NOVEMBER 23, 2020

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

WITH the advent of the new system with effect from April 1, 2019, of charging GST at much lower rates coupled with the complete denial of Input tax credit, the realty sector is in a state of flux. While most of the realty players had opted to continue with the earlier system for their on-going projects as of April 1, 2019, the need to have a relook at the existing models in term of the agreements entered into between the Developer and the Landowner, in respect of new projects, assumes a lot of significance. The obvious question that arises is, whether, the realty developers should continue with the time tested joint development/area sharing model or look at revenue sharing agreements, for their new projects.

As we know, in a typical joint development agreement, let's say, involving construction and development of 100 residential flats, the Developer could construct and deliver 40 flats to the Landowner while procuring the land development rights from the Landowner to sell his share of 60 flats. We commonly refer to this arrangement as a 60:40 JDA, in terms of which, the Landowner transfers development rights for the 60 flats in exchange for the construction and delivery of 40 flats from the Developer. In an area sharing arrangement, assuming that the total area developed is 1,00,000 square feet, the Developer would convey 40,000 square feet of constructed area to the Landowner, in exchange of procuring development rights for his share of 60,000 square feet.

Assuming that the above transaction is one of revenue sharing, the Developer would obtain the rights to construct and sell the entire quantum of 100 flats and pay GST on the entire quantum of the flats sold prior to Completion Date and share the post GST revenue with the Land Owner, in the ratio of, say, 60: 40 as between the Developer and the Landowner. A typical escrow bank account is opened, enabling the post GST paid revenue to seamlessly flow into the bank account of the Landowner. Being a share of the post GST suffered revenue, there would be no GST liability in the hands of the Landowner, in respect of the revenue that flows into his bank account.

In the pre-GST era, the JDA model was the most preferred, wherein, under the State VAT laws, the Developer was asked to remit VAT on the basis of the amounts collected by him against the future delivery of the undivided portion of the land falling under his share of the flats, on the basis that, the construction value of the flats to be conveyed to the Landowner was equivalent to the value of the undivided portion of the land attributable to the Developer's share of the flats. In the example considered above, the VAT Department considered that, the construction value of the 40 flats conveyed to the Landowner was equivalent to the value of development rights attributable to the 60 flats sold by the Developer. Notwithstanding that in some cases, the Tribunals had struck down the very levy of VAT on JDAs on the basis that these are essentially barter transactions and hence, cannot be subjected to the levy of VAT given the fact that the term 'consideration' under the VAT law only included monetary consideration, the VAT law enabled the Landowner to avail of input tax credit and adjust the same against his own VAT liability arising on account of the sale of his flats, which were treated as 'works contracts'. Needless to say, most of these Tribunal decisions are now pending before the High Court of the States, courtesy the Commercial Tax Departments of the States.

The levy of service tax has also gone through a lot of litigation, with the CESTAT, in Vasantha Green Projects v CCT, Rangareddy CCT 2018-TIOL-1611-CESTAT-HYD holding that, no service tax is leviable on the Developer on the construction and delivery of the flats to the Landowner, on the basis that, such construction cost / land cost was already included in the value of flats sold by the Developer. In the example considered above, the cost of construction of the 40 flats conveyed by the Developer to the Landowner, in pursuance of the JDA, is already included in the cost of the 60 flats sold by the Developer and consequently, levy of service tax on the construction value of the 40 flats would amount to a double taxation. As TIOL readers know, this decision of the CESTAT is pending in the Supreme Court 2018-TIOL-403-SC-ST-LB

Be that as it may…Notification No. 3/2019-CTR dated 29th March, 2019 has completely re-written the GST levy on the Realty players and the provisions contained in this all important Notification would apply in equal measure to both JDAs and revenue sharing agreements. As is well known, under this Notification, the Government has provided for GST to be charged at the highly reduced rates of 5% for non-affordable housing and 1% for affordable housing, subject to the Developer not being allowed to avail of ITC. The question that would arise is the GST rate that would apply to the construction of the flats conveyed to the Landowner by the Developer. While some of my fellow professionals feel that the Developer would need to charge GST @ 5%, my view is that, there is nothing in Notification No. 3/2019-CTR to suggest that the concessional rate of 5% can be extended to the construction of the flats conveyed to the Landowner by the Developer and consequently, the applicable GST rate would be 18%. As we know, any exemption notification needs to strictly interpreted. The impact of this GST levy on the Landowner could be very high under the JDA or area sharing agreement, given the very high GST rate.

