FEBRUARY 27, 2010

A half-baked attempt to overhaul Construction Service? Builders can brace for long battles in Courts

By Santosh Hatwar

IN this Budget, Finance Ministry has made an attempt to fix the Construction ‘Services’ sector (both residential and commercial construction activities) by proposing amendments to the definition of taxable services of ‘Commercial or Industrial Construction’ and ‘Construction of Complex’ and also bring in a new taxable service which proposes to levy service tax on certain incidental and ancillary activities (they only resemble ‘charges’ collected by builders/promoters and not ‘activities’ as mentioned by TRU – which is discussed in detail later on) undertaken by the builders to the prospective buyers.

Henceforth, the commercial or industrial construction activity undertaken by service providers would be just referred to as only ‘Commercial or Industrial Construction’. The word ‘service’ in clause (25b) and sub-clause (zzq) of clause (105) of Section 65 is proposed to be deleted and this deletion is of academic interest since the word ‘service’ was only an appendage in the above said clause and sub-clause.

Further, in the definition sub-clauses (zzq) and (zzzh) of clause (105) of Section 65 of the Finance Act, 1994, the following explanations are inserted respectively:

“Explanation.—For the purposes of this sub-clause, the construction of a new building which is intended for sale, wholly or partly, by a builder or any person authorised by the builder before, during or after construction (except in cases for which no sum is received from or on behalf of the prospective buyer by the builder or the person authorised by the builder before grant of completion certificate by the authority competent to issue such certificate under any law for the time being in force) shall be deemed to be service provided by the builder to the buyer;”;

“Explanation.—For the purposes of this sub-clause, construction of a complex which is intended for sale, wholly or partly, by a builder or any person authorised by the builder before, during or after construction (except in cases for which no sum is received from or on behalf of the prospective buyer by the builder or a person authorised by the builder before the grant of completion certificate by the authority competent to issue such certificate under any law for the time being in force) shall be deemed to be service provided by the builder to the buyer;”

The reasons for inserting these ‘explanations’ in the definition clauses of the respective taxable services is explained as follows by the TRU (in paragraph 8 of Annexure B of TRU letter dated 26.02.2010):

8.1 The service tax on construction of commercial or industrial construction services was introduced in 2004 and that on construction of complex was introduced in 2005.

8.2 As regards payment made by the prospective buyers/flat owners, in few cases the entire consideration is paid after the residential complex has been fully developed. This is in the nature of outright sale of the immovable property and admittedly no service tax is chargeable on such transfer. However, in most cases,
the prospective buyer books a flat before its construction commencement/ completion, pays the consideration in instalments and takes possession of the property when the entire consideration is paid and the construction is over.

8.3 In some cases the initial transaction between the buyer and the builder is done through an instrument called ‘Agreement to Sell’. At that stage neither the full consideration is paid nor is there any transfer in ownership of the property although an agreement to ultimately sell the property under settled terms is signed. In other words, the builder continues to remain the legal owner of the property. At the conclusion of the contract and completion of the payments relating thereto, another instrument called ‘Sale Deed’ is executed on payment of appropriate stamp duty. This instrument represents the legal transfer of property from the promoter to the buyer.

8.4 In other places a different pattern is followed. At the initial stage, instruments are created between the promoter and all the prospective buyers (which may include a person who has provided the vacant land for the construction), known as ‘Sale Of Undivided Portion Of The Land’. This instrument transfers the property right to the buyers though it does not demarcate a part of land, which can be associated with a particular buyer. Since the vacant land has lower value, this system of legal instrumentation has been devised to pay lesser stamp duty. In many cases, an instrument called ‘Construction Agreement’ is parallelly executed under which the obligations of the promoter to get property constructed and that of the buyer to pay the required consideration are incorporated.

8.5 These different patterns of execution, terms of payment and legal formalities have given rise to confusion, disputes and discrimination in terms of service tax payment.

8.6 In order to achieve the legislative intent and bring in parity in tax treatment, an Explanation is being inserted to provide that unless the entire payment for the property is paid by the prospective buyer or on his behalf after the completion of construction (including its certification by the local authorities), the activity of construction would be deemed to be a taxable service provided by the builder/promoter/developer to the prospective buyer and the service tax would be charged accordingly. This would only expand the scope of the existing service, which otherwise remain unchanged.

