New Service Tax Provisions for Builders

Introduction

The issue of the imposition of service tax on construction and sale of residential property has long been a matter of concern for the real estate and construction industry as well as for buyers of such residential property. It has gained much prominence after Budget 2010 because of significant amendment made therein towards taxability of sale of flats under service tax.

A ‘deemed service’ provision has been introduced in case of construction service w.e.f. 1-7-2010. Any industrial or commercial construction or construction of residential complex will be subject to tax if such complex or part thereof is sold prior to obtaining ‘completion certificate’. Consequently, installment purchases of immovable property will become chargeable to the service tax.

Notification no. 24/2010 dated 22 June 2010 has specified the effective date of operation of certain provisions of the Finance Act 2010, which include subject amendment, to be  1 July 2010.

Since the subject amendment is made by way of an ‘Explanation’, added to the Definition of service & since this Explanation is not merely for explaining or clarifying the scope but for expanding the scope of taxable service, it can be safely interpreted that this amendment can not have retrospective effect prior to 1-7-2010.

Following players in real estate sector will get affected by the Amendment.

A pure Developer/Builder, who might have outsourced or contracted out the construction activities to a Contractor, in the case of a civil works contract.

A Developer/Builder cum Contractor, who undertakes the construction himself and consequently doubles as a Contractor.

It needs to be noted however that a  contractor engaged by the builder for the purpose of construction of commercial or residential complex is anyway liable to pay the service tax under the relevant taxable category. Dispute was only in respect of the liability of the builder to pay the service tax on  sale of a flats  during construction to the prospective buyer.  Recent amendment brings into service tax net,  transactions of sale effected by builders and developers.

Pre-budget 2010 provisions in respect of construction service

Service tax provisions relating to construction  cover three types of services –

                                             i.      Commercial or industrial construction which is taxable w.e.f. 10-9-2004 

                                           ii.      Construction of complex (residential complex of more than 12 residential units) which is taxable w.e.f. 16-6-2005.

                                          iii.      If sales tax/VAT/works contract tax is payable on these construction activities, related services get covered under ‘works contract service’ w.e.f. 1-6-2007 and not under first two categories of services.

As far as sale of flats by builders is concerned,  it was more or less settled, on basis of Court decisions and CBE&C circulars, that a builder entering into contract for sale of flat or industrial unit (gala) or shop or a developer entering into contract for construction of an individual flat for personal residential use of client are not liable to pay service tax.

As a result where agreements are made with the prospective buyers, builders were mostly out of service tax net because in such cases it was considered that no service is rendered.

Changes made in Budget 2010

In the Finance Act, 2010, an Explanation has been added w.e.f. 1-7-2010, to definition of commercial or industrial construction and construction of residential complex, as follows -

Explanation.— For the purposes of this sub-clause, construction of a complex which is intended for sale, wholly or partly, by a builder or any person authorized by the builder before, during or after construction (except in cases for which no sum is received from or on behalf of the prospective buyer by the builder or a person authorized by the builder before the grant of completion certificate by the authority competent to issue such certificate under any law for the time being in force) shall be deemed to be service provided by the builder to the buyer.

Similar Explanation is added In case of commercial or industrial construction service, where in place of word complex, the words used are ‘construction of a new building’.

As a result of this Explanation, an activity which is not ‘service’ as per Court decisions and CBEC’s own earlier circulars will now be a ‘deemed service’ for purpose of levy of service tax, under above two categories of services.

Effect of the changed Provisions

It is important to note that extension of scope in the definition of taxable service has been made only in respect of commercial or industrial construction and construction of residential complex service, leaving works contract service un affected by the change.

For the two services covered, service tax will now be payable in cases of sales of flats/shops/galas, unless such sales are made & entire consideration is received after Completion Certificate is obtained for the property sold.

Time for obtaining completion certificate thus becomes a key factor in determining taxability of sales of flats under service tax. 

