JUNE 13, 2017

By S Sivakumar, LL.B., FCA, FCS, ACSI, MBA, Advocate

THE Government released the schedule of GST rates for services, as cleared by the GST Council, in its meeting held on May 19, 2017.

Realty Developers and Builders will accordingly get covered under either of the following two entries in the rate schedule -

As per Section 2(119) of the CGST Act, “works contract” means a contract for building, construction, fabrication,completion, erection, installation, fitting out, improvement, modification, repair, maintenance, renovation, alteration or commissioning of any immovable property wherein transfer of property in goods (whether as goods or in some other form) is involved in the execution of such contract. In terms of entries covered bySl Nos 5(b) and 6(a) of Schedule II to the CGST Act, construction services and works contract services, covered by Sl Nos 19 and 27 of the Rate Schedule, are to be treated as 'supply of services'.

So far so good… the question that would arise now is whether, Developers or Builders would have the choice of opting for classifying their output supplies under either of the entries referred to above, under the GST regime. As we know, the Realty Sector has both pure Developers and Builders. The term 'Developer' is used to refer to realty players who have outsourced the actual construction activity to contractors and consequently, cannot be treated as being engaged in transferring property in goods in the execution of works contracts. Builders are indeed engaged in execution of works contracts, though a part of their activity could be outsourced to contractors. In terms of agreements/contracts entered into by the Developers and Builders, we can basically think of two types of arrangements that are broadly followed by the Industry, viz. single agreements for sale of apartments/flats wherein, a single price (calculated on a per sft basis, with or without the break up for the portion of value attributable to the undivided interest in land) or the two agreements system wherein, separate agreements for sale of undivided portion in land and for the construction of the apartment/flat are entered into, with the prospective buyer of the apartment/flat.

Under the current law, it is more or less settled that, irrespective of the type of the agreement that they enter into, Developers and Builders can opt to pay service tax on 30% of the total value (inclusive of land) under Notification No. 26/2012-ST dated 20-6-2012 or under Rule 2A of the Service Tax (Determination of Value) Rules, 2006 in terms of which, service tax is payable on 40% of the construction value on the assumption that separate books of accounts showing the value of goods etc. are not maintained. Of course, Rule 2A has been amended with effect from 1-4-2016 to provide that, where the amount charged for works contract includes the value of goods as well as land or undivided share of land, the service tax shall be payable on thirty per cent of the total amount charged for the works contract. In effect, it is clear that under the current service tax law, realty works contractors have the option of paying service tax on 30% of the total value inclusive of land or on 40% of the construction value.

However, I am not sure if this logic is going to work under the GST law, given the fact that we don't have a valuation provision under GST, similar to Rule 2A of the Valuation Rules. Under the rate schedule, we have two separate and distinct entries under Sl Nos 19 and 27. A study of these entries seems to suggest that Bui lders who are to be treated as works contractors would necessarily need to go under Sl.No. 27while Developers (who are not actually engaged in the execution of works contracts) may be forced to go under Sl.No.19.

There is another angle to this discussion. Under both the entries, i.e. Sl.No.19 and Sl.No. 27, it is mentioned that full ITC is available (in the rate schedule). However, as rightly pointed out by learned professionals, a study of Section 17(5)(c) of the CGST Act does seems to suggest that, the input tax credit of the tax paid on input works contract services would be denied to realty players who opt to pay tax under construction services covered by Sl No. 19 of the rate schedule. Hence, on the face of it, it seems that ITC of the tax paid on input works contract services would be denied to Developers (who cannot be treated as executing works contract) who are required to pay tax under Sl No. 19 of the rate schedule and this, by itself, could result in large scale litigation. In what seems to be a major drafting error, the provision contained in Section 17(5)(c) could prevail over any rate schedule, to the utter detriment of the Realty Sector.

Ideally, Realty Players irrespective of whether they are Developers or Builders, should have the option of paying tax under GST under either of the two entries covered by Sl Nos 19 and 27 of the rate schedule, as is the case now in respect of service tax and plan their taxes in the most optimum manner.

For most part during the period 2007 to 2012 before the negative list based service tax law came into effect, residential realty players were paying service tax under three schemes, viz. under Notification No. 1/2006 (on 33% of the construction value), under Notification No. 12/2003 (on 30% of the construction value) and under the Composition Scheme for works contracts (@ 4% on the construction value). If one had expected that the GST would usher in some certainty in terms of levy of tax on the realty sector, there is bound to be disappointment for sure.

Though it would be legally difficult to defend the denial of ITC on input works contract services for players who are paying tax under Sl.No 19 of the rate schedule, the manner in which Section 17(5)(c) is drafted could create a lot of litigation.

Many Developers might prefer to 'convert' themselves into Builders under GST, given the risks associated with the differential rates and the provisions related to ITC. Even a small element of undertaking of construction activity on their own account would make Developers eligible to be termed as 'Builders'.

In terms of the rules/draft rules issued under the Real Estate Regulation Act, it seems that Developers and Builders would need to get into single agreements for sale of immovable property, as contrasted to the current system of some of these players entering into two agreements, viz. one, for the sale of the undivided portion of the land and the other, for the construction of the apartment). This requirement could create further complications depending on how these agreements are worded especially, in respect of clauses showing the value of land, value of construction, etc.

Yet another controversy could involve the denial of refund of ITC outflow under Sl.No.19, as contrasted to Sl.No.27 and the Department might take the stand that, Developers and Builders who enter into single agreements wherein, one price is fixed for the sale of the apartment/flat, the benefit of opting to pay tax under Sl.No. 27 is not available, leading to discrimination between classes of Developers and Builders based on agreements entered into.

It is not clear as to levy of tax under GST in respect of Joint Development Agreements, though there is little doubt that JDAs would get subjected to tax. Currently, the point of taxation of JDAs, vis-s-vis the Developers/Builders are different between the service tax law and the VAT law. It is anybody's guess as to whether Circular No. 151/2/2012-ST dated 10-2-2012, which has caused immense confusion under the current regime would continue to confuse, under the GST regime as well.

Needless to say… the effective GST rates under the two entries could vary widely, depending on the value of the land. Taking Bangalore as an example, if a residential project is coming up, let's say in the central business area, the land component could go up to 50% to 60% of the total cost, while, the land component could be as low as 15% to 20% in a project coming up in the outskirts of the city. The realty player would obviously want to go under Sl.No. 27 in respect of projects with a higher component for land but the moot question is whether, the Department would allow this?

Before concluding…

Assuming that the Developer and Builder would have an 'option' to choose either of the entries (covered by Sl.Nos 19 and 27), is it mandatory for this option to be exercised across all projects in the State or is it that, the Developer/Builder can change his option between his various residential projects depending on the 'land' component? I look to the Heavens for an answer !

Many of us who are involved in the Realty Sector were hoping that some sense of sanity would come about, under the GST regime. Unfortunately, it seems that the GST regime is bound to create more confusion for this Sector. A detailed circular from the CBEC covering the contentious issues would perhaps, help.