The finance ministry may exclude land value from the ambit of a new tax on under-construction houses, potentially taking the sting out of the proposed levy after it ran into a storm of protests from the real estate sector and exposed fissures within the government.

The 2010-11 budget has proposed a 10% service tax on 33% of the total cost of under-construction houses, which could increase the price tag of such properties by 3.3%. The new tax will come into effect once the budget is approved by Parliament.

But protests from a real estate sector worried that the tax could harm its nascent recovery and a demand by the urban development ministry to review it has forced the ministry to consider a retreat and look at ways to ease the burden on potential homebuyers.

Finance ministry officials said they were examining ways to separate land costs from the overall cost equation and take it out of the purview of the proposed tax. We are looking at the issue to see how this can be done, an official told ET.

Any change will make the new service tax more acceptable to all stakeholders and also introduce greater transparency in the pricing of homes by providing a break-up of cost. Its impact could be especially felt in major cities where land costs account for a bulk of the cost of under-construction properties.

The proposed reduction will bring in a huge relief to both consumers and realty companies, said an executive with Delhi-based real estate developer Ansal API.

The change could take much of the sting away from the proposed tax, especially since 67% of the property cost is not covered by it because it is considered as the cost of material used in construction.
Excluding land costs, the effective rate of service tax will fall to 1.75%, added Pradeep Jain, chairman of Parsvnath Developers.

Experts say the ministry could use circle rates or floor prices for areas set by states for computing land costs. But stripping out the land costs could prove complicated even when floor prices are available because ascribing land value to a flat in an apartment complex may be difficult.

Practices are not consistent in the whole of country so it will have to be seen how a mechanism can be worked out, said Rajeev Dimri, leader of indirect tax practice at BMR Advisors & Co.

The precedent of excluding land value from tax already exists in some form. State governments, for instance, do not include the value of land while imposing tax on works contracts.

Tax experts have questioned the legality of the proposed service tax, arguing that land is a state subject. Whether the centre can tax land or property is a challenge. Imposition of service tax on commercial renting has already been challenged and the appeal lies before the Supreme Court, said Mr Dimri at BMR Advisors & Co.

The service tax proposal signals a movement towards a unified goods and services tax framework, which will allow the centre and states to tax items in their respective domains. The centre has indicated rolling out GST from next April.