VAT (What) is the confusion all about in real estate- Part I

Ashish Kedia

This article is the first out of the two part series on this subject. This has been presented from the customer’s perspective. The second part  features the builder/ developer’s perspective.

The state government’s move to generate revenue by taxing the sale of flats and imposing a VAT levy on the same has stirred up a hornet’s nest! VAT to many, is seeming like a new entrant to the list of levies on the already heavily burdened real estate sector and therefore there is a stiff opposition that the government is facing from consumers and realtors both. But to many, it seems like fighting over a lost cause. This is because much too often, we have now been used to seeing government have its way in the form of retrospective amendments, clarifications, etc despite court decisions and public/ industry outcry.

To give a background to those amongst us unfamiliar with the history, The Government of Maharashtra in April, 2005 introduced an old wine in new bottle in the form of MVAT Act in lieu of the sales tax era. The government in 2006 realising the potential of real estate sector to generate revenue and sensing that thee sector is untaxed by Service tax as well as VAT, cleverly amended the definition of sale under the MVAT on 11th September, 2006 to retrospectively include w.e.f 20th June, 2006, agreements to carry out for cash or for deferred payment the building or construction of any movable or immovable property.

The above amendment, to the amazement of all, shook the founding principles of VAT which was till then considered to be a tax on sale of movable property. But by the above amendment, the Maharashtra government deemed contracts for sale of under construction property as a Works contract and not pure sale. Most of us who are familiar with the history also know that the above amendment was prompted by the decision of the Supreme Court in the case of K. Raheja Dev. Corp. wherein the Supreme Court opined that there cannot be works contract after completion of the construction and that the tax cannot be levied to the extent that work is completed before contractual relationship comes into existence.

The MCHI sensing the draconian effect of the amendment (which would make transactions of sale of immovable property leviable to VAT @ 5%, being a works contract) moved the High court challenging the constitutional validity of state to levy VAT on such transactions of sale of immovable property.

Inspite of departmental circulars justifying the move, the then Chief minister Late Shri Vilasrao Deshmukh in November, 2008 admitted that there should be not VAT on sale of flats and had assured the industry and denizens of Maharashtra that he would reconsider the decision by speaking to the State Finance Minister. These measures although didn’t provide relief, did hush up discussions about cascading effect of the tax. In wake of the ambiguity, most builders choose not to pay MVAT but provided clauses in their agreements safeguarding their right to recover VAT from property buyers. Some also sought deposits/ bank guarantees/ indemnity bonds.

While the flip-flop over the move continued, the government to soothe feelings and to garner revenue slashed the rate to 1% w.e.f. April, 2010 by way of a composition scheme, a move which was in a way welcomed. It was at this point in time when most buyers felt the pinch as many builders choose to pay the 1% tax, than face uncertainty. However to make matters worse, the Hon’ble High court in April, 2012 now, dismissed the bunch of petitions filed by MCHI and other builders.

The effect of the decision was that all builders and developers became liable to pay VAT for under-construction properties sold from June, 2006. Further, the tax during the intervening period (20 June, 2006 to 31 March, 2010) was to be computed in accordance with general provisions of Works contract and the beneficial rate of 1% was not applicable to such prior sales.

Further, the government sensing opportunity, which it was keen not to loose, hastened to issue a circular on 6th August, 2012 asking all builders and developers to pay VAT on transactions of sale of under construction property by 31st August, 2012 failing which penalty of 25% would be levied.

Aggrieved by this move and coercive action, MCHI knocked the doors of the Apex court asking for relief by staying the operation of the circular. The court did oblige by extending the time specified in the circular to 31st October, 2012.

In light of this milieu, let us also examine what the confusion around calculation of rate of tax is all about…

In case of such contracts called as Works Contract, the provisions of VAT provide 3 alternatives by which VAT can be calculated and the payer is free to choose the option he deems best:

Two options as prescribed under Rule 58 of MVAT Rules and the third by Section 42.

