In case of a Real estate and construction industry, where due to various political and economical reasons we have seen that there is a sharp downturn being noted in the sale of residential and commercial construction projects irrespective of fact that the prices of land are still reaching sky high. Therefore, in a current business and economic conditions where uncertainty prevails over everything it becomes financially not so viable for a developer to acquire and purchase the land from the land owners and then perform the construction activity. However, as we know that every problem comes with a solution. In order to ensure financial and commercial viability of the construction projects, one of the solution is that the developers enter into a “Joint Development Agreement” with land owners whereas the capital, construction and legal work will be carried out by the developer and the land will be provided by the land owner. Ultimately the developer and land owners share the profit in the any agreed ratio (Generally, it will be in the ratio of 60:40. However, the same may differ based on location, construction cost, development cost etc). It is sometimes also a tripartite agreement between the land owner, builder/developer and a contractor. We are discussing the first category of arrangement in this article.
In order to understand a practical functioning of Joint Development Agreement, let us take an illustration. For instance assume, ABC developers limited enters into a Joint Development Agreement with land owner Mr XYZ whereas in lieu of this agreement a total of 1000 residential units will be constructed by ABC ltd on the land provided by Mr XYZ whereas 40% of the units i.e. 400 units shall be given to Mr. XYZ and rest 600 units shall be taken by ABC ltd. Both can commercially sell the units in the open market. Land owner gets 400 units of flats in lieu of the land given and Developer gets 600 units of flats in lieu of the construction work done.
As we have learnt that with every problem comes a solution but it will also not be incorrect to say that with every solution comes the new problem. Of course, that’s the life cycle. As far as service tax law is concerned the moot problem that persists in this are the following:
A. Whether the agreement between developer and land owners is in the nature of joint venture?
B. If it is not a joint venture then whether the transaction of giving 400 units of flats in return of a land (i.e. a non - monetary consideration) amounts to service and whether the same is liable for service tax?
C. If it is liable for service tax, then what shall be the value adopted for levying service tax as the consideration given in land is in non-monetary form?
D. If the value is computed, then when shall the liability to pay service tax arises? i.e. what shall be the point of taxation? Is it at the time of transfer of development rights? Or at the time of entering into agreement or at the time of possession of flats?
Let us answer each question one by one:
A. Whether the agreement between developer and land owners is in the nature of joint venture?
CBEC vide circular No. 151/2/2012-ST dated 10th February, 2012, it has been clarified that applicability of service tax under these joint development models, shall be decided based on the principles enumerated in the transaction of revenue sharing between distributors/sub-distributors and film exhibitors where one supplies film and other exhibits the same in their theatre.
In the said circular, it is held that a joint venture is recognized as legal & juristic entity in the nature of partnership of constituent business entities. Further relied on Supreme Court judgment as to the meaning of joint venture wherein it was held that “the expression ‘joint venture’ connotes a legal entity in the nature of a partnership engaged in the joint undertaking of a particular transaction for mutual profit or an association of persons or companies jointly undertaking some commercial enterprise wherein all contribute assets and share risks. It requires a community of interest in the performance of the subject-matter, a right to direct and govern the policy in connection therewith, and duty, which may be altered by agreement, to share both in profit and losses”.
It is further clarified that two or more entities undertaking a particular activity for mutual benefit will be treated as joint venture only when they are sharing risks and rewards. In other words, where no risks and rewards are shared, they cannot be called as joint venture. In such case, the transactions between them constitute as took place between two separate persons.
In the instant case, land is contributed by Mr. XYZ and the same is developed by ABC ltd. Each of them are sharing built up area and no risks and rewards are being shared. So their association to construct residential complex cannot be called as joint venture. Therefore, in view of the principles laid down in the said circular, both developer and land owners are treated as different persons and not as joint venture.
B. If it is not a joint venture then whether the transaction of giving 400 units of flats in return of a land (i.e. a non - monetary consideration) amounts to service and whether the same is liable for service tax?
