Renting of Immovable Property

CA Pradeep Jain, FCA

Renting of Immovable Property – Delhi High Court Decision

The Division Bench of the Delhi High Court comprising of Justice Badar  Durrez Ahmed and  Justice  Rajiv Shikader gave  a milestone  judgment  on  18th  April, 2009, in the case of Home Solution Retail India Ltd and Others Vs. UOI and Others (2009-TIOL-196-HC-DEL-ST). The  issue  involved in  this case  related,  to  a batch  of Writ  Petitions challenging  the  legality,  validity and  vires of Notification No.24/2007 dated 22.05.2007 and Circular No.90/1/2008 dated 04.01.2008, issued by the Secretary, Ministry of Finance, Department of Revenue, Government of India.

In  this article,  an  attempt  has been  made  to  understand  the  crux  of the  decision  by Hon?ble High Court. Before discussing way forward of this judgment, let’s take a note of chargeability of service tax on renting of the immovable properties, Petitioners contention & basis of appeals and highlights of this judgment.

â Legal wires for Chargeability of service tax on renting of the immovable properties:

Service tax was sought to be levied on “renting of immovable property” w.e.f. 01.06.2007. The relevant definitions in this regard are as below:

Section 65 (90a) provides for the definition of “renting of immovable property” as: –

“It includes renting, letting, leasing, licensing or other similar arrangements of immovable property for use in the course or furtherance of business or commerce but does not include —

(i) renting of immovable property by a religious body or to a religious body; or

(ii) renting of immovable property to an educational body, imparting skill or knowledge or lessons on any subject or field, other than a commercial training or coaching centre.

Explanation [1]. — For the purposes of this clause, ?for use in the course or furtherance of business or commerce? includes use of immovable property as factories, office buildings, warehouses, theatres, exhibition halls and multiple-use buildings;

Explanation 2. — For the removal of doubts, it is hereby declared that for the purposes of this clause “renting of immovable property” includes allowing or permitting the use of space in an immovable property, irrespective of the transfer of possession or control of the said immovable property;

Section 65 (105) of Finance Act, 1994 provides for the definition of “Taxable service”. Sub clause (zzzz) of the said Section provides that

Taxable Service “means any service provided or to be provided to any person, by any other person in relation to renting of immovable property for use in the course or furtherance of business or commerce.”

As per Section 67 of the Finance Act, 1994 service tax is levied on “gross amount” charged. Exemption Notification No. 24/2007-ST, Dated 22.05.2007 has been issued, which exempts service tax on property tax paid in respect of such property. In other words, service tax in excess of the amount payable on the gross value minus the property tax is exempted. It can be inferred there from that what is taxable is the total rent minus the property tax. An example has also been provided in the said notification by way of illustration.

The relevant portion of the Notification is produced as under: –

“the Central Government, on being satisfied that it is necessary in the public interest so to do,  hereby  exempts the taxable service of renting of  immovable property, referred to in sub-clause (zzzz) of clause (105) of section 65 of the Finance Act, from  so much of the service tax leviable thereon as is in excess of the service tax calculated on a  value which  is  equivalent to the gross  amount charged  for renting  of such  immovable property  less taxes on such  property,  namely  property  tax  levied  and  collected by local bodies……….”

It has also been clarified in the CBEC?s circular No. 98/1/2008 Dated 04.01.2008, with regards to a query whether service tax paid under “commercial or industrial construction service” or “works contract service” towards construction of a building, be treated as an input service, for the service of “renting of immovable property” and service tax paid on the former can be availed as CENVAT credit and utilized for payment of service tax on the latter?  It  was clarified  in  the  Circular that  “right  to  use immovable  property  is leviable to service tax under renting of immovable property service” and hence Credit is  not admissible.

The relevant portion of the said Circular is produced as under: –

“…….Right to use immovable property is leviable to service tax under renting of immovable property service.

Commercial or industrial construction service or works contract service is an input service for the output namely immovable property.  Immovable property is neither subjected to central excise duty nor to service tax.

Input credit of service tax can be taken only if the output is a ‘service‘ liable to service tax or a ‘goods‘ liable to excise duty. Since immovable property is neither ‘service’ or ‘goods’ as referred to above, input credit cannot be taken………”

The above two, viz., Notification 24/2007 implying that the levy of service tax is on the rental income out of renting of immovable property and the circular clarifying that  Right to use immovable property per se is a taxable service, were challenged in the batch of Writ petitions.

