The boom in the construction industry has turned the real-estate sector into fertile ground for levy of indirect taxes. The combination of goods and services in real-estate projects attracts taxes both from the State (value added tax or VAT) and the Central (service tax) governments. There is confusion over taxation of real-estate projects in several areas including immovable property, indivisible contracts, mode of transfer of title and ownership, definition of construction activity under indirect tax legislations, scope and classification of works contract and services, abatement schemes, and the diverse arrangements possible between developers, investors and buyers.
Traditionally, the real-estate and construction sectors were associated with aspects of immovability, and given that levy of VAT pre-supposes existence and transfer of goods (a movable property), real-estate transactions largely fell outside VAT and were only subjected to stamp duties applicable on transfer of immovable properties. However, the Supreme Courts decision in 2005 in the case of K. Raheja Developers distorted the above view, and construction was understood to also involve supply of goods chargeable to VAT.
The Uttar Pradesh High Court brought in a new angle in 2007 in the case of Assotech Realty, holding that the ownership of property does not pass on to the buyer till the registered sale deed is executed so, there is no supply of movable goods to be charged to VAT. In 2008, the Supreme Court delivered another verdict in the case of Larsen & Toubro and observed that the intended sale was that of an immovable property, and, hence, the transaction between developer and buyer is not chargeable to VAT.
Owing to the contradictory decisions and the lack of clarity till date, applicability of VAT to real-estate projects remains open to varied interpretations.
The introduction of construction of complex service and commercial or industrial construction service as a taxable service in 2004-2005, and works contract service in 2007 provided a channel for levy of service tax on real-estate projects. Furthermore, the decision of the Delhi Tribunal in the case of BSBK, authorising the vivisection of turnkey contracts and segregation of the service element, gave credence to levy of service tax on construction contracts.
However, despite the legislative authority for charging service tax, contrary decisions from courts opened up fresh debates.
The Gauhati High Court, in the case of Magus Construction, held that the sale from developer to buyer is that of a completed construction work and the prospective buyer is not obtaining any service from the developer; on the other hand, in the case of GS Promoters, the High Court of Punjab and Haryana observed that there exists a service element in the construction activity and, hence, it should be taxed.
The levy of VAT and service tax on real-estate projects was further complicated with the evolution of different types of real-estate arrangements ranging from joint development models and investment models, to construction with undivided share in land and co-operative society models. The absence of clear legislation and contrary decisions have not helped either.
The new service tax legislation, in effect from July 1, 2012, classifies construction as a declared service mandating levy of service tax, while the definition of service itself excludes transactions in relation to immovable property, thereby leaving room for controversy.
Given that the construction industry is a key driver of economic growth, and given the tax revenues at stake, it is imperative that the State and Central governments formulate clear tax policies.
They should, however, bear in mind the impact of multiple taxes on the consumer and the industry. As we prepare to move into the GST regime, well-defined policies accompanied by enabling legislations are the need of the hour.