantification of tax payable on
assessment. Liability to pay tax and actual payment of tax are conceptually
different. But for the exemption the dealer would be required to pay tax in
terms of Section 3. In other words, exemption presupposes a liability. Unless
there is liability question of exemption does not arise. Liability arises in
terms of Section 3 and tax becomes payable at the rate as provided in Section
12. Section 11 deals with the point of levy and rate and concessional rate.

This decision implies that the
Governments ought to fix the base rate liability for the public at large and
then proceed to grant exemptions in specific circumstances. In GST, the rate
fixation powers are absolute powers with an upper cap of 40%. It appears that
the Governments have thoroughly mixed both these distinct and independent
powers and notifications are issued for effective rates without any base rate
fixation. If one were to examine the GST Council discussions until 1^st
July, 2017, the agenda of rate fixation culminated into the said rate slabs –
5%(necessities), 12% (processed commodities), 18% (standard commodities and
services), 28% (luxury products) and NIL rate. The entire exercise of rate
fixation by the fitment committee after the 14^th Council meeting
also categorised the rates into the above five rates only. In respect of
services, rates were fixed for taxable services keeping in mind the erstwhile
service tax rates and with majority of the service tax exemptions being
adopted. Therefore, the consensus over services was to tax them at a base rate
of 18% with concessions being given for specific categories.

Let’s take a look at the
notifications issued at the inception of GST which define the rate / exemption
structure:
N– 01/2017 fixed rates for goods u/s 9(1) – this contained a basket of four
rates, i.e., 5% / 12% / 18% and 28%;
N–02/2017 exempted goods u/s 11(1) containing all the NIL rated goods; N–11/2017
was issued u/s 9(1) and 11(1) providing service tax rates between 5%-28% – each
four-digit SAC classification (adopted from the internationally-accepted
standards) was assigned a single rate and in case there were multiple rates
under a single four-digit SAC, the SAC generally contained a residual category
with 18% rate; and N–12/2017 was issued u/s 11(1) exempting services with or
without conditions. The above actions of the GST Council and Governments convey
that services generally had a base rate of 18% and goods had a base rate under
five categories as proposed by the fitment committee.

However, the legal process adopted by
the Governments over rate fixation poses a serious question over all
notifications and in particular the subject real estate notifications which
have prescribed rates and corresponding conditions. The real estate
notification contains various conditions w.r.t. input tax credit, RCM payment,
landowner terms, etc. Placing conditions in rate notifications is clearly not
permissible u/s 9(1). Though the notification also spells out section 11(1) as
its source of power, the above verdict of the Supreme Court presupposing a base
rate liability would come into play. Consequently, ‘conditions’ under the real
estate notifications may be read down as beyond statutory powers.

The alternative view would be that
the Government(s) being the custodian of both powers can choose to combine the
powers and notify the effective tax rates rather than duplicating the process.
While this is certainly alien to indirect tax legislation, it is a possible
view that can be adopted to validate the actions of the Council /
Government(s). In such a scenario, the residuary entry specifying the peak rate
under each service heading could be termed as a base rate, i.e., cases where
the conditions of the specific entry are violated, one may be relegated to the
residuary entry.

Issue 2 – Whether the new real
estate scheme is optional / mandatory?

The new scheme with drastic reduction
in tax rates appears to be highly beneficial from a customer’s standpoint but
raises cost arithmetic of the developer (due to ITC restrictions) requiring a
change in the base price to consumers. This mathematical problem poses a
question whether this new scheme is mandatory at all.

The GST Council and press releases
suggest that the new scheme is mandatory for all new projects and ongoing
projects where the option to continue under the old scheme is not exercised.
The original entry has been completely substituted with this new entry and the
residuary entry specifically excludes services specified in the table from its
ambit.

The issue is also inter-linked with
the fundamental issue of whether N–03/2019 is a ‘rate notification’ or an
‘exemption notification’. It is settled law by the Supreme Court that rate
specifications are mandatory and conditional exemptions are optional.

