fiogf49gjkf0d
Service Tax
Background in brief :
Services in relation to construction activity are covered in
the service tax law under the three main categories of services in the Finance
Act, 1994 (the Act) viz.
Commercial or
industrial construction [S. 65(105)(zzq)]
Construction of
residential complex [S. 65(105)(zzzzh)]
Works contract service [S. 65(105)(zzzza)]
These taxing entries were introduced in the service tax law
at different times during 2004 to 2007.
A tremendous amount of controversy has been generated
recently on account of insertion of the following explanation in the sub-clause
(zzzzh) of S. 65(105) of the Act by the Finance Act, 2010 with effect from
1-7-2010 :
“Explanation — For the purposes of this sub-clause,
construction of a complex which is intended for sale, wholly or partly, by a
builder or any person authorised by the builder before, during or after
construction (except in cases for which no sum is received from or on behalf of
the prospective buyer by the builder or a person authorised by the builder
before the grant of completion certificate by the authority competent to issue
such certificate under any law for the time being in force} shall be deemed to
be service provided by the builder to the buyer.”
(A similar explanation is also inserted in sub-clause (zzq)
of the Act).
Consequent upon the Tribunal decision in the case of Daelim
Industrial Co. Ltd. v. Commissioner, 2006 (3) STR 124 (Trib.-Del.) and later
dismissal of Special Leave Petition filed by the department against the above
decision, already a debate was generated as to whether or not construction
services provided under any works contract were at all liable for service tax
prior to 1-6-2007 i.e. at the time of introduction of works contract service in
the service tax law.
To add to this controversy, the Supreme Court’s decision in
the case of K. Raheja Development Corporation v. State of Karnataka, 2006 (3)
STR 337 (SC) and ruling of the Authority for Advance Rulings in Re : Hare
Krishna Developers 2008 (10) STR 341 (AAR) created a controversy as regards
service tax applicability to builder/developer in cases where construction was
undertaken by a builder for a prospective customer under an agreement for sale.
The issue remained contentious on account of various clarifications and judicial
pronouncements although it was almost settled when the Board issued a
clarification vide its Circular No. 108/2/2009-ST dated 29-1-2009 inter alia
that the activity of a builder amounted to ‘self service’ and would not be
subject to service tax.
However, with the insertion of the above explanation in the
two cited sub-sections of the Act, the issue has resurfaced with even greater
force. The Government vide its Circular DOF No. 334/1/2010-TRU dated 26-2-2010
clarified the nature, background and reasons for the imposition of service tax
on the activity of sale of unit of commercial/industrial or residential complex.
An extract from the same is reproduced below :
“8.5 These different patterns of execution, terms of payment
and legal formalities have given rise to confusion, disputes and discrimination
in terms of service tax payment.
8.6 In order to achieve the legislative intent and bring in
parity in tax treatment, an Explanation is being inserted to provide that unless
the entire payment for the property is paid by the prospective buyer or on his
behalf after the completion of construction (including its certification by the
local authorities), the activity of construction would be deemed to be a taxable
service provided by the builder/promoter/developer to the prospective buyer and
the service tax would be charged accordingly. This would only expand the scope
of the existing service, which otherwise remains unchanged”.
The insertion of the explanation in both the categories of
services of construction has given rise to a number of issues as the explanation
seemingly has created a deeming fiction whereby money received by a builder or
developer for units under construction is considered a receipt towards taxable
service of construction even though the money is received towards the sale of
such unit for the reasons stated in the above circular. Assuming for the time
being that builders are liable for service tax unless they have sold the fully
completed residential or commercial unit, some important issues that emerge in
the scenario are discussed below :
It is required to note that the scope of definitions of
taxable services is extended only in respect of commercial or industrial
construction and construction of residential complex and not in the definition
of ‘works contract’ which also specifically includes contracts for construction
of commercial/industrial buildings or civil structure and contracts for
construction of new residential complex. Therefore, the question that arises is
whether intentionally no explanation was inserted under the works contract
service based on the reasoning that contracts entered into by the builders with
flat purchases are not works contracts.
Whether construction service provided for personal use of
buyer is taxable on account of the new explanation ?
