FEBRUARY 13, 2012  

By G Natarajan, Advocate, Swamy Associates

THE complexities of the issues pertaining to the levy of service tax on construction related activities, especially residential construction, are bigger than the boulders and stickier than the concrete. Though the attempt of the Board in trying to clarify various issues vide its Circular 151/2/2012 Dated 10.02.2012 is laudable, it still falls short of the expectations and leaves further smog on the subject.

In this article, first an attempt would be made to highlight the areas which still crave for an answer and then attempt would be made to understand the present circular.

Personal use

By and large and as also noted in the present Circular 151, there are two broad business models in the construction of residential complex.

++ The undivided share of land (UDS) or the UDS along with a semi finished structure would first be sold to the flat buyer, which is a transaction of sale of immovable property. Further, a construction agreement would be entered to construct the flat of specified description between the builder and purchaser.

++ An agreement to sell the flat will be entered into and the consideration would be received in instalments. After completion of construction, the flat would be sold and registered in the name of the purchaser.

It may be noted that the first case involves a provision of service by the builder to the purchaser, whereas the second case is purely a transaction of sale of immovable property. While the former would attract the levy of service tax, the later would not. This was also clarified vide CBEC Circular No. 108/2/2009 Dt. 29.01.2009, as below:

Generally, the initial agreement between the promoters/builders/developers and the ultimate owner is in the nature of ‘agreement to sell'. Such a case, as per the provisions of the Transfer of Property Act, does not by itself create any interest in or charge on such property. The property remains under the ownership of the seller (in the instant case, the promoters/builders/developers). It is only after the completion of the construction and full payment of the agreed sum that a sale deed is executed and only then the ownership of the property gets transferred to the ultimate owner. Therefore, any service provided by such seller in connection with the construction of residential complex till the execution of such sale deed would be in the nature of ‘self-service' and consequently would not attract service tax.

But it may also be noted that the first case also would not attract service tax as the purchaser is getting the flat constructed for his personal use, which is excluded from the ambit of the levy. This has also been clarified so in the said same circular, as below:

Further, if the ultimate owner enters into a contract for construction of a residential complex with a promoter/builder/developer, who himself provides service of design, planning and construction; and after such construction the ultimate owner receives such property for his personal use, then such activity would not be subjected to service tax, because this case would fall under the exclusion provided in the definition of ‘residential complex.

The term “personal use” is also defined in Section 65 (91a) as

For the removal of doubts, it is hereby declared that for the purposes of this clause, —

++ “personal use” includes permitting the complex for use as residence by another person on rent or without consideration.

Then what else is liable to service tax? This has also been clarified in the same circular as below:

However, in both these situations, if services of any person like contractor, designer or a similar service provider are received, then such a person would be liable to pay service tax.

Another situation, where the taxability can arise is the landowner entering into a joint development agreement with the builder, where certain portion of the constructed area, represented by certain number of flats are handed over to the landowner and where the landowner intends to sell the flats and not retain them for his “personal use”.

What emerges from the above is that the service provider by the builder to the ultimate buyer of the flat would not be taxable at all, as the ultimate buyer is constructing the said flat for his personal use.

If that be the position, the so called purpose of introducing the Explanation in the definition of these taxable services is without any reasoning. The reason is contained in the budget circular of 2010, which has also been taken note of by the Hon'ble Mumbai High Court, which upheld the validity of this Explanation. To quote from the circular,

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 installments 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 parrallely 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."

When services provided by the builder to the purchaser itself is outside the ambit of the levy on the ground of “personal use”, the purported reasoning of the introduction of the Explanation itself is flawed. Even after the introduction of Explanation, when a purchaser is entering into an agreement for sale and making periodical payments even before issue of completion certificate, though it is deemed as a taxable service, since it is for his personal use, it will not be taxable. Can the Explanation ignore the definition of “personal use” contained in the definition of “residential complex” and make sale of immovable property transactions as a deemed service, when the stated reason for such deeming fiction is non existent. If the intention is to tax the service provided by the builder to the purchaser, the exclusion for “personal use” should be removed.

