Service Tax on Real Estate – A Practical Perspective (PART – B)

CA Ankit Gulgulia

This article aims to discuss few essential issues that require to be addressed in light to the changes brought by negative list provisions, the jeopardy created by the board’s circulars and complexity of structures adhered to in this industry. Broadly the article shall cover the aspects as mentioned hereinafter: – (Strictly relevant to real estate only). Also read my Previous Article which is Part A of this Article on the Following link :-  Service Tax on Real Estate – A Practical Perspective (Part – A)

Abatement / Valuation in Construction Activity

As already discussed, section 66E gives way to service tax on construction activity as it considers construction activity as a declared service. As per section 66E (b),

– Construction of a complex, building, civil structure or a part thereof, including a complex or building intended for sale to a buyer, wholly or partly shall be a declared service, except where the entire consideration is received after issuance of completion-certificate by the competent authority.

– Competent authority means the Government or any authority authorized to issue completion certificate under any law for the time being in force and in case of non requirement of such certificate from such authority, from any of the following, namely:––

◊ Architect registered with the Council of Architecture constituted under the Architects Act, 1972; (20 of 1972.) or

 ◊  Chartered engineer registered with the Institution of Engineers (India); or

◊   Licensed surveyor of the respective local body of the city or town or village or development or planning authority;

–  “Construction” includes additions, alterations, replacements or remodeling of any   existing civil structure;

– Once the activity is a construction activity (and not falling in exemption, negative list), then it is significant to understand the valuation procedures.

–  As per notification no. 26/2012 dated 20^th June, 2012, SL. No 12 – Where the activity is nature of construction activity aforesaid, then abatement of 75% can be availed subject to following conditions:

◊ CENVAT credit on inputs used for providing the taxable service has not been taken under the provisions of the CENVAT Credit Rules, 2004.

◊ The value of land is included in the amount charged from the service receiver.

◊ Essentially as in case of ‘service portion in works contract’, the provisions relating to fair market value shall also apply. The amount charged shall be  the sum total of the  amount charged for the service including the fair market value of all goods and services supplied by the recipient(s) in or in relation to the service, whether or not supplied under the same contract or any other contract, after deducting-

(i) the amount charged for such goods or services supplied to the service provider, if any and

(ii) the value added tax or sales tax, if any, levied thereon

Provided that the fair market value of goods and services so supplied may be determined in accordance with the generally accepted accounting principles.

Reverse Charge Implications

For applicability of reverse charge, ensure that the service provider and service receiver in respect of service mentioned is as mentioned hereunder. If it is so then reverse charge shall apply.

S.No	Service	By (SP)	To (SR)
1	Insurance	Insurance agent	Any Person
2	Goods Transport by Road	GTA	-Factory- Society- Cooperative Society – Dealer under excise – Body corporate – Any partnership firm
3	Sponsorship	Any Person	– Body corporate-  Partnership firm in taxable territory
4	Any service	Arbitral tribunal Individual Advocate Support service provided or agreed to be provided by Government or local authority	Any business entity in taxable territory
5	Renting or hiring any motor vehicle designed to carry passenger	-Individual–  HUF- Proprietorship firms – Partnership firm – AOP	-Company-business entity registered as body corporate located in the taxable territory
6	Works Contract Service	-Individual–  HUF- Proprietorship firms – Partnership firm – AOP	-Company- business entity registered as body corporate located in the taxable territory
7	Supply of manpower for any purpose	-Individual–  HUF- Proprietorship firms – Partnership firm – AOP	-Company- business entity registered as body corporate located in the taxable territory
8	Any service	Any person in non taxable territory	Any person in taxable territory

Once reverse charge applies, the next thing is that what shall be proportions of taxes payable by the service provider and service receiver respectively. The same are as under,

S.No	Service	By (SP)	To (SR)
1	Insurance	Insurance agent	Any Person
2	Goods Transport by Road	GTA	– Factory- Society- Cooperative Society – Dealer under excise – Body corporate – Any partnership firm
3	Sponsorship	Any Person	– Body corporate- Partnership firm in taxable territory
4	Any service	1. Arbitral tribunal 2. Individual Advocate 3. Support service provided or agreed to be provided by Government or local authority	Any business entity in taxable territory
5	Renting or hiring any motor vehicle designed to carry passenger	-Individual–  HUF- Proprietorship firms – Partnership firm – AOP	– Company- business entity registered as body corporate located in the taxable territory
6	Works Contract Service	-Individual–  HUF- Proprietorship firms – Partnership firm – AOP	– Company- business entity registered as body corporate located in the taxable territory
7	Supply of manpower for any purpose	-Individual–  HUF- Proprietorship firms – Partnership firm – AOP	– Company- business entity registered as body corporate located in the taxable territory
8	Any service	Any person in non taxable territory	Any person in taxable territory