The term ‘Service’ has been defined under section 65(B)(44) of the finance act, 1994. The relevant extract is as follows:
"service" means
- any activity carried out by a person for another
- for consideration.
In the given case, activity of ‘construction’ is being carried out. Further, as the agreement is not in the nature of joint venture, therefore it can also be said that the parties to the transaction are two different persons and therefore the activity is carried out by one person for another person.
Consideration is involved in the transaction in a non-monetary form i.e. instead of giving ‘cash’ land lord is giving a piece of land in lieu of 400 flats received by it. Therefore, it can be said that developer is providing a service to the land lord by giving 400 units of flats and in return land lord is giving consideration for service in the non-monetary form of land.
Further, in the case of LCS City Makers Pvt Ltd vs CST, 2013(030)STR0033(Tri-Mad) wherein it was held that services by way of construction of residential complex to land owners who are transferring their rights in land and getting constructed flats are liable for service tax.
C. If it is liable for service tax, then what shall be the value adopted for levying service tax as the consideration given in land is in non-monetary form?
In terms of section 67(1), consideration can be both monetary and non-monetary. In case where consideration is not determinable ordinarily, then the same is required to be determined in terms of the Service Tax (Determination of Value) Rules, 2006.
Rule 3 of the Service Tax (Determination of Value) Rules, 2006 provides that:
a. the value of such taxable service shall be equivalent to the gross amount charged by the service provider to provide similar service to any other person in the ordinary course of trade and the gross amount charged is the sole consideration;
b. where the value cannot be determined in accordance with clause (a), the service provider shall determine the equivalent money value of such consideration which shall, in no case be less than the cost of provision of such taxable service.
In the instant case, the value of taxable service provided shall be the proportionate market value of the land on the date of allotment. However, if the same is not ascertainable then the value shall be the price at which similar flats are sold in the ordinary course of trade to other buyers. In case the price of flat undergoes a change over the period of sale then the value of similar flat as sold nearer to the date on which the land is made available for construction should be used for arriving at the value for the purpose of tax. Overall, the value in any case shall not be less than the cost of construction of the land owners share.
D. If the value is computed, then when shall the liability to pay service tax arises? i.e. what shall be the point of taxation? Is it at the time of transfer of land? Or at the time of completion of flats?
According to Rule 3 of these Rules, the point of taxation shall be earlier of the following events.
1. Date of receipt of consideration
2. Date of completion of service with respect to each event in case where invoice is not issued within 30 days
3. Date of issue of invoice.
Generally with respect to construction services especially between landlords and developer, there would not be any system of issue of invoices. Therefore only two of the above events would be relevant i.e. date of receipt of consideration or completion.
In case of Joint development agreements, the consideration received by developer is the date on which development rights are received by him. This is generally before the project commencement date. Accordingly service tax is required to be paid by 5th/6th of the month following the quarter in which such development rights are transferred.
A similar view has been taken in Circular 151/2/2012-ST dt.10.02.2012. Para 2.1 of circular clarifies that “Service tax is liable to be paid by the builder/developer on the ‘construction service’ involved in the flats to be given to the land owner, at the time when the possession or right in the property of the said flats are transferred to the land owner by entering into a conveyance deed or similar instrument (eg. allotment letter).
However, generally developmental rights are transferred before the commencement of construction and it very is harsh to levy service tax at such a point which leads to huge cash outflows for the developers at the start of project itself. Further, it is also difficult to arrive at value at that point as the construction cost and value of sale of similar flats is unknown. Therefore, the point of taxation has been a matter of issue in this regard. To conclude, many construction companies are taking divergent views based on their risk appetite to arrive at which point they prefer to pay service tax. An aggressive view would be to pay on completion of the commercial construction and on transfer of the possession of the flats and a safe view would be to pay at the time of transfer of developmental rights. However, there also exists a moderate view which is to pay proportionate amounts on completion of each event leading to total payment being made by the completion of whole construction.
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