8 June 2016 EY Tax Alert Delhi HC rules that Service tax shall not be leviable on under construction flats if contract price includes value of land Executive summary Tax Alerts cover significant tax news, developments and changes in legislation that affect Indian businesses. They act as technical summaries to keep you on top of the latest tax issues. For more information, please contact your EY advisor. This Tax Alert summarizes a recent ruling 1 of Delhi High Court (HC) wherein, the Court held that service tax cannot be charged under section 66 read with section 65(105)(zzzh) of the Finance Act, 1994, on sale of under construction flats. HC observed that, Rule 2A of Valuation Rules provides for mechanism to ascertain the value of services in a composite works contract involving services and goods but the said Rule does not cater to determination of value of services in case of a composite contract which also involves sale of land (i.e. undivided share of land to be acquired by the buyer). Neither the Act nor the Rules framed therein provide for a machinery provision for excluding all components other than service component 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. However, preferential location charges collected by the builder are leviable to Service tax under Section 65(105)(zzzzu) since they are a measure of additional value that a customer derives from acquiring a particular unit. 1 2016-VIL-284-DEL-ST
Background and facts Assessees are individuals who have entered into separate agreements with a builder to buy flats in a multi-storey group housing project. The builder in addition to consideration for the flats also recovered Service tax from the assessees for the services in relation to construction of complex and on preferential location charges. Assessees are aggrieved by the levy of Service tax on services in relation to construction of complex as defined under Section 65(105)(zzzh) of the Finance Act, 1994 and inter alia impugn the explanation to the said section introduced in the Finance Act 2010 (impugned explanation) as being ultra vires the Constitution of India. They also challenged Section 65(105)(zzzzu) of the Act which seeks to charge Service tax on preferential location charges collected by the builder. Thus, the issue involved is whether the consideration paid by the flat buyers to the builder for acquiring a flat in a complex, which is under construction, could be subject to Service tax. In this regard, assessees filed writ petition in Delhi HC. Assessee Contentions 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 Act and Rules do not provide any machinery for computation of value of services, if any, involved in construction of a complex and therefore, no Service tax can be imposed. Ltd. v. State of Karnataka 2 wherein it was held that the State Legislatures would have power to tax the element relating to transfer of property in goods and thus the power of Parliament would be limited to only the service component after excluding value of goods as well as value of land. They also relied on another SC ruling in case of CCE, Kerala v. Larsen & Toubro Ltd. and Ors. 3, wherein it was held that the Statute must clearly specify the three elements taxation, viz; the subject of tax, the person who is liable to tax and the rate and measure of tax. Further, in said case assessee s contention that the charging Section must itself specify that the Service tax is only on the service element of a composite contract and the statutory framework must provide for machinery provisions to ascertain the value of such element for the purposes of Service tax, were accepted by the SC. It was further contended that since Section 65(105)(zzzh) read with Section 66 of the Act did not restrict the levy of Service tax only to the service element of composite contracts, the said provisions could be applied only for imposition of Service tax on service contracts simplicitor and their application to composite contracts would render the said provisions unconstitutional. The preferential location charges are related only to the location of the immovable property and therefore such charges were not exigible to Service tax. It was also contended that for levy of Service tax it is necessary that there should be a service provider and service receiver. Therefore, the services rendered only after execution of flat buyer s agreement could be subject to tax as prior to the said date, in absence of the service recipient, the Construction service provided to itself cannot be subjected to Service tax. Assessee relied on the ruling of Supreme Court (SC) in case of Larsen & Toubro 2 2014-1-SCC-708 3 2016-1-SCC-170
Revenue Contentions By relying on the Karnataka HC decision 4 and Bombay High Court decision 5, revenue contended that the explanation to Section 65(105)(zzzh) and Section 65(105)(zzzzu) were valid and enforceable. The development of project results in the substantial value addition on bare land and includes various services such as consulting services, engineering services, management services, architectural services etc. These services are subsumed in the taxable service under Section 65(105)(zzzh) of the Act. Further, since the gross charges include value of land and construction material, only 25% of the Base Selling Price charged by a builder from the ultimate consumer is subjected to levy of service tax. However, in case of preferential location charges, the entire amount charged is for value addition and, therefore the same is chargeable to Service tax under Section 66 read with Section 65(105)(zzzzu) of the Act. HC ruling HC held that, 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 is enacted, that does not exist. The Parliament is fully competent to enact such legal fiction. In the present case the Parliament 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. The clear object of imposing the levy of service tax in relation to a construction of a complex is 4 W.P.(C) 24050-51/2010 dated 12 December 2012 - Confederation of Real Estate Developers Association and Anr. v. Union of India & Ors. 5 W.P.(C) 1456/2010 dated 20 January 2012 Maharashtra Chamber of Housing Industry and Anr. v. Union of India & Ors. 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 agreement for acquiring a unit in a project prior to its completion / development. Further, HC did not find any merit in the assessee s 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. The arrangement between the buyer and the builder is a composite one which involves not only the element of services but also goods and immovable property. Thus, while the legislative competence of the Parliament to tax the element of service involved cannot be disputed, 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. For the purposes of ascertaining the value of services, the Central Government had made Service Tax (Determination of Value) Rules 2006 (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. HC further held that, 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. In this regard HC relied on the SC ruling in case of CCE, Kerala v. Larsen & Toubro (supra) wherein it was held that, Circulars or other instructions could not provide the machinery provisions for levy of tax. The charging provisions as well as the machinery for its computation must be provided in the Statute or the Rules framed under the Statute. Therefore, 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 assessees 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. However, with respect to preferential location charges, HC held that they are a measure of additional value that a customer derives from acquiring a particular unit. Such charges cannot be traced directly to the value of any goods or value of land but are as a result of the development of the complex as a whole and the position of a particular unit in the context of the complex. Thus, Service tax is leviable on taxable services as defined under Section 65(105)(zzzzu) i.e. preferential location charges. Comments The first ruling in the context of construction service which deals with the settled principles of levy requiring statutory machinery provisions for valuation will have significant implication with reference to all under construction property agreements involving transfer of undivided share of land to the buyer. The decision is most likely to be litigated by revenue before SC. Since the HC has not disputed legislative competence to levy tax on service portion in a composite contract, but merely held it to be inoperative in the absence of machinery provisions, it will have to be seen as to how SC interprets the rules and notifications in this regard. The binding nature of the decision of Delhi HC involving central tax legislation will need to be analysed in the light of various judicial precedents to decide further course of action on this issue.
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