Requirement about Completion Certificate is however somewhat relaxed under the Service Tax (Removal of Difficulty) Order, 2010, made effective from 1.7.2010, whereby it is provided that such Certificate can be obtained either from

a.      Any Government Authority including Local Authority

b.      An Architect registered with the Council of Architecture

c.      Chartered Engineer

d.      Licensed surveyor of the respective local authority

Thus even after the amendment, to remain out of service tax net, a builder need not wait for sale of flats till Completion Certificate is obtained from Local Authorities but instead can obtain such certificate from an Architect or Chartered Engineer and can still avoid charge of service tax.

In all other cases, where such completion certificate is not obtained before sale of flats, the builder will be liable to pay the service tax. In most of the cases, builder constructs building by using funds from prospective buyers, paid by them on the basis of Bookings made for major part of such building before its completion. Thus except for few flats reserved for sale at higher price on ready possession basis, for most of the flats sold, service tax will become applicable.

Exclusion of Works contract service from the Amendment

As discussed above, even after the amendment, what is deemed to be a service is only construction of commercial buildings or residential complexes. This is because Amendment inserting Explanation is not made   in the definition of works contract service, but only in other two construction related services. 

The amendment therefore does not apply if the contract is covered under works contract service i.e. where Vat/Sales tax is payable on the contract.

Thus if a particular construction activity by a builder is covered under VAT provisions, service tax will not be payable on such construction even after the amendment.  Pre Budget legal position about non applicability of service tax in case of sale of flats will therefore still hold good even after the amendment in case of works contracts for construction.

Exclusion when construction service is provided for personal use of buyer.

Residential complex for service tax purposes does not include a complex which is constructed by a person directly engaging any other person for designing/planning/construction and is intended for personal use as residence by such person. The definition also explains that personal use includes promoting use of such property as residence by another person on rent or even without consideration.

In this connection, National Building Construction Corporation Limited (NBCC) requested the CBEC for a clarification on the applicability of service tax on construction of residential houses for Central Government employees.

In this case Ministry of Urban Development (GOl) has directly engaged the NBCC for constructing residential complex for central government officers. Further, the residential complexes so built are intended for the personal use of the GOI which includes promoting the use of complex as residence by other persons (i.e. the Government officers or the Ministers).

As such the GOl is the service receiver and NBCC is providing services directly to the GOl for its personal use. Therefore, as for the instant arrangement between Ministry of Urban Development and NBCC is concerned, Board has clarified vide F.No.332/16/2010-TRU Dated: 24, May 2010 (after the Budget 21010 Amendment) that the service tax is not leviable.

In the above clarification, if NBCC and Government are replaced by builder and individual buyer, it would mean that if an individual buyer is buying the property for his personal use from builder, then the transaction of sale is not covered under Service Tax. Clear clarification from CBEC is required on this interpretation, because the clarification referred to above has not been placed by CBEC in public domain.

Transitory provisions in case of bookings made/agreements executed prior to 1.7.2010

Date of booking is not relevant.

Date of provision of service is relevant as provision of service is the taxable event. Hence, if construction service is provided after 1-7-2010, service tax will be payable.

Transitory provisions in case of constructions started prior to 1.7.2010

If the construction is partly complete on 1-7-2010, service tax liability shall be ascertained as under.

Principally, provision of service is the ‘taxable event’, i.e. services provided after tax is imposed will be taxable. Thus, service tax will apply in respect of services provided or to be provided on or after 1-7-2010.

Receipt of payment or advance is not relevant for determining tax liability. Thus, a builder/developer is not liable to pay service tax in respect of services provided unto 1-7-2010. Such bifurcation is possible only if the builder/developer keeps proper accounts and records.

Running bills can be issued in respect of services provided up to 1-7-2010, backed by a Certificate from Architect/Chartered Engineer regarding stage of completion of construction covered by such bills raised. 

Transitory provisions in case of advance payments made by the customer prior to 1.7.2010

A specific exemption from service tax has been provided for advances received prior to 1.7.2010 vide Notification No. 36/2010 dt. 28.6.2010. As per Notification service tax is not payable on the amount of advance payment received before the 1.7.2010, for   taxable services to be provided, on or after 1.7.2010.  

Thus exception has been made for the advances received from the customers before 1.7.2010, even though construction service related to such advances is to be provided after the service has become taxable.

