Taxation is a power of the political sovereign authority and realization of taxes is essential for meeting State expenses which is meant for governance, of defence, development science and technology, health, education, food, shelter, healthier environment, irrigation, roads, transport and facilities for employment.

As India continues its scorching pace of economic growth, both Centre and States are trying to find out new means and ways to generate more revenue within the existing legal framework. During the last one decade, the real estate and construction sector has grown so rapidly that both the Centre and the State made efforts to realize some more revenue from this sector. The Union tried to levy service tax and the States started levying sales tax. The real estate services were taken as a significant source of revenue collection by both the Union and the States.

Under the present legal framework, sale or transfer of immovable property is governed under the Transfer of Property Act, 1882 and the sale of movable property is governed under the Sale of Goods Act, 1930 and hence liable to pay sales tax.

46th amendment of the constitution

Before the 46th Amendment of the Constitution, composite contracts, such as works contracts were not assessable to sales tax, as sales tax could be imposed only upon transfer of property in goods from one person to another. Consequently sales tax could not be imposed upon transactions which might have resembled sale but in fact were composite contracts of supply and services. Because of this, States were losing sales tax revenue to a large extent and this led to the 46th amendment of the Constitution which brought changes in the definition of the word ‘sale’ as given in Article 366 (29A) of the Constitution of India by incorporating those transactions which might have resemblance to sale but did not fall within the traditional concept of sale and judicially held to be not exigible to sales tax. The idea behind this amendment was to create a concept of ‘deemed sale’ by treating, with the help of a legal fiction, such a transaction as a ‘sale’ even if the same did not fall within the ambit of the definition of ‘sale’ as defined in the Sale of Goods Act. In other words, by bringing various transactions within the purview of the definition of ‘sale’, a transaction which was otherwise not a sale has been deemed to be a sale. After the 46th Amendment of the Constitution, the works contract which was indivisible one, by a legal fiction has been altered into a contract which is divisible, one for sale of goods and other for supply of labour and services. After the 46th Amendment of the Constitution, it was possible for a State to levy sales tax on the value of the goods involved in the execution of works contracts in the same way in which sales tax was leviable on the price of goods and the material supplied in a building contract which has entered into two distinct and separate parts. The properties that are transferred to the owner are the goods in the execution of works contract and not the conglomerates i.e. the building actually constructed. The 46th Amendment has done nothing more than making it possible for the State to levy sales tax on the price of the goods and the materials used in works contracts as if there is a sale of such goods and materials. As the Supreme Court in the case of Builders Association vs. Union of India (1989) 73 SW 370 has held that sub-clause (b) of clause (29A) of Article 366 should not be read as equivalent to a separate entry in the List- II of the Seventh Schedule to the Constitution of India enabling the State to levy tax on sale and purchase independent to Entry- 54 thereof. The power of the State to levy tax on sale and purchase of goods including the deemed sale and purchase of goods under Article 366 (29A) is to be found in Entry- 54 and not outside it.

Judgment of the Apex Court in K. Raheja’s Case

Pursuant to the amendment made to the Constitution, all the States enacted law to levy sales tax on works contract. However no tax was being levied on the real estate transactions taking it that the consideration passing from buyer of a flat/apartment to the developer did not attract VAT. However, the Supreme Court in K. Raheja Development Corporation vs. Union of India (2005) 141 SW 298 case held that if a Developer enters into a sale of a flat/apartment before construction is completed, it would be a works contract. Broadly it was based on the reasoning that an agreement to sale of a flat under construction is an agreement to construct a flat for an eventual buyer of a flat and an agreement to construct a flat building is a work contract. Although this judgment of the Supreme Court was in the context of the definition of ‘works contract’ under the Karnataka Sales Tax Act, the Excise Authorities were very much quick in adopting the issue and started demanding service tax on the labour portion of works contract and the States started levying sales tax on the material portion involved in the construction of the building treating the same to be a works contract.

Nature of Real Estate Transactions

Typically in real estate transactions, the land holder contributes the land, the developer constructs the building and sells the flats along with the proportionate rights in respect to the land. As a result, each owner becomes the owner of an apartment with corresponding undivided share in the land arid an undivided share in the common areas. The usual feature of such agreements is that the land holder will have no say or control in the development. Nor will the land holder have any say as to whom and at what cost the developer’s share of apartments are to be dealt with or disposed of. Land owner’s only right is to demand delivery of his share of constructed area and/or other consideration as per the agreement. Such agreements are neither contracts for construction, nor contracts for sale of apartments, but are contracts entered for mutual benefit. In a true joint venture agreement between the land owner and developer, the land owner is a partner or co-adventurer where the land owner has a say or control in the construction and participates in management of the joint ventures. In such situation, land owner is neither a consumer nor a service provider. Such joint ventures are comparatively rare. What is factually prevalent are the agreements which are a hybrid arrangements for construction, consideration and sale. Ordinarily, a developer is not interested in sharing the control of his business except assuring the land owner a specified constructed area and consideration.

