NOVEMBER 14, 2016

By S Sivakumar, LL.B., FCA, FCS, MBA, ACSI, Advocate & R Vaidyanathan, M.Com., M.Phil, Consultant

RULE 2(l) of the Cenvat Credit Rules, 2004, reads:

2(l) "input service" means any service,-

(i) used by a provider of output service for providing an output service; or

(ii) used by a manufacturer, whether directly or indirectly, in or in relation to the manufacture of final products and clearance of final products upto the place of removal

and includes services used in relation to modernisation, renovation or repairs of a factory, premises of provider of output service or an office relating to such factory or premises, advertisement or sales promotion, market research, storage upto the place of removal, procurement of inputs, accounting, auditing, financing, recruitment and quality control, coaching and training, computer networking, credit rating, share registry, security, business exhibition, legal services, inward transportation of inputs or capital goods and outward transportation upto the place of removal;

but excludes

(A) service portion in the execution of a works contract and construction services including service listed under clause (b) of section 66E of the Finance Act (hereinafter referred as specified services) in so far as they are used for -

(a) construction or execution of works contract of a building or a civil structure or a part thereof; or

(b) laying of foundation or making of structures for support of capital goods,

except for the provision of one or more of the specified services…

In effect, due to the above referred ‘exclusion clause, cenvat credit of the service tax paid is not available except when the input construction or input works contract service is used to provide an output construction/works contract service. Thus, cenvat credit is not available when the input works contract/construction service is used in the construction of an immovable property that is not sold off as works contract/(s). Thus, credit is denied in respect of construction buildings, corporate offices, commercial buildings like malls which are let out, etc. As we know, the Board had issued Circular No.98/1/2008-ST dated January 4, 2008 seeking to deny credit on input construction/works contract services on construction of immovable property which is rented out.

The relevant portions of the issue and the clarification issued by the Board, in this Circular, are reproduced below

Issue:

Commercial or industrial construction service [section 65(105)(zzq)] or works contract service [section 65(105)(zzzza)] is used for construction of an immovable property. Renting of an immovable property is leviable to service tax [section 65(105)(zzzz)].

Whether or not, commercial or industrial construction service or works contract service used for construction of an immovable property, could be treated as input service for the output service namely renting of immovable property service under the CENVAT Credit Rules, 2004?

Clarification:

Right to use immovable property is leviable to service tax under renting of immovable property service.

Commercial or industrial construction service or works contract service is an input service for the output namely immovable property. Immovable property is neither subjected to central excise duty nor to service tax.

Input credit of service tax can be taken only if the output is a 'service' liable to service tax or a 'goods' liable to excise duty. Since immovable property is neither 'service' or 'goods' as referred to above, input credit cannot be taken

Luckily, the Hon'ble High Court of AP had in CCE v Sai Samhita Storages Pvt Ltd, reported in 2011-TIOL-863-HC-AP-CX, read down this Circular, a decision that was followed by many CESTAT Benches. In order to get over the challenge to its 2008 Circular, the Government amended Rule 2(l) and 2(k) of the Cenvat Credit Rules, 2004, with effect from 1-4-2011, to specifically deny cenvat credit in respect of input works contract/construction services used for creating an immovable property, which is let out or used internally. Of course, capital goods used in the creation of immovable property would be entitled to credit, even under the existing law.

Be that at is may…….from the Realty Sector's perspective, the denial of credit in respect of creating of immovable property that is let out as contrasted to the availability of credit in respect of immovable property that is sold off as works contract, seems bizarre and illogical, as the very decision whether to let out the property or to sell the property or a part thereof, is driven purely by commercial considerations. It is a common practice for Developers who develop commercial malls, to look for buyers at the construction stage itself and when, this does not happen due to reasons beyond the control of the Developer, the Developer completes the construction and lets out the property, which is purely, a business decision. To say that credit would be allowed when the property is sold off and credit would not be allowed when the property is retained and let out reflects the complete lack of understanding on the part of the Babus, as to how the Realty Sector works. Talking specifically of a commercial mall with many commercial outlets/shops, it is common for the Developer to retain some shops and to sell off other shops in the course of construction and under the current law, credit is denied in respect of the inputs/input services used for construction of shops that are let out, as compared to those that are sold before completion, by the Developer.

Unfortunately, this major lacuna may continue under the GST regime, to the detriment of the Realty Sector.

Look at the exclusion clause contained in Section 16 of the model GST law, dealing with input tax credit, viz…

( 9) Notwithstanding anything contained in sub-section (1), (2), (2A) or (3) input tax credit shall not be available in respect of the following:….

(c) goods and/or services acquired by the principal in the execution of works contract when such contract results in construction of immovable property, other than plant and machinery;

(d) goods acquired by a principal, the property in which is not transferred (whether as goods or in some other form) to any other person, which are used in the construction of immovable property, other than plant and machinery;

A reading of the above indicates that, under the GST law, input tax credit would be denied when the goods and/or services are used for construction of an immovable property (other than plant and machinery) that is let out or that is used for internal purposes as a factory building or corporate office, etc. In other words, under the GST law, input tax credit would be allowed only when the immovable property is sold off as works contract, before completion of construction. The wording used in Section 16 of the model GST law, is extremely mischievous and misleading, in as much as, it can lead one to possibly conclude that input tax credit would be totally disallowed in respect of construction of all immovable properties, notwithstanding the fact that, when a residential or commercial building that is sold out in the course of construction is not treated as ‘immovable property' in the books of the Developer/Builder.

To deny input tax credit in respect of construction of factory buildings comes as a big dampener, especially, in the context of the Government's moves to encourage domestic manufacture which, obviously would entail construction of new factories and office buildings involving significant expenditure.

Before concluding...

Under the current service tax law, cenvat credit of the service tax paid on input services such as Architects, etc. is allowed, in respect of construction of a commercial building that is let out, as, credit is denied only on input construction/works contract services. However, it seems doubtful if credit would be available in respect of non-construction input services such Architects' services, Consulting Engineers, Interior Designers, Legal fees, etc, under the GST regime, given the manner in which the exclusion clauses in Section 16 of the model GST are worded.

The Realty Sector had hoped that this unfair treatment involving denial of credit on construction of commercial buildings that are let out would disappear under the GST law. Unfortunately, this does not seem to be the case.

In our view, denial of credit in respect of the construction of an immovable property that is let out, in contrast to one that is sold off as works contract, is clearly violative of Article 14 of the Constitution.