It should be noted however that this exemption is limited to amounts received as advance before 1.7.2010. For all subsequent advances liability will arise towards service tax as per normal provisions.

Service tax is payable on receipt basis and hence as one gets payment for construction service from customer, one has to pay service tax on that amount. If service tax is not shown separately in bill or amount received, the amount received should be taken as inclusive of service tax and then back calculations may be made.

 Rate of service tax

Service tax is payable on gross value of taxable services @ 10.3% (Service tax 10%, plus education cess of 2% plus SAH education cess of 1%).

Basic exemption for service tax

The exemption is Rs 10 Lakhs in first year of taxable service counting from 1-7-2010. If turnover in 2010-11 exceeds Rs 10 Lakhs, then there is no exemption and tax is payable on all services from 1st April 2011 onwards.

Valuation of service & Calculation of Service Tax Liability for a Builder/Developer

Principally, service tax is payable on value of taxable services.  Thus, if a service provider has proper costing records, it is permissible to deduct value of material and land (or calculate value of service on cost plus profit basis) and pay service tax on value of service @ 10.30%.

Developers and Builders have following alternative methods available under the service tax law for payment of service tax liability.

If the service is covered under service of construction of commercial buildings or residential complexes, builder can opt for Abatement Scheme applicable to these services, under which service tax is to be paid on 25%/33% of the gross value received, in terms of Notification 1/2006.  Alternatively, they can opt to pay service tax under Notification No. 12/2003-ST dated 20-06-2003, as per which, the service provider is exempted from paying service tax on the value of goods sold/transferred. The benefit of this Notification is very much available to Developers/Builders/Works Contractors.

With effect from 1.7.2010, any person providing taxable service of commercial or industrial construction or construction of residential complex (except completion and finishing services like glazing, plastering, painting, tiling, wood and metal joinery and carpentry, swimming pools, acoustic applications etc.) can opt to pay service tax as follows

(a) on 33% of gross amount charged if the gross amount does not include value of land

(b) on 25% of gross amount charged if the gross amount includes value of land (Till 1-7-2010, the 25% scheme was not available. Only 33% scheme was available).

The ‘gross amount’ should include value of goods and materials supplied or provided or used. Thus, if the customer provides some material, its value will have to be added for purpose of payment of service tax.

Conditions for this concession are

(a) No Cenvat of duty/service tax paid on inputs, input services and capital goods and

(b) No benefit of Notification No. 12/2003-ST dated 20-6-2003

If a project is covered under Works Contract service, (where VAT is paid)  the Realty players can opt to pay service tax either under Notification No. 12/2003-ST dated 20-06-2003, or under the Composition Scheme, applicable to works contractors.

Though the Department has been taking a view that the benefit of Notification 12/2003-ST dated 20-06-2003 cannot be extended to Developers and Builders, the Bangalore CESTAT, in the case of Sobha Developers Ltd v. CCE & ST (2009-TIOL-1188-CESTAT-BANG) has categorically held that the Developer is entitled to the benefit of Notification No. 12/2003. The service provider can have benefit either under Notification 12/2003-ST or 1/2006-ST and not both.

Important aspects for choice between the Alternatives available to Builder for Payment of Service Tax   

Comparative features of different alternatives are as under.

Options of  Abatement/Composition or Notification 12/2003 are available in respect of each of the contracts.  It can be said that there are as many works contracts as there are flats, in a housing project. 

As for choice between the alternatives, Developers who have contracted out the construction activity can find Notification No. 12/2003 or the Composition Scheme for Works Contractors more beneficial looking at significant benefit arising out of availment of CENVAT credit.

The 25% scheme is simple but the liability of service tax will be high, particularly at places where land costs are very high. Further Cenvat credit of service tax paid to contractor/sub-contractor is not available.  

Different options for different contracts can be adopted depending upon the amount of tax liability under each option.

Each contract can be treated as separate contract and valued differently.

Service tax liability on consideration received from Landlord

Where land is received from the land owner by the builder in consideration of some flats/galas to be given later in lieu of the land, service tax is payable on the value of flats offered to the landlord.

As soon as builder gets possession of land from land owner, it is ‘advance received’ and service tax will become payable next month.

