Sale of Premises – Service or Sale??

Construction business is growing at a rapid increase and it is expected that it will

continue to be achieve a higher value in the years to follow.

However with the introduction of VAT in the regime of collection of taxes, followed by the

introduction of Service Tax on Construction of Residential Complex has widened the

scope of collectibles of indirect taxation and it has been felt that the burden is not

beneficial to the need and desire of people.The levy of VAT on Works contract is on the

sales effected by way of transfer of property in goods (whether as goods or in some

other form) involved in the execution of a works contract, subject to such restrictions

and conditions as may be prescribed, in lieu of the amount of tax payable by him under

this Act, whether in respect of 65 the entire turnover of sales effected by way of works

contract or in respect of any portion of the turnover corresponding to individual works

contract, pay lump-sum by way of composition,—

(a) equal to 5% of the total contract value of the works contract in the case of a

construction contract, and

(b) 8% of the total contract value of the works contract in any other case, after

deducting from the total contract value of the works contract, the amount payable

towards sub-contract involving goods to a registered sub-contractor.

The construction contract as defined under MVAT Act, 2002 “shall mean construction

contract as may be notified by the State Government in the Official Gazette, from time to

time”

Under these circumstances immergence of complex business structure has taken place,

entities have framed multifaceted agreements to save taxes through tax planning.

Government (both state and Central) over the period has ventured themselves to cover

all types of agreements in the tax regime, so that loss of revenue can be avoided.

Following table shows the certain types of business agreements which are prevalent in

construction business and there effect to the taxation regime are certain types of

agreements which are common in the business world and following are the

corresponding views given by various government authorities

1. Landowner appointing contractor for building apartment & Landowner allotting the

flats in consideration for contract which contractor may sell them as his property.

The contractor constructs building on land (owned by Landowner) using the material

owned by contractor. Generally, such transaction would be considered as works

contract. However, the consideration is in form of certain premises.

Definition of Sale under MVAT Act 2002 [Sec 2(24)]: “sale” means a sale of goods

made within the State for cash or deferred payment or other valuable

consideration but does not include a mortgage, hypothecation, charge or pledge;

and the words “sell”, “buy” and “purchase”, with all their grammatical variations and

cognate expressions, shall be construed accordingly. Unless money consideration is

agreed upon, there is no question of sale as per Sales Tax Laws.

Definition of Sale Price under MVAT Act 2002 [Sec 2(25)]: “sale price” means the

amount of valuable consideration paid or payable to a dealer for any sale

made including any sum charged for anything done by the seller in respect of the

goods at the time of or before delivery thereof, other than the cost of insurance for

transit or of installation, when such cost is separately charged.

It can be interpreted from the combined definition of sale and sale price that unless

the money consideration is determined for transfer of property, the transaction is not

liable under MVAT Act.

Judicial Pronouncements:

The supreme court judgment incase of M/s. Gannon Dunkerley & Co. (9 STC

353) (SC) brings out the following criteria for construing sale transaction:

a. Basic conditions for valid contract.

b. Subject matter of sale is moveable goods.

c. Money consideration for sale.

d. Transfer of property i.e. transfer of ownership from seller to purchaser.

Consideration should be in money terms. If consideration is not in money terms,

i.e. in any other mode, it may be exchange or barter, but not a sale.

The supreme court judgment in case of CIT v. Motors & General Stores (P)

Ltd., (66 ITR 692) also emphasis on the money consideration with reference to

price defined u/s 2(10) of The Sale of Goods Act, 1930.

As per the pronouncements of M/s. Davi Dass Gopal Krishnan and Other (22

STC 430) (SC); M/s. Radhas Printers v. State of Kerela, (90 STC 201)

(Kerela) and Sales Tax Commissioner v. Ram Kumar Agarwal, (1967) (19

STC 400) (Allahabad High Court) it was held that ‘Other valuable

consideration’ must be interpreted on the basis of rule of ejusdem generic to

mean cheques, bills of exchange or such other negotiable instruments. Thus it

shall be concluded that unless consideration is in money terms, contractor cannot

be made liable to any tax under MVAT Act as the deal cannot be construed as

sale.

2. Owner of Land grants development rights to Developer who constructs the

superstructure. The Land and the superstructure are then separately conveyed by the

owner & developer respectively under tripartite agreement with the eventual buyer.

The Supreme Court in K. Raheja Development Corporation v. State of

Karnataka, 2006 (3) STR 337 (SC) delivered the judgment in context with the

arrangement of tripartite agreement between land owner, developer & prospective

buyer. The Supreme Court found that the developer was undertaking the construction

activity on the behalf of the prospective buyer. Under the Karnataka Sales Tax

Provision, the definition of a works contract being wide covers any type of agreement

reflecting construction, and the construction could be on behalf of owner of property

or even by Owner himself. The Court also stated that “if the agreement is entered

into after the flat or unit is already constructed, there would be no works

contract. But so long as the agreement is entered into before the

construction is complete, it would be works contract.”

