MAY 15, 2020

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

MUCH has been discussed and written, on the implications arising out of Clauses (c) and (d) of Section 17(5) of the CGST Act, 2017, for the Commercial Realty Sector.

For ease of appreciating the views expressed in this piece, I've reproduced the said statutory provisions below-

17(5) Notwithstanding anything contained in sub-section (1) of section 16 and subsection (1) of section 18, input tax credit shall not be available in respect of the following, namely:-

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(c) works contract services when supplied for construction of an immovable property (other than plant and machinery) except where it is an input service for further supply of works contract service;

(d) goods or services or both received by a taxable person for construction of an immovable property (other than plant or machinery) on his own account including when such goods or services or both are used in the course or furtherance of business.

Explanation. - For the purposes of clauses (c) and (d), the expression "construction" includes re-construction, renovation, additions or alterations or repairs, to the extent of capitalisation, to the said immovable property;

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Explanation. - For the purposes of this Chapter and Chapter VI, the expression "plant and machinery" means apparatus, equipment, and machinery fixed to earth by foundation or structural support that are used for making outward supply of goods or services or both and includes such foundation and structural supports but excludes-

(i) land, building or any other civil structures;

(ii) telecommunication towers; and

(iii) pipelines laid outside the factory premises.

We are aware of the judgment of the High Court of Orissa in M/s Safari Retreats Pvt Ltd - 2019-TIOL-1088-HC-ORISSA-GST wherein, the High Court had read down Section 17(5)(d) and had allowed ITC of the GST paid on goods and services used for construction of an immovable property that was used for renting out. Readers might refer to our article on this judgment, carried by TIOL on May 31, 2019.

As is to be expected, the Revenue has gone in appeal to the Supreme Court and the Apex Court has issued notice. It is to be noted that this judgment has not yet been stayed by the Apex Court.

Commercial Realty players have two choices, vis-à-vis these developments, viz. take ITC and utilize the same, irrespective of their location, as this judgment of the High Court rendered in respect of a central law, will have applicability throughout India, in which case, the only risk would be that of levy of interest under Section 50(1) of the CGST Act, should this judgment be overturned by the Apex Court.

Alternatively, they can avail of the ITC and park the same in their electronic credit ledger without utilizing the same in which case, interest cannot be levied as ITC is not utilized.

There is no question of levy of penalty, as the matter is sub-judice, with the matter pending before the Hon'ble Apex Court. Should the Apex Court uphold the judgment of the Orissa High Court, commercial realty players who have not availed of ITC would be hit by the time bar specified in Section 16(4) of the CGST Act, for the earlier years.

Without prejudice to these developments, a closer look at these Sections would indicate that the said Sections seek to deny ITC only on goods and/or services used 'for' construction of immovable property. As per judicial principles, the word 'for' is to be interpreted in a narrow manner and definitely, not in an expansive manner, as would have been the case, if the words 'in relation to' had been used in these sections. Thus, in my view, ITC is only to be allowed in respect of goods and/or services including works contract services, that are directly used for the construction of the immovable property, which essentially would mean the bare shell. In my further view, ITC in respect of post-construction activities such as, installation of electrical equipment, air-conditioning, Elevators and lifts, sign boards, DG Sets, fittings, post construction painting, etc., the said Sections clearly allow ITC of the GST paid on plant and machinery items, even if they are used for construction of the immovable property and thus, ITC is indeed available on DG Sets, Elevators Lifts, etc.

Taking this discussion forward…while interpreting these sections, one needs to keep in mind that the term 'works contract' has been defined in Section 2(119) of the Act, 2017 as under:

(119) "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;

A plain reading of this definition makes it amply clear that the Works Contract covers about 14 types of transactions and the activity involving 'construction' is just one amongst them. With Section 17(5) seeking to deny ITC of GST on goods and/or services used for construction of immovable property, there is no bar on ITC availment in respect of the other types of transactions mentioned in the definition of the term 'Works Contract'. Thus, ITC on Works Contract used for fitting out of furniture in an immovable property is very much available.

