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Service tax to hit
March, 08th 2010

Your dream home is now going to cost more. Simply because home buyers are now going to bear 10.3% service tax on properties under construction --  as proposed in the Budget 2010 -- which will lead to a tax outgo of 3.4% of the sale value of the house, according to experts.

Gaurav Karnik, associate director-real estate practice, Ernst & Young, says, The Budget has proposed an amendment in the definition of two existing taxable service categories -- commercial and industrial construction and construction of complex services. This amendment provides that unless the entire consideration for the property is paid after the completion of construction, the activity of construction would be deemed to be a taxable service provided by the builder/ promoter/ developer to the prospective buyer and the service tax would be charged accordingly.

Through this amendment, the government seeks to create a legal fiction whereby it deems any advance consideration charged by builders/ developers from buyers as consideration for service of construction of immovable property for and on behalf of the buyer rather than a construction for self for subsequent sale to the buyer.

The amendment would in effect bring all agreements in the nature of sale of immovable property (eg Flat Buyer Agreement) --where any advance payment is received by the builder/ developer prior to the completion of construction -- under the service tax. It would, thus, entail the payment of service tax on the sale price collected by the developer from the buyer, having the direct effect of increase in the real estate prices in the hands of the customer. Experts believe this would adversely affect the real estate sector, particularly when it was just beginning to show the signs of recovery.

Further, the proposed amendment may have a deep impact on how real estate transactions are structured in future due to issues relating to the valuation for the purposes of service tax levy. Instead of a single sale price, the consideration may be broken up into cost of construction and land so that service tax may be paid only on the value of services involved in the construction.

While currently the law also provides an option of paying service tax on 33% of the total consideration in respect of construction contracts, the same is grossly inadequate in the present context as it does not take into account the value of land involved (which, based on location, could form a major component of the sale consideration), says Karnik.

Another ambiguity which arises is the issue of valuation for the purpose of stamp duty. Stamp duty is currently levied on the value of constructed property. However, if the same is considered a service of construction, then the actual transfer is only of land and stamp duty should be charged only on the land value. But it is unlikely that the stamp duty authorities would accept this position, says Karnik.

The biggest impact of the service tax, however, would be felt by the prospective individual home owners seeking to buy flats/ properties in upcoming building projects. Given that the construction industry is an extremely capital-intensive industry with huge investment costs, capital generation for the building project is usually undertaken by receipt of advances from prospective buyers. This is intrinsic to the business model of the industry and hence it is unlikely that builders and developers would now commence to sell only constructed flats/ properties to be outside the purview of the service tax levy, says Karnik.

Therefore, the practice of advance bookings along with collection of advance payments is likely to continue and the builders/ developers would merely pass on the service tax to the customer for whom it will be dearer by that amount to own homes.

Further, unlike commercial undertakings purchasing real estate for offices etc, for whom it might be (in certain situations) possible to avail Cenvat credit, individuals would have to bear the same as an additional cost. This, along with the related new service tax levy on special services provided by a developer (such as preferential location, maintenance of parks, sewers, lighting etc) would make the dream of owning a home much dearer for the common man!

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