Keeping in view of the above legal proposition, it is worth noting that Developers of the real estate do not undertake any construction work for and on behalf of proposed customers/ allottees and the title in the flat/ apartment so constructed passes to the customer only on the execution of the sale deeds and registration thereof. Until the time the said sale deed is executed, the title, interest including ownership remains with the developers. The payments made by the prospective customers in instalments are aimed at facilitating purchase of flat/ premises by the probable purchasers so that they may not be required to pay whole of the price at a time. The initial agreement between the Promoter/Builder/Developer and the owner is in the nature of agreement to sale and is as per the provisions of the Transfer of Property Act, 1882. The same does not by itself create any interest in the property. Ownership of the property remains with the Promoter/ Builder/Developer. Only after completion of construction and full realization of the agreed sum, a sale deed is executed and only then ownership of property gets transferred to the ultimate owner.

Decision of Guwahati High Court in Magus Construction

The Guwahati High Court in Magus Construction (P) Ltd. vs. Union of India (2008) 17 VST 17 while examining the issue of levy of service tax on the real estate transaction held that while the Promoter/Builder/Developer undertakes construction activities, the relationship of service provider and the service recipient is absent and thereby the question of providing taxable service to some other person does not arise. The Guwahati High Court held that the construction activities done by Promoter/Builder/Developer are in respect of their own work and it is only the completed construction work which is sold to the buyers who may have made agreement for sale before the construction had actually started or during the progress of the construction activities or at the end of construction activity. Any advance payment made by prospective buyers or deposit receipts issued by the Promoter/ Builder/Developer is against the consideration of sale of flat /building to such prospective buyers and not for obtaining service from the Promoter/ Builder/Developer.

In fact, an agreement for sale of a flat that is under construction is not an agreement for construction of a flat but the same is simply a financing agreement, whereby the purchaser books a flat while it is under construction by the developer for himself as an entrepreneurial venture rather than on behalf of and under instructions from the buyer.

Judgment in K. Raheja’s case referred to larger bench

Recently in a judgment in Larsen & Toubro Ltd. vs. State of Karnataka 2008 17 VST 460’s case, the Apex Court has doubted the law laid down in the Raheja’s case and has referred the said judgment to a larger bench. In L & T’s case, the developer was engaged in development involving construction of flats and subsequent sale thereof. Revenue Department’s argument was that such sale is liable to tax for the reason that transaction for construction and sale of flats are in the nature of ‘works contract’. The Apex Court in the said referral order has held that it is important to bear in mind the distinction between two types of contract namely sale and works which rests on the principle that the contract of sale is one whose object is transfer of property in goods and delivery of possession of a chattel as a chattel to the buyer. When the object of the work undertaken by a payee is not the transfer of chattel as a chattel, the contract is one of work arid labour. The Apex Court further observed that if the ratio of Raheja’s case is to be accepted then there will be no difference between works contract and a contract for sale of chattel as a chattel.

Circular of Central Board of Excise & Customs

The Central Board of Excise and Customs also in view of the ongoing controversy as regards levy of service tax on construction of residential complexes, vide Circular dated 29-1-2009 has clarified that any service provided by a Promoter/ Builder/Developer in connection with the construction of residential complex till the execution of sale deed would be in the nature of self service and would not attract the scope of service tax. The circular of Central Board of Excise and Customs has not only settled that the disputes as regards levy of service tax on the real estate transactions but the same will also help in resolving the controversy as regards levy of sales tax on real estate transactions. Although the referral order of the Supreme Court in L & T’s case shall result in a bringing temporary relief for the real estate developers, until a larger bench renders its verdict, the need of the hour is to prevent the over zealous officials from levy of service tax which appears to be against the very concept of the works contract tax and the object of the 46th Amendment of the Constitution.


The Constitutional Amendment in Article 366 (29A) read with the relevant taxation entries has enabled the State to exert its taxing power in an important area of social and economic life of the community. In exerting this power, particularly relating to transfer of property in goods involved in the execution of works contract in building activity, the State might perhaps, be pushing its taxation power to the peripheries of the social limits of that power, and, perhaps even of the constitutional limits of that power. However it should be borne in mind that the real estate industry is very important for the economic growth of the country and the Government should not take it to be a tool to realize more revenue and force the industry to engage itself into long drawn litigations that too at a time when the world economy is passing through a phase of great recession.

Author:- Dr. Ashok Saraf, Senior Advocate, Guwahati High Court

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