JULY 21, 2017

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

IT seems that the confusion created under the GST law, in respect of the tax rates applicable to the Realty Developers especially, in major cities like Mumbai where the land prices are significantly high, continues to haunt the sector.

As we know, realty developers in Maharasthra (as well in many other states) were allowed the benefit under a composition scheme under the then prevailing MVAT Act, in terms of which, they were allowed to pay VAT @ 1% on the total value of the apartment including the value of the undivided portion of the land. Most of these developers had also opted to pay service tax under the then prevailing Notification No. 26/2012-ST dated 20-6-2012, in terms of which, service tax was paid on 30% of the total value inclusive of the land value. In effect, the total of VAT and service tax worked out to 5.5% on the total value including land, in the pre-GST era.

Under the GST law, we find the following two entries in terms of the notifications viz.

One would recall that, in terms of the recommendations of the GST Council, prior to the issuance of the notifications, the following two entries were found, viz.

The TIOL readers would note that there the reference to 'full ITC' is conspicuously absent in the notifications issued under the GST law, indicating that the provisions contained in Section 17(5)(c) of the GST Act could result in denial of credit of the tax paid by the Developers who are classifying their output activities under Sl No. 9954(i), as these players cannot be construed as executing works contracts within the meaning of Section 2(119) of the GST Act.

Be that as it may……. one huge dilemma that Realty Developers operating in major metros like Mumbai could face, would be the very high level of land prices. I am given to understand the land prices in these metros could work out to as high as, 50% to 70% of the total apartment value. Taking a conservative example of land cost being 50% of the total value of the apartment, the tax rate that the Developer operating in a major metro would need to charge to his flat buyer, if he classifies his outward supply under Sl No. 9954(i) would work out to 12.06% of the total value of the apartment inclusive of land, as he would be entitled to a standard deduction of 33% of the total value towards land (irrespective of the actual value of the land). On the other hand, if the Developer classifies his outward supply as one of works contract under Sl No. 9954(ii), he would be allowed to apply an effective GST rate of only 9% in our example (18% tax rate applicable on the construction value being 50% of the total value of the apartment inclusive of land).Thus, the effective GST rate calculated as a percentage on the total value of the apartment inclusive of land, would work out to 12.06% if the Developer classifies his outward supply under Sl No. 9954(i) or 9% if the Developer classifies his outward supply under Sl No. 9954(ii). Of course, the tax differential would be much higher, if the land value is to be higher, say 60% or 70% of the total value of the apartment.

Given the huge difference in the overall GST rates, the question that would arise iswhether, the Developer is allowed the option of classifying his outward supply under either of the two chapter headings, viz. 9954(i) or 9954(ii). In my humble view, if the Developer is directly engaged in the construction activity even to a very small extent and is therefore to be treated as a works contractor within the meaning of Section 2(119), he would have to necessarily classify his outward supply under Sl No. 9954(ii), while the activity covered by Sl No. 9954(i) is restricted to pure Developers who have entirely contracted out the construction activity (and are consequently not treated as works contractors under the GST law). The very fact that the Developer was paying tax under the then prevailing state VAT law would go to indicate that he is to be treated as a works contractor under the GST law, irrespective of the fact that such Developer might have been paying tax @ 1% of the total value of the apartment inclusive of the land value under the composition scheme.

In my view, even the manner in which the agreements are entered into by the Developer would not be a reason to determine the head under which the Developer is required to classify his outward supply. I understand that, in places like Mumbai, the Developer typically enters into a single contract wherein, a single consideration is agreed to for construction and sale of the apartment without the land value being shown separately. Even in these cases, there is nothing in the law to prevent the Developer to enter into an addendum/codicil agreement with his prospective flat buyer wherein, the value for the undivided portion of the land can be specifically agreed to, consequent to which, the Developer (being a works contractor) cannot be denied the benefit of charging the lower overall tax rate under Sl No. 9954(ii).

Even as a matter of planning, there is nothing in law to prevent for a pure Developer (who has contracted out the entire construction activity to a contractor) to convert himself into a works contractor by directly handling a very small portion of the construction activity and deriving the benefit of the lower overall tax rate under Sl No. 9954(ii), given the benefit of significantly lower tax rates (especially in major metros like Mumbai).

Before concluding…..

Very unfortunately, the confusion regarding the classification of the outward supplies/services by the Realty players and the consequent changes in the tax rates, which has been existing right from 2005, is continuing well into the GST regime.

Can the benefit of classification under Sl No. 9954(ii) be denied to Developers (who are to be treated as works contractors) who have entered into single agreements (specifying a single price for the sale of the apartment without specifying the break up between the land value and the construction value) in places like Mumbai? My view is a clear NO. It is always open to these Developers to either amend their existing agreements or enter into addendum agreements to provide for the bifurcation between the value of undivided portion of land and that for construction and take the benefit of the lower tax rate that is available to works contractors under Sl No. 9954(ii).