Redevelopment of properties (commercial/ residential):
Background:
During the past decade, redevelopment of society/ properties has tremendously increased mainly in metropolitan cities like Mumbai. Increased redevelopment activities have inter alia attracted attention of the Preventive/Anti-Evasion Wing of the Service Tax Dept. and inquiry is initiated or show-cause notice is issued in this regard. Some of the significant implications impacting redevelopment activity are discussed hereafter.
Common features in redevelopment:
Some of the commonly found features redevelopment arrangements are listed below:
(i) Societies usually own buildings and are often lessees of the land owned by MHADA/other bodies on which the building is built;
(ii) These societies are entitled to additional FSI under relevant regulations or statute, which can be used for development upon payment of appropriate premium;
(iii) Such societies grant development right to the builders/developers to demolish existing building and construct new buildings. Builders/ developers pay the appropriate premium for additional FSI entitled to the society and utilise the same for additional construction and/or development;
(iv) Each existing occupant in the building of the society, is given a flat/office in the newly constructed building of a bigger area than the existing area free of cost or without any additional consideration;
(v) The entire cost of new building and other related cost is fully borne by the builders or developers;
(vi) Builder or the developer is fully entitled to the proceeds from sale of remaining flats/ shops/ commercial premises to be constructed by him on the society’s properties through sale in the open market; and
(vii) Existing occupants also receive a specified monetary compensation and reimbursement towards rentals for alternate accommodation during the period of demolition of old building and construction of new building.
Any redevelopment arrangement between a builder or a developer and the society is mutually beneficial to all the affected parties or can be described as a barter deal inasmuch as:
(i) In addition to monetary compensation and reimbursement of rentals, existing occupants get a flat/office of a higher area in a newly constructed building at no extra cost;
(ii) The society would get newly constructed property with enhanced area and improved or better facilities;
(iii) Builders/developers gain through realisation of sale/proceeds of additional flats/commercial premises at market price which far outweighs the cost of obtaining additional FSI, construction cost of the new building and payment of rentals to existing occupants, all put together.
Redevelopment: Whether a service by a builder or developer?
Service tax authorities have issued show-cause notices contending that the builders/developers do not own the property undertaken for redevelopment and ‘service’ is therefore provided by the builder/developer to the society. The issue therefore needs to be analysed in detail.
In order to be liable to service tax, it is essential that, ‘service’ is provided by a service provider. The term ‘service’ is not defined under the Finance Act, 1994 (‘Act’). However, some meanings attributed to ‘Service’ are as follows:
(i) ‘Service’ — Black’s Law Dictionary:
The act of doing something useful for a person or company for a fee.
A person or company whose business is to do useful things for others, a linen service.
An intangible commodity in the form of human effort, such as labour, skill, or advice, contract for services.
(ii) ‘Service’ — Magus Construction Pvt. Ltd. v. UOI, (2008) 11 STR 225 (Gau.)
In the said ruling, the following was observed by the Gauhati High Court:
Para 29 “In the light of the various statutory definitions of ‘service’, one can safely define ‘service’ as an act of helpful activity, an act of doing something useful, rendering assistance or help. Service does not involve supply of goods; ‘service’ rather connotes transformation of use/user of goods as a result of voluntary intervention of ‘service provider’ and is an intangible commodity in the form of human effort. To have ‘service’, there must be a ‘service provider’ rendering services to some other person(s), who shall be recipient of such ‘service’.”
(iii) Service — Jetilite (India) Ltd. v. CCE, (2011) 30 STT 324 (New Delhi — CESTAT)
An extract from the Tribunal’s observation is provided below:
Para 65 “Being so, taking into consideration the common understanding of the definition of the term ‘service’ as well as the definition of the term ‘taxable service’ under the said Act, it is evident that the service contemplated under section 65(19) is the one which relates to service rendered by the service recipient. It may be taxable service or may not be so. However, the situation invariably contemplates existence of two entities in order to bring the case within the scope of definition of business auxiliary service. One entity which provides service to others is called a service recipient. Another entity is one which provides service to the service recipient in relation to the service rendered by such service recipient to others, and such entity is called the service provider.”
