Service Tax – sale of constructed houses – liable to pay Service Tax under ‘construction service’ and not under ‘works contract’ : Advance Ruling

NEW DELHI, APR 17, 2008 : THE questions before the AAR were,

1. Whether the activity of booking the residential units to be undertaken by the applicant is a taxable service liable to Service Tax under the provisions of section 65 (105) of the Finance Act, 1994?

2. Whether the applicant is liable to service tax under section 65 (105) (zzzh) of the Finance Act, 1994 under the notified taxable service of construction of Complex in case of Proposed Activity No.1?

3. Whether the applicant is liable to service tax under section 65 (105) (zzzh) of the Finance Act, 1994 under the notified taxable service of construction of Complex in case of Proposed Activity No. 2

Through the proposed activities 1 & 2, the applicant intends to develop a residential complex on its own land at its expense. The complex will have; more than 12 residential units, as also a club house and other common facilities. The applicant will book the residential units in favour of a particular buyer after taking a token booking amount and executing an agreement. The Full value of the residential unit will be indicated to the buyer at the time of booking. The sub plot on which the building has to be constructed is also specified in the Agreement. The physical possession of the residential unit will be given to the buyer after the construction activity is completed and the full payment is received. The construction material will be bought by the applicant in both the activities. The only difference between the activities 1 & 2 is that while in activity 1, the construction will be carried out by the applicant itself through its own labour, in activity 2, the construction will be carried out by engaging labour, contractors/ petty contractors who will carry out the work under the applicant’s supervision and control.

The AAR observed that the answer to the first question mainly depends on the answers to question No.2 and 3. Question 3 is practically the same as question No.2. So question No. 2 is answered first.

Question No. 2 in substance is whether in respect of the proposed activity No.1, any service “in relation to the construction of complex” is provided by the applicant to the booker/prospective buyer of the residential unit constructed and ultimately sold by the applicant.

The Authority observed, “We are of the view that the question has to be answered in the affirmative upholding the contention of the Revenue. It must be noted that the words “construction of complex” in (zzzh) is qualified by the preceding phrase “in relation to”. This expression – ‘in relation to’ is used by the legislature to widen the scope and dimension of the sub-clause so to establish a greater nexus between the construction and the services implicit in such construction. The expression ‘in relation to’ is of wide import. Thus, it is not merely the construction part of the activity that matters; the correlated and incidental services are all embraced within the scope of sub-clause (zzzh).

The Authority further observed,

“The whole purpose of inserting sub-clause (zzzh) in section 65(105) appears to be; to bring the services in connection with, the construction of residential complexes by the developers/promoter s within the net of taxable services. By introducing such a specific provision and defining the term ‘residential complex’, incidentally, the legislature wanted to obviate any controversy on the point whether the services of the nature involved in proposed activity No. 1 could at all [fall within the scope of (zzzza) dealing with works contract. The net of taxation is intended to be spread out so as to reach the entire gamut of Complex construction activities which are part of a commercial venture. The activity of building a residential unit on an earmarked plot in the Complex and making construction thereon as per the plan, design and specifications, obtaining various permissions and providing amenities as contemplated by clause 9(b) of the Agreement, apart from the provision of common infrastructural facilities before handing over the building to the customers would undoubtedly constitute ‘services provided or to be provided’ by the applicant. A host of facilities and amenities have to be or are contemplated to be provided under the terms of the agreement, apart from construction. Some or many of them may be common amenities which will be available to others who inhabit in the complex but they cannot be dissociated from the construction of the residential unit for the benefit of the booker/buyer. Package of services is necessarily involved in the activity viewed as a whole and that is the reason why the phrase “in relation to” has been used. The fact that the ownership and possession remains with the applicant throughout the process of construction and that the constructed residential unit can only be transferred to the booker/buyer on receipt of entire sale consideration does not have a real bearing on the question whether any services in relation to the construction of complex are required to be rendered by the applicant. The applicant, in our view, has laid undue stress on the aspect of ownership remaining with it till completion and on the element of control over construction. If the contention of the applicant is to be accepted, the entire purpose of sub-clause (zzzh) will be defeated or at any rate, it may become otiose. We do not think that the point of time at which the ownership gets transferred will be determinative of the applicant’s liability to pay service tax. Viewing from another angle, though in one sense, the applicant can be said to be constructing the residential unit on its own and not exactly on behalf of the booker, yet, the fact remains that the applicant does everything to honour its commitment to the customer (booker) from whom it receives valuable consideration in installments. The construction and allied services, it must be noted, is referable to the agreement with the prospective buyer and cannot be viewed in isolation. The possibility of the booker defaulting in payments of installments and the agreement being terminated in that event is really not material in evaluating the true nature of the transaction. ”

The Authority did not accept the contention of the applicant the proposed activities No 1 and 2 tantamount to self-service and that there is no recipient of service, as it found no legal or factual basis for such argument.