 The computation shall be as under:-

	Particulars	Amount (in Rs)
	Invoice Value (excluding tax)	15,00,000/-
	Service Tax  ( Total Service tax) @ 12.36% (A)	1,85,400/-
	Total Value	16,85,400/-
	Less: Tax Attributable to service receiver and to be borne by SR himself (75% of (A))	1,39,050/-
	Amount Payable by SR to SP	15,46,350/-
	ST payable by SR	1,39,050/-
	ST payable by SP	46,350/-

 Some issues:-

– Where SP is exempt under threshold limit, still SR shall be liable.

– Where SP levies tax wrongly in computation, SR is still liable to compute the tax correctly and vice versa. The tax liabilities are independent affair for both SR & SP.

– Valuation mechanism can be independently opted by either.

– 4^th Digit of PAN helps in identification of legal status of SP. For example PAN ALGPG0652T, it is P which indicates individual, C is company and H is HUF and so on.

– TDS shall be payable on amount paid to SP i.e. amount paid under reverse charge shall not be subjected to TDS. For more clarification read circular 4/2008 as issued by CBDT and our previous post with link here. – Conflict of Service Tax & Tax Deducted at Source

– No CENVAT can be used to pay amount under reverse charge. Once tax is paid, the Cenvat of such paid tax shall be available subject to Cenvat credit Rules, 2004.

Types of Models in Real Estate

Broadly there are six models that the trade & industry is prone to resort to. Though all of them are listed hereunder, this article shall take up only tripartite and joint development agreement for further discussion.

◊ Tripartite Business Model

◊ Redevelopment including slum rehabilitation projects

◊ Investment model

◊ Conversion Model

◊ Build- Operate – Transfer (BOT) Projects

◊ Joint Development Agreement Model

Tripartite Business Model

Parties in the model are generally three and may be bound by a single tripartite agreement or two separate contracts. (i) landowner (ii) builder or developer and (iii) contractor (who undertakes construction)

Issue involved is regarding the liability to pay service tax on flats/houses agreed to be given by builder/developer to the land owner towards the land /development rights and to other buyers.

Clarification: Here two important transactions are identifiable: (a) sale of land by the landowner which is not a taxable service; and (b) construction service provided by the builder/developer. The builder/developer receives consideration for the construction service provided by him, from two categories of service receivers: (a) from landowner: in the form of land/development rights; and (b) from other buyers: normally in cash.

(A) Taxability of the construction service:

(i)  For the period prior to 01/07/2010: construction service provided by the builder/developer will not be taxable, in terms of Board’s Circular No.108/02/2009-ST dated 29.01.2009.

(ii) For the period after 01/07/2010, construction service provided by the builder/developer is taxable in case any part of the payment/development rights of the land was received by the builder/ developer before the issuance of completion certificate and the service tax would be required to be paid by builder/developers even for the flats given to the land owner.

(B) Valuation:

(i)  Value, in the case of  flats given to first category of service receiver, is  determinable in terms of section 67(1)(iii) read with rule 3(a) of Service Tax (Determination of Value) Rules, 2006, as the consideration for these flats i.e., value of land / development rights in the land may not be ascertainable ordinarily. Accordingly, the value of these flats would be equal to the value of similar flats charged by the builder/developer from the second category of service receivers. In case the prices of flats/houses undergo a change over the period of sale (from the first sale of flat/house in the residential complex to the last sale of the flat/house), the value of similar flats as are sold nearer to the date on which land is being made available for construction should be used for arriving at the value for the purpose of tax. Service tax is liable to  be paid by the builder/developer  on the ‘construction service’ involved in the flats to be given to the land owner, at the time when the possession or right in the property of the said flats are transferred to the land owner by entering into a conveyance deed or similar instrument(eg. allotment letter).

(ii)  Value, in the case of flats given to the second category of service receivers, shall be determined in terms of section 67 of the Finance Act, 1994.

Joint Development Agreement

Under this model, land owner and builder/developer join hands (note that we are not including contractor directly in scheme of arrangements) and may either create a new entity or otherwise operate as an unincorporated association, on partnership /joint / collaboration basis, with mutuality of interest and to share common risk/profit together. The new entity undertakes construction on behalf of landowner and builder/developer.