The definition of the term ‘residential complex’ in S. 65(91a) of the Act specifically excludes a complex which is constructed by a person directly engaging any other person for designing/planning/ construction and is intended for personal use as residence by such person. The definition further provides that personal use includes permitting use of such property as residence by another person on rent or even without consideration. At this point, it is also relevant to note that applying criterion of personal use, CBEC in a clarification provided in respect of construction contract awarded by Government to NBCC contended to the effect that the Government buying property for its personal use from a builder viz. NBCC, the transaction of sale would not be covered by service tax. If one extends the interpretation to the situation of buying property for one’s personal use from a developer/builder, isn’t it in the fitness of things to contend that every person buying a residential unit for ‘personal use’ in terms of the definition of ‘residential complex’ inherently falls out of the purview of service tax in terms of the definition of ‘residential complex’ itself? A clarification from CBEC would put to rest the uncertainty over the vital and contentious issue at least in the case of builders of residential units to a large extent. The issue however as to the units bought for other than personal use and commercial or industrial properties still would remain open.
On going contracts as on July 01, 2010:
As the deeming provision vide Explanation is effective from 1-7-2010, services provided from this date only would be leviable to service tax. In case of ongoing construction of buildings as on this date, the issue of calculation of service tax liability arises as a number of permutations and combinations of situations are possible; such as construction completed partially, construction completed but completion certificate not received, bookings made and advances received partially and of different amount, in respect of different units etc. Further complications may arise on account of receipt of full amount in case of completed construction in respect of some units and partial receipt in respect of other units in the same building as on 1-7-2010. Further, in the same complex, some units may be only partially completed as on 1-7-2010 and therefore service as well as payment of money would be completed only after 1-7-2010. The builders/developers therefore would require proper accounts and records to facilitate such bifurcation. Typically all civil contractors issue running bills but builders/developers do not issue ‘running bills’ on prospective buyers as they only book units or flats to be sold to prospective purchasers. However, in any scenario, the ‘taxable event’ arising only on provision of service. Therefore, services provided before 1-7-2010 are not liable for service tax in case of liability arising out of deeming provisions. To ascertain the extent and stage of completion, one may have to obtain a certificate from an architect or a chartered engineer. The explanation has referred to ‘authority competent to issue completion certificate’. Vide order No. 1/2010 dated 22-6-2010, the Government has issued Service Tax (Removal of Difficulty) order, 2010 whereby it is provided that besides any Government authority, the following persons are authorised to issue a completion certificate for the purposes of sub-clauses (zzq) and (zzzzh) of S. 65(105) of the Act:
Any of the above persons thus may issue a completion certificate in respect of residential or commercial or industrial complex as a pre-condition for its occupation.
Service tax liability on advances:
When any advance is received towards a taxable service, service tax is liable to be paid. Accordingly, in normal course, advance received for services provided post July 01, 2010, the service tax liability would have arisen. However, Notification No. 36/2010 dated 28 -6-2010 has been issued to provide exemption to any amount of advance re-ceived prior to 1-7-2010 for various taxable services provided on or after 1-7-2010. The said Notification inter alia also applies to construction services in respect of residential and commercial/industrial construction services. Therefore, the entire sum of money received as advance from prospective purchasers towards any unit in a building by a builder or a developer prior to 1-7-2010 is not liable for service tax in case of construction services remaining pending to be provided in the period post 1-7-2010.
Valuation of element of ‘service’ for a builder/ developer:
Builders and developers have the options available under the law for determining their service tax liability.
- Pay service tax at prevailing rate on 25% of the gross value received where the price of the land is included.
- Pay service tax at prevailing rate on 33% of the gross value where the price of the land is not included.
[Note: In both the above options, while determining the ‘gross value’, value of goods and material supplied, provided or used is required to be added as per the condition laid down in Notification 1/2006-ST. Therefore, if the customer has supplied any material, its value will have to be added to the ‘gross value’ before working out 25% or 33% as the case may be. Further, no CENVAT credit is available, if any of the above options is selected].
- Pay service tax at prevailing rate taking benefit of Notification 12/2003-ST of 20-6-2003 under which value of the goods sold/transferred would be completely excluded and exempted.
Whether constitutional validity of the provision challengeable?
The above deeming provision applicable to build-ers/developers was challenged by them before various High Courts. The Bombay High Court in the case of Maharashtra Chamber of Housing and Industry v. UOI, (2010 TIOL 526 HC Mum.-ST) granted an interim stay to the petitioners. The Madras High Court also granted an interim stay in the case of A. P. Ravi v. UOI, (2010 TIOL 604 HC Mad.-ST).
