Recent Development in Service Tax and VAT in Real Estate
By Kantilal Jain, FCA
In the budget for 2010 both Central and State Governments have made certain amendments to levy tax on sale of immovable property under construction to enhance their revenue and to overcome certain judicial pronouncements. An attempt is made to discuss the implications of the above amendments on the real estate transactions as to how the general public will be affected by way of additional cost on account of the above mentioned amendments.
By the Finance Act, 2010 the Government has amended the definition of Commercial or Industrial Construction Service [Section 65 (25b) read with Section 65 (105) (zzq)] and construction of Residential Complex [Section 65 (30a) read with Section 65 (zzzh)].
The scope of these categories is expanded to cover sale of flats/units under construction. Builders/developers are now liable to service tax if any payment towards sale consideration is received before the grant of completion certificate by the competent authorities for such flats/units. This amendment overrides the Gauhati High Court’s decision in the case of Magus Construction Private Limited v/s UOI [2008 11 STR 225].
Therefore, if a builder/developer receives the entire sale consideration for flats/units after issue of completion certificate, the same is not liable to service tax.
There is an abetement of 75% of the sale value. Thus, the tax will be levied on 25% of the sale value of flat at the rate of 10.3%. For example if the agreement value of a flat sold under construction is Rs. 50,00,000/- then service tax @ 10.3% is payable on Rs. 12,50,000/- which works out to 1,28,750/-. Thus, there will be an additional burden of 2.6% on the agreement value of flat. The amendment will be effective from the date to be notified by the Central Government.
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The Maharashtra Government in the state budget has also introduced a new composition scheme on sale of under construction property along with land or interest in land @ 1% of the agreement value. The scheme is effective from 1st April, 2010 but the notification in respect of the same about the manner in which the tax is to collected by the builder/developer has not yet come. There is no set off for inputs.
It may be noted that already a composition scheme @ 5% is in operation which is effective from 20th June, 2006 i.e. the date on which the transfer of property under construction was brought within the ambit of VAT.
It may further be noted that the levy of tax on property under construction itself is challenged by Maharashtra Chamber of Housing Industry (MCHI) an association of builders by a writ petition in Bombay High Court (being Tax writ petition No. 2022 of 2007). The major issue involved in the writ petition is the competency of the State Legislature to enact the definition of Works Contract in the manner which suggests its applicability to the builders/ developers, in addition to the contractors. The definition talks about transfer of property in goods in the execution of works contract including the building, construction, ……. . The Government is competent to levy tax on construction (sale of goods involved in construction). Article 366 read with Article 246 (2) of the Constitution has authorised it to do so. But power to levy tax on building; i.e. Sale of flats is unimaginable. It appears that prima facie the Hon’ble High Court is convinced about this position and ordered for an interim relief for the members of the Association. The Hon’ble High Court has directed that the members of the MCHI should not be treated as ‘dealers’ liable to tax under the MVAT Act, 2002 in respect of sale of flats on ownership basis under the Maharashtra Ownership Flats Act, 1963 (MOFA Act), provided such members of MCHI submit the data and documents as mentioned in the Court Order. Thus, such members of MCHI have been absolved from registration and also from assessments till the disposal of the petition. However, the developers who are not members of the Association are not protected by the Court Order.
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It seems that to divert the attention of the public from the court matter, the Government has introduced new composition scheme @ 1% on the agreement value of the transfer of flat/unit under construction without providing any deduction for land etc.
There is an impression in the mind of people that this is a new amendment and only under construction flats/units sold after 1st April, 2010 are chargeable to VAT @ 1%. This is not so, the amendment regarding tax on flat/unit under construction is effective from 20th June, 2006. In this budget the Government has come out with new composition scheme of 1% of agreement value without any deduction for land against earlier composition scheme of 5%.
Though the new composition scheme is effective for the flat/units registered on or after 1st April, 2010 the notification in respect of the same regarding procedural aspect has not yet come. In the absence of the notification the builders are in a dilemma as to how and in what manner the tax is to be collected as the full sale price is not collected at the time of executing agreement for flat/unit which is under construction.
Thus in the hands of purchaser the overall cost of the flat/unit is going to increase by about 3.6% of the agreement value by way of Service Tax and VAT. In the given example of Rs. 50,00,000/- value of flat, the additional cost by way of Service Tax will be Rs. 1,28,750/- and by way of VAT will be Rs. 50,000/- making it a total of Rs. 1,78,750/-.
It is pertinent to note that the above cost can be avoided if a ready flat is purchased after builder obtains completion certificate.