CONSTRUCTION INDUSTRY AND PROPOSAL IN UNION BUDGET 2010

Vikas Khare, Practising Company Secretary, Partner KANJ & ASSOCIATES;

SERVICE

TAX

Chairman, Indirect Tax Sub Committee, Mahratta Chamber of Commerce, Industries, and Agriculture.

When a common man, who is renamed as AAM ADAMI by our politicians, is badly hit by inflation and more particularly by unaffordable prices of food grains, pulses, vegetables, Honorable Finance Minister , Shri Pranab Mukharjee came in an aircraft named Budget-2010 and thrown few goodies on Aam Adami. Along with that the minister also threw Petro Bombs. That act culminated into strong reactions across in India. At that time, whether anyone knew that FM had sent Drones in form of Fine Prints in the Finance Bill 2010 and Notification to attack the Aam Adami directly or indirectly? The fact is Drones have attacked the Aam Adami and the damages, immediate and the future with respect to construction industry, are summarized below: The Finance Minister has proposed significant changes in taxation of Construction Industry by way of Service Tax in the Union Budget for the year 2010-11. 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. The proposed changes are introduced in the Finance Bill 2010 and accordingly amendments are proposed in the definition of taxable services in sub-clause (zzq) of Clause 105 of Section 65 of the Finance Act, 1994 . Sub clauses (zzq) and (zzzh) are respectively for commercial or industrial construction and for construction of (residential) complex service. Both the amendments are on the same footings and the following explanations are proposed to be inserted in the charging section. Explanation.For the purposes of this sub-clause, the construction of a new building /complex which is intended for sale, wholly or partly, by a builder or any person authorized by the builder before, during or after construction (except in cases for which no sum is received from or on behalf of the prospective buyer by the builder or the person authorized by the builder before grant of completion certificate by the authority competent to issue such certificate under any law for the time being in force) shall be deemed to be service provided by the builder to the buyer;;

It is also proposed to add new service with respect to a residential complex, or a commercial building by inserting new sub clause (zzzzu)to cover the service provided to a buyer, by a builder of a residential complex, or a commercial building, or any other person authorized by such builder, for providing preferential location or development of such complex but does not include services covered under subclauses (zzg), (zzq), (zzzh) and in relation to parking place. The proposed clause has the following explanation: Explanation.For the purposes of this sub-clause, preferential location means any location having extra advantage which attracts extra payment over and above the basic sale price; The purpose of the amendments is to bring the Promoters and Builders under service tax net who remained outside the service tax net despite of lots of futile efforts by the Service Tax Department . It is worth mentioning, briefly, chronicled of the legal tussle between the Service Tax Department and promoters and builders. 1. Is service tax applicable on Builder, Promoter or Developer who builds a residential complex with the services of his own staff and employing direct labour or petty labour contractors whose total bill does not increase 4.0 lacs in one Financial Year was on the fire right from the introduction of these services.. The answer given by the Department vide Circular F. No. 332/35/2006-TRU, dated 1-8-2006 was that the contractor shall be liable to pay service tax on the gross amount charged for the construction services provided, to the builder/ promoter/developer under construction of complex .If no other person is engaged for construction work and the builder/promoter/developer undertakes construction work on his own without engaging the services of any other person, then in such cases in the absence of service provider and service recipient relationship, the question of providing taxable service to any person by any other person does not arise. Service tax exemption for small service providers up to an aggregate value of taxable services of Rs. 4 lakh provided in any financial year vide Notification No. 6/2005-Service Tax, dated 1-3-2005 is applicable for construction of complex service also. Commercial complex does not fall within the scope of residential complex intended for personal use. Hence, service provided for

construction of commercial complex is leviable to service tax. 2. On the issue on applicability of service tax on real estate developers/ builders it was Clarified vide F. No. B1/6/ 2005-TRU, dated 27-7-2005, that residential complex constructed by an individual, intended for personal use as residence and constructed by directly availing services of a construction service provider, is not liable to service tax. As per Section 68 of the said Act, in case of construction of complex service falling under Section 65(105)(zzzh) and commercial or industrial construction service falling under Section 65(105)(zzq) of the said Act, every person providing taxable service to any person shall be liable to pay service tax. 3. Letter F.No. V/DGST/22/Audit/Misc/1/2004, dated 16-2-2006 The Board vide Circular No. 80/10/2004-S.T., dated 2. 17-9-2004 [2004 (172) E.L.T.

