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L&T judgment of the Supreme Court

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Contents

Real Estate Industry – Varying Tax and Contracting PracticesA l i f th L&T J d tAnalysis of the L&T JudgmentImplicationsL&T - Previous ruling of the SCQ & AQ & A

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Real Estate Industry – Varying TaxReal Estate Industry Varying Tax and Contracting Practices

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Real Estate – Varying Practices

Taxation of Residential Real Estate Sector – Still Nascent and Evolving

Developers / Builders yet to get a grip on the optimum tax efficient / li t d l b it th t t JDA tcompliant models – be it on the customer agreements, JDAs, etc

VAT / Service Tax positions were driven by State level practices – No consistency across India

Same Developer may have had different VAT / service tax position for different projects across India

Differing contracting models – adds to the inconsistencies in tax positions

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In case of dual agreement model - Supreme Court ruling in K Raheja case applies - where applicability of VAT is upheld

In case of a single agreement model – Industry was eagerly awaiting the

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inIn case of a single agreement model Industry was eagerly awaiting the Supreme Court larger bench ruling in the case of L&T

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Real Estate – Contracting ModelsSingle Agreement model Dual Agreement Model

• A single agreement to sell the flat along with undivided interest in land executed with the

• Two agreements are entered into – one for sell of undivided share in land and another

intending purchasers• Arguments taken in most cases for no VAT, as

- The arrangement is not for undertaking construction for and on behalf of the prospective customer

agreement to build/construct• Agreement to build is essentially for

construction of the flats for and on behalf of the prospective customer

• The ownership in the constructed propertyprospective customer- Absolute ownership over the constructed

flat continues to remain with the builder -Ownership of property gets transferred to customer only after completion of

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The ownership in the constructed property passes to the customer by ‘accretion’ during construction (ie, as and when the property is being developed)

• After construction, mere possession of the t t d t i h d d

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construction- In case of termination of the agreement,

the customer does not enjoy any right in the flat or in the land - The builder would only be liable to refund the advance

constructed property is handed over• No separate sale deed is executed

between the Developer and the purchaser• Stamp duty is typically paid only on the

value of the land value or in some States

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ydeposit received

- Conveyance is executed by builder only after building is complete and possession is handed over - Conveyance is in respect of land as well as the flat constructed

on the guidance value of the flat, if higher

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of land as well as the flat constructed • Stamp duty typically paid on entire sale price

Different States – Different Practices

State Predominant Contracting Model

VAT Service Tax

Karnataka Dual Agreement Model Yes Yes – under worksKarnataka Dual Agreement Model Yes Yes – under works contract services

Tamil Nadu Dual Agreement Model Yes Yes – under works contract services

G D l A t M d l Y Y dGurgaon Dual Agreement Model Yes Yes – under Construction of complex services

Delhi Single Agreement Model Yes Yes – under Construction of complex

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Construction of complex services

Mumbai Single Agreement Model Yes - Mainly under composition option

Yes – under Construction of complex services

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West Bengal Single Agreement Model No Yes – under Construction of complex services

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Analysis of the L&TAnalysis of the L&T Judgment

Facts of the Case – L&T HC matter

Facts from L&T case

L&T had entered into development agreements with land owners (to develop and share constructed flats)and share constructed flats)

L&T had entered into agreements of sale with purchasers, wherein on completion of construction, the flats would be handed over to purchasers who will also get undivided interest in landwill also get undivided interest in land

Karnataka HC upheld the demand of sales tax on amounts collected by L&T from purchasers of flats treating it to be works contract turnover - L&T had appealed to SC against this ruling

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tiveThe two member bench of SC, referring the Raheja Development case to the

Chief Justice for re-consideration, observed as follows:

If ratio of Raheja Development is accepted, there would be no difference between

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An agreement to sell entered between Developer and prospective purchaser could be for future sale of flat (and not for undertaking construction on behalf of purchaser)

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Facts of the Case – Maharashtra Chambers of Housing

