JUNE 16, 2009

By Arvind P Datar, Senior Advocate

THE recent decision of the Delhi High Court in Home Solution Retail India Ltd. v Union of India - 2009-TIOL-196-HC-DEL-ST is unique for the simple reason that it is the first case where a High Court has struck down a notification levying service tax. Till date, the constitutional validity of service tax has been upheld by reference to various rules of interpretation and also relying on the aspect theory. While there is no doubt that there should be free play in the joints and there should be more latitude given to the legislature in taxing statutes, it is not necessary that the courts should reach the elastic limits of interpretation just to save a statute. In the first 20 years of the Constitution, the judges were more ready to strike down an unconstitutional levy and did not go to great lengths to somehow save a tax. In the recent past however, Justice Ruma Pal has delivered certain land mark decisions in dealing with taxing provisions - See BSNL v Union of India 2006-TIOL-15-SC-CT-LB and Godfrey Phillips Ltd. v State of UP 2005-TIOL-10-SC-LT-CB.

Services “in relation to”:

In the Delhi High Court judgment, the petitioner had challenged the legislative competence of the Union of India to levy service tax on renting of immovable property on the ground that this would come under Entry 49 of List – II of the Seventh Schedule to the Constitution. This issue was not decided in view of the conclusion reached by the High Court. The main contention that was accepted by the High Court was that the service tax was not on the renting of the immovable property itself but on the rendering of service “ in relation to ” immovable property. The High Court held that the service tax could be levied only on the value addition provided to the service recipient. There must be some service and some value addition by that service. If there is no value addition, there is no service. On this basis, it was held that mere renting of immovable property would not result in rendition of any service. If other services like air-conditioning are provided along with the property, it will fall within Section 65(105)(zzzz) of the Finance Act, 1994.

Supreme Court decisions:

The Delhi High Court placed reliance on decisions of the Supreme Court in T.N.Kalyana Mandapam Association v Union of India - 2004-TIOL-36-SC-ST , BSNL v Union of India 2006-TIOL-15-SC-CT-LB and All India Federation of Tax Practitioners v Union of India 2007-TIOL-149-SC-ST.

In the Kalyana Mandap case, service tax was levied on the renting of marriage halls. The Supreme Court held that it was not mere renting that was involved but property with fixtures, lighting etc. was also arranged. The Mandap Keeper provided a bundle of services and it was not a mere permission to use the particular property for one or two days.

The High Court also relied on observations in the All India Federation case where the Supreme Court stressed the need for the existence of services before service tax could be levied.

The expression “renting of immovable property” has been defined in Section 65(90a) as follows:-

(90a) “renting of immovable property” includes the renting, letting, leasing, licensing or other similar arrangements of immovable property for use in the course or furtherance of business or commerce but does not include –

(i) renting of immovable property by a religious body or to a religious body; or

(ii) renting of immovable property to an educational body, imparting skill or knowledge or lessons on any subject or field, other than a commercial training or coaching centre.

Section 65(105)(zzzz) reads in so far as it is relevant as follows:-

(105) “taxable service” means any service provided or to be provided-

xxxx xxxx xxxx xxxx xxxx

(zzz) to any person, by any other person in relation to renting of immovable property for use in the course or furtherance of business or commerce.

(Explanation 1 and 2 have not been reproduced)

Since the parent section levied service tax only on services “ in relation to ” renting of immovable property, the court struck down Notification No.24/2007 dated 22.05.2007 and Circular No.98/1/2008-ST dated 4.1.2008 as being contrary to the parent section. This notification made it clear that service tax would be levied on the gross amount of rent charged to the property and the only deduction permissible was municipal tax. The net result was that the very act of renting an immovable property became chargeable to service tax.