Considering the fact that different types of redevelopment agreements are entered into between the societies and the builders/developers, it would be impossible to lay down any general proposition as to whether a redevelopment arrangement results in a service provided by a builder/developer to a society or not.
A redevelopment arrangement is usually for the mutual benefit of the affected parties to the contract. Though not described, it appears to be in the nature of a joint venture arrangement, wherein role of each party is specified and contracted for. Hence, there is a possibility of a view depending on the terms of an agreement that redevelopment arrangement does not result in any ‘service’ provided by builders/developers to the societies. At the most, services performed in pursuance of redevelopment arrangement by builders/developers, amount only to self-service which cannot be subjected to service tax.
In this regard the following observation of the Tribunal in Rolls Royce Industrial Power (I) Ltd. v. Commissioner, (2006) 3 STR 292 (Tribunal) may be noted:
“……………….. The terms of the contract do not envisage or involve providing any consulting or engineering help to the owner. The operator is fully autonomous and responsible for the performance of operation and maintenance. Whatever engineering issues are involved, it is for the operator to find solutions for, and attend to in the course of operation and maintenance. He is not required to render any advice or to take any orders from the owner. He cannot pass on the responsibility for operating the plant in any manner to the owner. Thus, there are no two parties, one giving advice and the other accepting it. Service tax is attracted only in a case involving rendering of service, in this case, engineering consultancy. That situation does not take place in the present case. Therefore, we are of the opinion that the duty demand raised is not sustainable”
Attention is also drawn to the following observation of the Bangalore Tribunal in Precot Mills Ltd. v. CCE, (2006) 5 STT 35 (Bang.-CESTAT)
“………………
M/s. Precot Mills Ltd. is a corporate entity. It has got various units which function as separate profit centres. When service is rendered by one unit to the other, debit note is raised for the value of service in order to evaluate the perfor-mance of a particular unit. Ultimately there is only one balance sheet for the legal entity for M/s. Precot Mills Ltd. and not for the separate unit. In other words, the appellants, M/s. Precot Mills Ltd. do not receive any valuable consider-ation for service rendered by one unit of the appellant to the other unit, in view of the fact that each unit is part of the same legal entity which is the appellant. To put it differently, when one renders service to oneself, as in the present case, there is no question of leviability of service tax.”
Although the facts in both the above cases are dissimilar, the ratio of the rulings is relevant to the issue of redevelopment arrangement.
Further, as regards the contention that there is no liability to service tax in case of self-supply of service, further support can be found from the following:
Gauhati High Court Ruling in Magus Construction Pvt. Ltd. v. UOI, (2008) 11 STR 225 (Gau.)
Dept. Circular dated 17-9-2004 on Estate Build-ers in regard to Construction Services
Master Circular dated 23-8-2007 in regard to applicability of service tax on real estate builders
Dept. Circular dated 29-1-2009 regarding im-position of service tax on builders
Nevertheless, it needs to be expressly noted that whether a particular redevelopment arrangement results in any service provided by a builder/devel-oper to a society or not would depend upon the facts and circumstances and in particular terms and structure of a redevelopment arrangement. Further, it is a highly contentious issue. If a view is adopted that there is no service provided by a builder/developer to a society, the same would have to satisfy the judicial test.
Applicable Service categories:
Service tax provisions do not contain any spe-cific category for redevelopment. Hence taxability would have to be determined on the basis of service categories relevant to construction activi-ties viz.:
i) Commercial or industrial construction [section 65(25b)/65(105)(zzq) of the Act]
ii) Construction of Complex [section 65(30a)/65(91a)/65(105)(zzzh) of the Act]
iii) Works Contract [section 65(105)(zzzza) of the Act]
A substantial part of construction carried out in terms of a redevelopment arrangement would have to satisfy the essential taxability criteria specified in the definitions stated above in order to be made liable to service tax.