Facts from Maharashtra Chambers of Housing Industry case

Assessee had appealed to the Bombay HC on the constitutional validity of levy of VAT on agreement to sell flats to buyersof VAT on agreement to sell flats to buyers

Bombay HC, upholding the constitutional validity, held that

Works contracts have numerous variations

Not possible to accept the contention that contract for works in the course of which title is transferred to the flat purchaser would cease to be works contract

This ruling of the HC was contended before the SC

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tiveConstitutional validity of the expanded Section 2(24) of the MVAT Act as well as

Rule 58(1), Rule 58 (1A) of the MVAT Rules was challenged

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Judgment

View taken in Raheja Development on the definition of “works contract” is justified

Argument that agreement between Developer and flat purchaser is for sale ofArgument that, agreement between Developer and flat purchaser is for sale of flat and not to appoint Developer as contractor of flat purchaser, is devoid of merit

Incorrect to say that work is undertaken by Developer for himself and the owner y yand construction is not carried for and on behalf of purchaser

Levy of VAT only on value of material involved in execution of works contract, even though it is composite contract for works contract and transfer of immo able propert

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immovable property

Validity of MVAT Provisions

Amendment in explanation b(ii) to Section 2(24) brought because of judgment of

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Mode of valuation of goods provided in Rule 58(1A) has to be read to include value of goods only at the time of incorporation - even though property in goods passes later Rule 58(1A) accordingly to be read down to this limited extent

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passes later - Rule 58(1A) accordingly to be read down to this limited extent

Key Principles from the Judgment

Immovable Property Sale vs Works Contract

A contract comprising both works contract and transfer of immovable property, does not denude it of its character as works contractdoes not denude it of its character as works contract

Term “works contract” in Article 366 (29-A)(b) takes within its fold all genre of works contract and is not restricted to one species of contract to provide for labour and services alonelabour and services alone

Building contracts are species of works contract

Three conditions to be fulfilled to tax deemed sale of goods in works contract:

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there must be a works contract

goods should have been involved in execution of works contract

property in those goods must be transferred to third party either as goods

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inproperty in those goods must be transferred to third party either as goods or in some other form

Single indivisible contract for sale of flat is on par with contract containing two separate agreements

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Key Principles from the Judgment

Immovable Property Sale vs Works Contract (cont.)

Value of goods for levy of tax has to be value of goods at time of incorporation of goods in works - even though property passes as between Developer and flatgoods in works even though property passes as between Developer and flat purchaser after incorporation of goods

Works contract applicable only from the stage the Developer enters into contract with flat purchaser - Value addition made to goods transferred after agreement is entered into with flat purchaser can only be made chargeable to tax by States

No tax payable if no contract entered until completion of construction

The fact that building is intended for sale ultimately after construction does not

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g ymake any difference

Dominant Intention Test

The dominant nature test has no application in any contract that has element of

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inThe dominant nature test has no application in any contract that has element of works contract specified

Traditional decisions which have held that substance of contract must be seen, have lost their significance after amendment in the Constitution in 1982

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IMPLICATIONS

Impact in States where VAT is being paid…

Even Developers who are already paying VAT – to face valuation issues and credit reversals

SC h h ld th t VAT li bl l f t t d tSC has held that VAT applicable only from contract date VAT to be paid only on goods incorporated after agreement with the intended buyers

E h t t h diff t VAT t T ki h i f hEach agreement to have different VAT amounts – Tracking mechanism for each customer would be a challenge to the Developers

Input credit availment/ sub contractor deduction and reversals to be a challenge

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Many States do not have facilitating provisions

Even otherwise, availing credits/ sub contractor deduction on a pro-rata basis suo-moto will also be contentious

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inReversal of credits would impact overall costing and hence imposes challenges of recovery of lost credit/ sub contractor taxes from the customer

Industry will have to adapt to these changes

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Impact in States where VAT is being paid