It is a common practice that a landowner and builder would enter into a joint venture and share the constructed area in agreed proportion. The UDS portion of land pertaining to the builder’s portion would be sold and the amount would be appropriated by the builder. Further, the builder would also receive construction cost from the buyers. The builder would also construct landowner’s share of constructed area and hand over the same to the landowner. As the landowner would not normally use his constructed area for his personal use, the service provided by the builder to the landowner is a taxable service. But no monetary consideration is flowing from the landowner to the builder, but the builder is given the right to sell his share of the UDS portion of land and retain the proceeds. Now since 2006, it is non-monetary consideration has also been made part of overall consideration under section 67, the same is to be also considered.

But, in many cases, the landowner asks the builder to sell his portion of constructed area also. Accordingly, the UDS land pertaining to landowner’s share would also be sold by the builder, acting as a power of attorney of the landowner and a separate construction agreement would be entered into with the buyer. But the entire proceeds would be remitted by the builder to the landowner. In such circumstances, it is not clear whether the builder is providing service to the landowner (in which case, the service tax liability would arise) or to the purchaser (in which case, there would be no liability on the ground of personal use) or to both?

Below is diagrammatic arrangement of one of many possible in real estate industry.

In this regard it has been clarified vide Circular 148/17/2011-ST dated 13/12/2011, particularly paragraphs 7, 8, 9 apply mutandis mutandis in this regard.

Circular 148/17/2011- ST dated 13/12/2011 critically states that

–‘Para 6.  It is being represented that in certain situation the distributer and the theatre owner conduct business together and hence no service tax is leviable. Arrangement amongst two or more entities can either be on principal-to-principal basis or on partnership/joint/collaboration basis.  In the former, the constituent members are independent of each other and do not share any risk/revenue/profit/loss/liability of the other while in latter the constituent members join hands for mutuality of interest and share common risk/profit together’.(Note: Principle shall apply to all industries across the trade)

–  ‘Para 7.  Unincorporated joint venture, not operating on principal-to-principal basis, will exist only if the arrangement entered into between the two independent persons is also recognized as a person. It may be noted that the word “person” has not been defined in the Finance Act, 1994. As per Sec 3(42) of General Clauses Act, 1897 “person shall include any company or association or body of individuals, whether incorporated or not”. In this regard attention is invited to explanation to Sec 65 of the Finance Act, 1994 wherein the taxable service includes any taxable service provided or to be provided by any unincorporated association or body of persons to a member thereof’. (Note: Unincorporated association now finds specific disclosures in as much as distinct persons from its members)

– Para 8.  Such a joint venture is also recognized as a legal & juristic entity in the nature of a partnership of the constituent companies  by the Hon’ble Supreme Court of India in the case of New Horizons [1995 SCC (1) 478; 1994 -TMI – 83686] wherein it was held that “the expression ‘joint venture’ connotes a legal entity in the nature of a partnership engaged in the joint undertaking of a particular transaction for mutual profit or an association of persons or companies jointly undertaking some commercial enterprise wherein all contribute assets and share risks. It requires a community of interest in the performance of the subject-matter, a right to direct and govern the policy in connection therewith, and duty, which may be altered by agreement, to share both in profit and losses. The independence of joint venture as a separate legal entity, away from its constituent members, has further been fortified in the case of M/s Gammon India Ltd. Vs Commissioner of Customs, Mumbai, 2011-TMI – 204309 wherein the Hon’ble Supreme Court categorically denied the benefit of exemption to the JV as the impugned goods were directly imported by constituent member.

– Para 9. Thus, where the distributor or sub-distributor or area distributor enters into an arrangement with the exhibitor or theatre owner, with the understanding to share revenue/profits and not provide the service on principal-to-principal basis, a new entity emerges, distinct from its constituents. As the new entity acquires the character of a “person”, the transactions between it and the other independent entities namely the distributor/sub-distributor / area distributor and the exhibitor etc will be a taxable service. Whereas, in cases the character of a “person” is not acquired in the business transaction and the transaction is as on principal-to-principal basis, the tax is leviable on either of the constituent members based on the nature of the transaction and as per rules of classification of service as embodied under Sec 65A of Finance Act, 1994.

