By TIOL News Service

NEW DELHI, JUNE 07, 2016: THE Petitioners are buyers of flats from builders and paid Service Tax. They filed Petitions challenging the levy of Service Tax collected by the builder. According to the Petitioners, the agreements entered into by them with the builder are for purchase of immovable property and the Parliament does not have the legislative competence to levy service tax on such transaction. The Petitioners further claim that the Act and the rules made thereunder do not provide any machinery for computation of value of services, if any, involved in construction of a complex and, therefore, no such tax can be imposed.

The Petitioners contended that the entries relating to taxation in List I and List II of the Seventh Schedule to the Constitution of India were mutually exclusive and the Parliament did not have the power to levy tax on immovable property; thus, the levy of service tax on agreements for purchase of flats was beyond the legislative competence of the Parliament.

The Petitioners also contended that there was no service element in preferential location charges which were levied by a builder and the same related only to the location of the immovable property and, therefore, such charges were not exigible to service tax.

Before proceeding with the rival contentions, the High Court made an important observation that “the Respondents are not seeking to levy tax for taxable service under Section 65(105)(zzzza) of the Act (which was introduced by virtue of the Finance Act, 2007) as according to them builders engaged in constructing complexes and selling units are liable to pay service tax on the transaction with the purchaser only with effect from 1st July, 2010 by virtue of the impugned explanation to Section 65(105)(zzzh) of the Act. In the present petitions, it is not the case of the Respondents that builders/promoters/developers who develop residential complexes - such as the group housing project developed by the builder in this case - and sell dwelling units in the complexes to prospective users render taxable service under Section 65(105)(zzzza) of the Act, that is, services in relation to a works contract”.

In the light of above observation, it is to be noted that the present issue is limited to levy of Service Tax under Sec 65(105)(zzzh), but not under Sec 65(105)(zzzza) as works contract.

After hearing both sides, the High Court held:

No Service in case of flats sold to prospective buyers, but for the explanation inserted in Sec 65(zzzh)

It is a usual practice for builders/developers to sell their project at its launch. Builders accept bookings from prospective buyers and in many cases provide multiple options for making payment for the purchase of the constructed unit. In some cases, prospective buyers make the payment upfront while in other cases, the buyers may opt for construction linked payment plans, where the agreed consideration is paid in instalments linked to the builder achieving certain specified milestones. Whilst it may be correct to state that the title to the unit (the immovable property) does not pass to the prospective buyer at the stage of booking, it can hardly be disputed that the buyer acquires an economic stake in the project and in one sense, the services subsumed in construction - services in relation to a construction the complex - are rendered for the benefit of the buyer. However, but for the legal fiction introduced by the impugned explanation, such value add would be outside the scope of services because sensustricto no services, as commonly understood, are rendered in a contract to sell immovable property.

The explanation creates a legal fiction which is permissible – It is not levy on immovable property – No impingement of legislative field reserved for the States.

The use of a legal fiction is a well known legislative device to assume a state of facts (or a position in law) for the limited purpose for which the legal fiction enacted, that does not exist. The Parliament is fully competent to enact such legal fiction. In the present case the Parliament has done precisely that; it has enacted a legal fiction, where a set of activities carried on by a builder for himself are deemed to be that on behalf of the buyer. The imposition of service tax by virtue of the impugned explanation is not a levy on immovable property as contended on behalf of the Petitioner. The clear object of imposing the levy of service tax in relation to a construction of a complex is essentially to tax the aspect of services involved in construction of a complex the benefit of which is available to a prospective buyer who enters into an arrangement - whether by way of an agreement of sale or otherwise - for acquiring a unit in a project prior to its completion/development. There is no merit in the contention that the imposition of service tax in relation to a transaction between a developer of a complex and a prospective buyer impinges on the legislative field reserved for the States under Entry-49 of List-II of the Seventh Schedule to the Constitution of India.

Measure of Tax – Levy would fail if it does not provide for a mechanism to ascertain the value.

While the legislative competence of the Parliament to tax the element of service involved cannot be disputed but the levy itself would fail, if it does not provide for a mechanism to ascertain the value of the services component which is the subject of the levy. Clearly service tax cannot be levied on the value of undivided share of land acquired by a buyer of a dwelling unit or on the value of goods which are incorporated in the project by a developer. Levying a tax on the constituent goods or the land would clearly intrude into the legislative field reserved for the States under List II of the Seventh Schedule of the Constitution of India. In the present case, there is no machinery provision for ascertaining the service element involved in the composite contract. In order to sustain the levy of service tax on services, it is essential that the machinery provisions provide for a mechanism for ascertaining the measure of tax, that is, the value of services which are charged to service tax.

Service Tax (Determination of Value) Rules 2006 do not have provisions to deal with contracts which include land value:

For the purposes of ascertaining the value of services, the Central Government has made Service Tax (Determination of Value) Rules 2006 (hereafter 'the Rules'). However none of the rules provides for any machinery for ascertaining the value of services involved in relation to construction of a complex.Whilst Rule 2A of the Rules provides for mechanism to ascertain the value of services in a composite works contract involving services and goods, the said Rule does not cater to determination of value of services in case of a composite contract which also involves sale of land. The gross consideration charged by a builder/promoter of a project from a buyer would not only include an element of goods and services but also the value of undivided share of land which would be acquired by the buyer.

No machinery for excluding the non-service components:

Whilst the impugned explanation expands the scope of Section 65(105)(zzzh) of the Act, it does not provide any machinery for excluding the non-service components from the taxable services covered therein. The Rules also do not contain any provisions relating to determination of the value of services involved in the service covered under Section 65(105)(zzzh) of the Act. Thus the said clause cannot cover composite contracts such as the one entered into by the Petitioners with the builder. In absence of machinery provisions to exclude non-service elements from a composite contract, the levy on services referred to in Section 65(105)(zzzh) could only be imposed on contracts of service simplicitor - that is, contracts where the builder has agreed to perform the services of constructing a complex for the buyer - and would not take within its ambit composite works contract which also entail transfer of property in goods as well as immovable property.

Abatement Notifications cannot substitute Act or Rules:

In the present case, neither the Act nor the Rules framed therein provide for a machinery provision for excluding all components other than service components for ascertaining the measure of service tax. The abatement to the extent of 75% by a notification or a circular cannot substitute the lack of statutory machinery provisions to ascertain the value of services involved in a composite contract.

Validity of levy on preferential location under (zzzzu) upheld, but no Service tax as the contracts are composite:

Insofar as the challenge to the levy of service tax on taxable services as defined under Section 65(105)(zzzzu) is concerned, there is no merit in the contention that there is no element of service involved in the preferential location charges levied by a builder. They are in one sense a measure of additional value that a customer derives from acquiring a particular unit. Such charges may be attributable to the preferences of a customer in relation to the directions in which a flat is constructed; the floor on which it is located; the views from the unit; accessibility to other facilities provide in the complex etc. However, we accept the Petitioners contention that no service tax under section 66 of the Act read with Section 65(105)(zzzh) of the Act could be charged in respect of composite contracts such as the ones entered into by the Petitioners with the builder. The impugned explanation to the extent that it seeks to include composite contracts for purchase of units in a complex within the scope of taxable service is set aside.

Service Tax to be refunded with interest at 6%:

The concerned officer of Respondent No. 1 shall examine whether the builder has collected any amount as service tax from the Petitioners for taxable service as defined in Section 65(105)(zzzh) of the Act and has deposited the same with the respondent authorities. Any such amount deposited shall be refunded to the Petitioners with interest at the rate of 6% from the date of deposit till the date of refund.

(See 2016-TIOL-1077-HC-DEL-ST)