Relevant Statutory Provisions
Section 65B (44) of the Finance Act, 1994 (‘Act’)
‘Service’ means any activity carried out by a person for another for consideration, and includes a declared service, but shall not include –
a) an activity which constitutes merely, –
i) a transfer of title in goods or immovable property, by way of sale, gift or in any other manner; or
ii) a transfer, delivery or supply of any goods which is deemed to be a sale within the meaning of clause (29A) of article 366 of the Constitution; or
b) a provision of service by an employee to the employer in the course of or in relation to his employment;
c) fees taken in any Court or Tribunal established under any law for the time being in force.
………………..
Section 66E of the Act – Declared Services
The following shall constitute declared services, namely: – …………
(b) Construction of a complex, building, civil structure or a part thereof, including a complex or building intended for sale to a buyer, wholly or partly, except where the entire consideration is received after issuance of completion certificate by the competent authority.
Explanation. – for the purposes of this clause, –
……………….
(1) The expression ‘construction’ includes additions, alterations, replacements or remodeling of any existing civil structure;
……………..
Service portion in the execution of a works contract.
Section 67 of Act – Valuation of taxable services for charging service tax
(1) Subject to the provisions of this Chapter, where service tax is chargeable on any taxable service with reference to its value, then such value shall,
–
i) in a case where the provision of service is for a consideration in money, be the gross amount charged by the service provider for such service provided or to be provided by him;
ii) in a case where the provision of service is for a consideration not wholly or partly consisting of money, be such amount in money as, with the addition of service tax charged, is equivalent to the consideration;
iii) in a case where the provision of service is for a consideration which is not ascertainable, be the amount as may be determined in the prescribed manner.
Service Tax (Determination of Value) Rules, 2006 (“Valuation Rules”)
Rule 3 – Manner of determination of value
Subject to the provisions of section 67, the value of taxable service, where such value is not ascertainable, shall be determined by the service provider in the following manner –
a) the value of such taxable service shall be equivalent to the gross amount charged by the service provider to provide similar service to any other person in the ordinary course of trade and the gross amount charged is the sole consideration;
b) where the value cannot be determined in accordance with clause (a), 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.
Background
In Larsen & Toubro Ltd vs. State of Karnataka [2014] 34 STR 481 (SC) the Supreme Court held that building / construction contract is a ‘works contract as well as transfer of immovable property. In a building / construction contract, goods like cement, concrete, steel, bricks etc. are intended to be incorporated in structure and fact that they lost their identity as goods, does not prevent them from being goods.
However, the activity of construction undertaken by developer would be works contract only from the stage the developer enters into a contract with flat purchaser. If a contract with flat purchaser is entered only after construction is completed, goods used in construction cannot be deemed to have been sold for the fact that it is the building which is intended for sale ultimately.
Taxability of Joint Development Agreements usually involves three parties viz.
Landowner;
Builder and
Buyers of constructed units.
The same has been subject to several interpretations from time to time by CBEC and various High Courts and Tribunals. One of the burning issues in such agreements has been taxability of flats given by a builder to landowner in consideration of the grant of land development rights.
The Burning Issue is whether such flats given to landowner are to be valued:
at the price of land / land development rights given by landowner to the builder / developer or
at the price charged for similar flats from other buyers
To examine this, it is relevant to refer to the following circulars issued by the Government.
Clarification vide CBEC Circular No. 151/2/2012 – ST dated 10/02/2012 (Relevant Extracts)
Para 2.1
In case of Tripartite Business Model, the parties involved are:
i) landowner;
ii) builder or developer; and
iii) contractor who undertakes construction. Here two important transactions are identifiable viz.
Sale of land by the landowner which is not a taxable service; and
Construction service provided by the builder / developer.
The builder / developer receive consideration for the construction service provided by him, from two categories of service receivers:
a) From landowner: in the form of land / development rights; and
b) From other buyers: normally in cash.
For the period prior to 01/07/2010, construction service provided by the builder / development rights of the land was received by the builder / developer will not be taxable in terms of CBEC Circular No. 108/2/2009 – ST dated 21/01/2009.
