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Service Tax in relation to construction activities - A Case Study [Submitted by CA. Shivani Shah, June 03, 2008 The construction industry may face the Departments' wrath yet again!!! Harekrishna Developers The Applicant intends to develop a residential complex on its own land, which is already earmarked. At the time of booking, the customers enter into agreement that the building and the development of the residential units are to be done by the Applicant. The Applicant does a portion of such construction and contractors do the rest. Only, once the construction is complete and full payment is realized, the actual sale of land with the unit takes place. It was held that the activity of construction and building residential units on ear marked plots and making the construction as per the plan, design etc., obtaining permissions and providing common infrastructural facilities as per the agreement entered into between the Applicant and the buyer, would undoubtedly tantamount to rendition of service by the Applicant under clause (zzzh) of section 65(105) of the Finance Act, 1994, (herein after referred to as 'Act') i.e. under the taxable service category of 'Construction of Complex Services'. The arguments regarding the fact that the ownership is transferred only after the construction as per the agreement were rejected. It was held that undue stress is laid on the fact that the ownership remains with the Applicant till the completion. The plea of the Applicant on issue of self-service stood rejected since the Applicant did everything to honour its commitment to the buyers. Further, held that the engagement of a sub contractor does not absolve the Applicant of its liability. Thus, the master circular bearing number 96/7/2007-ST dated 23/08/2008 not accepted. Thus, this advance ruling in the case of M/s Harekrishna Developers (as given on 07/04/2008 on application by the Ahmedabad based dealer and pronounced by Hon'ble Justice PV Reddy, Chairmen, AAR) has revived an issue, which was settled by the Department about a year ago, after significant deliberations. Before delving deeper into the ruling, it becomes imperative to consider the background of the controversy regarding service taxability of builders / developers under construction of complex services. These services were first brought within the ambit of service tax w.e.f 16/06/2005 (vide Finance Act, 2005). The issue of levying service tax on builders / developers selling residential units first cropped up when the Director General of Service Tax (DGST) issued a circular in this regard, based on the Supreme Court's judgment in K. Raheja development Corporation vs. State of Karnataka ([2003] 3 STR 337 SC). In this case, the Apex Court had held that where a builder / developer sells a flat under construction for a consideration to be received in installments, such a transaction is a works contract and hence chargeable to VAT. The significant aspect in this case was that the case was unrelated to service tax. Subsequently, based on the ratio of the case of K. Raheja (supra), the DGST issued a circular F.No. V/DGST/22/Audit/Misc./1/2004/Mumbai dated, 16-02-2006, stating therein that as sales of residential units amounted to works contracts and since works contracts also involved services, such contracts were chargeable to service tax under the heading of residential complex construction services. The above DGST circular was challenged in a writ in the Bombay High Court. While the case was pending with the Court, the CBEC issued a clarification bearing Circular F.No. 332/352006-TRU dated 01-08-2006 stating that where the builder, promoter or developer builds a residential complex, having more than 12 residential units, by engaging a contractor for construction of such a residential complex, the contractor would be liable to pay service tax on the gross amount charged for the construction services provided to the builder under 'construction of complex' service. The circular also stated that if no other person was engaged for the construction work and where the builder undertook construction work on his own, then in the absence of the service provider and service recipient situation, the question service taxation of such contracts did not arise. Though the above circular was not explicitly clear in its language, it was nevertheless interpreted in a positive sense by trade and industry. Further, post this clarification, the Department raised the no demands on builders of residential complexes and the litigation in the Bombay High Court also did not proceed. With an intention to bring an end to the long standing controversy, the Government, in 2007 brought in a new category of taxable service namely 'works contract services' within the net of service tax. This category included within its purview, works contracts relating to residential complex construction services as well. Also, with a view to remove any doubts on the appropriate classification of the service, the Department clarified that if a specified contract is 'works contract' on which VAT / sales tax is payable, the service will be taxable under this new service category of 'Works Contract Service'. The advance ruling has however revived the controversy for the past periods and given a headway to the controversial chapter that seemed to have been relatively settled .The ruling holds that since the words 'in relation to' are used in the definition of taxable service, construction and other incidental and allied activities are covered therein and hence the sale of a residential unit, for which the purchaser book the unit in advance, would be covered under this category. In this regard the Authority has observed that though in one sense, the developer can be said to be constructing the residential unit on his own account and not on behalf of the customer, yet the developer did everything to honour his commitment to the customer from whom he had received valuable consideration. Thus an agreement to sell a 'to be built unit' would attract service tax while an outright sale of an already built unit would not attract the tax. Another point made by the Authority is that the clarification issued by the CBEC lacks clarity in terms of its intent and cannot be interpreted to mean that developers are not liable to pay service tax. Further, as to the issue of classification of a service with respect to two contending categories of residential complex services and works contract services, the Authority observed that as per Section 65A of the Act, the most appropriate category to classify the service in question is 'construction of complex services', irrespective of the fact that the service could also be brought within ambit of 'works contract services'. The ruling is thus primarily based on the representations of the Department against its own circulars. This has created confusion and has also given rise to the issue of whether the Department could so represent against its own clarifications. While the ruling has limited force in terms of its applicability, the Department has apparently started issuing show cause notices based thereon. The construction industry may thus expect nerve wracking demands from the Department yet again though the applicability of the AAR is restricted in its scope in view of section 96E of the Act. (The views expressed above are strictly personal)
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