Subsequently Definition of ‘sale’ in sec. 2(24) of the MVAT Act, 2002 was amended to

bring it in par with the Karnataka sales tax provision. As a result, works contract

came to mean “ the transfer of property in goods (whether as goods or in some other

form) involved in the execution of works contract including building, construction,

manufacture, processing, fabrication, erection, installation, fitting out, improvement,

modification, repair or commissioning of any moveable or immovable property.”

In Trade Circular No. 12T of 2007 dated 07.02.2007, the MVAT Department clarified

that tripartite arrangements would be liable to MVAT. VAT authorities interpreted the

judgment of K. Raheja as to mean that every agreement entered into before the flat

was constructed would become a works contract.

In the Re: Hare Krishna Developers 2008 (10) STR 357 (AAR), decision was

given in context with the arrangement as in case of K. Raheja for which AAR held it as

works contract service i.e. developer was carrying out construction for and on behalf

of the buyer.

3. Land owner himself undertakes construction and allots the flats to prospective buyers

but are subject to receipt of initial token money and execution of sale deed on

completion of construction. The land owner continued to enjoy rights and title over

the apartments till the execution of the registered sale deed.

In case of Assotech Realty Pvt. Ltd. v. State of UP [2007 (7) STR 129 (All)], Court held

that the developer was acting on its own behalf in constructing of flats & the right,

title and interest therein would only transfer over after sale deed was executed, after

construction had been completed. Court held that the arrangement was not a works

contract and that no sales tax would therefore be payable.

In the Re: Hare Krishna Developers 2008 (10) STR 341 (AAR), the arrangement

was similar to that of Assotech realty Pvt. Ltd. AAR held that the entry of

‘construction of complex service’ would cover all the activities relating to

construction of complexes including such an arrangement. It added that the time of

transferring of ownership would not determine the liability of service tax.

Controversy has been created after the decision of Gauhati High Court in case of Magus

Construction Pvt. Ltd. v. Union of India [2008 (11) STR 225 (Gau)], which referred to

tripartite agreement as outright sale and out of the purview of service tax. The decision

was based on the circulars during the period of 2004 to 2009 collectively point out

legislative intention that construction activity undertaken by the builder / developer

amounts to self service and will not be liable to service tax.

These different patterns of execution, terms of payment and legal formalities have given

rise to confusion, disputes and discrimination in terms of service tax payments.

Construction Activity

Developer agrees to undertake

construction

Transfer of property of goods, whether as goods or

in some other form, involved in the execution of

Works Contract

Agreement to sale of

immovable property which may be entered

before it is constructed.

Construction of Complex Service /

Commercial or Industrial

Construction based on nature of construction

Works Contract Service

Works Contract

chargeable to VAT

Controversy!!!!!

Summarization before entry of Explanation (Finance Act, 2010):

Builder Model Developer Model

Agreement to sell is executed between

purchaser and builder.

Developer enters into contract with the

prospective buyer.

Conveyance is executed by builder on post

completion and possession is handed over

to buyer.

Post construction, possession is handed

over & land is directly transferred to

society / owners of apartment (No separate

sale deed)

Contract for sale – No Construction

Contract

Construction Contract - No Contract for

Sale

Levy of Stamp Duty No levy of Stamp duty as the property in

goods involved in works contract passes by

attainment during process of work.

K. Raheja ModelK. Raheja Model

Models of construction activityModels of construction activity

Dealing of flat / space after the construction activity is completed

Dealing of flat / space after the construction activity is completed

Assotech & Magus Model

Assotech & Magus Model

No Service tax.Only Stamp Duty on

conveyance.

No Service tax.Only Stamp Duty on

conveyance.

Under the ambit of Service Tax as per New

Explanation

Under the ambit of Service Tax as per New

Explanation

Under the ambit of Service Tax as per New

Explanation

Under the ambit of Service Tax as per New

Explanation

Introduction of explanation in the sub clause (zzzzh) of the S. 65(105) of the

Act by the Finance Act, 2010 with effect from 01.07.2010:

Construction of a complex with intended for sale, wholly or partially, by a builder or any

person authorized by the builder before, during or after construction (except in case of

no sum received from or on behalf of the prospective buyer by a builder or any person

authorized by the builder before grant of completion certificate from authority

competent to issue the same under any law for being in force) shall be deemed to be

service provided by the builder to the buyer.