So the idea is to levy service tax in all cases of activity of construction of complexes/commercial or industrial buildings, other than those where the entire payment for the property is paid by the prospective buyer or on his behalf only after the completion of construction. Let us hope and pray that this legislative intent is put into practise effectively across the construction sector as intended by the Government/TRU, unless of course the ingenious builders/promoters come up with a smarter devise to still stay out of the tax net. There is no doubt that the scope of these explanations will be decided only after lengthy court battles only to be reversed by another bout of retrospective legislation sometime in future.

Further, the Finance Ministry also proposes to bring into service tax net certain incidental and ancillary activities (they are actually ‘charges’ related to construction services). The TRU explains away this new levy as follows (paragraph 8 of Annexure A of TRU letter dated 26.02.2010):

8. Special services provided by builder etc. to the prospective buyers such as providing preferential location or external or internal development of complexes on extra charges.

8.1 Construction of commercial or industrial structures was brought under service tax net in 2004 while construction of residential complexes became a taxable service in 2005. The scope of the existing services includes construction, completion and finishing, repairs, alterations, renovation or restoration of complexes. It has been reported that in addition to these activities, the builders of residential or commercial complexes provide other facilities and charge separately for them and these charges do not form part of the taxable value for charging tax on construction. These facilities include,-

(a) prime/preferential location charges for allotting a flat/commercial space according to the choice of the buyer (i.e. Direction- sea facing, park facing, corner flat; Floor- first floor, top floor, Vastu-having the bed room in a particular direction; Number- lucky numbers);

(b) internal or external development charges which are collected for developing/maintaining parks, laying of sewerage and water pipelines, providing access roads and common lighting etc;

(c) fire-fighting installation charges; and

(d) power back up charges etc.

8.2 Since these charges are in the nature of service provided by the builder to the buyer of the property over and above the construction service, such charges are being brought under the new service. Charges for providing parking space have been specifically excluded from the scope of this service. Development charges,  to the extent they are paid to State Government or local bodies, will be would be excluded from the taxable value levy. Further, any service provided by Resident Welfare Associations or Cooperative Group Housing Societies consisting of residents/owners as their members would not be taxable under this service.

The moot point to be noted is that all the so called ‘activities’ are only ‘charges’ collected by the builders/promoters in addition to the amounts collected towards the construction of complex or construction of commercial or industrial buildings, though the proposed clause (zzzzu) to be inserted in Section 65(105) of Finance Act, 1994 attempts to picturize this as a service in reference to a preferred location by the builder while undertaking the activity of construction of complex or construction of commercial or industrial buildings. Even assuming that they are activities, do they not come under the purview of the phrase ‘or a part thereof’ in clauses (25b) and (30a) of Section 65 of Finance Act, 1994?

Now, in its own wisdom the Government wishes to regard them as separate ‘activities’ whereas a first glance at the TRU clarification gives an impression that they are only in the nature of a valuation issue. In such a case, is it not wise on the part of the CBEC to resolve these issues by issuing a Section 37B order if it considers that these ‘charges’ should form a part of the taxable value under Section 67 of the Finance Act, 1994 instead of regarding them as a ‘separate taxable service’. Alternatively, is the Government implying that these ‘activities’ are not taxable hitherto. In that case, what if the service providers have already paid service tax on these charges? Will the Government refund such unlawful collection of tax on such ‘activities’? Legally and Constitutionally speaking it should.

Above all, in the light of the foregoing clarifications by the TRU, how should the service providers regard the different types of contracts (as explained in paragraphs 8.3 and 8.4 of Annexure B of the TRU letter dated 26.02.2010 – extracted above) where the construction activities (residential/commercial) undertaken fall under sub-clause (zzzza) of Clause (105) of Section 65 of the Finance Act, 1994 i.e. ‘Works Contract Service’? Further, how should they regard the so called ‘charges’ which are proposed to be treated as separate taxable service when such activities are undertaken as a part of ‘Works Contract Service’.

In all probability, given the scope of clause (zzzzu), the so called ‘activities’ enlisted therein are restricted only to clauses (zzq) and (zzzh) of Section 65(105) and does not apply to clause (zzzza) i.e. ‘Works Contract Service’. Similar would be the case with regard to the proposed insertion of explanations under clauses (zzq) and (zzzh); they may not be applicable to activities falling under clause (zzzza) of Section 65(105). Anyway lets brace for a long legal battle ahead.