From: Rebecca Andrews <rebecca.andrews88@yahoo.in>
Date: Fri, Feb 17, 2012 at 1:57 PM
Subject: Message from EGroup of SolapurCAs CBEC's Construction Services Circular Causes Confusion - Sivakumar S - 3S Solutions
To:
| CBEC Circular on Construction Services – Yet another googly on bouncy track? THE Board has come out, yet again, with a highly controversial Circular 151/2/2012-ST dated February 10, 2012, 'clarifying' certain issues related to the levy of service tax on construction services, to the field force. That it should take about seven years for the Board to express its view on the levy of service tax on joint development agreements speaks volumes about the absolute lack of clarity on the subject matter. I've tried to discuss the two most important issues dealt with in this Circular, in this piece. I've used the term 'pure Developer' from the factual point that, such Developer does not carry out the actual construction activity, which is actually carried out by the contractor/(s).At the very outset….. this circular has been issued to clarify issues related to two services, viz. Commercial or Industrial Construction services and Construction of complex services. Quite obviously, this circular does not clarify anything on issues related to the levy of service tax under 'Works Contract' services. This is rather surprising given the fact that, with the introduction of service tax on works contracts with effect from June 1, 2007, most of the players operating in the construction industry have shifted to classifying their services under 'works contract' services, given the fact that, 'works contract' services is a specific head as contrasted to 'Construction of complex' services or 'Commercial or Industrial construction' services. Moreover, as per Section 65A, works contract services being a specific head, service providers are duty bound to classify their services under this head in preference to the other two services. In my view, with the introduction of service tax on works contracts, nine out of ten cases in the construction sector would fall under this service. One does not then understand the practical utility of continuing to issue clarifications on construction services, given the legal position that, these clarifications will not be applicable to works contract services. Service tax on pure Developers/Builders Be that as it may …. let's try to analyse certain important 'clarifications' that the Board has issued. Firstly, the circular makes a statement that, pure Developers/Builders who have completely sourced out the construction activity to contractors are liable to pay service tax with effect from July 1, 2010, in terms of the Explanations added by the Finance Act, 2010 bring into effect, the concept of 'deemed services' under the construction services. It seems that this Circular is making a clear distinction between Developers/Builders who carry out the construction activity and Developers/Builders who have fully outsourced/contracted out the construction activity. In the Board's view, while the former is taxable for the period prior to July 1, 2010 (and obviously from June 16, 2005), in the case of the latter, the Developers/Builders who do not undertake the construction will come into the service tax net with effect from July 1, 2010 under the 'deemed services' concept. I have no issues with this view, by the way, in so far as the taxability of Developers/Builders who undertake construction activity is concerned, for the period prior to July 1, 2010. However, the Board's view that, pure Developers/Builders who do not undertake the construction activity are also liable from July 1, 2010 might be unsustainable. In terms of the decision of the Apex Court in State of Andhra Pradesh v. L & T Ltd (2008) 17 VST 001(SC)which has been relied upon by several High Courts including the Karnataka High Court in theSkyline Constructions case (2001) 37 VST 290, a pure Developer who does not undertake the construction activity is not a works contractor within the meaning of the VAT law. It is the contractor who is treated as the works contractor, liable for payment of tax under the VAT law. Viewed in this context, a pure Developer/Buyer, referred to in the Board Circular in the tripartite agreements model, is not a works contractor under most State VAT Laws. In terms of the definition contained in the Finance Act, 1994, for a person to be treated as a 'works contractor' under the service tax law, it is a pre-requisite that, he should be a works contractor under the VAT law. If this view is accepted, a pure Developer who does not undertake the construction activity cannot be treated as a 'works contractor' under the service tax law. Can the pure Developer/Builder who is not a works contractor under the service tax and is consequently not liable to service tax under 'Works Contract' services which is a specific head (even by the Board's own admission vide Circular No. 128/10/2010 dated August 24, 2010), can still be covered under Construction services, which is generic head, by virtue of this Circular? I highly doubt the legal sustainability of the Board view in the light of the well-established judicial principle that once a service is exempted under a specific category, it cannot be brought under a generic head. Be that as it may, vis-à-vis pure Developers/Builders…. this Circular would seem to have given a quite burial to the famous Circular No. 108/2/2009 dated January 29, 2010, in as much as, by clarifying that even pure Developers/Builders would be taxable from 1-7-2010 despite not undertaking construction work, the Board is seen to be reiterating the view that, so long the construction activity is undertaken by the Developer/Builder, even party, service tax is leviable for the period prior to 1-7-2010, even if the Developer/Builder enters into an agreement of sale of the flat as an immovable property, as contrasted to entering into two Agreements, viz. one agreement for the sale of the undivided portion of the land and the other, for the construction of the flat. In terms of the