Possibility of claiming refund of excess VAT paid (depending on the stage of booking) by Developers / purchasersAnalysis of composition scheme vs regular / abatement methods for payment of VAT – assumes more significance

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Impact in States where no VAT is paid…

State Governments would now aggressively pursue Developers

Many States may not even be required to make retrospective amendments to levy VAT

Definition of “works contract” in State Legislations typically include any agreement for carrying out for cash, deferred payment or other valuable consideration, the building / construction of any immovable propertybuilding / construction of any immovable property

Completed Projects Developers may not be able to recover VAT from purchasers

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Ability to avail past VAT credits/ sub-contractor deductions should be examined and may be a challenge

Implications where assessments complete and legal ability for the authority to

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inreassess, to be examined – as the ruling is an “interpretation of the law” as it always existed and not a “change in law”

Implications not confined to transaction with end customers – implications on J i t D l t A t (“JDA”) t b i d

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Impact in States where no VAT is paid

States could introduce a voluntary compliance scheme for payment of arrears (without penalty and possibly interest) as a facilitation measure

Recently some states, even prior to ruling, have taken an interpretation that “under construction contracts” would be exigible to VAT

Delhi has recently made detailed amendments to the rules – to cover residential transactions

Haryana has recently issued a circular covering JDA

Industry representation to States is an option that should be explored

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Industry representation to States is an option that should be explored

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Joint Development / Collaboration Agreements…

Joint Development / Collaboration Agreements also get covered

Typical arrangement involves landowner providing developmental rights to Developer to construct buildings on the land provided by landowner, in exchange for share in revenue from sale of flats or share in constructed flats

Landowners’ share of building constructed by the Developer, would be covered as works contract liable to VATworks contract – liable to VAT

Argument of barter may not hold good

Developer does not take title to land – but receives money for the proportionate l d d b th l d di tl t th D l ’ h

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land conveyed by the landowner directly to the Developer’s purchaser

Some State VAT laws have already clarified taxability of such transactions

Haryana and Karnataka have issued specific circulars wrt JDA

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Delhi has recently made detailed amendments to the rules

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Joint Development / Collaboration Agreements

Practical issues wrt discharge of tax on JDA transactions

Varied practice on valuation - No uniformity wrt valuation of construction services deemed to be carried out by the Developer for the landowner in lieu of land

No clarity on the time for payment of taxes

Recovery of tax from Landowners - JDA should provide for this to avoid disputesy p p

No clarity on liability of Landowner on pre-sales of his share of units

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Karnataka Circular No KSA CR 121/09-10 dated December 7, 2009

Valuation of consideration payable by the LO to the developer for construction of his share of building

Where Developer collects amounts separately from his customers towards theWhere Developer collects amounts separately from his customers towards the share of undivided interest in the land

Aggregate of all such amounts collected would be considered as consideration payable by the LO to the developer for construction of his share of building for levy of VAT

If no separate amount is collected by the developer from the customers towards the undivided interest in land

Aggregate of amounts declared by the developer to be the value of undivided share of l d t f d t t hil i t i ith l t th iti h ll b

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land transferred to customers while registering with relevant authorities shall be considered as the value for payment of VAT by the developer

If value of the undivided share of land transferred is not declared separately at the time of registration

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Aggregate of amounts fixed under the relevant law for payment of duty of registration of transfer of such land shall be the value for payment of VAT by the developer

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Haryana Circular Memo No. 152 /ST-1 dated May 7, 2013

Valuation of consideration payable by the LO to the developer for construction of his share of building

Where Developer/builder collects amounts separately from his customers towardsWhere Developer/builder collects amounts separately from his customers towards the share of undivided interest in the land

Aggregate of all amounts collected would be considered as consideration payable by the LO to the developer for construction of his share of building - liable to works contract tax

If no separate amount is collected by the developer from the customers towards the undivided interest in land

Aggregate of amounts declared by builder/developer to be the value of undivided share f l d t f d t t t th ti f i t ti h ll b id d th