1st Option:

Under this, the value on which VAT is payable can be arrived at, inter-alia by effecting the following important deductions from the total contract value:

– Cost of Land (determined as per Bombay Stamp Rules).

An important point to note over here is that earlier, land cost only to the extent of 70% of sales value could be deducted. However, the said condition has been deleted retrospectively by notification dtd. 30th July, 2012;

– Charges paid to Sub-contractor

– Labour and Service charges towards services like architect’s and other professional’s fees, machine hire charges, manpower supply charges, etc., (i.e. service elements provided under the contract);

– Cost of Consumables (like water, electricity, etc.) the property in respect of which is not transferred to the buyer, cost of establishment and other similar expenses relating to supply of labour and services.

After effecting the above deductions, the resultant taxable portion is to be divided into 0%, 4/5% and 12.5% rate of goods and tax shall be worked out accordingly.

2nd Option:

This is a simplistic approach to the above procedure: Herein, a flat deduction @ 30% in respect of labour portion of building construction contracts is given. Thus in lieu of calculating the actual labour and service element in the contract, a flat deduction of 30% of contract value maybe availed.

It is also relevant to note here that, in both the above options, full credit of VAT paid on purchases shall be available for set-off against VAT liability of the builder.

3rd Option:

This is a composition scheme, meaning, the law understands the difficulty in splitting such contracts into service and labour portion thereby treating the entire contract as one. In such cases, an adhoc rate of 5% is provided on the total contract value without any deductions. In such cases however, set-off shall only be granted on 96% of purchase price. Please note, the department has in this case also specified, that no deduction in respect of land shall be available to person following this method.

The above 3 options are further complicated or rather simplified for a 4th option for agreements entered into on or after 1st April, 2012.

Under this option, a flat VAT @ 1% is payable on the entire agreement value.

Having assimilated the above, it is evident that the last option is least taxing (both monetarily and arithmetically).

Let us now proceed to understand the various contentions and queries put forth by the government, realtors and public at large:

 Is this levy applicable to only residential properties or commercial properties as well?

This levy is applicable to any property (residential or commercial or otherwise) purchased on or after 20th June, 2006 and the construction in respect of which was still on at the time of execution of agreement.

 One main contention is that in view of the deductions as mentioned above, effective tax will always work out to less than 5% (i.e. around 0.5% to 2.5%).

Our Opinion: The above rate has been worked out considering inter-alia following three important deductions:

i) Cost Of Land

ii) Cost of Services which have used in construction of flat, and

iii) Set-off of VAT paid on purchases against VAT payable on sale

Here it is important to note that the builder is not mandated to pass on benefit in respect of set off on purchases. Also deduction for land/ services is allowed only when full rate of VAT is charged and not when builder has availed composition rate of 5%.

Even considering the builder passes on the benefit of set-off on purchases to customer, it is highly dubious the rate would go to as low as 1% – 2%.

Hence, the government’s contention of a nominal effective rate is merely eyewash.

 Builders are fooling buyers by not giving them exact calculations in respect of VAT and charging exorbitant/ adhoc amounts in the name of VAT

In general parlance, it is not true that builders have not given exact calculations of VAT liability for reason to fool buyers. As seen above, the calculations above are itself so complex that no builder have them ready off hand and most would have to approach their accountants to determine the best method and exact liability.

Another case in point is that no businessman (builder/ developer) would prefer to give such intricate calculations, as it also means giving out a lot of information pertaining to his trade in the open.

However, simplistically the customer to ensure he doesn’t pay more to the builder can simplistically calculate VAT payable as 5% of the agreement value. Also customers can ask the builder for a letter/ debit note with his VAT registration no. embossed upon it stating the amount collected as VAT.

The builder may have asked customers for adhoc amounts at the time of agreements as they are also going though the same uncertainty and adopted this practice to safeguard their interest. The customers can ask for refund of any amount collected over and above that stated in the letter.