Commercial Realty Developers who engage works contractors split their contracts, as between the construction of the bare shell/building and the post construction activities, so that, ITC can be availed on the latter. I have come across many cases where a turnkey contract is awarded to a works contractor, which will surely lead to denial of ITC on the activity including the post construction activities.

Now, let's look at the Explanation to Section 17(5)(c) and (d), reproduced earlier, which seeks to expand the scope of the term 'construction, to include re-construction, renovation, additions or alterations or repairs, to the extent of capitalisation, to the said immovable property'. While interpreting this explanation, we would need to keep in mind that the expansive definition of 'construction' to include additions, alterations, etc., can only be applied to an existing immovable property, as the words 'to such immovable property' have been used in the said Explanation. Thus, denial of ITC is only applicable only in cases where, the registered taxable person who owns an immovable property, undertakes additions, repairs, etc, to such immovable property. In other words, this explanation will not apply to cases where, the registered taxable person engages works contracts to undertake repairs to a building that is not owned by him, even if such expenses are allowed to be capitalized under the accounting standards. A typical case would be that of maintenance of a software park owned by a Developer, by a third party service provider. Another example would be that of a software company, which has taken a building on lease from a Developer and wherein, the company incurs huge capital expenditure for purchase and installation of fitouts. As we know, these expenses are allowed to be capitalized under the accounting standards issued by the ICAI. Since these expenses are not capitalized to an immovable property that is owned by the software company, ITC is very much available.

Another case would be that of a registered taxable person, who incurs capital expenditure on a bare shell building that is leased out to him. It is common to come across such arrangements these days. The question that would arise is whether, the lessee, in this case, would be allowed ITC in respect of the capital expenditure incurred on the leased building, which, let's assume, is further leased out to multiple sub-lessees after being fitted out. In this case, the expanded definition of 'construction' cannot be applied and, in my view, as ITC would be available even in respect of civil works, which, though in the nature of civil construction, are not undertaken to an immovable property that is owned by such lessee/registered taxable person.

Commercial Realty Players who let out premises with fitouts would be well advised to enter into two separate agreements with their tenants, who in most cases, are IT companies, instead of entering into single agreements for the leasing out of the fitted out premises with a single rental value often calculated on a per sqft basis. In such cases, an additional defence, in case ITC is sought to be denied under Section 17(5), would be to the effect that, the transaction of leasing out of fitouts cannot be treated as one of leasing out of immovable property and consequently, ITC cannot be denied on goods and services used vis-à-vis these furniture/fitout items.

Before concluding…

It would seem that many of the advance rulings that have denied ITC under clauses (c) and (d) of Section 17(5) vis-à-vis the commercial realty sector have not correctly interpreted the import of these sections. I am sure that the appellate fora would be kinder to the commercial realty sector.

I see that some advance rulings have also denied ITC in respect of plant and machinery items on the basis that these plant and machinery will acquire the character of immovable property once they are embedded into the building. In my view, such an interpretation is wholly unsustainable, as the allowability of ITC is to be arrived at, on the nature of these assets when they are received by the registered taxable person and not on the basis that they are subsequently embedded in the building. In my strong view, ITC is available on purchase of movable assets irrespective of their subsequent use.

One would do well to remember that, Sections 17(5)(c) and (d) are an exception to the rule that ITC is indeed available in respect of all business activities, whether currently undertaken or proposed to be undertaken and hence, will have to be restrictively interpreted. Thus, in my view, ITC of the brokerage paid for purchase of land that is developed for commercial purposes, is not covered by these sections.

One wonders as to why the Government has chosen Commercial Realty sector for this harsh treatment vis-à-vis ITC, which has been continuing from the service tax era. As we know, in order to overcome the various judgments of the High Courts that held that, cenvat credit incurred on construction of a commercial building that is let out cannot be denied, the Government went for a change in definition of 'inputs' and 'input services' with effect from 01.04.2011, in the erstwhile Cenvat Credit Rules, 2004. One wonders as to how ITC can be denied to a commercial realty developer who lets out his property while ITC is allowed to the very same developer if he sells the commercial property, before obtaining OC, as a works contract.

Strange indeed are the ways of our lawmakers.

[The views expressed are strictly personal.]