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of land transferred to customers at the time of registration shall be considered as the value for payment of VAT by the builder/developer

If value of the undivided share of land transferred is not declared separately at the time of registration

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Aggregate of amounts fixed under the relevant law as the value of undivided share shall be considered as the value for payment of VAT by the developer

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Delhi Rule Amendment

Collaboration agreements or joint development agreements or similar other agreements/arrangements liable to VAT under DVAT

Valuation of consideration payable by the LO to the developer for constructionValuation of consideration payable by the LO to the developer for construction of his share of building shall be highest of the following amounts:

Actual value of construction including the profit, transferred by the builder to the LO; orLO; or

Where separate conveyance/sale deed is executed - Value in the sale deed for the purpose of payment of stamp duty less any such amounts paid by the builder to the LO; or

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tiveCircle rate of proportionate area of land transferred by the land owner to the

builder as notified under Delhi (Prevention of Undervaluation of Instruments) Rules, 2007 prevailing at the time of execution of the works contract

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Where separate circle rates for land and construction is not notified in a specified area, then the prevailing circle rates in that locality

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Service Tax – Classification Issues…

Declared services, under the new service tax regime under Section 66E, include

construction of a complex building civil structure or a part thereof including aconstruction of a complex, building, civil structure or a part thereof, including a complex or building intended for sale to a buyer, wholly or partly, except where the entire consideration is received after issuance of completion-certificate by the competent authority - Section 66E(b)

service portion in the execution of a works contract - Section 66E(h)

As both construction of complex services and works contract services are

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declared services

Debate on classification primarily due to difference in rates under the new service tax regime

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3.09%/3.71% on entire sale value vs 4.95% on construction agreement

Contracts which are treated as works contract for the purpose of levy of VAT / sales tax should also be treated as works contract for the purpose of levy of

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service tax

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Service Tax – Classification Issues…

Since VAT is to be paid on all construction agreements – natural classification would be works contract – is construction services entry obsolete?

Implications where booking is done for an already under construction propertyImplications where booking is done for an already under construction property – consideration post booking to be treated as “works contract services” and prior to be treated as “construction of complex services”?

Classification merits representation before CBECClassification merits representation before CBEC

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Supreme CourtSupreme Court –Earlier L&T Case

Developers – No VAT position…

Possibility of taking a no VAT position by Developers – when entire construction activity is outsourced

Preferably with one main contractor

Developer should not procure any goods directly

Place reliance on L&T Case [2008-TIOL-158-SC-VAT] of the Supreme CourtIn case of a sub-contract, the property in goods is directly transferred to the contractee - hence, the main contractor ceases to execute the works contract

There can only be one deemed sale

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Mere privity of contract between main contractor and the contractee would not alter the position

No works contract

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Contractee Main Contractor Sub-contractor

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Single direct deemed sale

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Developers – No VAT position

Principles also upheld by the latest L&T case by the SC

Value of goods for levy of tax has to be value of goods at time of incorporation ofValue of goods for levy of tax has to be value of goods at time of incorporation of goods in works

Even though property passes as between Developer and flat purchaser after incorporation of goods

Developer margins would be free from VAT

VAT charged by the contractors would be a cost

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No VAT position could impact the classification under service tax

Suggested to adopt this position only after obtaining an advance ruling

Will be litigious otherwise

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inWill be litigious otherwise

Documentation is the key – customer agreements, main contract, etc to be structured / drafted appropriately

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Q&A

2013

MR

Adv

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Amitabh Khemka

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3 B

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amitabh.khemka@bmradvisors.com

+91 98212 98432C +91 98212 98432

Disclaimer

This presentation has been prepared for the clients and Firm personnel only. The presentation is meant for general guidance and no responsibility for loss arising to any person acting or refraining from acting as a result of any material contained in this p g g g ypresentation will be accepted by BMR Advisors. It is recommended that professional advice be sought based on the specific facts and circumstances. This presentation does not substitute the need to refer to the original pronouncements

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C h a l l e n g e U s

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