Real estate industry has been in limelight for reasons, right or wrong every season from economy to environment, from tax to transaction, from consumer to court. This time it struck chord with tax battle. We are discussing about recent Judgment by Delhi Court on service tax levy on construction and sale of flats in case of Suresh Kumar Bansal vs. Union of India.
By setting aside levy of service tax on construction and sale of flats introduced by virtue of Explanation to Section 65(105)(zzzh) of Finance Act, 1994 on very interesting premise gave rebirth to good old debate almost settled by earlier rulings. Law makers who worded penchant Explanation must be proud for its being most discussed, debated, disruptive to levy tax on a transaction. This ruling is getting a vehement push across media and surely being pegged as big relief to home buyers. It surely holds weight but it imperative to go into the nitty gritty of entire case which emerged on reference of various decisions of Supreme Court and why the relief may not last long. Read on….
Here the petitioner or Appellant is not a Builder or company, but 2 Individuals who happened to be Advocates. They booked flats in a Housing Project based out at Noida and entered into a Flat Buyer’s Agreement with Builder for construction of their respective flats. Builder charged service tax on services in relation to construction of complex and on preferential location charges. Aggrieved by the service tax levy, they moved Writ petition in Delhi High Court challenging the levy on both construction service and on preferential location services.
Issues in Question before HC
1. Whether the consideration paid by flat buyers to a builder/promoter/developer for acquiring a flat in a complex, which under construction/development, could be subjected to levy of service tax ?
2. Whether Explanation to Section 65(105)(zzzh) of the Act introduced by virtue of Finance Act 2010 which seeks levy of service tax on construction of flats wherein consideration has been received before obtainment of completion certificate is ultra vires of the Constitution of India ?
3. Whether Preferential location charges charged by Builder is leviable to service tax ?
Arguments by Petitioner
On Construction and Sale of Flats
♣ That, the agreements entered into by them with the Builder are for purchase of immovable property and the Parliament does not have the legislative competence to levy service tax on such transaction. In support they relied on recent decision of the Supreme Court in Commissioner Central Excise and Customs, Kerala and Ors. v. Larsen & Toubro Ltd. and Ors.: (2016) 1 SCC 17.
♣ That in case of composite contracts, power of Parliament to levy tax would be limited to only on the service component after excluding the value of goods as well as the value of land from such contracts.
♣ That the charging section should clearly provide that the levy is on service element of contract and in absence of any such provisions, service tax cannot be levied.
♣ That the Act and the rules made thereunder do not provide any machinery for computation of value of services, if any, involved in construction of a complex and, therefore, service tax levy should fail.
♣ That the contention raised by Petitioners would also be equally valid for the taxing provisions introduced with effect from 1st July, 2012.
♣ Relying on recent decision of the Supreme Court in Commissioner Central Excise and Customs, Kerala and Ors. v. Larsen & Toubro Ltd. and Ors.: (2016) 1 SCC 170 in support of their contention that in order to levy tax, the Statute must clearly specify the three elements of taxation, namely,
- the subject of tax;
- the person who is liable to tax; and
- the rate and measure of tax.
♣ The abatement to the extent of 75% by a notification or a circular cannot substitute the lack of statutory machinery provisions to ascertain the value of services involved in a composite contract. The charging provisions as well as the machinery for its computation must be provided in the Statute or the Rules framed under the Statute.
There was no service element in preferential location charges which were levied by a builder and the same related only to the location of the immovable property and, therefore, such charges were not exigible to service tax.
Defence by Revenue
- Impugned Explanation sought to levy tax on sale of under construction flats w.e.f 01.07.010 wherein advance payment has been received was held constitutionally valid in Maharashtra Chamber of Housing Industry and Anr. v. Union of India and Ors. wherein aforesaid Explanation was treated as constitutionally valid.
- Development of a project results in the substantial value addition on bare land and includes various services such as consulting services, engineering services, management services, architectural services etc. These services are subsumed in the taxable service as contemplated under Section 65(105)(zzzh) of the Act.
- Since Gross charge includes value of land and construction material, only 25% of the Base Selling Price (BSP) charged by a builder from the ultimate consumer is subjected to levy of service tax.
What did Delhi HC observed and held ?
Let’s take a look at observations of Delhi HC on different aspects, key snippets.
+++On activity is a service or pure sale or a combo
‘Whilst it may be correct to state that the title to the unit (the immovable property) does not pass to the prospective buyer at the stage of booking, it can hardly be disputed that the buyer acquires an economic stake in the project and in one sense, the services subsumed in construction – services in relation to a construction the complex – are rendered for the benefit of the buyer.’