The scope of construction of complex/commercial or industrial construction liable to service tax has been expanded w.e.f. 1-7-2010 to tax advances received by builders/developers from prospective buyers for flats/offices which are under construction. The relevant extracts from Dept. Clarification clarifying the scope of expanded service in the Ministry’s Circular Letter D.O.F. No. 334/1/2010-TRU (Annexure B), dated 26-2-2010 was reproduced in February 2011 issue of BCAJ and therefore is not repeated here (refer para 2 on page 57)
In this context and as analysed in February Issue of BCAJ, Notification No. 36/2010-ST, dated 28-6-2010 provides that advances received by the builders/developers from prospective buyers prior to 1-7-2010 for flats/offices under construction have been exempted from the purview of expanded scope of construction of complex/commercial or industrial construction service. This exemption is extremely relevant inasmuch as, in many show-cause notices issued by the service tax authorities in the issue of redevelopment, the advances received by builders/developers from prospective buyers for the subsequent period is treated as value of taxable service, provided by a builder/developer to a society.
Redevelopment of flats/offices of existing occupants made prior to 18-4-2006 without any monetary consideration — Free of cost:
It is now a settled position that taxability to service tax is to be determined at the time when service is provided. In this regard, reliance can be placed on the Gujarat High Court ruling in Reliance Industries Ltd. v. CCE, (2010) 19 STR 807 (Guj.) and other rulings as well. Hence, in the context of construction services, taxability is to be determined based on the date on which relevant construction is completed.
Section 67 of the Act relating to valuation of a taxable service was significantly amended w.e.f. 18-4-2006. One of the more significant amendment relates to enactment of specific provisions for valu-ation of taxable services in cases where service is rendered for a consideration not determined in monetary terms (either fully or partly). This is discussed in para 1.6 below.
In terms of these provisions read with Rule 6 of the Service Tax Rules, 1994 as existed prior to 18-4-2006, no service tax is payable if services were rendered free or without any monetary consideration.
Vide, CBEC Circular No. 62/11/2003-ST, dated 21-8-2003, it was clarified that, even if a service is taxable, there will be no service tax if service is provided free, as value of service tax will be zero.
In the light of the foregoing, it would appear that in cases where flats/offices are allotted to existing occupants of a society in the new building (constructed prior to 18-4-2006) free of cost in pursuance of redevelopment agreement between a society and the builders/developers, there would be no liability to service tax in terms of the valuation provisions as they existed prior to 18-4-2006.
Redevelopment made for existing occupants after 18-4-2006:
Service tax is demanded in regard to flats/offices built and allotted to existing occupants free of cost by treating the entire sale proceeds of additional flats/commercial premises received by the builders/developers in the subsequent years as the value of taxable services. Hence this aspect needs a detailed discussion, more particularly after the introduction of the Valuation Rules w.e.f. 18-4-2006. The amended section 67 of the Act effective from 18-4-2006 has conceptually changed the provisions relating to valuation of service for the levy of service tax. In addition, Service Tax (Determination of Value) Rules, 2006 (Valuation Rules) have been notified to come into force from 19-4-2006.
Prior to its substitution, section 67 of the Act read as “For the purpose of this Chapter, the value of taxable service shall be the gross amount charged by service provider for such service provided or to be provided by him”. The newly introduced section 67 provides for ‘cost of service in the hands of recipient of service’ and ‘value of similar service’ as the basis for valuation, which is in complete departure from the earlier position in law which restricted itself to ‘gross amount charged’ by a service provider. Thus in the light of amended section 67 read with the Valuation Rules, the following is analysed.
Value of ‘similar’ service:
According to Rule 3(a) of the Valuation Rules, in case of a taxable service where consideration received does not consist wholly of money, then value is required to be determined, based on the gross amount charged by a service provider for similar service provided to any other person in ordinary course of trade.