The plain interpretation of above said provision is that sum received by the builder from

prospective buyer before completion of construction i.e. grant of “OC” is subject to

Service Tax w.e.f. 01.07.2010.

In order to achieve Legislative intent and bring in parity in tax treatment, to expand the

scope of existing service; the Explanation has been included. The three models of

construction activity are now covered under the ambit of service tax.

The amendment is introduced to enact a deeming fiction per which any amount received

prior to grant of Certificate of Completion are deemed to be consideration for the

performance of construction services by the builder to the buyer. However, exemptions

are provided incase such construction services are provided to Jawaharlal Nehru

National Urban Renewal Mission and Rajiv Awaas Yojana, services provided

wholly within a port for certain specified purposes and services provided wholly

within a port an airport.

The construction service provided for personal use of buyer would not be covered by

service tax.

Vide Notification 36/2010 dated 28.06.2010, the sum of money received in advance

from prospective purchasers towards any unit in a building by a builder / developer prior

to 01.07.2010 is not liable to service tax in case of construction services remaining

pending to be provided in the period post 01.07.2010

The Service tax (Removal of Difficulty) Order, 2010 dated 01.07.2010 widens the

scope of authority competent to issue Certificate of Completion by including an architect

registered under the Council of Architecture constituted under the Architects Act,

Chartered Engineers registered with the Institution of Engineers (India), or the licensed

surveyor of the respective local body or development or planning authority.

Options available under the Services applicable to Builders and Developers:

a. Commercial or Industrial Construction [S. 65(105)(zzq)] & Construction of Residential complex

[S. 65(105)(zzzzh)]

Option

s

Amount Payable as ST CENVAT Credit

1. 10.30 % on value of services CENVAT Credit on capital goods, input

services and input goods

2. 10.30 % on 33 % of gross

amount including value of

materials supplied

No CENVAT Credit.

3. 10.30 % on 25 % of gross

amount including value of

materials supplied and value of

land

No CENVAT Credit.

b. Works Contract service [S. 65(105)(zzzza)]

Option

s

Amount Payable as ST CENVAT Credit

1. 10.30 % on value of services

(excl. value of material

supplied)

CENVAT Credit on capital goods, input

services and input goods

2. 4 % of gross amount including No CENVAT Credit on inputs.

value of materials supplied

The deeming provision applicable to Builders / Developers was challenged by them

before various High Courts. The Bombay High Courts in case of Maharashtra Chamber of

Housing and Industry v. UOI (2010 TIOL 526 HC Mum. - ST) and Madras High Court in the

case of A. P. Ravi v. UOI (2010 TIOL 604 HC Mad. - ST) has granted an interim stay to

petitioners. However, recently in the case of G. S. Promoters v. UOI, 2011 (21) STR 100,

Punjab & Haryana High Court has pronounced its judgment and upheld the validity of the

explanation inserted in S. 65(105)(zzzzh). The petitioner pleaded that sale and purchase

was beyond legislative competence of Union Legislature. If construction activity is not

undertaken by a builder, then the builder cannot be considered to be service provider in

relation to services of construction activities. The High Court observed that “the entries

in the lists being merely topics or fields of legislation, they must receive a liberal

construction inspired by a broad and generous spirit and not in a narrow pedantic

sense.” Taxing of such transaction is not outside the purview of the Union Legislature

when it does not fall in any of the taxing entries of State List. From the observations

made by High court it can be contended that –

1. The presence of service or not has to be obtained not only from

builders point of view but also from the recipient’s angle.

2. Service is definitely involved when construction is carried out or

before construction and before flat is sold and therefore levy could not be held

unconstitutional.

In view of above it is obvious that decision would be challenged in Hon. Supreme Court.

Further, there may not be any further consequence of the judgment in the jurisdiction of

Bombay & Madras High Court. The ultimate burden of service tax would be borne by flat

buyers as department may continue attempts to recover service tax. The issue is highly

complex and multifaceted.

HOWSOEVER THE GOVERNMENT WOULD TRY THE LEVY OF STAMP DUTY, SERVICE TAX

AND VAT WILL INDIRECTLY LEADS TO HIGHER CASH OUTFLOW FROM THE FINAL BUYER

POINT OF VIEW.

THE BASIC NEEDS OF SHELTER IS SOMEWHERE BEING NEGLACTED BY THE

GOVERNMENT , AND UNDER CURRENT CIRCUMSTANCES IT SEEMS THAT LACK OF

CLARIFICATION ON THESE MAATERS ARE RESULTING INTO LOTS OF AMBIGUITY AND IT

MAY WIDEN THE SCOPE OF OTHER METHODS OF TAX PLANNING WHICH MAY NOT BE

ETHICAL FFROM THE POINT OF VIEW OF LEGISLATION AND SOCIETY.