Cenvat Credit Changes will drastically affect Realty Players

By S Sivakumar, CA

IT would seem that the FM has singled out the Realty Sector for some rough treatment, in so far as the amendments to the cenvat credit scheme are concerned.

In terms of Notification No. 3/2011-Central Excise (N.T.) dated March 1, 2011, the Government has effect some fundamental changes in the cenvat credit scheme, which would drastically affect Industry in general and the Realty Sector, in particular. We will restrict our discussions on how these changes would affect the Realty Sector.

Expansion in the scope of Exempted Services will affect Realty Players

Clause 2(e) of the Cenvat Credit Rules, 2004 (‘CCR'), which defines ‘exempted services' has undergone a major change. The revised definition of ‘exempted services', to take effect from April 1, 2011, reads as follows

“exempted services” means taxable services which are exempt from the whole of the service tax leviable thereon, and includes services on which no service tax is leviable under section 66 of the Finance Act, 1994 and taxable services whose part of value is exempted on the condition that no credit of inputs andinput services, used for providing such taxable service, shall be taken.

Explanation.- For the removal of doubts, it is hereby clarified that "exempted services" includes trading”.

It seems that all services in respect of which, abatement is claimed (in terms of Notification No. 1/2006 as amended from time to time) would now get treated as ‘exempted services', as per the expanded definition. The notable amongst these is ‘Construction of Complex' services, wherein, the Realty players pay service tax on 33% of the gross amount charged. By sheer contrast, in my view, “Works Contract” services would not be treated an exempted service under the expanded definition, as there is no condition that cenvat credit should not be used.

It would also seem that, the Realty players who avail of the benefit of Notification No. 12/2003 would not treated as providing ‘exempted services', as there is no bar in availment of credit under the said Notification, as contrasted to Notification No. 1/2006.

The concept of ‘exempted services' assumes importance in the context of Rule 6(3) of the CCR, which requires the proportionate credit attributable to ‘exempted services' to be reversed.

Change in the definition of 'Inputs'

The existing definition of “inputs”, as contained in Rule 2(k) is being substituted with a brand new definition, which reads as follows:

(k) “input” means–

(i) all goods used in the factory by the manufacturer of the final product; or

(ii) any goods including accessories, cleared along with the final product, the value of whichis included in the value of the final product and goods used for providing free warranty forfinal products; or

(iii) all goods used for generation of electricity or steam for captive use; or

(iv) all goods used for providing any output service;

but excludes-

(A) light diesel oil, high speed diesel oil or motor spirit, commonly known as petrol;

(B) any goods used for-

(a) construction of a building or a civil structure or a part thereof; or

(b) laying of foundation or making of structures for support of capital goods,except for the provision of any taxable service specified in sub-clauses (zn), (zzl), (zzm),(zzq), (zzzh) and (zzzza) of clause (105) of section 65 of the Finance Act;

(C) capital goods except when used as parts or components in the manufacture of a finalproduct;

(D) motor vehicles;

(E) any goods, such as food items, goods used in a guesthouse, residential colony, club or arecreation facility and clinical establishment, when such goods are used primarily forpersonal use or consumption of any employee; and

(F) any goods which have no relationship whatsoever with the manufacture of a finalproduct.

Change in the definition of 'Input Service'

The existing definition of “Input Service”, as contained in Rule 2(l) is being replaced with a new definition, which reads as follows:

(1) “input service” means any service, -

(i) used by a provider of taxable service for providing an output service; or

(ii) used by a manufacturer, whether directly or indirectly, in or in relation to the manufactureof final products and clearance of final products upto the place of removal,and includes services used in relation to modernisation, renovation or repairs of a factory, premisesof provider of output service or an office relating to such factory or premises, advertisement or salespromotion, market research, storage upto the place of removal, procurement of inputs, accounting,auditing, financing, recruitment and quality control, coaching and training, computer networking,credit rating, share registry, security, business exhibition, legal services, inward transportation ofinputs or capital goods and outward transportation upto the place of removal;

but excludesservices,-

(A) specified in sub-clauses (p), (zn), (zzl), (zzm), (zzq), (zzzh) and (zzzza) of clause (105)of section 65 of the Finance Act (hereinafter referred as specified services), in so far as theyare used for-

(a) construction of a building or a civil structure or a part thereof; or

(b) laying of foundation or making of structures for support of capital goods,except for the provision of one or more of the specified services; or

(B) specified in sub-clauses (d), (o), (zo) and (zzzzj) of clause (105) of section 65 of theFinance Act, in so far as they relate to a motor vehicle except when used for the provision oftaxable services for which the credit on motor vehicle is available as capital goods; or

(C) such as those provided in relation to outdoor catering, beauty treatment, health services,cosmetic and plastic surgery, membership of a club, health and fitness centre, life insurance,health insurance and travel benefits extended to employees on vacation such as Leave orHome Travel Concession, when such services are used primarily for personal use orconsumption of any employee;

How these changes in the definitions of “Inputs” and “Input Services” could affect Realty Players

A combined reading of the new definitions for “Inputs” and “Input Services” could lead to the following conclusions, in so far as they relate to the Realty Sector:

++ Cenvat credit of the service tax paid on certain input services, viz. Architects' Services, Construction of Complex services, Commercial or Industrial Construction services, Works Contract services and Airport services can be taken only if the assesse is also providing any of these output services. While I see no harm to the Residential Realty Sector, the Developers and Builders who are into renting of immovable property services would be drastically hit, as the service tax paid by them to their contractors who actually construct the commercial complexes would not be available as cenvat credit. In effect, the Government would seem to have legalized its views contained in the infamous Circular No. 98/1/2008-ST dated January 4, 2008, where a view was taken that assesses who are rendering taxable services under ‘Renting of Immovable Property' services cannot avail of cenvat credit of the service tax paid on construction of the commercial or industrial complexes. The only saving grace here is that, this amendment is prospective, with effect from April 1, 2011 and will not affect the credit already availed, prior to April 1, 2011.

