Although the title given above is very wide, the scope of this quick write up is limited to liability to pay tax on agreements for sale of flats or units in a building under construction by builders and developers in the State of Maharashtra, keeping in view the likely impact of recent decision of Bombay High Court in the matter of Maharashtra Chamber of Housing Industry and others (51 VST 168).
The controversy regarding liability to pay VAT on agreements for sale flats and units by builders and developers has been looming around for over six years. While the Sales tax Department has been contending that through such agreements the builder enters into a contract to construct building for and on behalf of the purchasers, therefore, such contracts fall under the category of ‘Works Contract’, the builders say these agreements are for sale of immovable property, thus liability to pay VAT does not arise.
It may be noted that in a case where a builder sells readymade flat i.e. after the flat is constructed, there is no controversy, it is considered as a sale of immovable property and there is no question of VAT liability. The debatable issue arises only in those cases where builder enters into an agreement for sale of flat with prospective buyer when the construction is yet to commence or is under progress. Such agreements are normally referred to as “Under Construction Contracts/Agreements”. Till the judgment of Hon’ble Supreme Court in case of K. Raheja Development Corporation vs. State of Karnataka 141 STC 298 (SC), such contracts were considered to be for sale of immovable property and the Sales Tax Department did not contemplate any levy on the same. However, after the above judgment a debatable position arose.
The Sales Tax Department of Maharashtra holds a view that the judgment is applicable in all cases, hence, will cover all “under construction agreements” for flats/premises. On the basis of this view the Commissioner of Sales Tax issued a Trade Circular, viz. Circular No.12T of 2007 dated 7th February, 2007. Similarly, a new definition of “Works Contract” was introduced by amending section 2(24) of Maharashtra Value Added Tax Act. 2002 (MVAT Act), w.e.f. 20th June 2006, so as to bring the position of the said definition at par with the definition as was under consideration before the Supreme Court in the case of K Raheja. Changes were also made to the Maharashtra Value Added Tax Rules, 2005, vide notification dated 1st June, 2009 (with retrospective effect from 20th June, 2006), in respect of determination of value in case of works contracts involving such agreements.
However, inspite of the above mentioned changes and the judgment of the Supreme Court, the builders as well as the purchasers of such flats and units held a strong view that in most of the cases, it was possible to contend that such agreements (“under construction contracts”) were not covered under the Sales Tax Laws and they were not liable to tax under MVAT Act as a Works Contract.
Amongst others, the facts of K. Raheja’s case were cited vis-à-vis agreement for sale of flats and units as being generally entered into in the State of Maharashtra. The facts of K. Raheja’s case were such that there the value for undivided share in land was shown separately and the cost of construction was shown separately. However, when such is not the position i.e. when the cost of land and construction are not shown separately, then such contracts cannot be made liable to tax. There is no enabling power with the State Government to bifurcate the composite value into land and construction. Hence, if such construction agreements are considered to be for sale of immoveable property and they cannot be taxed as works contracts under Sales Tax Laws.
With this view in mind, the association of builders and developers i.e. Maharashtra Chamber of Housing Industry (MCHI) and others preferred a writ petition before the Bombay High Court challenging the constitutional validity of the amendment to section 2(24) of MVAT Act, consequentially challenging the insertion of Rule 58(IA) of MVAT Rules, 2005 and the Circular dated 7th February, 2007. A few others also filed similar writ petitions, including challenging the notification dated 9th July, 2010. The Bombay High Court recently disposed of this group of writ petitions vide its order dated 10th April, 2012.
Among several arguments, on behalf of petitioners, main arguments were on the ground that the agreement for sale entered into between a builder/ developer and the purchaser of a flat is basically agreement to sale an immovable property. Such an agreement cannot be considered as a ‘works contract’.
A contract which involves sale of immovable property cannot be split by the State Legislature, even if there is an element of a works contract. In other words the State Legislature cannot locate a sale of immovable property and then attempt to trace out what are the goods involved in the execution of the contract; It was also argued that a works contract involves only two elements viz.
(i) the transfer of property in goods; and
(ii) supply of labour and services. If a third element is involved in the contract viz. the sale of immovable property it does not constitute a works contract and hence to such a contract, the legal fiction created by Article 366(29A) does not apply.
