MARCH 06, 2012

Service Tax on realty sector - Will Govt bring about much-needed clarity and fairness?

S Sivakumar, CA

NO other industry would have been subjected to absolutely unclear statutory provisions and rules related to service tax, as the Realty Sector has been, over the years. Every year during the Budget time, this Sector craves for clarity and gets, instead, more confusion in the form of statutory amendments and circulars from the CBEC.

Here is an attempt to throw light on some of the major service tax controversies dogging this Sector….

Works Contract Services vs Construction Services

As we know, service tax on commercial/industrial construction services was introduced from 10-9-2004 while, residential construction services was brought into the net from 16-6-2005. Even as the confusion arising out of the introduction of service tax on construction services was beginning to settle down, the Government, for inexplicable reasons, introduced a new service, viz. Works Contract services, with effect from 1-6-2007. The same activity, viz. construction, being subjected to the levy under a new category raised questions on the legality of the collection of service tax by the Government for the period prior to 1-6-2007. With many High Courts taking the view that, service tax cannot be levied on works contractors for the period prior to June 1, 2007, it seems that no service tax could have been levied on construction services for the earlier period.

Even as the confusion caused by the introduction of the new service, viz. works contracts, was beginning to settle down, the Government has brought about a series of significant amendments to the service tax law applicable to construction services, without touching the provisions related to works contract services. Some of these include the introduction of the Explanations to the basis definitions related to construction services, effective from 1-7-2010, the issuance of a highly controversial Circular No. 108/2/2009 dated 29-1-2009 and of course, the issuance of the latest CircularNo. 151/2/2012 dated 10-02-2012 . In terms of these circulars and the amendments to the statutory provisions, Developers/Builders who have classified their services under 'construction services' are liable to pay service tax on joint development agreements (in respect of 'services' rendered to land owners), pay service tax on the basis of the concept of 'deemed services' linked to the obtaining of the Completion Certificate, etc. None of these provisions are applicable to Developers/Builders who have classified their services under 'works contract' services. Thus, a Builder who has classified his services under 'works contract services' will not pay service tax on joint development agreements while another Builder, who has, perhaps, very unfortunately, classified his services under 'construction of complex services' or 'commercial or industrial construction services' will now be asked to pay service tax on joint developments. Can anything be more confusing and perhaps, unjust? And, where is the need for the Government to continuously tinker with the service tax provisions related to 'construction services' even when, as per the Government's own Notification, new contracts entered into after 1-6-2007 have to be compulsorily classified under ' works contract services; which is a more specific head.

It is highly ironical that the Government has repeatedly come out with circulars and notifications which have served only to significantly increase the confusion that is already prevailing, rather than, to provide clarity. Circular No. 108/2/2009 is a typical example of a circular which nobody including the Department understood and in respect of which, the Government itself has come out with positions which are completely contradictory to the stand taken in this circular. Where was, then, the need to issue this Circular, in the first place, Sir?

All along, the Department has been taking the view that, Developers/Builders are rendering' exempted services' to the land owners, in terms of the joint development agreements. The Government would seem to have made a complete U Turn now, by taking the view in its circular dated 10-2-2012 that Developers/Builders are rendering 'taxable services' to the land owners. And, should it take a sweet seven years for the Board to come out with its view on joint developments.

The significant differences that exist in terms of the statutory provisions that are applicable to 'works contract services' and 'construction services' will have to be reconciled at some point of time and one hopes that the forthcoming Budget will bring about this much need reconciliation and the consequent clarity.

Why is the Government hell bent to deny/restrict CENVAT credit to Realty Sector?

Service tax, as most of us understand, is a tax levied on services. But, it does looks like, the Government wants to levy service tax even on the sale of goods by the works contractors. The Government has been taking a view that the benefit of Notification No. 12/2003 dated June 20, 2003 cannot be extended to the Realty Players. Several Show Cause Notices have been issued to the Realty players, not-withstanding the fact that, several Tribunals have held that the benefit of this Notification cannot be denied to 'deemed sales transactions'. The Apex Court has also established this principle that, service tax cannot be levied on the goods value of the transaction, in the BSNL case, the IMagic Creative case and several other cases. The law flowing out of these decisions is that, once a transaction or a part of a transaction is held to be a sale, the same transaction or its part cannot be held to be a service and subjected to the levy of service tax. As is known, the Parliament, by adding a new Clause 26A to Article 366, by the 46 th Amendment in 1982, has enabled the States to levy sales tax on six types of transactions including civil works contracts. These transactions are referred to 'deemed sale' transactions, more, in order to drive home the fact that, these transactions could not be subjected to tax earlier to 1982, as contrasted to the other 'sale' transactions. From a tax and legal perspective, it would seem that, there is absolutely no distinction between a sale and a deemed sale for taxation purposes.