For the period after 01/07/2010, construction services provided by the builder / developer is taxable in case any part of the payment / development rights of the land was received before the issuance of completion certificate and the service tax would be required to be paid by builder / developers even for the flats given to the landowner.
Value, in the case of flats given to landowner, is determinable in terms of section 67(1) (iii) read with Rule 3(a) of Service Tax (Determination of Value) Rules, 2006, as the consideration for these flats i.e., value of land / development rights in the land may not be ascertainable ordinarily. Accordingly, the value of these flats would be equal to the value of similar flats charged by the builder / developer from the second category of service receivers. In case the prices of flats / houses undergo a change over the period of sale (from the first sale of flat / house in the residential complex to the last sale of the flat / house) the value of similar flats as are sold nearer to the date on which land is being made available for construction should be used for arriving at the value for the purpose of tax. Service tax is liable to be paid by the builder / developer on the “construction service” involved in the flats to be given to the landowner, at the time when the possession or right in the property of the said flats are transferred to the landowner by entering into a conveyance deed or similar instrument (e.g. allotment letter).
Clarification vide Education Guide dated 20/06/2012
Para 6.2.1
In case of flats / houses agreed to be given by builder / developer to the land owner towards the land / development rights and to other buyers, two important transactions are identifiable:
Sale of land by the landowner which is not a taxable service; and
Construction service provided by the builder / developer.
The builder / developer receive consideration for the construction service provided by him from two categories of service receivers: (a) from landowner: in the form of land / development rights; and (b) from other buyers; normally in cash. Construction service provided by the builder / developer is taxable in case any part of the payment / development rights of the land was received by the builder / developer before the issuance of completion certificate and the service tax would be required to be paid by builder / developers even for the flats given to the landowner. ………….
Value, in the case of flats given to first category of service receiver will be the value of the land when the same is transferred and the point of taxation will also be determined accordingly.
Clarification vide CBEC Circular F. No. 354 /311/ 2015 TRU dated 20/01/2016 which supersedes Education Guide dated 20/06/2012 and revives Circular dated 10/02/2012.
Para 4
The Circular dated 10/02/2012 is in accordance with the provisions relating to valuation as laid down in the Finance Act, 1994 and the Service tax (Determination of Value ) Rules, 2006. As regards the Education Guide, it has been clearly stated in the Education Guide, 2012 that it is merely an educational aid based on a broad understanding of a team of officers on the issues. It is neither a “Departmental Circular” nor a manual of instructions issued by the Central Board of Excise and Customs. To that extent it does not command the required legal backing to be binding on either side in any manner. The guide was released purely as a measure of facilitation so that all stakeholders could obtain some preliminary understanding of the new issues for smooth transition to the new regime. Hence, Circulars such as the present one would prevail over the Education Guide, 2012. Hence, in valuing the service of construction provided by a builder / developer to a landowner who transfers his land / development rights to builder for getting in return constructed flats / dwellings from builder / developer, the service tax assessing authorities should be guided by the said Board Circular dated 20/02/2012 and not the Education Guide.
Ruling of Madras High Court in Southern Properties & Promoters vs. CCE (2015) 52 GST 413 (MAD)
In this case the appellant was providing taxable service under the category of “Construction of Residential Complex Service”. They entered into a joint venture agreement with a land owner for construction of 72 flats in three blocks, (viz. 24 flats in each block). The appellant, by virtue of the joint venture agreement, owned 48 flats and the land owner owned the remaining 24 flats as his share equivalent to the land. That the appellant paid service tax on the sale of 48 flats to independent third parties after claiming the benefit of abatement. But they failed to pay service tax on the cost of 24 flats alleged to be the share of the land owner and the reason stated by the appellant was that they had not received any amount from the landowner for the construction of the flats allotted to them. Hence, show cause notice was issued demanding service tax. The appellant filed a reply stating that since they did not pay any amount to the land owner towards the land cost, they had not paid service tax for the flats held by the land owner.
