FEBRUARY 29, 2012

By Nitesh Jain, CA

SINCE 2005 the service tax law was made applicable to the realty sector though in a partial way whereby the contractors or the developers were only brought into the tax net. In 2010 the law was further amended to bring the builder also into the tax net whereby the sale of flats done by the builder before receiving the building use certificate was made taxable. Amid all this the departmental officers have always been questioning the various business models being operational in the realty sector and imposing tax on the same. Many Show cause notices were and are being issued day in day out to the realty sector players even for period prior to 2010 on the grounds that the law was applicable from 2005 itself. Now Circular 151/2/2012 dated 10.02.2012 has been issued by the CBEC wherein some very important clarifications have been given with regards to the service tax issues faced by the realty sector and it has raised the hope that spurious litigation imposed by the department will now get resolved in favour of the trade.

Before going into detailed analysis of the clarifications issued and its relevance it will be worthwhile to note that these clarifications apply both to the residential as well as commercial realty sector unlike the previous circular 108/02/2009-ST dated 29.01.2009. The department has long contended and wrongly so in my view that the clarification that existed in the past were specific to residential construction only and thus did not apply to commercial sector and the same was taxable since 2005 onwards. The current circular makes a specific reference to both the taxing entries Section 65 (105) (zzq) and (zzzh) Commercial and residential sub clauses respectively. Now onwards the departmental officers will not be able to take refuge in the hitherto wrong argument that there is no board clarification for the commercial sector.

Clarification 1.

Tripartite business model

Many a times when a realty scheme is launched various internal business setups are employed for various reasons primary among them being capital gains tax planning and stamp duty savings. This is so because the land is owned by someone and the developer is someone else. If the landowner sells the land as such to the developer and then the developer constructs the scheme and further sells it, stamp duty becomes payable twice. So the land owner and the builder/developer get together and launch the scheme and give the physical construction work to an independent contractor/s. When the sale deed is made the land owner, developer and the buyer all become party to it. The land owner takes the pre-decided amount for the share of his land and the developer takes the share for construction part.

The department was treating the developer/builder as person providing construction service as he was not the owner of the land concerned and demanding tax from him since 2005. In some cases SCN have been issued including the land value as well. This circular has now clarified that in this model 2 transactions are taking place

a. Land owner is selling the land which is not taxable at all under service tax

b. Construction service being provided by the developer/builder to the end consumer this was the grey area.

In this transaction now the circular has clarified that prior to 1.07.2010 there will be no service tax at all and post 1.07.2010 service tax will be leviable only if the booking amount is received prior to issuance of building completion certificate.

It is further clarified that if the land owner is getting flats in lieu of land than that transaction will also become taxable and the value of these flats will be taken as to being similar to the first flat sold to a third party. This proposition it seems is taken from the Valuation Rules wherein if value of a particular service is not possible to be determined in terms of money than the same can be valued as per the value of similar services being offered to someone else. The only problem here is that this approach is manipulation prone and the builder may try to keep the value of his first third party sale on the lower side and thereby reduce the eventual tax liability on the flats being transferred to the land owner.

Clarification 2

Redevelopment including slum rehabilitation projects :

b. As the builder has got the right to build additional flats and if he does so prior to 1.07.2010 that too will not be taxable.

c. Sale of additional flats post 1.07.2010 before issuance of building completion certificate will only be taxable.

Clarification 3

Investment model :

In modern times, a major player in realty sector is the investor, who is not interested in self use of the property but is into trading thereof. When a construction scheme is launched the builder takes investments from such investors and allots specific post construction space to them where during or after the construction the investor gets the right to sell the same as per his own liking. The builder gets the much needed fund flow and the investor gets to do trading of realty.

Post 1.07.2010 the builder will have to pay service tax on payments received from the investors as the flat/office is being allotted to them against receipt of money. Importantly it further clarifies that in-case the investor decides to exit from the project by selling his allotted share of space to someone else than the builder will be allowed to take credit of the tax paid earlier under rule 6 (3) of the Service Tax Rules, 1994.

Post 1.07.2010 the builder will have to pay service tax on payments received from the investors as the flat/office is being allotted to them against receipt of money. Importantly it further clarifies that in-case the investor decides to exit from the project by selling his allotted share of space to someone else than the builder will be allowed to take credit of the tax paid earlier under rule 6 (3) of the Service Tax Rules, 1994.

Clarification 4

Conversion Model:

Sometimes an old building is taken over by a builder/developer or a contractor and certain changes are made in it to make it tenable for use as a commercial or residential unit. The circular clarifies that mere change in the status of usability of the building will not prompt a levy of service tax. But if some construction services as defined in the relevant sub clause are provided to make the building suitable for changed status than the same shall be taxable. In other words exact facts of each case will have to be looked into before deciding the taxability.

Clarification 5

Non Requirement of completion certificate / where completion certificate is waived or not prescribed

There are certain areas in India where building construction laws and bye laws do not mandate issuance of Building Use permission certification at the end when the project is completely constructed without which the property cannot be used. But as the service tax law is applicable to the whole of India, and as builders are taxable only on those sales which take place before the issuance of such certificates. To circumvent this practical hassle being faced by the builders the board had issued a an order no. 1/2010 dated 22.06.2010 whereby other than the local authority certain other qualified professionals as under were also given the authority of issuing these certificates:

a. Architect

b. Chartered Engineer

c. Licensed Surveyor of the local body

The circular has clarified that in case where completion certification process is not prescribed or is waived than the builder should get a similar certificate from any of the above mentioned professionals so as to make the assessment possible.

Clarification 6

Joint development agreement model:

Under this model, land owner and builder/developer join hands 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.

The circular fails to give clarity on this important aspect and prefers to refer another circular 148/2011 dated 13.12.2011 which was issued for clarification on transactions in the movie distribution business. There is not much to compare between the two transaction other than saying that if a new entity is created by the land owner and the builder the eventual sale takes place by that entity than service tax shall apply to this new entity only and going from the tone of the earlier clarifications it can be safely assumed that the sale of units done only post 1.07.2010 before issuance of BU certification will only be taxable and no tax shall be payable on transaction done prior to 1.07.2010.

Conclusion

Considering the fallacy of the past clarifications issued, this circular gives some real relief to the realty sector and will bring sanity to the otherwise faulty approach of the department on the issues being hitherto clarified. Earlier clarifications were issued only keeping in mind the residential construction industry, this is the first circular being issued which takes into account though half heartedly the commercial construction sector as well. Having said so I would also like to raise some concerns that some of the clarifications are contrary to the provisions of law and how the judiciary takes it will only be seen with passage of time. Some clarifications are half hearted and will need further clarifications in the near future.

Many builders facing unnecessary and costly litigation may now get relief in case there issues stand clarified by this circular and its a welcome step by the Board in the interest of the trade.

Certain issues which are clarified in the circular are not taken up in the above analysis as the same are not relevant for the realty sector.