However, there have been some recent Tribunal decisions in cases involving photography services, hotel services, etc., wherein, a view has been taken that the benefit of Notification No. 12/2003 is not available to transactions other than 'sale transactions', more in the context of goods and materials that are consumed in the process of providing the output service. Armed with these decisions, the Department has been taking the view that, the benefit of Notification No. 12/2003 cannot be made available to Developers, Builders and Contractors, as they are engaged in 'deemed sale' transactions and not 'sale' transactions. The Department has been taking the view that, the Realty Players who have classified their services under 'Construction of Complex' services and 'Commercial or Industrial Construction' services are compulsorily required to go under Notification No. 1/2006, under which, service tax is to be paid on 33% of the gross amount charged. The Department's enthusiasm to have the Realty players go under Notification No. 1/2006 as contrasted to Notification No. 1/2003 is understandable, in the context of the fact that, cenvat credit is denied under the former. But, is this approach justified especially in the context of the binding decisions of the Apex Court?

Point of Taxation Rulesare 'practically impracticable'

The Point of Taxation Rules, 2011 ('POTR') contain some of the harshest and highly impracticable provisions concerning the Realty Sector, in as much as, the three services concerning the realty sector, viz. Works Contract services, Construction of complex services and Commercial or Industrial Construction services, have been brought under the concept of 'continuous supply of services'. As per Explanation 1 to Rule 6 of the POTR, where the provision of the whole or part of the service is determined periodically on the completion of an 'event' in terms of a contract, which requires the service receiver to make any payment to service provider, the date of completion of each such 'event' as specified in the contract shall be deemed to be the date of completion of provision of service. In terms of the explanations to Rule 6 of the POTR, the implication is that, where the construction agreements entered into by the Realty Developers and Builders provide for specific dates related to the completion of the events, (for example…laying of slab is an event)requiring the customers to make payments, then, such dates would be deemed to be date of completion of each such event,irrespective of the actual date the event is completed. These are draconian provisions, in as much as, the service tax liability would get triggered on the basis of dates mentioned in the construction agreement, not-withstanding the fact that, no construction activity might have commenced. Moreover, Realty players are also concerned with the provisions related to prosecution, under which, non-raising of invoices within 14 days would trigger prosecution proceedings under Section 89 of the Finance Act, 1994. It is clear that, these provisions are hugely impracticable and the Realty Players would find it impossible to implement these Rules. One would expect the Government to take the Realty Sector outside of the 'continuous supply of services'. There seems to be no justification in bringing the Realty Sector under the 'continuous supply of services' and one should hope that the Government makes the necessary amendments.

No justification in denying cenvat credit to Commercial Realty players

The Government would seem to have singled out the Commercial Realty sector for some rough treatment in the Budget for FY2011-12, by going in for draconian amendments to the definitions of 'inputs' and 'input services'. In terms of these changes, Developers and Builders who are into renting of immovable property services are not allowed cenvat credit in respect of amounts paid by them to contractors, architects, etc. 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, under 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. It seems rather strange and odd that, while realty players who are into construction residential complexes are allowed to avail of cenvat credit of the amounts paid to contractors and architects, the same credit is denied to commercial realty players who have let out their commercial buildings. The Government would need to take a broader view of the cenvat credit scheme and ensure that, no particular segment is discriminated against as this would go against the very purpose of the scheme.

While on the subject of cenvat credit for the Realty Sector…. It seems that cenvat credit in respect of architects' services, input construction services, etc., would not be available for the Preferential Location or Development of Complex services, classified under Section 65(105)(zzzzu) of the Finance Act, 1994. Here again, there is no justification for the denial of cenvat credit to this particular service, when cenvat credit is available to construction services.

Before parting…..

The Government would seem to have completely bungled up, in terms of the service tax provisions that are applicable to the Realty Sector, if the plethora of statutory amendments, circulars and notifications and the contradictory stand by the Government are any indication. This perhaps explains the kind of litigation that this Sector has seen. Without clarity and fairness, how can the Government expect compliance?

One sincerely hopes that the Government makes amends this time around, for all the confusion that it itself has created. Let's hope that the Hon'ble FM is listening.