T3] has clarified that Estate Builders (i.e. who gets such construction done) are not covered under the ambit of these services. It is only the hired contractors engaged by these builders who are to be taxed. In a decision of Supreme Court in case of 4. M/s. Raheja Development Corporation v. State of Karnataka [2005 NTC (Vol. 27)-243 the Honble Court has clarified that the activities undertaken by builders for construction of flat/building for or on behalf of the prospective customers for consideration in cash or deferred payment is covered under the works contract and not under sale. 4. The Department come out openly and commented that divergent practices are being reported by field formations and in most of the cases, builders are avoiding

registration in view of CBEC Circular No. 80/10/2004-S.T., dated 17-9-2004. Further, there is wide gap between the amount charged by builders from their customers for such work contract (sale) and the amount on which contractors are discharging their Service tax liability. The various miscellaneous charges like cost of the land, development charges, maintenance charges, etc. are not included in the taxable

value of services provided by the assessee. 5. It is further clarified that the Circular No. 80/10/2004-S.T., dated 17-9-2004, has no applicability with reference to Construction of Complex Services which was brought under service tax net only w.e.f. 16-6-2005, as an independent service. The definition of taxable service under section 62(zzh) includes Any service provided or to be provided to any person by any person in relation to construction of complex, and is wide enough to include estate builders. In such cases, the tax liability is posed on both builders and hired contractors being independent service providers. in the construction business, different practices and financial arrangements concerning (a) promoters, developers & builders, (b) land owners (c) contractors and (d) buyers exist. These practices influence the taxable value under the construction of complex services. In all such situations, the taxable value under section 67 shall be the gross amount charged by the service provider (builder in this case) for such services provided or to be provided by him. This read with Notification No. 18/2005-S.T., dated 7-6-2005 entitles a builder/contractor an abetment of 67% on the gross amount charged, which shall include the value of goods and material supplied. Further, there is no deductions/exemptions provided for computation of such taxable value in the composite contract. 6. The Service Tax Department got real strength from the order of the Advance Ruling authority in the matter of Construction of Residential Complex service . The question before the Advance Ruling Authority was whether booking and construction of residential units with own labour is taxable as Construction of Residential Complex service in view of words construction of complex qualified by in relation to

widening the scope. It is ruled that point of time at which ownership gets transferred or control over supervision do not determines liability. Activities performed as per agreement terms for which consideration in installments received from customers. Construction and allied services referable to agreement with prospective buyer and not to be viewed in isolation. Facilities and amenities cannot be dissociated from construction and incidental activities also taxable. Construction of Residential Complex

service being more specific, impugned construction is classifiable under such service and not under Works Contract service - Sections 65(30a), 65(105)(zzzh), 65(105)(zzzza) and 96D of Finance Act, 1994. While ruling on the issue whether construction of residential units engaging contractors is taxable the Authority held that applicant is accountable to buyer and remains service provider vis-a-vis the buyer for construction by engaging own labour or by sub-contracting. Impugned activity not one of self-service as service recipient is buyer of flat as per agreement. Engagement of sub-contractor do not absolve applicant of the responsibility of providing services in relation to construction of residential unit agreed to be sold to customer ultimately. 7. Then the circular of the DGST was superseded by a consolidated Circular No. 96/7/2007-S.T., dated 23-8-2007 wherein it has been clarified vide clause No. 079.01(b) as follows : If no other person is engaged for construction work and the

builder/promoter/developer/any such person undertakes construction work on his own without engaging the services of any other person, then in such cases, (i) service provider and service recipient relationships does not exist, (ii) services provided are in the nature of self-supply of services. Hence, in the absence of service provider and service recipient relationship and the services provided are in the nature of self-supply of services, the question of providing taxable service to any person by any other person does not arise. 8. In GREENVIEW LAND & BUILDCON LIMITED Versus COMMR. OF C. EX., CHANDIGARH2008 (11) S.T.R. 113 (Tri. - Del.) it was held that Assessee not engaging any contractor or service provider in relation to construction of complex and entire work carried out by themselves as developer and builder and ready built flats sold. Demand confirmed by original authority on basis of DGST Circular dated 16-2-2006 C.B.E. & C. Circular No. 96/7/2007-S.T., dated 23-8-2007 superseding previous circular as submitted clarified that no taxable service provided in absence of service provider