In such case, value of service will have to be found out on basis of value of service of identical or similar flat/shop or on basis of cost of construction plus reasonable profit.

Provisions with respect to Cenvat Credit

Cenvat credit on construction activities of one project can be adjusted towards output service tax on sale of another project, provided both the projects are not covered under composition option (25%/ 33%)

As per rule 6 of Cenvat Credit Rules, Cenvat credit is not available if output service is exempt from service tax. Subject to this restriction, Cenvat credit among various projects is indeed inter-changeable, particularly if one opts for centralized registration.

Credit of service tax paid on various input services like telephone, courier, mobile, bank charges, audit, security, catering etc can be utilized against service tax payable on construction services. However if certain projects are covered under composition option, pro rata credit will get disallowed as per provisions of rule 6 of Cenvat Credit Rules

Refund of Service Tax on Booking Cancellation

If Service tax has been charged to customer on the basis of booking and deposited with department & later on booking is canceled by the customer, refund of service tax paid earlier can be made to him. 

Amount of service tax so refunded can be adjusted against the subsequent payments of service tax. As per rule 6(3) of Service Tax Rules, if excess tax is paid, in respect of service which is not provided either wholly or partially for any reason, the excess service tax paid can be adjusted against service tax payable for subsequent period, if the value of services and tax thereon is refunded to the person from whom it was received.

Registration

A builder can either take separate service tax registration for each project or have centralized registration after studying pros and cons. If proper records etc. are kept, centralized registration will be preferable.  It may be advisable to register each project separately in following cases – (a) If some services are exempt and some taxable or (b) valuation basis for each project is expected to be different,.

Tax payable only by a Builder

If a customer who has purchased a flat/commercial unit/industrial gala/shop from builder/developer, sells it before Completion Certificate, such sale is not laible under service tax

The words used in the ‘Explanation’ are ‘by the builder or a person authorized by the builder’. A customer is not a person authorized by builder to enter into contract for construction. Hence, a customer cannot fall within that definition.

Even otherwise, service tax is payable on value of taxable service which has already been paid by builder/developer. Even if the customer sales the flat or unit or shop at higher price, it does not mean that cost of construction has increased.

Preferential location and development of complex’ service

As per section 65(105) (zzzzu) of Finance Act, 1994, any service provided or to be provided, to a buyer, by a builder of a residential complex, or a commercial complex, or any other person authorized by such builder, for providing preferential location or development of such complex but does not include services covered under sub-clauses (zzg), (zzq), (zzzh) and in relation to parking place, is a ‘taxable service’. Explanation. — For the purposes of this sub-clause, ‘‘preferential location’’ means any location having extra advantage which attracts extra payment over and above the basic sale price.

CBE&C, has clarified as follows – (Annexure- A to JS (TRU-II) D.O. letter F. No.334/1/2010-TRU dated 26-2-2010)

It has been reported that in addition to these activities, the builders of residential or commercial complexes provide other facilities and charge separately for them and these charges do not form part of the taxable value for charging tax on construction. These facilities include,- (a) prime/preferential location charges for allotting a flat/commercial space according to the choice of the buyer (i.e. Direction- sea facing, park facing, corner flat; Floor- first floor, top floor, Vastu- having the bed room in a particular direction; Number- lucky numbers); (b) internal or external development charges which are collected for developing/maintaining parks, laying of sewerage and water pipelines, providing access roads and common lighting etc; (c) fire-fighting installation charges; and (d) power back up charges etc.

Since these charges are in the nature of service provided by the builder to the buyer of the property over and above the construction service, such charges are being brought under the new service. Charges for providing parking space have been specifically excluded from the scope of this service. Development charges, to the extent they are paid to State Government or local bodies, will be would be excluded from the taxable value levy. Further, any service provided by Resident Welfare Associations or Cooperative Group Housing Societies consisting of residents/owners as their members would not be taxable under this service.

Immediate Steps to be taken by a builder/developer  

Apply for registration within 30 days.

Prepare and submit running Bills till cut off date i.e. 1-7-2010, backed by Architect Certificate for the construction completed up to 1.7.2010

Make full disclosure about construction value not offered to service tax so as to avoid penalty for suppression of facts.