Even before the wound caused due to levy of service tax in the recent Budget on renting of immovable property was yet to be healed, here is some salt being sprinkled on the wound by issue of a circular last week. The industry was up in arms in various writ courts against the levy of service tax on renting of immovable property challenging its constitutional validity on the basis of the power of the central government to levy service tax on the subject matter which seemingly fell under state governments purview.

While the dispute on propriety of the levy of service tax by the central government was yet to be decided by the appropriate courts, the government now issued a clarification stating that service tax paid on input services in the nature of construction service or work contract service that are used in construction of an immovable property, which is meant to be rented or leased, will not be eligible for CENVAT credit for those who provide renting of immovable property service.

The clarification is going to be a double whammy for the industry inasmuch as it will result in payment of output service tax without being allowed input tax credit thereby causing cascading of tax which is against any good VAT system.

It appears from the bare reading of the circular that as if it was predetermined to deny the credit and then an attempt was made to give reasons for such denial by way of a circular. The clarification starts with an incorrect proposition that right to use immovable property is leviable to service tax. Service tax is applicable on renting, letting, leasing, licensing of an immovable property. Therefore, the subject matter of service is the tangible immovable property being let out or rented or licensed and not the right to use such property, which is intangible in nature.

The circular seeks to clarify that immovable property is neither goods nor service and, hence, any inputs used in creation of such immovable property should not qualify for CENVAT credit. What is ignored while taking this view is the very definition of input service under the CENVAT rules which is the foundation of the CENVAT scheme. The input service for CENVAT credit purposes inter alia includes services used in relation to setting up, modernisation, renovation or repairs of premises of output service provider or an office relating to such premises. It needs no emphasis to state that the rules issued by the government will always have overriding effect over any administrative clarifications issued like the instant. Therefore, when the rules governing CENVAT scheme allow CENVAT credit on input services used for setting up of premises, the question is can a circular deny the benefit sought to be granted by the rules which has overriding effect over circular.

The other provision in CENVAT rules which has been ignored while issuance of the circular is the provision which makes an active exception to allow unrestricted utilisation of CENVAT credit for specified services even when used in provision of taxable and exempt services. Commercial construction service is one such specified service where government permits unrestricted utilisation of CENVAT credit even when such service is used partly in provision of taxable services and partly in non-taxable services.

It is obvious that commercial construction service will always be used to construct an immovable property and if this be so, in light of the fact that government has specifically allowed credit on commercial construction service and that too under a category making an exception to the general rule of credit, what remains to be guessed is the sanctity of the instant circular. The circular will result in a scenario where any other service provider using commercial construction service where the connection of this input service would be rather remote with his output service would be allowed the credit that too under a special category whereas the person engaged in renting of immovable property will be denied the credit of the input service used in constructing the very same property which plays direct role in his service rendition.

There is an urgent need to review the present circular and issue suitable amendment before it results in pile of litigation.

Prasad Paranjape & Vishal Lahoti
(The authors are with PricewaterhouseCoopers)