By TIOL News Service

NEW DELHI, FEB 23, 2011: WHAT happens when you enter into an agreement to provide service (with no mention of Service Tax as there was no tax on the services at the time of providing the service) and Service Tax is imposed on the service and the client refuses to bear the tax as there was no contractual obligation?

File a civil suit and the Delhi High Court has recently allowed such a suit.

The Plaintiff Society is owner of the building Pearey Lal Bhawan located at 2, Bahadur Shah Zafar Marg , ('the suit premises') and the principal lessee of the land. The Plaintiff had entered into a registered Lease Deed on 09.10.2006 'first lease' with the Defendant, ('Satya Developers') in respect of an area measuring 2818 sq. ft. on the ground floor of the premises Pearey at Lal Bhawan . On 16th October, 2006, the parties entered into an Agreement for Maintenance of Common Services and Facilities in respect of the leased premises.

With effect from 1st June, 2007 the Central Government, by amending Chapter V of the Finance Act, 1994, levied service tax on the renting of immoveable property for business purposes. The plaintiff contends that the said levy tax is in the nature of an indirect tax, which has to be deposited by the service provider, after collecting the same from the user of the service. It is de-facto and de-jure a tax on the service and not a tax on the service provider. It contends that the burden of service tax has to be borne by the user of the service provided.

The plaintiff submits that service tax, levied by the Central Government, is not in the nature of a tax on property, as under the Constitutional scheme only the State Legislatures have the power to levy tax on property, but a levy on the service, and to be collected from the beneficiary of the service, such as the lessee Defendant, in this case. The suit states that in keeping with this position of law the bills of lease rental and maintenance charges sent to the Defendant from June, 2007, onwards included an amount on account of service tax and cess at the rate of 12.36% on the rent payable.

Satya Developers, the defendant, denies the suit claim, and denies that service tax has to be paid after collecting the same form the user.

Satya Developers point out to the relevant clauses of the Lease Deed, particularly Clause 5 reads as under :

"5. That the lessor shall continue to pay all or any taxes, levies or charges imposed by the MCD, DDA , L&DO and or Government, Local Authority etc" .

The defendant also relies on clause II (1), which reads as under :

" II (1) That the Lessor to pay all rates, taxes, ground rent, house-tax charges, firefighting tax, easements and outgoing charges imposed or payable to the MCD, L&DO , DDA or Government in respect of the demised premises payable by the Lessor and discharge all its obligations well in time" .

It is argued that the parties clearly agreed that all taxes would be borne and paid by the Plaintiff thus the question of Defendant paying any taxes much less service tax does not arise.

The defendant contends that service tax, is a tax on property and if the plaintiff has any grievance in respect of the imposition of service tax it is open for the Plaintiff to take up the matter in the appropriate forum with the Central Government.

The following issues arise for consideration by the High Court:

1) On whom does the incidence of taxation fall, in this case, having regard to the materials and documents on the record;

2) Is the plaintiff entitled to the money decree, as claimed, or any other relief:

3) Relief.

The controversy requiring decision by the Court is narrow and limited. It is whether the burden of service tax, levied on the service or facility of leasing (of the suit premises) should be borne by the lessor (i.e. the service provider) or the lessee (i.e. the defendant, user). There is no dispute that the parties did not visualize that this kind of a levy would be made in respect of lease, or rental of commercial properties; it is also undisputed that the levy was made effective in 2007, after the parties had entered into the agreement. The defendant denies liability to pay, submitting that the conditions in the contract clearly stipulate that all taxes, etc. are to be borne by the plaintiff landlord. It relies on principles of interpretation of contract, to submit that when parties visualize situations and provision for them, it is not open to either of them to roam outside the express terms, and try to discover obligations when none exist.

The High Court observed that it is true, that the contracts entered into between the parties in this case, spoke of the plaintiff lessor' s liability to pay municipal, local and other taxes, in at least two places. The Court, however, is not unmindful of the circumstance that service tax is a species of levy which the parties clearly did not envision, while entering into their arrangement. It is not denied that leasing, and renting premises was included as a 'service' and made exigible to service tax, by an amendment; the rate of tax to be collected, is not denied. If the overall objective of the levy " as explained by the Supreme Court, were to be taken into consideration, it is the service which is taxed, and the levy is an indirect one, which necessarily means that the user has to bear it. The rationale why this logic has to be accepted is that the ultimate consumer has contact with the user; it is from them that the levy would eventually be realized, by including the amount of tax in the cost of the service (or goods)."

The High Court noted that Section 64-A of the Sale of Goods Act, 1930, visualizes and provides for situations where levies of tax are imposed after the contract (for sale of goods) is entered into.

This provision also clearly says that unless a different intention appears from the terms of the contract, in case of the imposition or increase in the tax after the making of a contract, the party shall be entitled to be paid such tax or such increase. Although there is no explicit provision to that effect, enabling lessors such as the plaintiff, to the service tax component, there is sufficient internal indication in the Act, through Section 83 read with Section 12-A and Section 12-B suggesting that the levy is an indirect tax, which can be collected from the user (in this case, the lessee).

Issue No. 1: Is therefore, answered in the plaintiff's favour, and against the defendant.

Issue No. 2 : In view of the findings on issue No. 1, the Court is of the opinion that the plaintiff is entitled the declaration and injunctions claimed against the defendant, to the effect that the latter is liable to pay and refund the service tax liability. The plaintiff is also entitled to the amounts claimed.

Issue No. 3: In view of the findings on Issue Nos. 1 and 2, the suits are entitled to succeed. They are, accordingly decreed in terms of the reliefs sought by the plaintiffs. It is clarified that this is subject to the levy of service tax being ultimately upheld, finally. In the circumstances, the plaintiff is entitled to costs, in both the suits.

(See 2011-TIOL-114-HC-DEL-ST in 'Service Tax')