current law on levy of VAT/sales tax on sale agreements, in the light of the binding effect of the decision of the Supreme Court in the K Raheja case, even sale agreements which are also referred to as 'single agreements' are liable to the levy of VAT in many States including Karnataka. If a transaction is treated as a works contract within the meaning of the VAT law, it would be very difficult to take the view that, such an agreement is not a works contract for service tax purposes. Hence, it would no longer be wise to go by the view that sale agreements cannot be subjected to service tax. This has been my strong view, even before the issuance of this Circular. Service tax on joint development agreements Secondly and more importantly, the Circular makes a highly controversial statement that, Developers and Builders are liable to service tax even in respect of the flats/apartments constructed and exchanged with the Land Owners, under what are typically referred to Joint Development Agreements. In my strong opinion, this view is legally unsustainable and reflects a complete lack of understanding on the Board's part. Let's first discuss what a joint venture is. A joint venture is an association of two or more persons to carry out a single business enterprise for profit [Words and Phrases, permanent edition, Vol. 23, p.117] {Cited in (1997) 89 Com Cases 849, pp.867-868}. In terms of Black's Dictionary 9th Edition, 2009 (page 915), "Joint Venture" is a business undertaking by two or more persons engaged in a single defined project. The necessary elements are: (1) an express or implied agreement ; (2) a common purpose that the group intends to carry out; (3) shared profits and losses; and (4) each member's equal voice in controlling the project The Accounting Standard No. 27 issued by the Institute of Chartered Accountants defines Joint Venture as a contractual arrangement whereby two or more parties undertake an economic activity, which is subject to joint control.In terms of the Apex Court's decision in New Horizons Ltd v. Union of India (1997) 89 Com Cases 849, p.867 (SC), 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 is clear that the joint development agreements entered into between Land Owners and Developers / Builders assume the character of a joint venture, in as much as, the Land Owner brings in the land and the Developer brings in his expertise to build and market the property, for sharing of profits and losses. In most cases, the joint development agreement provides for the exchange of a certain portion of the total built up area by the Developer, in exchange for the portion of the land, in what is essentially a transaction involving a barter.Service tax gets attracted only when there are two parties, viz. the service provider and the service receiver. In a joint venture, the concept of mutuality prevails in as much as, there are no parties involved. Some of the cases in which the CESTAT has taken the view that joint ventures are not covered under service tax are Initiating Explosives Systems v. CCE, Kolkata-V, Sunshield Chemicals Ltd v. CCE, Raigad, CCE, Chennai v. Sundaram Finance Ltd and Glaxo Smithkline Pharmaceuticals Ltd. v. CCE, Mumbai. More importantly, in CST v. Puravankara Projects Ltd, the Bangalore CESTAT had taken a prima facie view that, in joint development agreements, no service is rendered by the Developer to the Land Owner. Hence, the current judicial view is clearly against joint development agreements being subjected to service tax levy. And, what happens to the 'dominant intention' test enunciated by the Supreme Court in several cases and notably in the BSNL case (2006-TIOL-15-SC-CT-LB). Is not the 'dominant intention' in the case of a joint development agreement, one of partnership and not one of provision of service? How can service tax be then levied, in the absence of a service provider-service receiver relationship? Even the Board has recognized that transactions between two contracting parties, on a principal to principal basis, are not to be treated as 'services' in terms of Circular No. 109/03/2009 covered by F. No. 137/186/2007 - CX. 4 dated 23-02-2009. In this Circular which was issued with regard to the applicability of service tax on screening of films by theatre owners, the Board has clarified that under the particular type of arrangement which typically is undertaken between the theatre owners and the distributors of films, a revenue sharing model operates whereby a fixed and predetermined portion/percentage of revenues earned from the sale of cinema tickets goes to the theatre owners and the residual portion/percentage is paid over to the distributors. The Board had clarified that in such a situation, the two contracting parties act on a principal to principal basis and do not provide any services to each other and consequently no service tax would apply. In this rather benevolent Circular (which may seem so untypical of the Board), a clear has been articulated that, in any revenue sharing arrangement, the contracting parties do not provide services inter se to each other but merely come together to jointly undertake an economic activity and to share the economic gains resulting from such activity and hence, service tax cannot be levied. Though this view has been expressed in the context of the levy of service tax on movie theaters, the concept is nevertheless, applicable to the case of joint development agreements, in my opinion. I fail to understand as to how the exchange of flats by the Developer/Builder for part of the land owned by the Land Owner is any different and how can the Board make a sudden U Turn and now take a view that such agreements are taxable, especially, in the light of the views expressed in Circular No. 109/03/2009. Let's view this issue from another angle. Assuming, for the sake of argument, that the Developer indeed renders taxable service to the land owner, how does one compute the value of such services, considering the fact that the transaction involves non-monetary consideration. As per Rule 3 of the Valuation