What about the Board Circular? The authorized representative of the applicant has drawn attention to para 79.01 of the Circular No 96/7/2007-ST dated 23/8/07 (issued by CBEC) in an apparent bid to draw support to his contention by invoking the principle of contemporaneo expositio The relevant part of the query posed and answered in the said paragraph of the Circular is as follows:-

“Whether service tax is liable under construction of complex service (zzzh) on builder, promoter, developer or any such person (a)…(b) who builds the residential complex on his own by employing direct labour”.

This query answered as follows:-

“(b) If no other person is engaged for construction work and the builder / promoter / developer / any such person undertakes construction work on his own without engaging the services of any other person, then in such cases,-

(i) service provider and service recipient relationship does not exist,

(ii) services provided are In the nature of self-supply of services.

The AAR observed that the situation covered by the Board Circular query is one of outright sale of a residential unit after the construction, the construction having been done without reference to any agreement with the customer/buyer. The recipient of service is not in the picture at all at any stage of construction. The developer and the buyer come face to face after the entire process of construction is complete and the building ready for occupation is offered for sale in such a situation, it cannot be said that any services were extended by the developer to the buyer. The relationship between the developer and the buyer is purely one of seller and buyer. But, the factual position is qualitatively different in the case of proposed activity no.1.

Question No.3

There is no material difference between the proposed activity no.1 and 2. The factual matrix in relation to the proposed activity no.2 is almost the same except that the applicant, instead of directly building the residential unit itself, will be sub-contracting the work. The applicant is accountable to the bookers/buyers and remains to be a service provider vis-a-vis the buyer. The engagement of sub-contractor to do a substantial part of the construction work does not absolve the applicant of the responsibility of providing services in relation to the construction of residential unit agreed to be sold to the customer ultimately. Question no.3 is therefore answered in the affirmative and in favour of the Revenue.

Question No.1

The question is formulated by the applicant as follows:-

“Whether the activity of booking the residential units to be undertaken by the applicant is a taxable service liable to service tax under the provisions of section 65 (105) of the Finance Act, 19047”

The AAR observed that it seems that the question as framed lacks in clarity. The question, if literally read, is confined to the first step of ‘booking’ the residential unit but not the series of activities that follow the booking and entering into the agreement. However, it is clear from what is stated in the application and also the arguments of the learned authorized representative that the applicant wants a ruling on the broader question whether the service tax liability is fastened on it by reason of undertaking the construction on an identified plot and handing over the constructed unit to the customer on receipt of the entire consideration.

The AAR observed, “While discussing the question no.2 and 3, we have recorded the conclusion that the proposed activities 1 and 2 undertaken in accordance with the terms of the draft agreement attracts service tax liability under section 65 (105) (zzzh) of the Finance Act, 1994. Therefore, it is unnecessary to give a separate ruling on this question.”

Is the Service construction or works contract? Here also the applicant lost badly due to ignorance. There was no need to raise this issue before the AAR as it had been already clarified by the Board. The AAR proceeded to clarify the issue based on principles of classification and held that the service would fall under “construction” and not works contract.

TRU ‘s letter F. No. B1/16/2007- TRU dated the 22nd May, 2007 clarified as follows

9.9 Various trade and industry associations have raised apprehension in respect of classification of a contract either under the newly introduced works contract service or under erection, commissioning or installation and commercial or residential construction services.

9.10 Contracts which are treated as works contract for the purpose of levy of VAT / sales tax shall also be treated as works contract for the purpose of levy of service tax. This is clear from the definition under section 65(105)(zzzza) .

Had this been brought the notice of the Authority, certainly the decision would have been different.

In conclusion, AAR gave answers to questions 2 and 3 in the affirmative and accordingly ruled that the applicant is liable to pay service tax in respect of the proposed activity 1 and 2 under sub-clause (zzzh) of section 65 (105) of Finance Act, 1994. The first question need not be specifically answered.

Now the AAR’s Ruling will open a Pandora ‘s Box throughout the country and demands will fly – though the AAR’s decision is not binding on the rest of the world, this will be used with great persuasive value as one delivered by a former Supreme Court Judge.

Maybe assessees should keep a watch on the applications before the AAR and implead themselves as amicus curie, so that the Authority is informed of the factual position.