Brief analysis of ‘similar’ — Some of the meanings attributed to ‘Similar’ are as under:
- ‘Similar’ means resembling or similar; having the same or some of the same characteristics— (Webster’s Online Dictionary)
- ‘Similar’ means ‘having a marked resemblance of likeness; of a like nature of kind — (Oxford English Dictionary)
On the basis of the foregoing, it would appear that the word ‘similar’, does not mean identical but there should be resemblance between two services in order to constitute the services as similar services. Various factors would have to be considered in order to determine whether two services are similar or not.
In the context of Central Excise, the Supreme Court has observed with reference to ‘electrical appliances normally used in the household and similar appliances used in hotels’ etc., that “the statute does not contemplate that goods classed under the words of ‘similar description’ shall be in all respects the same. If it did, these words would be unnecessary. These were intended to embrance goods not identical with those goods.” [Nat Steel Equipment v. Collector, (1998) 34 ELT 8 (SC) quoted and followed in CCE v. Wood Craft Products Ltd., (1995) 77 ELT 23 (SC)]
Valuation on the basis of equivalent money value of consideration:
Rule 3(b) of the Valuation Rules provides that where the value cannot be determined in accordance with clause (a) [i.e., Rule 3(a) on basis of value of similar service], the service provider shall determine the equivalent money value of such consideration which shall, in no case be less than the cost of provision of such taxable service.
Thus, if the value of similar services cannot be ascertained, the ‘value’ will be ‘equivalent value of consideration’. Such ‘equivalent value’, to be determined by service provider himself, shall not be less that cost of provision of such service.
It is pertinent to note that Valuation Rules make no provision for method of calculation of ‘cost’ of the taxable services. No guidelines have been issued by CBEC prescribing methodology to be adopted for the purposes of valuation.
Implications in the context of redevelopment:
Under a redevelopment arrangement, flat/office is provided to an existing occupant free of cost, in pursuance of an agreement between a society and the builder/developer. Hence, immediate beneficiary of redevelopment is the flat/office occupant, whereas society would be a remote beneficiary of redevelopment in the existing sense that there would be enhancement of property value and increased/better facilities that would be available.
Whether or not there is a flow of consideration (monetary or otherwise) from a builder/developer to a society in terms of amended section 67 of the Act, is a highly complex and contentious issue for which there is no ready answer.
Assuming, there is flow of ‘consideration’ arising from the redevelopment arrangement between builders/developers to a society, the taxable value of service in terms of Valuation Rules would be determined as under:
i) Option 1 — Amount equivalent to the gross amount charged by a builder/developer to any new buyer of flat/office for similar service provided in the ordinary course of trade and gross amount charged is the sole consideration.
This would have to be determined based on an examination of the facts of a given case duly supported by independent documentary evidences.
ii) Option 2 — In case, value cannot be determined in accordance with Option 1 above, builder/developer would have to determine equivalent money value of such consideration, which shall not be less than the cost of provision of taxable service factoring mainly cost incurred for obtaining FSI, the en-tire cost of construction, rentals paid for the period during demolition and construction period, etc. This will differ depending on the facts of each case.
As yet, no methodology is prescribed by CBEC to determine equivalent monetary value of consideration in terms of the Valuation Rules. However, in this regard, recourse may be made to Guidelines issued by CBEC under Central Excise for computing cost of captive consumption liable to excise duty, on the basis of Cost Accounting Standard (CAS 4) issued by The Institute of Cost & Works Accountants of India. This basis has been approved by the Supreme Court in CCE v. Cadbury India Ltd., (2006) 200 ELT 353 (SC).
In case there is any liability to service tax on the builder/developer, it would appear that the same would be subject to various benefits available under the applicable exemption/abatement notifications granting full or partial exemption from payment of service tax.
Alternatively, benefits may also be available under the CENVAT Credit Rules, 2004 subject to compliance of stipulated conditions.
Conclusion:
Redevelopment of properties is a very complex subject and issues relating to service tax under re-development are equally complex. Issues involved are likely to be litigated extensively in due course of time. Till the time, there is a reasonable level of clarity on the complex subject, it would be in the interest of concerned builders/developers to factor service tax while finalising redevelopment arrangements.