A cursory view of N–03/2019 clearly
depicts that the notification emerges from ‘public interest’ (refer press
release), contains conditions for availment and has limited its applicability
based on certain parameters (such as flat area, REP conditions, project start
date, etc.). Though both section 9(1) and 11(1) have been invoked, Governments
would certainly be placed in a tricky situation while defending the real estate
rates as being a compulsory levy (as a tariff) or an optional levy (as an
exemption). Where it is contended that the levy is compulsory, all conditions
(such as ITC, RCM, etc.) then stand as a violation of section 9(1) and where it
is contended that the said notification is an exemption with prescriptive
conditions, the notification would be treated as optional.

The implication of treating the entry
as being an exemption also raises a parallel question over the base rate. The
answer to this may probably lie in the residual entry (clause xii) which taxes
services at 18% if not classified elsewhere (though the explanation bars
classification for all the aforesaid real estate entries).

Issue 3 – Can a notification
take away validly availed ITC on transition?

N–03/2019-CT(R) requires the
developer to re-state the ITC balance as on 1^st April, 2019 for new
and on-going projects under the beneficial rate scheme based on futuristic
arithmetical formulation. Annexure I and II of the said notification specify
the ITC to be retained / repaid based on an extrapolatory formula once the
beneficial rates are availed. The intent is to deny dual benefit of low tax
rate and ITC during the transitory phase, especially where percentage of
construction and percentage billing are at variance.

In
simple terminology, the formula attempts to extrapolate the actual ITC availed
on inputs or input services (whether utilised or not) up to 31^st
March, 2019 to a statistical number until project completion. This is then
proportionately reduced for residential or commercial apartments booked prior
to 1^st April, 2019 to the extent of instalments collected from such
apartment buyers. For example, Rs. 10 ITC on a project which is 10% complete is
extrapolated to 100 and then attributed to the value of advances for booked
apartments until 1^st April, 2019 for which tax would have been
payable at the original rates. Assuming 20% flats are booked as on 1^st April,
2019 and 25% of the advance has been collected, the restated ITC would be Rs. 5
(100*20%*25%). Since the developer has already availed Rs. 10, the balance Rs.
5 becomes repayable as excess ITC availed. If there is a shortfall, the
developer becomes entitled to take additional ITC to the extent of the
shortfall. In effect, ITC would be available only to the extent of value of
supply taxed at rate 8% / 12%.

The said formulation is based on
multiple statistical assumptions:

a)   Uniformity in ITC availment during the tenure
of the project;

b)   Similarity in the schedule of advance
payments from customers;

c)   Consistency on the pattern of construction by developer;

d)   Correlating percentage of invoicing with
percentage of construction completion;

e)   Accuracy of total project costs, etc.

In a transaction-based levy, has the
Government been empowered to restrict ITC based on statistical results? Is it
also empowered to retroactively reverse ITC rightfully availed and / or
utilised? The answer may probably be NO. The Supreme Court in various instances
has held that ITC rightly availed in compliance with statutory provisions on
the date of availment is as good as ‘tax paid’. It is an absolute right which
cannot be withdrawn, more so by delegated legislations. The Supreme Court has
also stated that ITC is a benefit / concession and hence statutory conditions
need to be strictly complied with.

The notifications have been issued
drawing powers from section 11(1) which permits prescription of certain
conditions for complete or partial exemptions. Explanation 4(iv) to the
notification requires that ITC is reversed as a condition to the availment of
the exemption. This seems to be the apparent source of power for the
Government.

But, section 17(1) and (2) specify
reversal of ITC only in cases of wholly exempt supplies and does not extend to
partially exempt supplies. The section also does not envisage any delegation of
powers for restricting ITC. Section 16-18 permits reversals of validly availed
ITC to the electronic credit ledger only through statutory provisions. However,
the notification requires reversal of ITC of both availed and utilised ITC. The
notification fails to appreciate that attribution of an input invoice
(especially services) to a taxable / exempt activity can be performed only at
the time of its availment and once the credit is rightfully availed, it loses
its original identity. Therefore any attempt to trace a credit after availment
/ utilisation to a taxable / exempt activity for purpose of reversal in
computations would be a futile and inaccurate exercise.

