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Service Tax Department breaks the Slumber
15 February, 2012 Ahmedabad :
Service Tax Department breaks the Slumber

Issues Clarification on divergent practices in Construction sector

Service tax department believes that the powers to issue clarifications on law need not be used suo-motto but only in situation when the trade makes loud noises and is coming knocking at its door; they are left with no option but to act. Circulars are the tool available with the Revenue Department to clarify which the law have failed to spell out in clear words. But if the Circulars misses the mark, the tax payers start feeling the pinch. It has been the experience of the trade that the tax laws in this country have always been embroiled in confusion and the law enforcers have grasped such situations to penalize the honest tax payers.

Service tax on Builders was a non-starter for the government since the courts initially held that view that no service was rendered by the builders to their purchasers. To overcome the impact of such adverse rulings of the Courts, the Service Tax provisions were amended in the year 2010 and the concept of deemed service during the course of sale of flats/units etc by builders to their purchasers were introduced. This concept was introduced with some riders and failed to take care of various situations prevailing in the construction industry. The impact of such changes was felt uniformly across the length and breadth of this country and as a result various builder lobbies across the country sought take refuge in Courts. However, a series of adverse rulings during the past one year have left the builder community with no option but to collect and pay service tax on sale of flats/shops/units to their purchasers.

Nearly two years after bringing in a law by deeming fiction holding that sale of flats/shops/units would amount to providing of service, the department has woken up from their slumber and recently issued a Circular No.151/02/2012 dated 10.02.2012 clarifying the manner of taxing various situations emerging from the practice prevailing in the construction industry. It seems that the governing body of Central Excise, Customs and Service tax believes that the powers to issue clarifications on law need not be used suo-motto but only in situation when the trade coming knocking on its door and they are left with no option but to act.

This circular reveals the manner of taxing divergent business models and practices being followed in the construction industry like Tripartite Business Model consisting landowner; builder or developer; and contractor who undertakes construction. The circular clarifies that construction service provided by the builder/developer is taxable in case any part of the payment/development rights of the land was received by the builder/ developer before the issuance of completion certificate and the service tax would be required to be paid by builder/developers even for the flats given to the land owner. The circular has also clarified that value in the case of flats given to landowner would be equal to the value of similar flats charged by the builder/developer to other purchasers. In case the prices of flats/houses undergo a change over the period of sale i.e. from the first sale of flat/house in the residential complex to the last sale of the flat/house, the value of similar flats as are sold nearer to the date on which land is being made available for construction should be used for arriving at the value for the purpose of tax.

Another popular model being investment in real estate it has been clarified that under investment model, before the commencement of the project, the same is on offer to investors. Either a specified area of construction is earmarked or a flat of a specified area is allotted to the investors and as it happens in some places, additionally the investor may also be promised a fixed rate of interest. After a certain specified period an investor has the option either to exit from the project on receipt of the amount invested alongwith interest or he can re-sell the said allotment to another buyer or retain the flat for his own use. The clarification states that under Investment model, after 01/07/2010, investment amount shall be treated as consideration paid in advance for the construction service to be provided by the builder/developer to the investor and the said amount would be subject to service tax. If the investor decides to exit from the project at a later date, either before or after the issuance of completion certificate, the builder/developer would be entitled to take credit of the Service Tax to the extent he has refunded the original amount. If the builder/developer resells the flat before the issuance of completion certificate, again tax liability would arise.

It is also clarified that mere change in use of the building does not involve any taxable service, unless conversion falls within the meaning of commercial or industrial construction service. In certain states, completion certificates have been waived or are considered as not required for certain specified types of buildings. The equivalent of completion certificate issued by Chartered Engineer or Licensed surveyor should be used as the dividing line between service and sale. In case of Joint Development Agreement Model, land owner and builder join hands and may either create a new entity or otherwise operate as an unincorporated association, on joint/collaboration basis, with mutuality of interest and to share common profit together. If the new entity undertakes construction on behalf of landowner and builder it will be treated as separate entity.

Although these clarifications may ease the anxiety of the builder community and also result in avoiding litigations with the department, its real long term effect needs to be watched and seen. The clarifications seem to have opened new areas of disputes and also have failed to take care of all divergent practices followed by the construction industry in India. The law enforcers will be bound by such clarification being issued by the governing body of Service Tax.

Courtesy: From the desk of Monish Bhalla, Founder, www.servicetaxonline.com
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