The amendment to Section 2(24) has the effect of expanding the definition of the expression sale of goods under Article 366(29A) and is, therefore, beyond the legislative competence of the State Legislature. The Trade Circular dated 17th February, 2007, the amendment to Rule 58 and the Notification dated 9th July, 2010 indicate the agreements which are contemplated to be brought within the purview of Section 2(24). Those agreements are agreements simplicitor for the sale of immovable property; A contract which is governed by the Maharashtra Ownership Flats (Regulation of the Promotion of Construction, Sale, Management and Transfer) Act, 1963 (MOFA) cannot be regarded as a works contract. Such a contract is an agreement for the purchase of immovable property in its complete sense.
In a works contract property gets transferred as a result of accretion during the course of the execution of the contract and there is no transfer of immovable property simplicitor. The essence of a works contract is the transfer of property by accretion. Consequently, where a contract involves sale of immovable property, it can never be regarded as involving a works contract.
When a promoter appoints a sub contractor and gets a building constructed, that contract is a works contract under Article 366(29A) and a transfer of the property in the goods involved in the execution of the works contract takes place to the developer. That would be the first deemed sale. When the developer enters into an agreement with a purchaser under the MOFA thereafter, this does not involve a sale of goods since that would amount to a second deemed sale of the same goods which cannot be brought to tax.
On the other hand, the learned Advocate General, appearing on behalf of the State Government, submitted that:
(a) The provisions of Section 2(24) which defines the expression “sale” fall within the compass of Article 366(29A);
(b) A works contract is a contract to execute works and encompasses a wide range of contracts. The expression works contract is not restricted to building contracts having only two elements viz. the sale of material and goods and the supply of labour and services;
(c) The well settled connotation of the expression works contract is that a building contract may also involve in certain situations a sale of land;
(d) An unduly restrictive or contrived meaning should not be given to the provisions of Article 366(29A) of the Constitution otherwise the object underlying the constitutional amendment would be defeated;
(e) The purpose underlying the enactment of the deeming fiction in Article 366(29A) was to override the limited definition of the expression sale in the Sale of Goods Act, 1930 and to isolate the sale of goods element involved, inter alia, in a contract which is a works contract;
(f) A works contract is one where there is a con-tract to do works and it does not cease to be such merely because any other obligation exists.
(g) In an agreement which is governed by the MOFA, a conveyance of the interest in the flat or at any rate an interest therein is created at the stage of the execution of an agreement under Section 4.
(h) The Trade Circular and the amendment to Rule 58(1A) are only clarificatory in nature.
The Hon’ble High Court, after considering rival sub-missions, referred to many judgments. The Hon’ble High Court, in its order, also went through the 61st Report of Law Commission, 46th Amendment to the Constitution of India, section 2(24) of MVAT Act, Rule 58(1) & 58(1A) of MVAT Rules, relevant circulars and notifications. Notable amongst others, the High Court referred to a publication i.e. ‘Hud-son’s Building and Engineering Contracts’ (Eleventh edition, page 3). The High Court, at para 22 of its order, noted as follows:
“Hudson’s Building and Engineering Contracts contains an instructive elucidation of a building or engineering contract:
‘A building or engineering contract may be defined, for the purposes of this book, as an agreement under which a person, in this book called variously the builder or contractor, undertakes for reward to carry out for another person, variously referred to as the building owner or employer, works of a building or civil engineering character. In the typical case, the work will be carried out upon the land of the employer or building owner, though in some special cases obligations to build may arise by contract where this is not so, for example, under building leases, and contracts for the sale of land with a house in the course of erection upon it.’
The extract from Hudson is indicative of the fact that in a typical case work will be carried out upon the land of the employer or building owner though in some special cases an obligation to build may arise by contract where this is not so. The author cites the illustration of building leases and contracts for the sale of land with a house in the course of erection upon it. The elaboration of the concept in Hudson is indeed on the same lines as the judgment of the Supreme Court in Builders’ Association which notes the variations implicit in the notion of works contracts.
