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05 Jun 2014

Challenges for real Estate sector – Post L&T judgment

By: G. Mahadevan
 GST, Taxation   Add a comment

The Supreme Court has ruled against L&T and in favor of the revenue on the subject of competence of the States to levy VAT on contracts for sale of immovable property. Many post ruling analyses have suggested that the Apex Court ruling may impact real estate developers.

In this context, this piece tries to address two questions that are interesting:

(i) Is it a major change in the concept and the tax scheme of the construction contracts executed by the realty sector?

(ii) Is the ruling going to complicate the mechanism of tax incidence on construction contracts?

Be it service tax or VAT, works contracts have always been a challenge and a cause of litigation, primarily from a valuation perspective. Section 67 of the Finance Act 1994 (as amended from time to time and read with the related rules on valuation of taxable services), provides that value of the service portion in the execution of the works shall be equivalent to the gross amount charged for the works contract less the value of the property in goods transferred in the execution of the works contract. In cases where the value has not been determined as above, service tax shall be payable on forty percent of the total amount charged for the works contract in the case of original works; in the case of other works contract including maintenance, finishing, repair, completion etc service tax shall be payable on sixty percent of the total value of the contract. In the case of maintenance or reconditioning or repair or servicing of goods, service tax shall be payable on seventy percent of the value of the contract.

An important question is whether the recent ruling of the Apex Court on the L&T matter conflicts with the provisions of the service tax. What then is the value on which the quantum of VAT levy depends? According to the judgment, the value of the goods which can constitute the measure for levy of tax has to be value of goods at the time of incorporation of goods in works, even though property passes between developer and flat purchaser after incorporation of said goods. This leads one to a situation for the determination of the proportionate levy of VAT after the agreement to sell is entered. If a project has been completed partially, it is the value addition after the agreement is entered into that becomes liable to VAT levy.

Here are some questions for the real estate sector to consider:

Is it easy to determine the value of the contract that has been completed before the agreement is executed and more particularly in the case of multi-flat projects with different phases of construction?

The onus of proper determination lies with the tax payer despite the clarity provided by VAT circulars.

The next question is on the values already determined and reported to VAT authorities through the periodical returns either under regular scheme or COT scheme. What is the adjustment needed to be done by the tax payer or the VAT department wherever taxes have been paid in excess or VAT input credit has been availed in excess?

On the subject of service tax, the question that may be faced by the real estate sector is whether service tax would be levied on the construction service or on the works contract with retrospective effect. Since the present judgment treats these contracts as works contracts under VAT, they may be treated as works contract under service tax also.

In cases where construction is complete but OC has not been issued, the applicability of service tax is quite clear as a consideration might have been received. But the issue of VAT needs to be made clear though it is interpreted that no VAT would apply.

In the case of joint development agreements between developer and the land owner, it may be interesting to see as to how the service tax levy would be attracted based on the provision that non-monetary consideration would attract service tax, if this judgment is applied.

To specifically answer the two questions raised at the beginning of this write-up:

(i) Yes, it is a major change because the concept of Works Contract has been clearly interpreted by the Apex Court failing the dominant intention test and other contentions advanced.

(ii) It may make the determination of service tax levy even more cumbersome though VAT levy issue has been addressed through two agreements and action already has been taken.

This analysis assumes significance in the wake of any possible representation by the Real Estate Sector during the Pre-Budget discussion with the new government in order to redress their grievances.

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