and service recipient relationship. The Latter circular prima facie in favour of assessee and applicable retrospectively as is by way of clarification of law. The said Circular not available when matter decided by lower authorities. The Matter remanded to be decided in the light of circular ibid - Section 65 (30a) of Finance Act, 1994. 9. In MAHAKAUSHAL BUILDERS WELFARE ASSOCIATION Versus SUPDT. OF CUS. & C. EX., JABALPUR Circular dated 16-2-2006 issued by Director General of Directorate of Service Tax, Mumbai not creates liability for payment of service tax if assessee not liable to pay tax under law relating to service tax -. 10. Further the Supreme Court observed on correctness of proposition laid down by its division bench regarding works contract ratio decidendi that If the ratio of Raheja Development Corporation v. State of Karnataka [2005 (5) SCC 162] is to be accepted then there would be no difference between works contract and a contract for sale of chattel as a chattel hence, the judgment of Division Bench in the case of Raheja Development (supra) needs re-consideration by the Larger Bench. 11. In Magus Construction Pvt Ltd Versus Union Of India the High Court of Gauhati observed that It may be pointed out, at the very outset, that tax on services is an "indirect tax" and is a relatively new concept in India. As a matter of fact, Government of India had introduced the levy of "service tax", i.e., tax on the services, for the first time, in the year 1994, borrowing the concept from developed countries. The basic purpose of this levy has been to increase revenue, treating the act(s) of rendering service, as an additional source of revenue. Depending upon its own socio-economic compulsions, each country evolves its system of taxation adapting either a "comprehensive approach" or "selective approach". Under the concept of "comprehensive approach", all services are taxable unless any of the services is specifically excluded ; whereas under the system of "selective approach", only specified services are taxable and it is the system of "selective approach ", which India has adopted. This distinction needs to be kept in mind, when we proceed further Further, in K. Raheja Development Corporation [2005] 5 SCC 162 the apex court was considering the issue relating to "sales tax" and the issue therein was not at all related

to "service tax". While interpreting the provisions of "sales tax" under the Karnataka Sales Tax Act, 1957, the apex court held, in K. Raheja Development Corporation [2005] 5 SCC 162 , that the definition of "works contract", given under the Finance Act, 1994, is very wide and is not restricted to the "works contract" as commonly understood, i.e., a contract to do some work on behalf of someone else. 38. The quoted portions of the abovementioned circular make it very clear that the activities of the petitioner-company do not fall within the purview of "taxable service" so as to attract levy of "service tax". In Commissioner of Income-tax v. Aspinwall and Co. Ltd. [1993] 204 ITR 225, the Kerala High Court has held that a circular of the Central Board of Direct Taxes has the force of law and can even supplant the law in the cases, where it is beneficial to the assessee and has mitigated or relaxed the rigour of the law, In the light of what has been laid down in the catena of decisions referred to above, it becomes clear that the circular, dated August 1, 2006, aforementioned, is binding on the department and this circular makes it more than abundantly clear that when a builder, promoter or developer undertakes construction activity for its own self, then, in such cases, in the absence of relationship of "service provider" and "service recipient", the question of providing "taxable service" to any person by any other person does not arise at all. In the result and for the reasons discussed above, this writ petition succeeds and the impugned notice is hereby set aside and quashed P & B Community wants certainty about applicability of Service Tax. 12. On the backdrop of the above the Finance Minister has tacitly introduced the above changes as these were not part of the Budget speech. On the proposed amendments the Board has clarified in para 8 as under vide letter D.O.F. No.334/1/2010TRU New Delhi, dated26th February2001: Service tax on construction services: 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 instalments 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.