Therefore, as a matter of first principle, it cannot be postulated that a contract would cease to be a works contract if any more than only two elements are involved in its execution viz. (i) a supply of goods and materials; and (ii) performance of labour and services. In the modern context and having regard to the complexity of work, it would be simplistic to reduce the connotation of works contracts to contracts only involving the aforesaid two elements. When the Forty Sixth Amendment was enacted, no decided case had reduced the substratum of a works contract only to contracts involving the aforesaid two elements. As a matter of principle it would not be permissible to constrict or restrict the scope of works contracts and to exclude from their purview contracts involving situational modifications. Indeed, as Hudson’s treatise notes, a works contract may even involve a factual situation of a building lease or a contract for the sale of land with house in the course of erection upon it.”
The High Court further noted at para 24:
“Works contracts have varying connotations. The scale and complexity of commercial transactions in modern times has increased on a scale that has been unprecedented before.
The modern complexity of business is as much a product of as it is a cause for the complexity of regulatory mechanisms. Traditional forms of contract undergo a change as business seeks to meet new requirements and expectations from service providers in an increasingly competitive market environment. Increasing competition, following the opening up of the Indian economy to increased private investment has had consequences for the land market and the business of building and construction. The nature and complexity of building contracts has changed over time. The obligations which business promoters assume under works contracts may vary from situation to situation and contractual clauses are drafted to meet the demands of the trade, the needs of consumers of services and the requirements of regulatory compliance. So long as a contract provides obligations of a contract for works, and meets the basic description of a works contract, it must be described as such. The assumption of additional obligations under the contract will not detract from the situation or the legal consequences of the obligations assumed.”
While dealing with various provisions of the MOFA, the High Court referred to various decisions under MOFA and under Bombay Stamp Act, 1958, and, noted as follows:-
“The Act imposes restrictions upon a developer in carrying out alterations or additions once plans are disclosed, without the consent of the flat pur-chaser. Once an agreement for sale is executed, the promoter is restrained from creating a mortgage or charge upon the flat or in the land, without the consent of the purchaser. The Act contains a specific stipulation that if a mortgage or charge is created without consent of purchasers, it shall not affect the right and interest of such persons. There is hence a statutory recognition of the right and interest created in favour of the purchaser upon the execution of a MOFA agreement. Having regard to this statutory scheme, it is not possible to accept the submission that a contract involving an agreement to sell a flat within the purview of the MOFA is an agreement for sale of immovable property simplicitor. The agreement is impressed with obligations which are cast upon the promoter by the legislature and with the rights which the law confers upon flat purchasers.
Agreements governed and regulated by the MOFA are not agreements to sell simpiciter, as construed in common law. The legislature has intervened to impose statutory obligations upon promoters; obligations of a nature and kind that are not traceable to the ordinary law of contract.”
The Hon’ble Court, at para 30 of the order, also referred to certain provisions of Maharashtra Apartment Ownership Act, 1970, and noted:
“The provisions of the Apartment Ownership Act, 1970 hence recognise an interest of the purchaser of an apartment, not only in respect of the apartment which forms the subject matter of the purchase, but an undivided interest, described as a percentage in the common areas and facilities.”
In conclusion, while upholding the constitutional validity to of section 2(24) of MVAT Act, the High Court noted that “The submission which has been urged on behalf of the petitioners proceeds on the foundation that a works contract is a contract for the purpose of work which involves only two elements viz. a supply of goods and material and a supply of labour and services. Works contracts have numerous variations and it is not possible to accept the contention either as a matter of first principle or as a matter of interpretation that a contract for work in the course of which title is transferred to the flat purchaser would cease to be a works contract. As the Supreme Court noted in its judgment in Builders’ Association of India vs. Union of India (1989) 2 scc 645, the doctrine of accretion is itself subject to a contract to the contrary. The provisions of the MOFA, enacted in the State of Maharashtra, evince a legislative intent to protect the interest of flat purchasers by creating an interest in the property which is agreed to be acquired, in terms of the statutory provisions.”
The challenge to Rule 58(1A) was rejected on the ground that the legislature had acted within the field of its legislative powers in devising a measure for the tax by rightly excluding cost of land from the value liable to tax.