â Appellant’s contention and Basis of Appeals in writ Petitions:

It was alleged by the petitioners in the batch of writ petitions that by virtue of the said notification  and  circular a completely  erroneous interpretation  is placed on  section 65(90a)  and  section  65  (105)  (zzzz)  of the  Finance Act,  1994  as amended  by the  Finance Act,  2007.  It was further alleged that because of this incorrect interpretation, service tax is sought to be levied on the renting of immovable property as opposed to service tax on a service provided “in relation to the renting of immovable property”.

In  nut  shell,  the  petitioners have  raised  the  question  as  to  whether the  Finance Act, 1994  envisages the  levy  of service tax  on  letting  out  /  renting  out  of immovable property  per se or whether services  in  relation to renting  of immovable  property service are leviable to service tax?

The  Petitioners,  who are  either landlords or tenants in  respect  of leased  premises, contented  on  the  validity of the  said  Notification  (supra)  that  though  this notification speaks of an exemption it also refers to the taxable service as “a service of renting of immovable  property”.  This, according to the view of petitioners, is not so envisaged under the said act. They argued that section 65(105)(zzzz)  refers to  the  service provided or to be provided to any person, by any other person, in relation to renting of immovable property for use in the course or furtherance of business or commerce. The  reference in  the  said  provision  is not  to  the  taxable  service of renting of immovable  property but to the taxable service “in relation to” the renting of immovable property.

The  petitioners’ contention  construe  that  while  the  Act  does not  treat  renting  of  immovable property as a taxable service, the takings of the notification are purely based on the cock-and-bull story that the taxable service is the renting of immovable property  itself.  On  this  basis  it  has been  contended  that  service tax  is sought  to  be  recovered  from the  petitioners on a pure misconstruction of the statutory  provision.

Similarly, the impugned circular whilst providing a clarification in respect of commercial and  industrial  construction  service has perceptibly clarified  that  the  “right  to  use  immovable property is leviable to service tax under the renting of immovable property service”. According  to  the  petitioners, the  clarification  therefore  travels beyond  the  provisions of the  said  act  by contemplating  a service tax  on  the  renting  of immovable property itself.

Consequently,  the  petitioners asserted on  the  validity of said  notification  dated  22/05/2007 and said circular dated 04/01/2008 and sought to set aside them as being  ultra vires the said act.

Alternatively, the petitioners have taken the plea that, in case, if it is held that such a tax  is  envisaged  then  the  provisions  of section  65(90a),  section  65(105)(zzzz)  and section  66  insofar as they relate  to  the  levy  of service tax  on  renting  of immovable property would add up to a tax on land and would therefore fall outside the legislative capability of Parliament, as the said subject is covered under Entry 49 of List II of the Constitution  of India and  would  fall  within  the  exclusive domain  of  state  legislature. Hence forth such, provisions would have to be declared as un-constitutional.

â Cases Referred

The counsel appearing on both sides have sought to place reliance on following cases: –

1.)   T.N.Kalyana Mandapam Association Vs. Union of India (2004-TIOL-36-SC-ST)

The Supreme Court considered the issue of the taxable service provided by a mandap keeper. In this case Supreme Court held that the taxable service provided as a caterer by a mandap keeper was within the legislative competence of the Parliament and could not be construed as a tax on the sale and purchase of goods. In  this context,  the  Supreme Court observed that  it  was   well-settled  that  the measure  of taxation  cannot  affect  the  nature  of taxation  and,  therefore,  the  fact that service tax is levied as a percentage of the gross charges for catering did not alter or affect the legislative competence of the Parliament in the matter.

The Delhi High Court observed that the said conclusion of the Supreme Court clearly distinguishes between the case of a mandap keeper and that of a person who rents out an immovable property for use in the course or furtherance of business or commerce.  Consequently, the Supreme Court decision in the case of Kalyana Mandapam does not advance the case of the respondents. On the other hand, it does go towards clarifying the stand taken by the petitioners.

2.)   Doypack Systems Pvt Ltd

2002-TIOL-389-SC-MISC

In this case the Supreme Court elucidated the scope of the phrase “in relationto” as to cover the widest amplitude. The Court observed as under:

“The  expressions ‘pertaining  to’,  ‘in  relation  to’ and  „arising  out  of’,  used in  the deeming provision, are used in the expansive sense. The expression ‘arising out of’ has been used in the sense that it comprises purchase of shares and lands from income arising out of the Kanpur Undertaking.”

The Supreme Court further emphasized that  a tax cannot  be  struck  down on  the ground  of lack  of  legislative competence by enquiring  whether the  definition accords with what the layman’s view of service is. It noted the well-settled principle that in matters of taxation, the courts permit greater latitude to the statute to pick and choose objects and rates for taxation and has a wide discretion with regard thereto.