13. Whether Builder will be entitle for 67% Abatement The present abatement notification no 1/2006 1-3-2006 will not as it is will be applicable to the proposed service tax on builder. Further, the CENVAT credit of duty on inputs or capital goods or the CENVAT credit of service tax on input services, used for providing such taxable service is not available if the abetment is claimed. Similarly, exemption under notification No. 12/2003Service Tax, dated the 20th June, 2003 is not available if the abetment is claimed. Legality of the Levy 14. It is well settled principle in GANNON DUNKERLEY & CO. LTDs case ( when the levy of Works Contract Tax was imposed under the power to levy tax on sales) that the Government cannot give artificial meaning to the entries appearing in the Seventh Schedule and assume powers to levy of taxes. In the whole issue the Government has conveniently ignored a basic issue, whether promoter and builders are service providers or property dealers. It can be seen from the circulars referred earlier that Government has been going back and forth in giving clear answer to the issue. If the fact is accepted that they are property dealers then how they become service provider at the same time. Just by calling a property dealer as a service provider, whether he becomes a service provider? Whether he becomes service provider because he gets the consideration in installments? Probably government wants its share in pie. The Government has every right to do so but it shall do it in more graceful and legal manner. If a builder is owner of a land and if he enters into contract for sale of future property which he is going to construct whether it will become service just because the buyer has agreed to pay the consideration in installments? It is also worth to note that the Supreme Court Bench comprising Honble Mr. Justice S.N.

Variava and Honble Mr. Justice A.K. Mathur on 2-8-2004 dismissed the Petition for Special Leave to Appeal (Civil) No. 24294 of 2003 filed by Commissioner of Central Excise, Vadodara against the CESTAT Order No. ST/7/2003-NB(A), dated 4/5-6-2003 and reported in 2006 (3) S.T.R. 124 (Tri. - Del.) (Daelim Industrial Co. Ltd. v. Commissioner). The Appellate Tribunal in its impugned order had held that works contract is not liable to Service tax under consulting engineer services as the contract cannot be vivisected and part of it (design and detailed engineering, commissioning of the plant) subjected to Service tax.The Tribunal after going through the clauses of the contract, had held the contract to be a work contract on turnkey basis and not a consultancy contract to be liable to Service tax under consulting engineer services. [Commissioner v. Daelim Industrial Co. Ltd. 2007 (5) S.T.R. J99 (S.C.)]. Though it is not said in so many words, the ratio of the Judgment is while executing a turnkey project what is subject matter of a contract in resultant property and any service going into building of a property is self service (input service). Such input services may be purchased from outside contractors or may be by way of captive production engaging self work force. Self Service is no service liable to service tax as the provider and the recipient is the same person. What is ultimately sold in the contract is resultant property and not the bundle consisting of goods and input services. It is also to be noted that the Contract executed by a buyer is for the resultant property and not for the input services of the supplier of the property. The new levy will also amount to a tax on land and would therefore fall outside the legislative competence of Parliament inasmuch as the said subject is covered under Entry 49 of List II of the Constitution of India and would fall within the exclusive domain of the state legislature. As such, the proposed explanations seem to be apparently un-constitutional. Thus, after this amendment the litigations between the Government and the Promoters and builders are expected. 15. The new Service with respect to Construction It is also proposed to add new service with respect to a residential complex, or a commercial building by inserting new sub clause (zzzzu)to cover the service provided to a buyer, by a builder of a residential complex, or a commercial building, or any other person authorized by

such builder, for providing preferential location or development of such complex but does not include services covered under sub-clauses (zzg), (zzq), (zzzh) and in relation to parking place. The proposed clause has the following explanation: Explanation.For the purposes of this sub-clause, preferential location means any location having extra advantage which attracts extra payment over and above the basic sale price; In my opinion, this can be called as service by any stretch of imagination. It is very common in construction industry that some of the locations in the complex have more intrinsic value and some locations have disadvantageous factors associated with it. For example, a particular flats has view of panoramic valley and back side flats has a view of cemetery. The builder will sell the flats facing valley at premium and facing cemetery at discount. Where is the question of Service? Builder may charge for podium garden extra to a buyer, is it a service? For the reasons stated earlier the proposed levy also seems to be illegal as what is being sold is property and it is not a subject matter of service.

16. Is it to Prepare for GST? Other reason for coverage of Promoters and Builders could be to prepare for the flawless Goods and Service Tax which is round the corner. It is expected that under the GST the Promoters and Builders would be given full Cenvat Credit of input credit of input services and may be capital goods deployed in providing output services. If that is the reason then why Government should indulge into an arm twisting tactics to collect the Service Tax from builders. It is to be appreciated that there will be statutory authority under GST to tax builders. That authority is not presently available to the Government under present set of laws.