 Whether there will be any liability if agreement was executed prior to June, 2006 but construction and possession is given after June, 2006?

Yes, in such cases too there shall be a VAT liability which shall be calculated based on the value of installments paid/ payable to the developer post June, 2006.

 The agreement was entered into after 90% of the construction pertaining to building was complete and all payments were made near to the date of agreement and post it. Will VAT still be levied on the entire amount of agreement?

Well, the answer to above question is a Yes going by the intention and clarifications issued by the department.

However, if the builder is ready to take an aggressive stand, it may be contended that VAT is payable only on value of portion pertaining to building completed after execution of agreement. This is because the SC has opined in the case of K. Raheja Development Corp. that ‘there cannot be works contract after completion of the construction and that the tax cannot be levied to the extent that work is completed before contractual relationship comes into existence’

 It has been said that it is the VAT is the obligation of builder/ developer? If that is the case, is the customer liable?

While it is true that builder is the person liable to pay VAT to the department, he certainly has a right to recover the same from the customer. Thus the customer should, in order to find answer to this query, refer his sale agreement and check whether there is a clause giving the right to the builder to demand taxes over and above the agreement price. If the sale price is inclusive of taxes/VAT, the builder cannot demand the amount of VAT from the customer.

 What about cases where the builder has taken a deposit. Can he also recover interest over and above VAT from the customer in such case?

In cases where the builder has taken deposit from the customer, he cannot recover any amount towards interest as it can be contended that it was his duty to pay the amount under protest to the government. But in cases of indemnity bonds/ bank guarantees, such argument may not be so feasible.

 The builder has also charged amounts towards maintenance, electricity deposit, society formation charges, water charges, development charges, etc. Are such amounts also liable to VAT?

The above amounts, to the extent they have actually been incurred by the builder towards various expenses, shall be allowed as a deduction from the agreement value.

 The Supreme court has ordered stay on payment of interest and penalty. Is the customer still liable to pay the same?

While it is true the court has ordered a stay on payment of interest, it is only effective during the period until October/ case is being heard. Thus the customer, on the basis of court order may not pay interest to developer as he is also not obliged to pay the same to the government. However, if the levy of MVAT is upheld by the Supreme court, customers shall definitely have to pay interest as it is highly unlikely the government would waive its right to demand interest.

 Is the Supreme Court verdict a reason to celebrate

While the verdict is certainly a reason for realtors to heave a sigh of relief as they have been granted time until October to pay the tax, but for consumers it hardly assumes any significance. This is because the Supreme Court has granted builders time until October to register and pay VAT to the government but for the consumers, it is them from whom the tax would be recovered.

It has been mentioned by the court that in case the matter is adjudicated in favour of MCHI-CREDAI, the VAT paid will have to be claimed as refund.

 It has been argued by the government that the levy has been around 6 years and such hue and cry around the issue now is unjustified

In response to the above, it could be said that the government was also fully aware that such a levy would become the bone of contention amongst property buyers and builders. Further, bringing in VAT @ 1% w.e.f. April, 2010 (brought in owing to representations made by developer associations for a simple method) and not giving it retrospective effect is outright discriminatory and unjust.

 If the issue has been around for more than 6 years, who is responsible for the delay

Reason for delay is the system of litigation in India. The case against the imposition of levy was filed in 2007. The Hon’ble High Court could come out with a verdict only in 2012. The inordinate delay in adjudicating cases combined with lack of political will on the part of government to bring in clarity/ simplicity is the reason for delay and confusion.

While it is true this note may not have answered all your questions, it is unfortunate that there is no clear answer to some questions in the absence of clarity from government and other bodies. Going by the current state of affairs, we only have the option to wait for the Supreme Court’s expeditious ruling on the matter. All I can say to conclude is that the perils on investing in this sector only seem to be increasing by the day.

(The author is a Chartered Accountant and is a Partner at A V Kedia & Associates, Mumbai. He can be reached at [email protected])