Real estate sector loses tax battle

MOHAN R. LAVI | Updated on March 12, 2018 Published on November 06, 2013

There is no escaping a tax on construction.

The SupremeCourt has favoured the taxman, saying that works contract tax is here to stay

The real estate sector and tax department have always eyed each other with suspicion. The real estate sector has held that the tax department has singled them out for harsh treatment.

For years, it contested the levy of works contract tax – or a tax on construction inputs – after the introduction of VAT. Finally bringing a long court battle to an close, the Supreme Court last month ruled that the works contract tax should stay, even with the introduction of VAT.

Simply put, the builders argued that the works contract tax was an double burden when VAT was already being levied on the sale of property. The apex court in Larsen and Toubro & Anr. vs State of Karnataka & Anr ruled last month that works contract tax would be levied on the construction inputs and VAT on the sale price.

It upheld its verdict on works contract tax given by a two-judge bench in 2005 in the K Raheja Development Corporation vs State of Karnataka case. This was two years after the introduction of VAT in Karnataka.

The works contract tax, payable to the State government, comes into being when there is a development agreement or tripartite agreement. The development agreement is a pact between the builder and purchaser for the transfer of completely constructed property for a consideration to the latter. A tripartite agreement also involves the owner in a similar transaction. These agreements mention the cost of construction as well, and this is used in the computation of the works contract tax.

There is no other binding condition for the applicability of works contract. Raheja Development did enter into development and tripartite contracts, therefore bringing it into the ambit of works contract tax.

Its contention that works contract tax does not apply to a completely constructed building was not accepted by the court. To reiterate, the legal position now is that a completely constructed building will attract VAT and its inputs works contract tax. But that still leaves the question of how these inputs are to be valued.

Larsen and Toubro case

On this issue, the apex court has upheld the provisions of the Karnataka Sales Tax Act, under which diverse construction activities and building contracts for monetary consideration are included.

The value of the goods which can constitute the measure of the levy of the tax has to be the value of the goods at the time of incorporation of goods in the works, even though property in goods passes later. Hypothetically speaking, if a property is sold for Rs 20 lakh, the works contract tax will be levied on the value of goods used in construction, say, Rs 10 lakh, while VAT will be levied on the remaining Rs 10 lakh.

The amount of Rs 10 lakh would be mentioned in the development agreement. However, if the actual cost of construction runs up to more than this it is liable to attract VAT.

The apex court has directed the Maharashtra Government to interpret its sales tax rules accordingly, allowing for both works contract tax and VAT to be levied.

Impact of decision

This decision concluded the much litigated interpretation of levy of VAT/Sales Tax on agreements for sale of under-construction property. Many States have also amended their VAT laws to incorporate the rationale of the decision in K. Raheja. However, there could still be challenges in respect of valuation of the goods.

The clarifications to be issued by the Maharashtra government could throw more light on this. The decision could open up another revenue stream for the government — the wide definition of the term “works contract” could mean that service tax could be slapped on some of these transactions.

It appears that the tax department and the real estate sector will continue to regard each other with suspicion for some time to come.

(The author is Director, Finance, Ellucian.)

Follow us on Telegram, Facebook, Twitter, Instagram, YouTube and Linkedin. You can also download our Android App or IOS App.

Published on November 06, 2013
This article is closed for comments.
Please Email the Editor