17. What will happen to the construction of a new building /complex getting Completion Certificates after the Finance Act, 2010 is given an assent by the President of India and

Notified? Whether Service Tax will be attracted? In my opinion service tax will be attracted on the whole amount paid by the buyer to the Promoter unless Government issues notification to that effect. Thus, the Government is required to give enough clarity to ensure that unknown and unforeseen liability should not hover and then fall on them or their buyers. The Government may consider giving an exemption from service tax for installments already paid and realized by the Promoters and Builders through banking channel before the enactment of the Finance Act, 2010. The impact of service tax under different situations is shown in annexure A.

Role of the Government The Government shall not enforce this levy as it is not going to stand on legal grounds . Legal disputes in indirect taxes are not good for the assessee, as, any such dispute affects him and/or the end consumer and the industry as a whole. Probably Government has taken a chance with thought in mind that an assessee can win legal battle but not war of legal disputes as Government holds atomic weapon of retrospective amendments. Now time has come to show that Assessees can also win legal wars. Any assessee will not mind any indirect tax when it is legal and enforced with clarity. It is time that the Government plays its role in the interest of Construction Industry and the Consumers of Construction Industry which includes Aam Adami.

Annexure A THE EFFECT OF NOTIFICATION ON THE DIFFERENT EVENTUALITIES The new Explanation provides that: For the purposes of this sub-clause,

It shall be the construction of a new building or the construction of a complex which is intended for sale, wholly or partly, by a builder or any person authorized by the builder before, during or after construction shall be deemed to be service provided by the builder to the buyer

The construction of a new building or a complex will not be treated as service when no sum is received from or on behalf of the prospective buyer by the builder or the person authorized by the builder before grant of completion certificate by the authority competent to issue such certificate under any law for the time being in force). The effect of the explanation with respect to following situations will be as under

Situation

Issues

Taxability/ Comments

Project is in construction stage in the month of march 2010 and expected to be completed by December 2010. 60% of the consideration is received by the builder.

In this case completion certificate will be received after the enactment of Finance Act, 2010. At that time, assume 75% of the consideration would be received by a builder.

As per the proposed amendment if no sum is received from the prospective buyer by the builder before grant of completion certificate. Hence it would be a taxable Service. Builder will have to pay service tax. As per section 67 (3) The gross

What will be the amount on which service tax would be payable?

On 40% (after deducting paid sum)

amount charged for the taxable service shall include any amount received

On 25% (after deducting paid sum)

towards the taxable service before, during or after provision of such service. Therefore, Service Tax Department may insist for tax on 100% of amount (already paid and to be paid).

Or any other percentage.

Construction is completed to 100% on 1 February 2010. 100% of the consideration is received by the builder form all buyers on 25 February 2010. Application for completion certificate made on 1st March 2010. Completion Certificate received on 1st June 2010. Service Notified as taxable service on 16 May 2010.
th st

Construction is completed even before the Budget proposal. Consideration is also received in full. Only technical formality of Completion is pending. However, Completion Certificate received after the Service Notified as taxable service on 16 May 2010.

As all the sum is received from or on behalf of the prospective buyer by the builder before grant of completion, it would be a taxable Service builder will have to pay service tax. As per section 67 (3) The gross amount charged for the taxable service shall include any amount received towards the taxable service before, during or after provision of such service.

Therefore, 100% of amount (already paid and to be paid) would be taxable

Construction is completed to 100% on 1 February 2006. 75% of the amount is paid by one of the buyer. Completion certificate received on 1st March 2007. However due to dispute with him in a court of law the possession was not given. On 1st June 2010. Dispute is resolved and buyer made balance payment of 25% and builder handed over possession. Service Notified as taxable service on 16 May 2010
st

Construction is completed long back. Consideration to the extent of 75% is also received. 25% of the amount is not paid by the buyer due to legal dispute. Now dispute is settled and balance amount is paid when the service is taxable.

As per the proposed amendment if no sum is received from prospective buyer by the builder before grant of completion certificate then it would not be a taxable service. As 75% amount was received before the completion certificate and 25% received when the service got notified. Hence it would be a taxable Service builder will have to pay service tax. As per section 67 (3) The gross amount charged for the taxable service shall include any amount received towards the taxable service before, during or after provision of such service.

In short if any sum is received prior to completion certificate it will be a taxable service from the notified date and considering the attitude of Service Tax Department, service tax would be asked on 100% amount in view of Section 67. The above situations have been assumed and answers are given from the Departments perspective. There could many unforeseen complex situations in reality. The new levy is going to create more disputes if it is enforced in the same format as proposed.