Circular, dated 7th February, 2007, was held to be clarificatory in nature, and, the notification dated 9th July, 2010 was upheld on the basis that the composition scheme is made available at the option of a registered dealer. There is no compulsion or obligation upon a registered dealer to settle or opt for a composition scheme.
Although, Bombay High Court has dismissed the writ petitions upholding the constitutional validity of the amendments to section 2(24), certain aspects still remain to be answered, one of them may be the basic route of amendment i.e. the K. Raheja’s case, which is pending for consideration before a larger bench of the Supreme Court. A similar issue is also involved in the matter of Larsen & Toubro. Thus, whether an agreement for sale of flats (under construction agreement) can be included in the definition of works contract (and, therefore, can be dissected into three elements i.e. land, labour and goods) or it is to be considered as an agreement for sale of immovable property only (as that is the substance as well as the intention of the parties), the final answer can be provided now only by the Supreme Court.
However, till the Supreme Court provides us guidance in the matter, the sales tax authorities in Maharashtra can enforce the levy of tax on all such transactions of agreements to sale flats (under construction contracts), entered into on or after 20th June, 2006.
The question, therefore, arises how to calculate the quantum of tax which a builder/developer may be liable to pay and whether the same can be passed on to the ultimate purchasers of such flats and units.
Let us now consider the relevant provisions of MVAT in this regard. It may be noted that once it is accepted that such “under construction agreements” are covered by the concept of ‘works contract’ it follows that the builder has to be considered as a contractor and the purchaser of flat as the principal. Thus, all such provisions as are applicable to a normal contractor will apply to the builder also. The following important aspects may be noted in this regard:
1. The liability to pay tax under the MVAT Act is on the dealer (as defined). A dealer having turnover of sales more than the prescribed limits is liable to take registration.
2. A registered dealer shall pay tax on his turnover of sales of ‘goods’ at the rates prescribed in the Schedule. Before making payment of tax as above he is entitled to deduct the amount of input tax credit (setoff of taxes paid on purchases) as may be available to him in accordance with the Rules.
3. An unregistered dealer, although liable to pay tax on his turnover of sales, is not entitled to collect tax from the purchasers and also not entitled to claim input tax credit.
4. In case of works contract, tax is levied under the concept of ‘deemed sale’ of goods. Thus, the rate of tax applicable has to be considered with reference to the nature of goods involved, the property in which passes from the contractor to the principal in the course of execution of works contract.
5. As the agreements for sale of flats have one composite value of the transaction, there is no price mentioned separately for land, services and goods, the value of goods involved has to be determined in accordance with the provisions of Rule 58 of MVAT Rules.
6. Rule 58(1) provides for deduction of various charges in relation to services and Rule 58(1A) provides for deduction in respect of value of land.
7. In case of construction of building done through sub-contractor/s, deduction is also available for amounts paid to sub-contractor/s.
8. In case of difficulty in arriving at the value of various services involved in the execution of works contract for the purposes of deduction u/r 58(1) a table is appended to the Rule, listing various types of contracts and a lumpsum percentage of deduction from the total contract value. (In case of construction of building contract, rate of deduction on account of services is provided at 30%.)
9. For agreements, registered on or after 1st April, 2010, there is a specific composition scheme, designed for these kinds of agreements, whereby a registered dealer (builder) may opt to discharge his tax liability by paying composition money @ 1% of total agreement value. Although the composition scheme contains certain conditions and restrictions such as no deduction u/r 58 and no setoff etc., many may find it easy to follow.
10. There is another composition scheme, known as 5% Composition Scheme, applicable to construction contracts (as defined). However, the said scheme was designed in the year 2006 with reference to normal construction contracts. (i.e. contracts having basically two elements supply of goods and labour). The Rule to provide deduction for value of land was introduced in the year 2009 and thereafter the composition scheme of 1% was notified, which has a specific reference to agreements entered into by builders and developers including value for transfer of interest in land.
11. For agreements, registered before 1st April, 2010, till a specific scheme is designed by the Government, the builders may have to go through the exercise of determining value u/r 58, calculate setoff of taxes paid on input and discharge their tax liability.
