Top retailers are an aggrieved lot. Upset over the governments decision to charge service tax on the already stinging rentals, they are planning to challenge the decision in a court of law.

Several leading retailers like Kishore Biyani of Pantaloon Retail (Future Group), BS Nagesh of Shoppers Stop, Noel Tata of Trent and Vinay Nadkarni of Globus among others had a meeting in Mumbai to initiate their future course of action.

A couple of legal firms have already been roped in to advise them on the issue, said sources. Retailers will initially make a representation to the government under the aegis of the Retailers Association of India (RAI). If things still do not work out, they might consider legal options, top officials said.

We are examining ways of tackling the issue. If better sense does not prevail, we will not hesitate to seek legal recourse, said Gibson Vedhamani, president of RAI. The Union Budget imposed a 12% service tax on commercial rentals. The education cess on services has also gone up from 2% to 3%, taking the total service tax to be paid by the developer or the property owner to 12.4% of the rental income.

Technically, service tax on rentals will have to be borne by landlords who lease out space to retailers. Currently, over 90% of the modern formats are leased by retailers. However, several lease agreements hold a clause which states that any additional tax or levy will have to be borne by the lessee.

Bottomlines of retailers who operate on thin margins and high volumes are under severe pressure because of the high rentals in an overheated real estate market across the country. Most retailers are unwilling to pass on the burden to consumers since it would negate their competitive edge, i.e., pricing vis--vis the traditional kiranas who do not pay rent. There are a couple of retailers, however, who are planning to pass on the burden to consumers.

Rent is not a service from any angle. It is an unthinking decision made by the government without clearly examining the cause and effect. It will only add to the inflationary trend, said Kishore Biyani, CEO of Pantaloon.

Rentals are now expected to touch over 15% of sales from around 7-8% in the previous years, and retailers are worried over the eroding margins. Globally, rentals constitute just 3-4% of sales for retailers and no service tax is charged on rentals, industry officials said.

The rush to secure prime locations has led to unrealistic expectations by mall and real estate developers. To deal with the pressure, several malls have begun moving into fixed rental and profit/revenue share to reduce pressure. The ratio of rentals for anchor tenants to regular tenants is also expected to go up from 1:3 to 1:10. Retailers are focusing on stepping up the mix of markets from metros to smaller towns where rentals are relatively lower than metros.

The direct effect of the service tax will be another 1% which is detrimental to our business which operates on thin margins. We are surprised that the government has done this to an industry where growth has just taken off, said Andrew Levermore, CEO of HyperCity. Modern retail is currently growing at over 35% in urban and tier-II markets and several formats are furiously expanding across the country to corner space at prime locations. But the tax might just throw the retail growth story into a spin.