Another issue in this condition is
whether this reversal is ‘person specific’, ‘project specific’ and / or ‘period
specific’. While the notification says that the accounts are to be maintained
project-wise, the computation mechanism gives mixed views – for example, where
a project is taken over by a new developer, would the incoming developer have
access to this 80/20 criterion from project inception or from its take-over?
The formula certainly does not capture this scenario. What happens where there
is a shortfall in the 80/20 rule in initial years (due to sand / jelly
purchase) and sufficiently complied when viewed from a project level at its
finishing stages? The notification suggests that each year is independent on
this front. The press release states that the calculation has to be performed
project-wise and year-wise.

On the other hand, there is an
attempt (through amendments in Rule 42) to reverse credit based on ‘carpet
area’, a clear departure from the requirement of section 17 which specifies
‘value’-based computations. Rule 42 goes on to require reversal right from the
commencement of the project without considering the year of availment of the
credit. This clearly disturbs the uniform law that ITC is final by the end of
the September returns following the financial year closure. Real estate
projects which face delays crossing more than five years would be saddled with
the task of going back to the origin of the project. Thus, one school of
thought clearly raises red flags over the vires of the notification to
prescribe reversal of ITC from multiple fronts.

The other conservative school of
thought would be that real estate notifications are more akin to exemption
notifications and the powers of conditional exemptions are wide enough to
provide substantive and procedural conditions, and this would cover ITC
restrictions in any form even though not empowered under the ITC provisions.
Being an optional notification and having opted for the exemption, one may have
to strictly abide by the conditions of exemption or otherwise continue paying
tax at the higher rate.

Issue 4 – Whether imposition of
RCM under 80/20 procurement rules, booked / unbooked apartment ratio rule,
i.e., on future contingencies, is a sustainable legal condition?

80/20
procurement rule

N–07/2019 imposes RCM on the
developer where the procurements of the project from registered persons fall below
80%. Tax is to be paid at 18% on the shortfall on reverse charge basis except
for cement which is taxable at 28%. There is a requirement of apportionment of
credit exclusively to commercial segment at standard rate, commercial segment
at beneficial rate, residential segment at beneficial rate, common credits and
then test the same at the project level. This condition has certain
shortcomings:

a.   This
condition is based on an outcome which may be known only at the end of the
financial year;

b.   In
a transaction levy regime where ‘supply’ has to be identified, it appears to
defeat the basic cannon of taxation of identifying the subject of levy;

c.   The
notification imposes a tax on an ad hoc figure @ 18% which clearly runs
contrary to the requirements of section 9(3)/9(4). These sections envisage only
a ‘supply / transaction’-based RCM levy and not a result-based RCM levy;

d.   One
would not be in a position to raise the self-invoice on RCM transactions of
9(4) under 80/20 rule.

Unbooked
apartment RCM rule

N–04 and 05/2019 impose RCM on
intermediate transactions to the extent of unbooked residential apartments at
the end of the project. This is on the premise that unbooked completed
apartments are outside the ambit of GST. The tax payable is determined based on
carpet area ratios of booked / unbooked apartments, a ratio completely foreign
to GST law. Such ratios also deviate from the economic value-add of a service
and result in disparity in the cost burden to end-customers on the basis of
carpet area ignoring commercial value. Moreover, it appears to be a back-door
entry to tax completed apartments also evident from the cap fixed to that of
underconstruction apartments.