Rules which have become effective from April 18, 2006, there are two methods that are provided for converting the value of the non-monetary consideration into a monetary value. As per the first method, the 'gross amount charged' by a service provider, for rendering a service in the ordinary course of business, would be the amount charged, assuming that no additional consideration has flown to the service provider. As per the second method, where it is not possible to arrive at the 'gross amount charged', the service provider will have to determine the equivalent money value of such non-monetary consideration, which cannot be less than the cost of provision of the taxable service. Obviously, it is the second method which could get pressed into service, if a view is taken by the Department that the developer renders a taxable service, vis-à-vis the land owner. And, how does one value the services, in a case involving the developer and the land owner, given the stipulation that such value cannot be less than the costs involved? And, how does one go about computing these costs, in the highly complex environment involving real estate transactions? The Board's view that the valuation is to be done in terms of rule 3(a) of Service Tax (Determination of Value) Rules, 2006 by comparing the value of other similar flats, seems highly impracticable and unsustainable. Taking this reasoning forward, what would happen if the joint development agreement talks of a token amount to be paid by the developer to the land owner, in addition to the exchange of the built up area with the portion of the land? In this case, can a view be taken that since the part consideration consists of cash, it is the cash element which will form the 'gross amount charged' for purposes of levy of service tax? Let's look at this from yet another angle. Let's assume that, the Land Owner enters into works contractors with his prospective customers, for selling the flats that he is go get, as part of the joint development. Surely, these would be treated as works contracts, for purposes of levy of service tax, despite that the Land Owner is not engaged in the actual construction activity. In the light of this Circular, the Developer/Builder is treated as the works contractor in respect of the flats to be exchanged with the Land Owner. Now, the question that arises is, this… can the same transaction of construction of flats earmarked for the Land Owner be subjected to the service tax levy twice… once, in the hands of the Developer and again, in the hands of the Land Owner? Not, for sure. And, finally, the transaction between the Developer/Builder and the Land Owner is in the nature of transaction of 'self-service' by the Land Owner. In other words, the Land Owner is employing the Developer/Builder for building flats for the Land Owner himself. The fact that the Land Owner might sell these flats subsequently, would not change the concept of the 'self-service' involved here, in terms of the Board Circular No. 108/2/2009 dated January 19, 2009, referred to in this Circular. Hence, even from this angle, there would be no service tax liability on joint development agreements. I would wonder if the Board has taken this view on joint development agreements, based on the decision of the Hon'ble Supreme Court in the case of Faqir Chand Gulati v.Uppal Agencies Pvt Ltd. In my view, this decision cannot be transported to the service tax law. In this decision, the Apex Court had held that the builder, entering into a joint development agreement with the Land Owner, is to be treated as a service provider, under Section 3 of the Consumer Protection Act, 1986 and the Land Owner is entitled to civil remedies, in the case of default by the Builder. But, we must bear in mind the fact, that the decision of the Apex Court given under the Consumer Protection Act cannot be transported into the service tax law, as the CPA, 1986 does not even define the term 'real estate' and hence, this case cannot be made applicable to the joint development agreements entered into between Land Owners and the Developers and Builders. Before parting … The Board has, yet again, come out with a Circular dealing with very important issues concerning the Realty Sector, in a rather casual manner. Sadly, the Circular makes no attempts in substantiating the Board's view that joint development agreements are taxable. Given the fact that most Realty projects are getting promoted under the joint development mode, this Circular would create a huge problem for the Developers, who would be well advised to challenge this circular in the judicial forums. For Developers and Builders who have classified their services under Works Contracts, the best thing to do would be to simply ignore this Circular. The views expressed by the Board vis-à-vis joint development, in the specific context of construction services, are not applicable to works contract services As aforesaid, with the introduction of service tax on works contracts with effect from June 1, 2007, one does not understand the need to continuously tinker with the existing provisions applicable for construction services. As such, the Realty Developers and Builders have been left to play in an unpredictable and bouncy track consisting of potholes, in the form of totally unclear tax provisions. The Board would now seem to have bowled a googly. In many cases, the Adjudicating Officers have passed orders, treating the 'services' rendered by Developers to Land Owners as 'exempted services' and asking these Developers to pay service tax/reverse proportional cenvat credit, under Rule 6(3). I would wonder as to the fate of these orders in the light of this Circular, most of which are already before the Tribunal. And, for indirect tax professionals (like me), this Circular provides a huge opportunity, as litigation related to the Realty Sector is bound to increase, manifold.
FEBRUARY 17, 2012 - Taxindiaonline By S Sivakumar, CA (The Author is Director, S3 Solutions Pvt Ltd, Bangalore) |
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