Undisputedly, the contract between a buyer and a builder/promoter/ developer in development and sale of a complex is a composite one. The arrangement between the buyer and the developer is not for procurement of services simplicitor.
Comment: It was not a case of pure service or sale but composite contract.
+++On classification of activity as Works Contract
‘The present transaction of construction of flats is composite contract which will be classified in the nature of works contract as held by the Supreme Court in Larsen and Toubro v. State of Karnataka (supra).’
Comment: However, HC did not examine this as it was out of current issue in question and kept it open. SCNs would have already been issued against builders on transaction pre-negative list either alleging classification under ‘Construction of Complex’ or ‘Works Contract Service’. This decision may not apply on those cases where alleged classification is under ‘works contract’, the same has to be looked into on case to case basis,
+++ On activity prior to 01.07.2010
HC opined that there is no conflict on that fact that service tax on impugned activity was not taxable prior to Finance Act, 2010.
+++On Rule 2A of Service Tax Valuation Rules
Whilst Rule 2A of the Rules provides for mechanism to ascertain the value of services in a composite works contract involving services and goods, the said Rule does not cater to determination of value of services in case of a composite contract which also involves sale of land.
Comment: What an observation !. Since it is a composite contract of construction and sale of flats, in absence of machinery provisions to exclude non-service elements from a composite contract, the levy can’t stay.
+++On Legislative Competence of Parliament to levy tax on activity and validity of ‘Explanation’
‘The controversy whether a legislature has the competence to enact a law has to be judged in the context of the pith and substance of that law.
The use of a legal fiction is a well-known legislative device to assume a state of facts (or a position in law) for the limited purpose for which the legal fiction enacted, that does not exist. The Parliament is fully competent to enact such legal fiction.
‘The imposition of service tax by virtue of the impugned explanation is not a levy on immovable property as contended on behalf of the Petitioner. The clear object of imposing the levy of service tax in relation to a construction of a complex is essentially to tax the aspect of services involved in construction of a complex the benefit of which is available to a prospective buyer who enters into an arrangement – whether by way of an agreement of sale or otherwise – for acquiring a unit in a project prior to its completion/development.’
Comment: Accordingly Delhi High Court reiterated the earlier settled view holding Explanation in vires to Constitution.
+++On Valuation mechanism in law and exclusivity
‘Even in those composite contracts which are by legal fiction deemed to be divisible Under Article 366(29-A), the value of the goods involved in the execution of the whole transaction cannot be assessed to sales tax. As was said in Larsen and Toubro v. State of Rajasthan: (SCC p. 395, para 47).
“The cost of establishment of the contractor which is relatable to supply of labour and services cannot be included in the value of the goods involved in the execution of a contract and the cost of establishment which is relatable to supply of material involved in the execution of the works contract only can be included in the value of the goods.’
In the present case, we find that there is no machinery provision for ascertaining the service element involved in the composite contract. In order to sustain the levy of service tax on services, it is essential that the machinery provisions provide for a mechanism for ascertaining the measure of tax, that is, the value of services which are charged to service tax.’
Comment: There has to be exclusivity in taxation of a transaction, wherein State can tax only levy tax on value of goods and Centre on service portion. If Statute does not provide for mechanism to arrive at Value of services rendered, the levy would fail.
+++On availability of Abatement on this activity
‘The abatement to the extent of 75% by a notification or a circular cannot substitute the lack of statutory machinery provisions to ascertain the value of services involved in a composite contract.’
Preferential location charges are charged by the builder based on the preferences of its customers. They are in one sense a measure of additional value that a customer derives from acquiring a particular unit. …………. Such charges cannot be traced directly to the value of any goods or value of land but are as a result of the development of the complex as a whole and the position of a particular unit in the context of the complex.’
What did Delhi HC hold ?
- Struck down levy of service tax on construction and sale of unfinished flats tax under section 66 of the Act read with Section 65(105)(zzzh) of the Act and ordered refund of any amount collected and deposited as service tax to the Petitioners with interest at the rate of 6% from the date of deposit till the date of refund.
- Confirmed levy of service tax preferential location charges.
Before Signing off…..
Time and again Government has proved its intention to levy service tax on these transactions by suitably amending the service tax law by overruling the Top Court Judgments. It will not be surprising if you can expect an amendment to the effect of introducing valuation provisions in service tax so as to negate the verdict. HC did not dispute that the activity in question can be classified under ‘Works Contract Service’, but did not even examine. The applicability of judgment on transaction post 01.07.2012 is not clear and to be examined and looked into. But A Home Owner has all the right to take stand against paying service tax.