++ Per se, there are no implications arising out of the revised definitions, for the Residential Realty players, as they can continue to avail of the cenvat credit for the input services like construction services, etc. It is rather unfortunate that, while the Residential Realty players are allowed cenvat credit in respect of input construction services, the Commercial Realty players who have let out the premises are not allowed cenvat credit in respect of the input commercial construction and other services.

++ Another development which would affect both the players is that, cenvat credit of the duty paid on the capital goods would no longer be available. This is rather unfortunate for the Residential Realty players who have classified their services under ‘Works Contract' services or have opted to go under Notification No. 12/2003, as under these Notifications, there is no bar for availment of cenvat credit of the duty paid on capital goods.

++ The Preferential Location or Development of Complex services, classified under Section 65(105)(zzzzu) and which have become taxable effective 1-7-2010 do not find a place here. Does it then mean that, Developers and Builders who pay service tax under this head cannot take cenvat credit of the service tax paid on input construction services, etc.

++ By definition, the construction of a building or a civil structure thereof, is not an input. Where is the justification for this statutory amendment? What is the harm if a Builder or Developer buys goods like steel and cement, avails of cenvat credit and pays output service tax on the full rate? How can a benefit which is available to all other service providers be denied to a Developer or Builder? Is this not discriminatory in nature?

The good old Rule 6(5) of CCR is dead and gone

The famous or infamous Rule 6 of the CCR has been completed modified in the Budget and here again, the Realty Sector would stand to be a major loser. As we know, under Rule 6(5), there was no need to reverse the credit attributable to the exempted services, in respect of the 17 input services specified in Rule 6(5), as contrasted to Rule 6(3), under which, such a reversal was mandatory. The most unfortunate fall out of this Budget is that, this great Rule 6(5), under which, 100% cenvat credit was allowed so long as the any of the 17 services listed under this Rule was not exclusively used for providing an exempt service, has now been withdrawn. The Commercial Realty sector was one of the largest beneficiaries of Rule 6(5) of the CCR, as ‘Commercial or Industrial Construction' services, apart from certain other services like Architect's services, etc. fell under Rule 6(5). In fact, the Circular No. 98/1/2008-ST dated January 4, 2008, which sought to deny cenvat credit to the Commercial Realty players who are deriving rental revenues is in contrast with the statutory provisions contained in Rule 6(5). I am quite saddened that Rule 6(5) is part of history now.

And, now, Developers/ Builders to be penalized for crimes committed by their Contractors

In yet another major negative development concerning the Developers/Builders who have opted for the Works Contract (Composition Scheme for Payment of Service Tax) Rules, 2007, the Government has proposed to insert a new sub-rule (2A) in Rule 3 of the CCR, the text of which is given below:

“(2A) The CENVAT credit of tax paid on taxable services as referred to under sub-clauses (zzd), (zzq) and (zzzh) of clause (105) of section 65 of the Finance Act, 1994, shall be available only to the extent of 40% of the service tax paid when such tax has been paid on the full value of the service after availing CENVAT credit on inputs.”

The TRU has clarified, in terms of its Budget Circular dated 28 th February 2011, that that this new sub-rule is being added to restrict the cenvat credit availmentto 40% of service tax paid by the Works Contractor, oncertain input services, viz. erection, commissioning and installation, commercial or industrial construction and construction of residential complex, where the service provider (providing services to the Developer/Builder/Contractor who has opted for Works Contractor services) has paid service tax on the full value of the service after availing of cenvat credit on inputs i.e. without availing exemption notification 1/2006-ST dated 01.03.2006. The Circular further explains that this move has been brought about to ensure that the credit on inputs is not availed of indirectly while availing of the said composition scheme by the service providers.

How on earth can the Developer/Builder find out the Scheme under which, his service provider would fall, Sir? As we know, Notification No. 1/2006 prohibits availment of cenvat credit by the assessees who have opted for this Notification and consequently, service providers rendering services to Developers/Builders are expected not to avail of cenvat credit when they have opted for Notification No. 1/2006. How fair is it to penalize the service recipient, viz. the Developers / Builders for any crime that might be committed by their service providers. Any, how can the Developer/Builder ensure that, his service provider has not availed of cenvat credit, except, to take over the accounting function of his service provider. The move to restrict cenvat credit to the Developer/Builder Works Contractor, based on the availment of cenvat credit by the service providers, is very unfortunate, obnoxious and unsustainable and reflects a perverse mindset.

What would be the case, if the service provider has opted for Notification No. 12/2003 or has opted for the Works Contractor scheme? Obviously, this provision restricting cenvat credit, in the hands of the Developer/Builder Works Contractor, would not apply. As a tax planning measure then, the Developers/Builders should ask their contractors to opt for Notification No. 12/2003 or to opt for the Works Contractor scheme.

It must be kept in mind that, most Developers and Builders have opted for the Composition Scheme for Works Contractors and this particular amendment could play havoc. The sooner this obnoxious provision is

Before concluding…

It does seem that the changes in the cenvat credit regime would hit the Realty Sector in a drastic manner. The other changes in the service tax law would affect the Realty Sector to as much an extent, as it does, to the other segments of the Industry. Perhaps, the new requirement to collect service tax on an accrual basis could affect it more.

For a Government which swears by the value added tax model and which talks of unifying the state and central indirect taxes under one banner under the GST, the move to go in for statutory provisions to deny credit on what are essential inputs and input services for the Realty Sector does not augur well and goes against the basic principle behind the value added tax model.

(The Author is Director, S3 Solutions Pvt Ltd, Bangalore)