Income Tax decisions:

It is interesting to refer to two Supreme Court judgments arising under the Income Tax Act, 1922 which have a bearing on the levy of service tax on services in relation to immovable property. In Sultan Brothers Pvt. Ltd. V CIT (1964) 51 ITR 353, the Supreme Court was concerned with a building in Bombay which had been let out for six years for running a hotel. Apart from a monthly rent of Rs.5,950/-, another sum of Rs.5,000/- per month was charged for furniture and fixtures. The assessee wanted the entire income to be taxed as profits and gain from business or alternatively as income from other sources. On the other hand, the Department assessed the rental income as income from house property under Section 9 of the old Act and the furniture and fittings under income from other sources. The Supreme Court held that the letting out of a building could not be separated from letting out of the furniture. An examination of the lease deed indicated that the intention was to use both in an inseparable manner. In an interesting decision, the Supreme Court held that the inseparability was not physical and did not depend upon the possibility of removing the furniture. But the inseparability arose from the intention of the parties. If the parties intended that the building as well as the furniture should be enjoyed together, then the income from both will not be under income from house property. This was classified to be income falling under income from other sources. The income could not be assessed either as business income or as income from house property.

This decision lays stress on the need to determine the intention of parties. It will not be possible to levy service tax blindly on the entire rental income received. From the agreement, it will be necessary for the Department to ascertain the exact service that has been provided and attribute the consideration for the same.

In another case, the facts were even more interesting. There was a large block of residential buildings and shops in Calcutta . These flats and shops were let out on monthly rentals. In addition, the company which owned the said property, provided hot and cold water, arranged for scavenging, watch and ward facilities, etc. The company purchased high voltage A/c current in bulk and converted it into low voltage current in the company's own power house and used it within the premises. It had its own pump house and boiler. It has provided electric lifts that worked for 24 hours (this must have been a unique feature almost 50 years ago). To provide all these services, the company maintained a number of employees and made an additional charge to the tenants in the flats and shops. The Department was concerned with the taxability of income from the services rendered to the tenants. The Department treated part of the receipt as income from house property and part as income from the other sources. After referring to various English decisions and earlier Supreme Court judgments, the court held that the entire amount had to be taxed only as income from business. [ Karnani Properties v CIT 82 ITR 547: (1971) 3 SCC 568.] The services rendered by the assessee to the tenants were carried on continuously in an organized manner with the set purpose and with a view to earn profits.

It is perhaps this kind of service that will alone be subject to service tax. It is further submitted that the burden of proof will be on the Department, in each case, to ascertain the service that has been rendered in individual cases. It will not be permissible to levy service tax on the entire rental income.

Legislative competence:

Apart from the question of absence of service, the other major question that ought to have been answered by the Delhi High Court was legislative competence of Parliament to levy service tax on immovable property or even services “relating to” immovable property. Interestingly, Entry 92C and Article 268A were inserted by the 88 th Amendment to the Constitution. But both these have not been notified till date. Therefore, for the present, the power of Parliament to levy service tax can be traced only to Entry 97. Therefore, service tax even on activities “ in relation to ” immovable property would be permissible only if it can be established that the State Government has no competence to levy tax on them.

Therefore, the hypothetical question that arises is whether service tax can be taxed by the State Legislature in exercise of the power under Entry 49 of List-II. If a landlord collects not only rent but also separate charges for provision of water, watch and ward, provision of air-conditioner, hot water supply, etc., can it be said that the State Government will have no power to levy tax on the consideration received for the use of the building (rent) and also the amenities? If the intention is that the tenant should pay the entire amount, and the renting of the building and service are not separable, it is submitted that the State Legislature would have the competence to levy tax on the composite amounts consisting of rent and amenities. If this view is correct, then it automatically follows that service tax cannot be levied by Parliament.

It has been repeatedly held that legislative entries must be given the widest possible interpretation. Accordingly, Entry 49 of List-II should also receive the widest possible interpretation. The reference to “tax on land and buildings” will also include any incidental service that is rendered along with the building. If there is a building tax to be levied by the State Government, it will be difficult to argue that the State Legislature will not have the competence to levy tax on the amenities as well that are provided by the landlord. Once such a levy comes within the competence of State Legislature, it will be automatically excluded from List-I. This is made clear by the decision of the Supreme Court in International Tourist Corporation v State of Haryana AIR 1981 SC 774. State's legislative competence will be taken away only when Entry 92C is notified; thereafter, the service portion will be taxable only by Parliament.

Therefore, the impact of Entry 49 of List-II remains to be considered. Section 65(105)(zzzz) has also been challenged in other High Courts. It is sincerely hoped that they would go into this important issue as well.