Construction Service
/ Works Contract- Residential Apartments
- Impact of Larsen & Toubro
[ K.Raheja] Judgment.
- Madhukar N Hiregange
Commercial tax is a largest [maximum] contributor
of revenue to every State. There were attempts in late 1990s and later by Sales
Tax authorities to cover works contract under tax. However in several disputes,
it was held that there was no sale and therefore not taxable.
States were keen to get the huge revenue from
this sector [ presently about 10% of the
GDP of India] into taxation. The
Government by way of the 46th amendment to the Constitution of India
inserted an article 366 (29A) to enable several such activities which were held
as not liable as a sale. States took some time [ 2002 to 2005] to make laws to
specify what was a works contract and started to collect the tax on the same
from the contractors and dealers involved in works contract of indivisible
nature.
The contract broadly can be classified under
A) Where
the sale is insignificant to service. Then it would be considered as a service
only.
B) Where
the service is insignificant to sale. Then it would be considered as a sale
only.
C) Where
the service as well as sale elements are significant. Then it would be
considered as a works contract. The works contracts further could be bifurcated
as under:
I.
In relation to Immovable
property [Buildings, Plant & machinery permanently embedded in earth,
Transmission towers, roads, dams bridges etc.]
II.
Movable property [ bus bodies,
machinery repairs, electroplating, galvanisation etc]
Dominant
Intention Test
In normal course to decide whether the contract
is one of sale or service the dominant objective or intention of the
contracting parties would be important. However once a contract is a works
contract then the dominant intention test is no longer applicable due to the
deeming fiction created by change in the law[1].as
per the Landmark decision by Supreme Court by a 3 member bench.
Divisible
Contracts Vs Indivisible Contracts
Where there are separate contracts for the
supply of the goods and another contract for the service or erection,
construction, repair, mounting, dyeing, fabricating etc then the supply would
be considered as a sale. The activity of labour/ skill / use of machinery etc
to complete the job would be said to be service. These type of contracts are
divisible contracts[2].
The conditions including the penalties built into the purchase order/ work
order on different terms for the supply and service would add to the clarity
and avoid disputes.
The Andhra Pradesh HC[3]
observed that there were no standard formulae to determine whether a
transaction was works contract or sale transaction and that it would depend on
the facts and circumstances. While
dealing with the issue in hand, it held that the dealer had entered into a
maintenance agreement with the customer to charge labour and overhaul charges
at a particular rate and replacement of spares at another particular rate. The
Court held that this is a contract of sale and sales tax would be applicable
only on the value of spares charged by the customer;
There is a contract which is awarded for a lump
sum. However there is a bill of quantity attached to the same along with the
amount payable for each component of supply as well as each component of service.
Billing is done exactly as per the break up provided. This maybe considered as
a divisible contract. This would also be as per the latest decision of Kone
Elevators, which is also as per the Larsen & Toubro of 2013. This view
would not hold good however where such break-up is only for payment mile
stones.
Sale of Immovable Property in the course of
construction: The Larger Bench of the Supreme Court has
confirmed the earlier order in K.Raheja
of the Karnataka High Court that even in the contract for sale of immovable
property in future, there is a works contract and that portion of the work
which is incomplete as on the date of the contract would be liable to tax.*[4] It
was observed in the decision that the dominant intention test would not be
applicable for works contract.
Sale of Completed Construction:
This also means that once the building is complete as evidenced by the
certification by an Architect or registered qualified engineer duly supported
by electricity bills, there would be no sales tax applicable.
Analysis
of the Larsen & Tubro in 2013 following the earlier K.Raheja & L&T
of Karnataka High Court of 2005
The decision of could be of immense value in
immovable property transactions irrespective of the option of composition or
otherwise in most States.
We examine some of the issues raised and
decision thereunder:
1. Even
in case of a single agreement to sell an apartment in future with certain
specification, there is a works contract involved. It cannot be said that the
construction is done for the developer and NOT done on behalf of the buyer. [
Para 110] Therefore even in single contract agreements service tax would be
payable on the balance of construction to be done.
2. The
development agreement between the owner of land and developer is a transaction
of transfer of immovable property as well as works contract. [ para 111] The
transfer of in progress property [ that which the landlord sells in the course
of construction] would be liable to service tax in the hands of the developer.
3. The
goods portion in works contract is permissible to be taxed even if taxed after
incorporation as long as it does not tax transfer of immovable property. [ Para110]
The deduction for land is available from the value.
4. The
works contract is only from the stage the develop enters into a contract with
the apartment buyer. The value addition made to the goods transferred after the
date of agreement is entered into can ONLY be made chargeable to tax. [ para
115] This means that only on the portion incomplete VAT is chargeable. By
extension service tax also would be only on that balance amount.
5. Where
at the time of construction and until construction is complete there was no
contract with any buyer, the goods used in construction cannot be deemed to
have been sold by the builder since there is no purchaser. [ para 117] This confirms the understanding
that once complete no VAT would be applicable. Consequently even service tax
would not be applicable post completion.
Impact of Above decision can
be understood by way of an illustration: Apartment in Bangalore being sold
initially at Rs. 5000 per sft. Agreement to sell {Immovable property portion}
is Rs. 2500 and Construction agreement is Rs.2500. At the start of the projects
Rs. 2500 would be liable to VAT ( depending on option) and Service Tax at 4.944
( 12.36 x 40. Assumed to be total of 9 % = Rs. 225 per sft. At 50% completion
the price would be around Rs.6000/- again normally broken into 3000 for each
component. However as per the L&T judgment 50% of the construction is
complete. Therefore agreement to sell would be Rs. 4500 and construction
Rs.1500. At the rate of 9% it would be Rs.135 per sft. Towards the end it would
be less than Rs. 50 per sft. Once complete neither VAT nor Service Tax would be
applicable. This benefit could be passed onto the buyers.
The real estate industry has
slowly started to take advantage of this decision by getting percentage
completion certificates and depending on the quantum of completion adding the
completed construction value as a component in the agreement to sell [ which is
for immovable property] in addition to the value of undivided interest in land.
This would benefit the buyers for sure depending on at what stage they entered
into an agreement with the developer.
However some developers may
continue to follow the earlier method to maintain uniformity, ensure that the
credit reversals are not necessary in K-VAT and additional record keeping
requirement.
Therefore the L&T judgment
while taxing the single contracts has also been a boon where it has clearly
clarified that to the extent of completed part, there cannot be a tax as that
part is an immovable property.
This article is based on a
chapter of – CST – Handbook [ With GST Impact] to be published by Puliani Law
House, Bangalore.
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