The
fundamental rule of taxation is that there should be certainty on the subject,
time and measure of levy. The Supreme Court in Govind Saran Ganga Saran
vs. Commissioner of Sales Tax and Ors (1985 AIR 1041) held that the
components which enter into the concept of a tax are well known. The first is
the character of the imposition known by its nature which prescribes the
taxable event attracting the levy, the second is a clear indication of the
person on whom the levy is imposed and who is obliged to pay the tax, the third
is the rate at which the tax is imposed, and the fourth is the measure or value
to which the rate will be applied for computing the tax liability. If these
components are not clearly and definitely ascertainable, it is difficult to say
that the levy exists in point of law. Any uncertainty or vagueness in the
legislative scheme defining any of those components of the levy will be fatal
to its validity. These futuristic conditions appear to make the levy uncertain
and vulnerable to challenge.

Issue 5 – Notification grants
benefit to ‘A’ by fulfilment of conditions by ‘B’?

The notification distinctly has
scenarios where benefit to one is subject to the actions of another. This is
absurd

Instance 1: N–03/2019 grants
beneficial works contract rate for affordable housing projects to contractors
subject to fulfilment of the minimum 50% carpet area by the developer. The
exemption is topped with a condition that any shortfall in area would result in
withdrawal of exemption by way of an RCM payment by the developer. Moreover,
the notification 7/8-2019 does not back this levy with an amendment in the RCM
table u/s 9(3).

Instance 2: N–03/2019 grants
beneficial rates to developer provided landowner discharges all the taxes on
his share of apartments sold prior to completion and reversal of ITC on
unbooked apartments. Non-fulfilment of conditions by the landowner on his share
may adversely affect the availment of beneficial rate.

The above conditions of the
notification would necessarily have to be whittled down suitably for its
sustenance.

Issue 6 – Whether condition of
prohibiting tax payment through credit is within the vires of tax
discharge?

N–03/2019 mandatorily directs the
developer to discharge all beneficial rate taxes only through cash. This rule
emerged from discussions in the GST Council that developers are discharging
only 1-5% of their output through cash ledgers. With this assumption, the
Council decided that the new scheme debarring availing of input tax credit
should not result in any credit balance and hence payments should be directed
to be made through cash ledgers only. This runs contrary to the mandate of
section 49(4) which permits rightful electronic credit ledger balance to be
used for payment of any output taxes. Input tax credit is as good as tax paid
and differential treatment to this would defeat this value-added tax scheme.
Developers having input tax credit balance would be left with a dead number if
it is not permitted to be utilised against output taxes. For a developer
engaged only in construction activity, this condition effectively lapses the
input tax credit balance accumulated over the years of operation of the
company.

Issue 7 – What would be the
implication in case of change in any variable of the real estate project (such
as cancellation of flat, valuation of affordable flat, change in project
composition, cancellation of project, etc.)?

The
real estate notification has set up a complex matrix based on project variables
such as apartment dimensions, residential to commercial composition, pre- and
post-1^st April, 2019 flat inventory, etc. For example, a new
commercial plan may emerge in the third year of the project reclassifying the
project from an RREP to an REP. This changes the entire dynamics of rate
structure and transitional ITC working right from 1^st April, 2019.
Another example could be a flat previously treated as booked and WIP as on 1^st
April, 2019 is subsequently cancelled. Clause 22 of the real estate FAQ
provides some guidance on this matter but this has multi-faceted implications
on RCM, ITC, etc. The notification does not provide for any claw back of
previous workings. The developer would fall into a situation where the entire
cost structure is impacted and the burden of additional taxes cannot be
recovered from any one. Once again, the Supreme Court’s verdict in Govind
Saran Ganga Saran (supra) may come to the rescue of the tax payers.

The above complexities are just the
tip of the iceberg. The real estate notifications have been intermingled with
the RERA law which is itself in an adolescent stage – any ambiguity will have
repercussions on tax computations, making it difficult for managements to take
decisions. The functioning of this entire scheme through exemption
notifications makes matters very complex. A tax payer who is denied exemption
on certain facts on a future date would be placed in severe hardship as there
is no mechanism to undo all compliances ancillary to the exemption and
reinstate it to the base rate scenario. A fundamental question also lingers
whether this is interfering with fundamental rights in taking business
decisions?