The Adjudicating Authority adjudicated the case and came to hold that the classification of the service provided by them was not in dispute. In so holding the Adjudicating Authority further held as under:
“I observe that it is the ‘appellant’ who provided the service of construction of flats by virtue of entering into a ‘JV’. As per section 65 (105)(zzzh) of the Act, taxable service means “any service provided or to be provided to any person in relation to construction of complex”. The phrase “any service” in relation to construction of residential complex service is wide enough to cover all services including construction service.” ………………………
(f) Further, in the Finance Act, 2010 communicated vide Board’s DOF No. 334/1/2010 – TRU, dated 26/02/2010, in order to achieve the legislative intent and bring in parity in tax treatment, an explanation to sub-clause to section 65(105)(zzzh) of the Act had been inserted to provide that unless the entire payment for the property is paid by the prospective buyer or on his behalf after completion of construction (including its certification by local authorities), the activity of construction would be deemed to be a taxable service provided by the builder or promoter or developer to be the prospective buyer and the service tax would be charged accordingly. The above explanation to sub-clause to section 65(105) (zzzh) of the Act has applicability from the date of existence of the section and hence is having retrospective effect from 16/06/2005. Therefore, I observe that all the earlier Board’s Circulars are to be read with the above explanation.”
Accordingly, the Adjudicating Authority confirmed the demand.
The contention of appellant before the Tribunal was that the appellant had not received any consideration in the form of money in respect of 24 flats handed over to the landowner and therefore tax should be demanded on the basis of the cost of land. The plea of the department before the Tribunal was that the value of taxable service should be equivalent to the gross amount charged by the appellant to provide construction of the similar 48 flats. The contention of the department before the Tribunal is reproduced, hereafter:
“3…… He drew the attention of the Bench to Rule 3 of the Service Tax (Determination of Value) Rules, 2006. He submits that the value of such taxable service shall be equivalent to the gross amount charged by the applicant to provide construction of the similar 48 flats. He relied upon the decision of the Tribunal in the case of Prince Foundation Ltd. vs. CST (2014) 33 STR 448 (Tri. – Chen.), where stay was granted partially.”
After hearing both sides, the Tribunal on a consideration of Rule 3 of the Valuation Rules, which provides the manner of determination of value in respect of taxable service, namely the service defined u/s. 65(105)(zzzh) of the Act, came to hold that the value of taxable service should be equivalent to the gross amount charged by the service provider to provide similar service to any other person, that is to say, the value of taxable service rendered in relation to the flats sold to independent persons. Accordingly, the Tribunal held that the appellant has failed to make out a prima facie case for waiver of pre-deposit.
Aggrieved by the Tribunal’s order of pre-deposit, the appellant approached the Court. The observations of the High Court are as under:
“From a reading of the above said provisions, it is clear that section 65(105)(zzzh) of the Finance Act, 1994 relates to construction of complex, whereas section 65(105)(zzzza) of the Finance Act, 1994 relates to works contract. It is not in dispute that the appellant is engaged in the promotion and construction of residential complexes and not engaged in works contract. It is relevant to note that the plea now taken by the learned counsel appearing for the appellant that the appellant is entitled to the benefit of Notification No. 29 dated 22nd May, 2007 has not been taken by the appellant either before the Adjudicating Authority or before the Commissioner (Appeals) (Para 18).
Prima facie, we are not inclined to entertain this appeal, in view of the specific admission by the appellant before the Adjudicating Authority that the services rendered by the appellant would fall u/s. 65(105)(zzzh) of the Finance Act, 1994. Even otherwise, the language of section 65(105)(zzzh) and the nature of the services provided by the appellant is for construction of flats provided to the land owner and the transfer of land is only for the purpose of providing such taxable service, we fail to understand as to how the appellant would say that there is no liability to pay service tax in respect of 24 flats handed over to the land owner after rendering taxable service as defined u/s. 65(105)(zzzh) of the Finance Act, 1994. If there is no monetary consideration in the transaction, then section 65 of the Finance Act, 1994 provides for various methods for valuation. Hence, it is for the appellant to establish that his plea that the value of the land should be taken into consideration is a matter for the Tribunal to decide on merits at the time of hearing of the appeal (Para 19)..