In other words, prior to introduction of the Explanation, there was no lack of equity at all, as both the two types of transactions (referred to as (i) and (ii) above) were not taxable, i.e case (i) on the ground of personal use and case (ii) on the ground of self service. But, while introducing the Explanation it has been presumed that case (i) is taxable and only case (ii) was not. If the Explanation has the effect of nullifying the exclusion for personal use, then case (ii) now becomes taxable and case (i) remains outside the levy on the ground of personal use, still creating inequality.

Or is it the intention to allow the benefit of “personal use” only to the cases where a “residential complex” (having more than 12 residential units) itself is constructed by a person for his personal use (example – a company constructing a staff quarters) and not to the cases where an individual is constructing a residential unit for his personal use? If so, is it just and fair? Is it not contrary to Section 65 (30a), according to which construction of complex also includes construction of a part thereof?

Joint Ventures

It is a common practice that a landowner and builder would enter into a joint venture and share the constructed area in agreed proportion. The UDS portion of land pertaining to the builder's portion would be sold and the amount would be appropriated by the builder. Further, the builder would also receive construction cost from the buyers. The builder would also construct landowner's share of constructed area and hand over the same to the landowner. As the landowner would not normally use his constructed area for his personal use, the service provided by the builder to the landowner is a taxable service. But no monetary consideration is flowing from the landowner to the builder, but the builder is given the right to sell his share of the UDS portion of land and retain the proceeds.

But, in many cases, the landowner asks the builder to sell his portion of constructed area also. Accordingly, the UDS land pertaining to landowner's share would also be sold by the builder, acting as a power of attorney of the landowner and a separate construction agreement would be entered into with the buyer. But the entire proceeds would be remitted by the builder to the landowner. In such circumstances, it is not clear whether the builder is providing service to the landowner (in which case, the service tax liability would arise) or to the purchaser (in which case, there would be no liability on the ground of personal use) or to both?

Works Contract Service

Commercial or industrial construction service and construction of residential complex service were introduced with effect from 10.09.2004 and 16.06.2005 respectively. Subsequently works contracts was introduced as a separate taxable service from 01.06.2007, which also covered construction of complex and commercial or industrial construction activities. There is a view, though debatable, that prior to 01.06.2007, only pure service activities would be taxable and only from 01.06.2007, composite activities involving supply of goods and services, normally recognized as works contracts would become taxable. But, once works contracts is introduced as a separate taxable service, the construction activities undertaken by builders / contractors, which involves both supply and use of various materials like cement, steel, etc. as well as labour involved in construction would get classified only under works contract service. The existing taxable services of commercial or industrial construction {Section 65 (105) (zzq)} and construction of complex service {Section 65 (105) (zzzh)} would not cover activities in the nature of works contracts. This has also been conceded by the CBEC in its circular No. 128/10/2010 Dated 24.08.2010, in the following words.

As regards the classification, with effect from 1-6-2007 when the new service ‘Works Contract service' was made effective, classification of aforesaid services would undergo a change in case of long term contracts even though part of the service was classified under the respective taxable service prior to 1-6-2007. This is because ‘works contract' describes the nature of the activity more specifically and, therefore, as per the provisions of Section 65A of the Finance Act, 1994, it would be the appropriate classification for the part of the service provided after that date.

Hence the existing services of construction of complex service and commercial or industrial construction service have only limited application now. It would cover the cases which are pure services, where the client / customer procures and supplies all materials. If that be the case, what is the relevance of various abatements prescribed for the service?

If that be so, what is the relevance of Explanation introduced under construction of complex service and commercial or industrial construction service, when no such Explanation was introduced under Works Contract Service?

The case where only an agreement to sell is entered into and the flat is later sold and registered, would not fall under works contract service, as there is no transfer of property in this case but only transfer of immovable property. This transaction may fall under the construction of complex service. But again the issue of “personal use” rears its head.

Now, let us look in to the clarifications issued vide Circular No. 151/2/2012 Dt. 10.02.2012.

Before parting...