3.) ALL India Federation

2007-TIOL-149-SC-ST

4.) BSNL v. Union of India

2006-TIOL-15-SC-CT-LB

5.) Commissioner of Income-tax, Bangalore v. B.C. Srinivasa Shetty

2002-TIOL-587-SC-IT-LB

6.) Union of India v. Inter Continental

2008-TIOL-83-SC-CUS

â Interim Stay granted by following High Courts from collection of service tax in terms of Section 65 (105) (zzzz) of the Finance Act, 1994

1.)   Bombay High Court –W.P No. 1263 of 2007 – Stay Order dated 30.07.2008

2.)   Andhra Pradesh High Court –W.P. No. 6572 of 2008 – Stay Order dated 27.03.2008

3.)   Gujarat High Court –Special Civil Application No. 5269 of 2008 – Stay Order dated 28.03.2008

4.)   Delhi High Court –W.P.(C) No. 1659 of 2008 – Stay Order dated 03.03.2008

5.)   Madras High Court –W.P. No. 30276 of 2007 – Stay Order dated 09.10.2007

â Delhi High Court’s judgment:

The Division Bench of the Delhi High Court pronounced its verdict in favour of the assesseess / petitioners and held that Notification No.24/2007 and Circular dated 04.01.2008 are ultra vires the said Act. The relevant part of the decision is produced as under: –

Paras 34, 35 and 36 of the Order reads as follows:

“From the above discussion, it is apparent that service tax is a value added tax. It is a tax on value addition provided by a service provider. It is obvious that it must have connection  with  a service  and,  there  must  be  some value  addition  by that  service. If there is no value addition, then there is no service. With this in mind, it would be instructive to analyse the provisions of Section 65(105)(zzzz).  It  has reference to  a service provided  or to  be  provided  to  any person,  by any other person  in  relation  to ‘renting of immovable  property for  use in  the  course  or furtherance of business or commerce”. The  wordings  of  the  provision  are  so structured  as to  entail  –  a service provided or to be provided to ‘A’ by ‘B’ in relation to ‘C’. Here, ‘A’ is the recipient of the service, ‘B’ is the service provider and ‘C’ is the subject matter. As pointed out above by Mr. Ganesh, the  expression “in relation to” may be  of widest  amplitude,  but  it  has been  used in  the  said  Act  as per its context.  Sometimes, “in  relation  to” would  include  the  subject  matter following it  and  on  other occasions it  would  not.  As in the case of the service of dry cleaning, the expression “in relation to dry cleaning” also has reference to the very service of dry cleaning. On the other hand, the service referred to  in  Section  65(105)(v),  which  refers to  a service provided  by a real  estate  agent  “in  relation to real estate”, does not, obviously, include the subject matter as a service. This is so because real estate by itself cannot by any stretch of imagination be regarded as a service. Going back to the structured sentence, i.e. – service provided or to be provided to ‘A’ by ‘B’ in relation to ‘C’, it is obvious that ‘C’ can either be a service (such as dry cleaning, hair dressing, etc.)  or not a service by itself, such  as  real  estate.  The expression “in relation to” would, therefore, have different meanings depending on whether ‘C’ is a service or not a service. IF ‘C’ is a service, then the expression “in relation to” means the service ‘C’ as well as any other service having connection with the service ‘C’. Where ‘C’ is not a service, the expression “in  relation to” would have reference only to some service which has a connection with ‘C’. But, this would not imply that ‘C’ itself is a service.

From this analysis,  it  is clear that  we  have to  understand  as to  whether renting of immovable  property for  use in  the course  or furtherance of business or commerce  by itself  is a  service. There is no dispute that any service connected with the renting of such immovable property would fall within the ambit of Section 65(105)(zzzz) and would be eligible to service tax. The question is whether renting of such immovable property by itself constitutes a service and thereby, a taxable service. We have already seen that service tax is a value added tax. It is a tax on the value addition provided by some service provider. Insofar as renting of immovable property for use in the course or furtherance of business or commerce is concerned, we are unable to discern any value addition.  Consequently, the  renting of immovable  property  for  use  in  the course  or furtherance of business  of commerce  by  itself  does  not  entail  any value addition and, therefore, cannot be regarded as a service. Of course, if there is some other service, such as air conditioning service provided along with the renting of immovable property, then it would fall within Section 65(105)(zzzz).