However, recently in the case of G. S. Promoters v. UOI, 2011 (21) STR 100, Punjab & Haryana High Court has pronounced its judgment and upheld the validity of the Explanation inserted in S. 65(105) (zzzzh) . In this case, the petitioner sought to declare the Explanation to S. (105)(zzzzh) of the Act and CBEC Circular No. 334/3/2010 -TRU dated 1-7-2010 as unconstitutional. According to the peti-tioner, the Explanation enlarged the scope of the levy beyond the concept of service by including therein sale. It was pleaded that sale and purchase was beyond the legislative competence of the Union legislature. If construction activity is not undertaken by a builder, then the builder cannot be considered to be a service provider in relation to services of construction activities. The petitioner relied upon the stay granted by the Bombay High Court on this issue. They also placed reliance on the decision in the case of Magus Construction P. Ltd. v. UOI, 2008 TIOL 321 HC wherein it was held that if construction activity is not undertaken by a builder, the builder cannot be considered a service provider of construction service.
The High Court did not accept the contentions of the petitioner and made the following observations:
- Referring to the Supreme Court’s judgment in All India Federation of Tax Practitioners & Others 2007 (7) STR 625 (SC), it was observed that the Supreme Court has upheld the power of the Central Government to levy tax on services under Residuary Entry 92 of the Union List and that legal back-up was further provided by Article 268-A in the constitution vide the 88th Amendment in 2003.
- On the scope of the legislative entry, it observed that “the entries in the lists being merely topics or fields of legislation, they must receive a liberal construction inspired by a broad and generous spirit and not in a narrow pedantic sense.
- The High Court took note of the fact that there was no challenge to the effect that there was any encroachment in the legislative power of the State legislature through the above amendment except the submission that there was element of sale which was sought to be taxed.
- Relying on the decisions of State of Madras v. Gannon & Dunkerley & Co. (Madras) Ltd., AIR 1958 SC 560, Imagic Creative P. Ltd. v. CCT, 2008 TIOL 04 SC VAT and Tamil Nadu Kalyana Mandapam Association v. UOI, 2004 (167) ELT 3 (SC), the High Court observed that service tax is a tax on service and not on a service provider. Quantification of tax should not be confused with the nature of tax and discussed at length on the aspects of ‘nature of tax’ and ‘measure of tax’.
- The High Court distinguished the judgment of the Gauhati High Court in the case of Magus Constructions Pvt. Ltd. 2008 (11) STR 225 (Gauhati) by merely observing that the Circular dated 1-8-2006 issued by CBEC taken note of by the Single Member Bench of the Gauhati High Court would not apply when service recipient is a purchaser of flat. The levy of tax is on service and not on the service provider. Construction services are certainly provided even when a constructed flat is sold. Taxing of such transaction is not outside the purview of the Union legislature when it does not fall in any of the taxing entries of the State List.
In terms of the above observations made by the High Court, it was held that the contention that there is no element of service of construction involved in a builder selling a flat cannot be accepted. Whether there is a service or not has to be obtained not only from builder’s angle but also from the recipient’s angle. Only service in relation to construction is sought to be taxed and it is definitely involved when construction is carried out or before construction and before flat is sold and therefore the levy could not be held unconstitutional.
The judgment being the first final ruling by a High Court on the issue of constitutional validity has generated sharp reactions among legal fraternity on account of various issues in addition to the legal or technical issue of relevance of Article 268A of the Constitution of India and insertion of Entry 92C in the Union List as the Court has referred to it as ‘legal back-up’. Leaving this aspect aside for the time being, the other issues that arise are:
- Whether or not, the aspects of ‘nature of tax’ and ‘measure of tax’ while delivering the judgment had relevance as on examining the Explanation inserted in S. 65(105)(zzzzh), the question that arises is whether it merely deals with ‘measures of tax’ and that it maintains a nexus with the essential character of having ‘element of service’ of the levy? Or does it create only a deeming fiction by declaring the construction activity as ‘service’, when a part payment is received by a builder from a prospective buyer when essentially the trans-action is of sale of immovable property.
- Further, while distinguishing the case of Magus Construction (supra), only reference to CBEC Circular dated 1-8-2006 is made and the P & H Court has stated that the circular will not apply when service recipient is a purchaser of flat and the levy is on the service and not service provider and construction service is certainly provided. Comparing the facts of both the cases, one may hardly find any difference and therefore the ground on which the distinction is made appears not easily digestible.
Conclusion:
In view of the above, it appears almost certain that the decision would be challenged before the Hon. Supreme Court. Further, there may not be any consequence of the judgment in the jurisdiction of the Bombay High Court and the Madras High Court as they have granted the interim stay in the matter. Yet elsewhere uncertain and untoward situation for the builders as well as flat buyers may continue as attempt by the department for the recovery of service tax may be made. The issue being highly complex and contentious, judicial testing seems inevitable.
[Note: Readers may note that the subject being complex, only preliminary issues are discussed above. A few other issues including a vital issue relating to builders involved in redevelopment activity would be discussed in subsequent issue of BCAJ.]