Para 6 of above circular was a complete U-turn on the part of revenue with respect to its earlier circular F. No. 137/186/2007 – CX. 4 dated 23rd February, 2009, Para 2.2 of which states as under:

2.2. Another type of arrangement is where the contract between the theatre owner and the distributor is on revenue sharing basis i.e. a fixed and pre-determined portion i.e. percentage of revenue earned from selling the tickets goes to the theatre owner and the balance goes to the distributor. In this case, the two contracting parties act on principal-to-principal basis and one does not provide service to another. Hence, in such an arrangement the activities are not covered under service tax.

Chronologically, how things have evolved:-

– In 2009, CBEC suggests that revenue sharing and principal to principal basis is same arrangement. In this case, the two contracting parties act on principal-to-principal basis and one does not provide service to another. Hence, in such an arrangement the activities are not covered under service tax

– In 2011, CBEC suggests that revenue sharing and principal to principal basis are different arrangement. It gives birth to concept of unincorporated association in case of revenue sharing agreements. Taxability of services provided by individual members to such association and vice versa is being suggested.

– In 2012, CBEC suggests to apply the principles of unincorporated association to Joint development agreement.

– In 2012, Negative list clears that unincorporated association and its members shall be deemed to be distinct persons.

Jeopardy above, clearly demarcated what trade is facing on service tax front.

Some Judgement on Joint Development

(A) Tribunal decision that activity done by each member of Joint Venture is not ‘service’ to other member:

– In Mundra Port and Special Economic Zone Ltd. v. CCE (2011) 33 STT 364 = 15 taxmann.com 33 (CESTAT), assessee had constructed rail line between port and railhead under private-public sector collaboration on revenue sharing basis. It was held that this is not ‘Business Support Service’. – – In the same case, the assessee, who was licensee of Government of Gujarat for development of port had appointed sub-licensee to maintain container terminal, for which the sub-licensee was paying royalty and profit sharing. It was held that this is also not business support service.

Though the decision is in respect of ‘Business Support Service’, the principle should apply to all revenue sharing arrangements.

– In Nyco SA v. CST (2009) 20 STT 113 (CESTAT), a joint venture company was formed to share expertise and know-how of both the parties. Fruits of joint venture were shared by both the parties. It was held that sharing of knowledge cannot be termed as providing consulting engineering service as expertise acquired is used for own benefit along with others.

– In CCE v. Sundaram Finance (2007) 9 STT 100 (CESTAT), it was observed that work done by a joint venture partner is in the nature of ‘in-house services’ rendered by him as partner of the JV company.

(B) CESTAT has taken the view that joint ventures are not covered under service tax are Initiating Explosives Systems v. CCE, Kolkata-V, Sunshield Chemicals Ltd v. CCE, Raigad, CCE, Chennai v. Sundaram Finance Ltd and Glaxo Smithkline Pharmaceuticals Ltd. v. CCE, Mumbai. More importantly, in CST v. Puravankara Projects Ltd, the Bangalore CESTAT had taken a prima facie view that, in joint development agreements, no service is rendered by the Developer to the Land Owner. Hence, the current judicial view is clearly against joint development agreements being subjected to service tax levy.

(C) In MORIAS CONSTRUCTION CO. (P) LTD. VERSUS COMMR. OF C. EX. & S. TAX, RANCHI, it was held that decision of the Hon’ble Supreme Court in the case of K. Raheja Development Corpn. v. State of Karnataka – 2006 (3)S.T.R. 337 (S.C.) = (2005) 5 SCC 162 is not applicable in the case of the appellants as the appellants have not undertaken any building activity on behalf of anyone. They have merely developed the property and built the flats for themselves and the land owner as a joint venture project. The sale of the flats to others has taken place only subsequently and therefore no service has been rendered for the ultimate flat owners by the appellants. Also supported by decision of Hon’ble Allahabad High Court in the case of Assotech Realty Pvt. Ltd.v. State of U.P. – 2007 (7) S.T.R. 129 (All.) and master Circular No. 079.01(sic), dated 23-8-2007 issued by the Board to clarify that no service tax is payable by a person who builds the residential complex on his own by employing direct labour since in such a case the service provider and service recipient relationship does not exist.

