Infrastructure companies that build and manage projects on behalf of the government may have to take a hit on their bottom lines as costs may rise after finance ministry decided to impose service tax on them for the right to develop the project.

North Block says the right to use or right to develop is akin to renting out commercial space, which is a service that should attract service tax.

A circular issued by the Central Board of Excise and Customs, the apex indirect taxes body under the finance ministry, says government or its agency by an agreement transfers the 'right to use' and/ or 'right to develop' for a period specified, usually thirty years or near about, to the concessionaire, for upfront lease amount or payment of annual charges. Thus, the government or its agency is providing 'renting of immovable property service' (renting of vacant land to be used for furtherance of business or commerce) making the concessionaire a service receiver and the agency liable to pay itself becomes liable to pay service tax.

The tax will not apply to the core construction activity in the case of all projects executed in the build, operate and transfer (BOT) mode.

The levy will apply to all projects for which the agreement was entered in July 2010. The tax will be levied at the rate of 10%.

The developers will have to cough up tax for the past period as government agency will not take up any incremental liability nor allow for increase in toll charges so easily.

In the case of future contracts, the overall cost would go up as the government agency would not take the hit and pass the cost to service recipient. "The clarification has far reaching implications for the infrastructure industry... It could make the infra projects more expensive as private developers would have to take the hit for any surprise tax liability," said Pratik Jain, partner, KPMG.

The current practice in some infrastructure projects is to link its construction with development of commercial space to maximise returns. The circular says that when the concessionaire undertakes the construction himself, he will not be treated as a service provider since the construction had been undertaken by him on his own account.