In view of the forgoing discussion, we hold that Section 65(105(zzzz) does not in terms entail that the renting out of immovable property for use in the course or furtherance of business of commerce  would  by itself  constitute  a taxable  service and  be  exigible  to service tax  under the  said  Act.  The obvious consequence of this finding is that the interpretation placed by the impugned notification and circular on the said provision is not correct. Consequently, the same are ultra vires the said Act and to the extent that they authorize the levy of service tax on renting of immovable property per se, they are set aside.”

The  Hon’ble  High  Court based its findings and  resolved  the  issue  by delving  upon  the following two issues:

1.  Interpretation of the term “in relation to”.

2.  Absence of value addition by the service provider.

The High Court has interpreted the term “in relation to renting of immovable property” and went on to consider whether the term “in relation to” would even cover “renting of  immovable property” per se, or would cover only the services which are “in relation to” such “renting of immovable property”.

While  dealing  with  this issue,  the  Hon’ble  High  Court took note  of various decisions interpreting the term “in relation to” and also observed that  services are of two kinds, viz., property oriented and performance oriented.  It is further observed service tax is a value added tax and when there is no value addition, there is no service tax.

Quoting from the decision, the Hon’ble High Court noted that if services are provided to “A” by “B”, in relation to “C”, “A” is the service recipient, “B” is the service provider and “C” is the subject  matter. The  Hon’ble  High  Court has laid  down that  the  question whether the term “in relation to” in the above example would refer to the subject matter “C” itself is dependent upon the context.

The  Hon’ble  High  Court went  on  to  observe that  if “C” by itself  is a service, the expression “in relation to” would cover “C” also and if “C” by itself is not a service, the expression  “in  relation  to” would  not  cover “C” as such,  but  would  cover only those peripheral services, which would add value to the subject matter.

The Hon?ble High Court has compared the definition of taxable service for dry cleaning  services, which reads as “any service provided or to be provided by any person to any other person,  in  relation  to  dry cleaning” and  came  to  a conclusion  that  in  this case, since dry cleaning by itself is a service, the expression “in relation to” would cover dry cleaning per se also.  On the contrary, according to the High Court though the definition  of taxable service for real estate agent service reads as “any service provided or to be  provided by a real estate agent, in relation to real estate”, the same shall not cover real  estate per se, since it is not a service.

The Delhi HC has, while dealing with the question as to whether renting of immovable  property  for  use in  the  course  or furtherance of business or commerce  by itself  is a  service, has also held  that  any service  connected  with  the  renting  of such  immovable  property would fall within the ambit of Section 65(105)(zzzz) and would be exigible to  service tax. Of course, the HC has specifically held in Para 35 of its order that if there is  some other service,  such  as air conditioning  service that  is provided  along  with  the  renting of immovable property, then it would fall within Section 65(105)(zzzz).

Now, it is well known that the Landlords/ Lessors do provide a lot of services like letting out of fitouts, furniture, provision of air-conditioning, providing common parking space, providing common facilities, common power supply, etc.  as part of an overall  package  and, in terms of the Delhi HC judgment, all of these services would indeed get covered  under „Renting  of  Immovable  Property’ services. In  other words,  the  Delhi  HC’s judgment holding that „renting of immovable property’ is not a service, is only, qua, the  activity of renting  of the  immovable  property  without  any additional  services being  rendered.  If any other services get provided by the Landlord or the Lessor, the provisions of Section 65(105)(zzzz) stand automatically attracted, as per the Delhi HC.

The question is whether renting of such immovable property by itself constitutes a service and, thereby, a taxable service. Service tax is a value added tax. It is a tax on the value addition provided by some service provider. Insofar as renting of immovable property for use in the course or furtherance of business or commerce is concerned, we are unable to discern any value addition.  Consequently, the renting of immovable property for use in the course or furtherance of business of commerce by itself does not entail any value addition and, therefore, cannot be regarded as a service. Of course, if  there  is some other service, such  as air conditioning  service provided  along  with  the  renting of immovable property, then it would fall within Section 65(105)(zzzz).

So  the  High  Court held  that  Section  65(105)(zzzz)  does not  in  terms  entail  that  the renting  out  of immovable  property  for  use in  the  course  or furtherance of business of commerce  would  by itself  constitute  a taxable  service and  be  exigible  to  service tax under the Act. The obvious consequence of this finding is that the interpretation placed  by the  impugned  notification  and  circular on  the  said  provision  is not  correct.  Consequently,  the  same  are  ultra vires the  said  Act  and  to  the  extent  that  they  authorize the levy of service tax on renting of immovable property per se, they are set  aside.

The Highlights of the decision are: –

ü  Service  in  relation to renting  of immovable  property  means  a service which  is distinct and different from mere renting of immovable property itself.