At the first blush, we are not inclined to accept the plea of the department that the case in respect of valuation, it may fall under Rule 2 or 3 of Valuation Rules and the amendment made in the year 2012. We are not inclined to go into the effect of amendment as pleaded by the standing counsel and we are not inclined to make any observation as that would influence the mind of the Tribunal as to the applicability of such Rule on the merits of the case…… (Para 20).
The Tribunal is justified in ordering pre–deposit of Rs.12 lakh as against demand of Rs. 27 lakh.
Relevant overseas judgment on the Issue
In Direktor na Direktsia ‘Obzhalvane I upravlenie na izpalnenieto’ – grad Burgas pri Tsentralno upravlenie na Natsionalnata agentsia za prihodite vs. Orfey Balgaria EOOD [2013] 38 STT 289 (ECJ), assessee acquired building right over land owned by various owners and agreed to provide certain portions of constructed property in consideration thereof. Department argued that assessee had agreed to provide construction services and received consideration thereof on date of establishment of building right. It was also argued that value of consideration received by assessee was open market value of construction services provided.
The European Court of Justice ruled that:
When building right was established in favour of assessee as a consideration for construction services agreed to be provided, such establishment of building right amounted to receipt of consideration and such construction services became chargeable on date of establishment of building right.
Such charge will arise only if, at time when right is established, all relevant information concerning that future supply of services is already known and value of that right may be expressed in monetary terms.
Moreover, value of such building right cannot be based on open market value of construction services to be provided; it must be based on value of building rights received.
Mere possibility that building right may get extinguished by assessee not exercising such right does not bar charge of service tax, as on such extinguishment, assessee may seek refund / credit of tax paid earlier.
Conclusion
The ruling of Madras High Court, though in the context of law prevalent prior to 01/07/2012 is relevant despite the fact that the matter has been remanded to Tribunal for final determination of valuation, the Court has observed in para 20 that they are not inclined to accept the plea of the department that the case in respect of valuation may fall under Rule 2 or 3 of the Valuation Rules.
Based on the judgment of ECJ referred in para 7 above and considering the principle of reciprocal consideration, a view could be adopted that the value of construction services by builder to landowner should be based on the value of land development rights received in return from the landowner by the builder. The value of land development rights is clearly discernible in the form of prorata value of land given up by the landowner and such value of land should be determined at the time of entering into the contract.
The value of land is always available at the time of execution of development contract. In the State of Maharashtra, development rights are liable for stamp duty and market value of such rights is prescribed vide the Government Ready Reckoner. Hence, as a reasonable view in terms of provisions of section 67(1)(i) & (ii) of the Act, the prorata value of land rights given up by the landowner can only be taken as basis for determining the value of construction services provided by builder because that is what the builder gets in return. It appears that Education Guide dated 20/06/2012 represents the correct position of law. If the value however, is not ascertainable, only then resort can be made to section 67(1)(iii) of the Act read with Rule 3(a) of Valuation Rules.
However, caution is advised while adopting the view stated in paras (a) to (c) above inasmuch as, more particularly post issue of CBEC circular dated 20/01/2016, the service tax department has issued show cause notices in large number to demand service tax on the basis of market value of similar flats in terms of Rule 3(a) of the Valuation Rules. Hence, this issue is likely to witness an extensive round of litigations and finality thereon could take a very long time. Considering far reaching implications of the matter on the real estate sector, it is suggested that CBEC needs to understand these transactions and then clarify the matter vide a detailed order u/s. 37 B of the Central Excise Act, 1944 which is also applicable to service tax.
The entire discussion above is however subject to the basic ‘fact’ which requires to be understood by all concerned that when a landowner is given constructed units or flats by the developer, it is part of the ‘cost’ of the developer. The consideration payable to the landowner towards land or purchase of development rights comprises of constructed premises with/without consideration in monetary terms. The consideration for the service that the developer provides both to the landowner and other purchasers of units, comes only from the other purchasers and on which the service tax is already paid / payable. No other consideration for the ‘service’ provided by the developer is received by him. Therefore without the receipt of any additional consideration, fastening liability on the value other than that is attributable to service would be beyond the scope of section 67. Secondly, the market value of the newly constructed units is attributable to the “land value” and not towards construction service. Therefore, the whole exercise initiated by the department is capable of being challenged.