(D) In a recent landmark judgement of Chennai CESTAT, LCS City Makers Pvt. Ltd. Versus Commissioner of Service Tax, Chennai, 2012 (6) TMI 363 – CESTAT, CHENNAI, few essential points have come out and as detailed hereunder:

a. On Lack of Service Provider / Service Receiver relationship in JV, it was held that “12.4. We find that para 3 of the clarification dt 29-01-2009 deals with cases where flats are sold after construction. In the instant case, the UDS is sold first and an agreement for construction is entered into with individual buyers. The situation in respect of Land Owners also is the same. Firstly, UDS is registered in their name and then the Developer constructs flats for the original Land Owner, becoming UDS holder after registering UDS in his name, as per the terms of the contract. So this is clearly outside the scope of the clarification given by CBEC. In these cases there is a service provided to the UDS holders including the original Land Owners.”

b. On contention of personal use, lordship have clearly based findings on essence of contractual arrangement by stating that “it is clear that the Land Owner had engaged the Developer for construction of flats for him in a complex, in his share of land, which flats could be sold by him. So the residential complex as a whole was not for personal use. The exclusion in the definition of the service is for a complex intended for personal use. The clause cannot be applied to individual flats in a complex. So we do not see much merit in this argument”.

c. On the contention that prior to 19.4.2006, non monetary consideration could not be taxed, it was held against the assessee, by relying on Mahim Patram Pvt. Ltd Vs. UOI-2007 (7) STR 110 (SC) wherein it was held that “25.A taxing statute indisputably is to be strictly construed. [See J. Srinivasa Rao v. Govt. of Andhra Pradesh& Another – 2006 (13) SCALE 27]. It is, however, also well-settled that the machinery provisions for calculating the tax or the procedure for its calculation are to be construed by ordinary rule of construction. Whereas a liability has been imposed on a dealer by the charging section, it is well-settled that the court would construe the statute in such a manner so as to make the machinery workable.” Further it was held in LCS City makers that “From 16-06-2005 the section 65 (105) was amended to read taxable service means any service provided or to be provided . Thus service to be provided became taxable from that date but that does not mean that service provided from that date was not taxable if consideration was received earlier. Thus we do not agree with the contention of the appellant in this regard. The new provision can be interpreted to mean only that prior to that date no tax was to be paid at the time when consideration was received but tax was to be paid at the time when service was provided. This position has been clarified by CBEC in its circular B1/6/2005-TRU dated 27-07-2005.”

PLC/EDC/IDC/Power Back Up Charges Prior to 1.7.2012

• As per D.O.F. No.334/1/2010-TRU dated 26th February 2010 ,these charges are in the nature of service provided by the builder to the buyer of the property over and above the construction service, such charges are being brought under the new service (other than routine construction service, hence no abatement was available). Charges for providing parking space have been specifically excluded from the scope of this service. Development charges, to the extent they are paid to State Government or local bodies, will be would be excluded from the taxable value levy. Further, any service provided by Resident Welfare Associations or Cooperative Group Housing Societies consisting of residents/owners as their members would not be taxable under this service.

– To appreciate the impact of above circular, one must have a brief ground on how the EDC/IDC charges are recovered by the industry from clients. Generally the EDC/IDC is payable to statutory authorities on the basis on area of land; such amount is then recovered from customers on per sq. Ft basis. In light of this fact, it is very difficult to say that only that amount which is paid to state government has been duly recovered. If it is over and above of what is paid to state government, in such scenario it is liable to taxed under service tax. Essentially and least to say, a plain reading of above circular wouldn’t help.

PLC/EDC/IDC/Power Back Up Charges w.e.f 1.7.2012

–  Post 1^st July, 2012 i.e. in negative list era still several issues haunts real estate industry regarding implications of PLC/EDC/IDC and others. Some of them are as under:

• Whether EDC / IDC shall be chargeable to service tax at all?

• If yes, whether they shall be clubbed under bundling provisions such that the effective rate of tax is 3.09% only?

• Whether Rule 5 of Point of taxation Rules, 2011 is applicable on such tax?

• PLC to be taxed at 3.09% or 12.36%?

• Interest / Penalty paid on such EDC/IDC are general issue in the trade. Whether the fact that who’s delayed the payment shall be reason on which levy of service tax can depend on?

Conclusion –  Before parting, i would like to end by saying that it is high time for revenue/ TRU’s to clear the air on many such issues in real estate/construction or works contract activities for levy of service tax. All clarifications issued are required to be consistent and trade and commerce needs to interact more with revenue authorities with their respective associations.

Read Other Articles from CA Ankit Gulgulia (Jain)

About the Author:

Author is practicing Chartered Accountant in New Delhi and specialising in Indirect Taxes, Corporate Laws and Management Advisory. He can be reached at +91-9811653975 or Ankitgulgulia@gmail.com.