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"Service Tax not chargeable on Under-construction flats/villas too" rules Delhi High Cour

If neither the Statute nor its Rules provide for a mechanism to calculate the Service Tax, it cannot be levied” rules the Delhi High Court. Notifications & Circulars are only adhoc / administrative in nature and are not backed by any authority.

Service Tax, like few other acts in India, has been subjected to extensive judicial interpretation, thanks to the legislators. The recent judgement of the Delhi High Court on Service Tax has interpreted Rule 2A along with Sec 65 (105)(zzzh), probably the first salient and comprehensive interpretation thus far.

The Finance Act, 2010 brought composite contracts under the ambit of Service Tax and thereby Construction contracts, Flat/villa sale agreements were liable for Service Tax. Consequentially, the Rule 2A was amended to include a mechanism to determine the value of Service in composite agreements. Under these rules, composite agreements are entitled for an abatement of 75% of the Gross Agreement value towards value of goods & materials comprised therein. The remaining 25% will be construed as Service component and accordingly taxed at the applicable rates of Service Tax.

In the present case “Suresh Kumar Bansal Vs Union of India” the Delhi High Court considered the below:

  1. Whether Rule 2A of the Valuation Rules (introduced w.e.f on July 01, 2012) provides for a mechanism to calculate the Services Tax liability on composite agreements entered between Developer and a Flat buyer and

  2. Whether Service Tax can be levied on “Preferential Location” charges levied by a Developer. It is not uncommon for Developers to charge a premium for few select flats in a project basis its location for eg floor rise, pool facing or Vasthu compliant etc.

Taxing Mechanism:

In Composite Agreement entered between a Developer/Promoter and a buyer, the Gross Agreement Value includes 3 different elements apart from margins viz

  1. Value of immovable property viz land,

  2. Value of goods & material used for construction and

  3. Value of Services like labour.

The Court observed that while the aforesaid Rule 2A provides a mechanism to arrive at about the “Value of Goods” in composite agreements, the vital element of every Developer Agreement viz “Value of Immovable property” has not been covered in this Rule.

The court noted “Whilst Rule 2A of the Rules provides for mechanism to ascertain the value of services in a composite works contract involving services and goods, the said Rule does not cater to determination of value of services in case of a composite contract which also involves sale of land. The gross consideration charged by a builder/promoter of a project from a buyer would not only include an element of goods and services but also the value of undivided share of land which would be acquired by the buyer.”

The Court, drawing reference to the recent Supreme Court’s ruling on “CCEC, Kerala vs L&T Ltd” also noted that “neither the Act nor the Rules framed therein provide for a machinery provision for excluding all components other than service components for ascertaining the measure of service tax. The abatement to the extent of 75% by a notification or a circular cannot substitute the lack of statutory machinery provisions to ascertain the value of services involved in a composite contract.”

Taxability of Premium Charges on Preferential location:

The Petitioners contented that the Developer cannot levy Service tax on the “Preferential Location Charges” as the same related only to the location of an immovable property and therefore such charges were not eligible for Service Tax.

The Government contended that Sec 65 (105) (zzzzu) was introduced to include the preferential locational charges as a taxable service for Service Tax. The explanation to this sub-section states “Preferential location means any location having extra advantage which attracts extra payment over and above the basic sale price;”

The Court while rejecting the challenge against levy of Service Tax under Sec 65 (105) (zzzzu), noted that “we do not find any merit in the contention that there is no element of service involved in the preferential location charges levied by a builder. We are unable to accept that such charges relate solely to the location of land. Thus, preferential location charges are charged by the builder based on the preferences of its customers. They are in one sense a measure of additional value that a customer derives from acquiring a particular unit. Such charges may be attributable to the preferences of a customer in relation to the directions in which a flat is constructed; the floor on which it is located; the views from the unit; accessibility to other facilities provide in the complex etc. As stated earlier, service tax is a tax on value addition and charges for preferential location in one sense embody the value of the satisfaction derived by a customer from certain additional attributes of the property developed. Such charges cannot be traced directly to the value of any goods or value of land but are as a result of the development of the complex as a whole and the position of a particular unit in the context of the complex.”

Personal Comments:

  • Whilst there have been sizeable number decisions around various aspects of the Service Tax Act, this is the first salient and comprehensive decision on whether there are adequate taxing mechanisms provided within the Statute itself or its rules.

  • The existing provision of 75% abatement excludes “Value of Goods” from composite agreements and does not exclude “Value of Immovable Property”. This, the Court held as non-existence of an effective machinery for levy of Service Tax.

  • This decision once again establishes that Circulars / Notifications are purely adhoc and administrative in nature. Taxation by way of Circulars / Notifications are not backed by authority of law and is contrary to Article 265 of the Constitution of India.

  • This decision, which is on a Central Legislation has to be applied by tax authorities across India unless there exists a conflicting decision by another State High Court. We can expect the Government of India to appeal before the Supreme Court as the ruling is set have serious revenue implications.

(These are the personal views/opinions of the Author and readers are requested to seek formal legal advice prior to acting upon any of the information provided herein. This update is not intended to address the circumstances of any particular individual or corporate body.)

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