In last few years the price of commercial real estate has increased manifold, primarily due to rapid economic growth and increase in commercial activity leading to high demand for commercial office space. Levy of service tax on renting of commercial property with effect from June 1, 2007 has further aggravated the situation.

The service tax has been levied on all forms of leasing and licensing of immovable property for furtherance of business and commerce, including factories, office buildings, warehouses, etc.

This levy has been challenged by the trade/industry circles on various grounds. The most important issue that has been raised is about the authority of the Union government to levy tax on rentals. This is because service tax is a Union subject, whereas tax on land and building is a State domain. It is further being argued by many that renting of immovable property does not involve any element of service.

Recently, in a writ petition filed before the Madras High Court, an interim injunction was granted by the court restraining the government from collecting service tax on rent of commercial space. Though the injunction would apply only to the petitioner, the final decision in this regard is awaited with anticipation.

While the levy itself is a subject of contention, the applicability of service tax on lease agreements signed prior to date of introduction of this levy is also not free from doubt. It can be argued that in the case of renting, the taxable event would be the date when the service provider parts with the property in favour of the tenant. Accordingly, it can be argued that such existing lease transactions should not attract service tax.

This view also draws support from a CBEC circular issued in relation to Banking and other Financial Services. It was clarified that lease or hire purchase agreements entered prior to the date of introduction of the levy would not be charged to tax, so long as the property/ goods have also been received by the lessee before the introduction of the levy. Further, in a recent tribunal judgment in relation to applicability of service tax on hire-purchase agreements, it has been held that the higher rate of service tax would not be applicable for the contracts executed prior to hike in the rate of tax.

However, the revenue authorities are likely to take a view that renting is a continuous service and, therefore,

rentals received after the date of introduction of this levy would be subject to service tax. This could result in litigation between the taxpayers and the revenue authorities. Since it is not uncommon to have long-term lease contracts, an appropriate clarification on the issue would help the taxpayers.

While the impact of this levy is being felt by various sections of trade and industry, the levy is having significant impact on retail sector. Its so because retailers are not able to claim any credit of the service tax paid on rentals in the absence of any service tax or excise duty liability on their output.

Given these controversies and issues, it is interesting to wait and watch the outcome of the decision of the Madras High Court on this issue. If the court rules in favour of taxpayers, it will be received with a sigh of relief. However, if that is not the case, taxpayers will have no choice but to look forward to the Goods and Services Tax (GST) regime, which would probably allow seamless flow of tax credits between goods and services and mitigate the tax cost.

Siddharth Mehta, Manish Mishra
The writers are with KPMG India