ü  The transaction of renting of immovable property by itself is not taxable in terms of Section 65 (105) (zzzz) of the Finance Act

ü  Service tax is Value Added Tax and hence only the , ”value added” is liable to be taxed by way of service tax.

ü  The Act of   renting of immovable property by itself does not provide any value addition to any person.

ü  In the case of lease, the right of possession is transferred whereas in the case of license, there is a transfer of permissive possession.  Such transfer of right cannot be considered as service; and

The Hon’ble court has not given judgment on validity of Section 65 (105) (zzzz) of the Finance Act but     quashed or set aside the operative part of the subject notification and circular which entails levy of service tax on renting of immovable property.

â Issues emerged by this Decision

This Decision has led to emergence of new issues before the Industry. Some of them are being highlighted as under: –

1.) How will  this decision  get  implemented  at  the  ground  level,  especially,  in  cases, where  a composite  rent  is charged  by the  Landlord/Lessor  for  letting  out  the commercial or industrial property and also for providing common services?

As per the  Service Tax  (Valuation  Rules)  of 2006,  the  gross amount  charged  on which service tax is to be collected, would include the portion of the overall rentals as are attributable to the letting out of the bare/worm shell, which as per the Delhi HC, is not a taxable service. There is no provision in the service tax for an artificial bifurcation to be carried out, to ascertain the portion of the ‘rent’ as is attributable to the activity of ‘letting out of the  property’ which, as per the Delhi  HC,  is not a taxable service.

The Government has and option to provide for abatement from the gross rent, so as to  represent  that  the  levy  is only on  services in  relation  to  renting  and  not  on renting per se.

2.) What are the implications of this order in respect of transactions outside of Delhi?

Article 226 of the Constitution places two important limitations upon exercise of the powers of the High Court, viz.

• The  writ  issued  by the  court cannot  run  beyond  territory subject  to  its jurisdiction.
• The  authority to  which  High  Court is empowered  to  issue  the  writs must  be amenable to the jurisdiction of the court either by residence or by location.

It is clear then that the decision of the Delhi HC would not apply to  lease/rental agreements entered into, in respect of premises located outside of the jurisdiction of the  Delhi  High  Court,  even in  respect  of the  parties who have  filed  the  writs. Thus, even in respect of the petitioners, it is only the properties located within the jurisdiction of Delhi would get covered by the HC decision while, properties outside of Delhi, would still not be covered.

3.) And, lastly, where does this decision of the Delhi High Court leave the hapless Developers/Landlords / Lessors?

Very unfortunately, the extensive coverage of this judgment in the press has already created  an  impression  that  the  Delhi  High  Court has struck  down the  service tax levy on commercial rentals, which as we saw, is totally incorrect. Now,  there would be a clamour from the tenants for service tax not to be charged on the  rents paid  by them while  the  Department  would  continue  to  insist  that  the  landlords/lessors pay  service tax  on  commercial  rentals.  The Landlords/Lessors could easily get caught in a ‘Catch 22′ situation.

4.) Whether the Refund of service tax already paid on renting of immovable properties will be allowed or not?

• If the service tax has already been paid but not collected from the recipient of service, refund claim can be made within one year from the relevant date under Section 11B of the Central Excise Act, 1944.
• If  the  service tax  has already been  paid  and  collected  from the  recipient  of service, the  recipient  of service may claim the  refund  provided  that  he  can substantiate that he has not passed the burden of tax to any other person.

Further a new question arises as to what will happen to refund for a period prior to one year from the relevant date in terms of the Section 11B of the Central Excise Act, 1944?

This issue is subjective and depend upon legal interpretation of levy being illegal or unconstitutional  so as give right  to  claim refund  either with  in  specified  period of one year in terms of Section 11B of the Central Excise Act, 1944 or filing a suit or  writ petition to claim refund for extended period of limitation.

â Before parting ………

Hence, it may be safely concluded in view of recent judgment of the Hon’ble Delhi High  Court and relevant provisions of the Finance Act that service tax is not leviable on mere  renting  of the  immovable  property  and  on  transactions  involving  transfer of rights,  in  some form or other in  immovable  property  like Lease agreements,  Leave  and  License agreements, etc.

Before parting with this batch of cases, the High Court observed that it has not examined the alternative plea taken by the petitioners with regard to the legislative competence of the Parliament in the context of Entry 49 of List 11 of the Constitution of India. Such an examination has become unnecessary because of the view it has taken on the main plea taken by the petitioners.

Now the lobbies of lessors / landlords are eagerly waiting for the Decision of Apex Court so that the ambiguity arisen by this decision is ascertained and issue comes to an end.