The relevant extracts from Notification No. 3/2019-CTR are reproduced below…

Provided also that where a registered person (landowner- promoter) who transfers development right or FSI (including additional FSI) to a promoter (developer- promoter) against consideration, wholly or partly, in the form of construction of apartments, -

(i) the developer- promoter shall pay tax on supply of construction of apartments to the landowner-promoter, and

(ii) such landowner - promoter shall be eligible for credit of taxes charged from him by the developer promoter towards the supply of construction of apartments by developer- promoter to him, provided the landowner- promoter further supplies such apartments to his buyers before issuance of completion certificate or first occupation, whichever is earlier, and pays tax on the same which is not less than the amount of tax charged from him on construction of such apartments by the developer- promoter.

If the Landowner would have been entitled to avail ITC of the GST charged to him by the Developer, it would have been OK. But, for reasons best known, in terms of Notification No. 6/2019-CTR dated 29th March, 2019, the time of supply of the construction service rendered by the Developer to the Landowner has been fixed as t he date of issuance of completion certificate for the project, where required, by the competent authority or on its first occupation, whichever is earlier. Obviously, what is a boon for the Developer is a bane for the Landowner. Despite being allowed to avail ITC of the GST charged to him by the Developer, the Landowner, for all practical purposes, will not be able to utilize the ITC, as this would flow to him after the project has already got completed. Moreover, a substantial portion of the ITC would remain unutilized in the hands of the Landowner, given the fact that the GST charged to him by the Developer would be at 18% while the output GST rate for the flats sold by him as works contracts would suffer GST at the rate of 5%. One is not able to understand at all, this rationale of fixing the time of supply as the date of the Completion Certificate, a concept that has also found its way into Notification No. 4/2018-CTR dated 25th January, 2018. Under the erstwhile service tax law, we had the highly confusing Circular No. 151/2/2012-ST dated 10th February 2012, which also indicated that the service tax would be leviable at the time when the flats are transferred to the Landowner by the Developer, through a conveyance deed.

By entering into a revenue sharing arrangement, the Developer and the Landowner would be able to completely eliminate the GST attributable to the construction of the Landowner's share of the flats, as there would be no transfer of the flats to the Landowner at all. In fact, the concept of Landowner's share and the Developer's share does not exist in a revenue sharing agreement.

As between the JDA and the revenue sharing agreement, with the liability getting shifted to the Developer to pay GST under the reverse charge mechanism, in respect of the development rights transferred by the Landowner, the GST liability could get fastened on the entire quantum of flats lying unsold under the revenue sharing agreement, while, in the respect of the JDA, the RCM liability will be only on the unsold flats pertaining to the Developer's share. But, the impact arising out of this could be minimal given the fact that the GST rate that would be applicable would be 5% for non-affordable housing projects and 1% for affordable housing projects.

Thus, it would clearly seem that the revenue sharing arrangement would be a more effective tax route, when we consider the overall GST impact on the entire housing project.

Before parting…

Can Notification No. 6/2019 -CTR dated 29th March 2019 be challenged as being of excessive delegation and can the Developer and the Landowner agree that the Developer will charge GST on the value of construction of the flats to be conveyed to the Landowner, as and when he receives the consideration from the sale of his portion of the flats? In this case, the Landowner would be able to utilize the GST charged to him, against the GST collected from the sale of his portion of the flats as works contracts? Perhaps, yes. Notification No. 6/2019-CTR, being a beneficial notification, cannot be thrust on the Developer, it would seem.

In respect of many JDAs that were signed before 01.04.2019 and wherein the Developers have opted to go under the new scheme, the Developers may need to tweak the sharing ratios, as the impact of non-availability of GST would hit them hard.

The new law that has come into effect from 01.04.2019 has been very unkind to the commercial realty sector, involving construction of commercial properties that are let out. But, more on this, by way of another article.

[The views expressed are strictly personal.]