The constitutional validity of the levy of service tax on rent payable for lease of commercial immovable property is highly doubtful.
One of the most inequitable provisions in this year's Budget is the levy of service tax on rent payable for lease of commercial immovable property. This provision comes into force from June 1, 2007. The landlord now has to pay property tax to the local municipality, income-tax on the rental income, and the tenant will now have to pay service tax on the rent paid to the landlord. There is no service tax on immovable property used for religious and educational purposes.
It has also been made clear that service tax is payable for rents paid for factories, warehouses, theatres and exhibition halls. With service tax plus educational cess at 12.36 per cent, every tenant will now pay service tax equivalent to six weeks of rent.
The constitutional validity of the levy of service tax on rentals on such immovable property is highly doubtful. Entry 49 of List-II of the Seventh Schedule refers to tax on land and building. It has been held that this tax can be levied on the mere existence of the land or building. It has been further held that all entries must be given widest possible interpretation.
If there is no "service" provided by the landlord, there would be no scope for levy of service tax on the rentals and such a tax would come within the scope of Entry 49. A tax on land and building would also include a tax on the rent payable for such land and building. A few years ago, service tax was levied on kalayana mandapams/mandap-keepers (marriage halls). This was challenged on the ground that only State governments had the legislative competence to levy tax and such tax amounted to "tax on land and building".
The Supreme Court rejected this contention in Tamil Nadu Kalyana Mandapam Association vs Union of India (2004 5 SCC 632). The court pointed out that, in the case of a mandapam, it is not just renting of premises for a few hours. A mandap-keeper provides lighting arrangements, furniture, fixtures, floor coverings, and so on. He also advises the quality of service that can be provided. In the case of star hotels, there are wide varieties of services which will provide necessary effect and ambience. A mandap-keeper also provides services relating to decoration and organising the mandap. The nature of the contract is not a mere transfer of immovable or movable property.
A different situation
In the case of renting of immovable property, the situation is different. Mere renting of office space does not involve any service apart from handing over vacant possession of the property. However, if a lease deed also requires landlord to provide services such as maintenance and upkeep of the property, certainly this component can be subject to service tax. Unfortunately, there is a deduction of 60 per cent on the amount paid for use of a kalyana mandapam or hotel. For renting of immovable property, the only deduction is the property tax paid. Notification 24/2007-ST dated May 22, 2007, points out that if the rent is Rs 1 lakh and the property tax is Rs 2,000, service tax will have to be paid on Rs 98,000.
In Gujarat Ambuja Cements Ltd vs Union of India (2005 4 SCC 214), the Supreme Court pointed out that legislative competence has to be determined by the object of the levy and not the incidence thereof. Even though a liberal interpretation must be given to taxing entries, no tax can be levied on a subject matter which is not included in that particular entry. If, in substance, tax is not referable to a field given to the State (or Centre), the court will not allow the statue to intrude upon that field.
In Bharat Sanchar Nigam Ltd vs Union of India (2006 3 SCC 1), the Supreme Court was concerned with the question of whether provision of mobile phone connection amounted to a sale or a service or both. If it was a sale, the State Government could tax it; if it was a service, then the Central Government could alone levy service tax.
If the transaction had the characteristics of both sale and service, the court held that the contract should be capable of being segregated in two distinct components. The service component could be taxed by the Centre while the sale component could be taxed by the State Government. In other words, the contract must have two distinct taxable events. If the contract cannot be segregated or the parties did not have any intention of creating any separate rights, then it was not open to the State Government to create a notional sale and levy tax thereon.
Fillip to evasion
Apart from the constitutional validity, the levy of such tax is bound to encourage rampant tax evasion. Rentals will now be paid up to Rs 8 lakh which is the exemption limit for service tax and the remaining component will be simply collected in cash. It is also possible that in the case of multi-storied buildings, rentals may be paid by different companies, each within the ceiling limit of Rs 8 lakh. One more doubt is whether the exemption of Rs 8 lakh will be available to each co-owner if the building is owned by more than one person. Over the last few years, there has been an increasing tendency to indiscriminately levy tax on contracts rather than tax on services.
Arvind P. Datar (The author is a senior advocate of the Madras High Court.)