Can you briefly explain the pre-budget 2010 provisions in respect of construction service?
The service tax provisions relating to construction services cover two types of services - (a) Commercial or industrial construction which is taxable w.e.f. 10-9-2004 and (b) Construction of complex (residential complex of more than 12 residential units) which is taxable w.e.f. 16-6-2005.
If works contract tax is payable on these construction activities, these services would get covered under ‘works contract service’ w.e.f. 1-6-2007.
Initially, there were disputes regarding services provided by a builder or a developer for construction of residential complex or commercial premises.
However, on basis of Court decisions and CBE&C circulars, it was more or less settled that a builder entering into contract for sale of flat or industrial unit (gala) or shop or a developer entering into contract for construction of an individual flat for personal residential use of client are not liable to pay service tax.
What is the change made in Budget 2010?
In the Finance Act, 2010, an Explanation has been added w.e.f. 1-7-2010, to the definition of ‘commercial or industrial construction’ and ‘construction of residential complex’, as follows -
Explanation.— For the purposes of this sub-clause, construction of a complex which is intended for sale, wholly or partly, by a builder or any person authorised by the builder before, during or after construction (except in cases for which no sum is received from or on behalf of the prospective buyer by the builder or a person authorised by the builder before the grant of completion certificate by the authority competent to issue such certificate under any law for the time being in force) shall be deemed to be service provided by the builder to the buyer.
In case of commercial or industrial construction service, the words used are ‘construction of a new building’ in place of ‘complex’. Otherwise, the wording is identical.
Thus, by a ‘deeming provision’, an activity which is not ‘service’ as per Court decisions and CBE&C’s own earlier circulars will be a ‘deemed service’ for the purpose of levy of service tax.
Note that the Explanation being added is not a valuation provision.
Can you tell me in brief the effect of the change?
The effect of the change is that the service tax will not apply only when a builder sales a ready flat or shop or industrial unit (gala) after Building completion certificate is obtained from local authority (like Municipal Corporation, Municipality, Gram Panchayat etc.) and entire consideration is obtained only after building completion certificate is obtained.
In all other cases, the builder will be liable to pay the service tax. It is well known that in most of the cases, builder constructs buildings mainly on raising funds from prospective buyers. Further, even after building is completed and ready for occupation, there is delay in obtaining building completion certificate from the authorities (Now the delay will be more and ‘cost’ of obtaining the certificate will rise further).
Thus, practically in all cases, the builder/developer will be liable to pay service tax, except in case of few flats or shops or commercial galas, which he usually keeps for sale at a later date at higher prices. Even in this case, the builder/developer will not be liable only if entire transaction (including receipt of money) takes place after obtaining ‘completion certificate’ from municipal or other competent authority.
Is the amendment with retrospective effect?
Though the amendment is termed as ‘Explanation’, it is not merely to clarify the intention of Parliament but to put a completely artificial meaning to the ‘construction service’ by introducing a deeming provision. The Explanation is not merely explaining or clarifying the scope but expanding the scope of taxable service.
It cannot have retrospective effect prior to 1-7-2010.
Will the amendment apply to works contract service?
The amendment will not apply if the contract is covered under works contract service i.e. where Vat/Sales tax is payable on the contract.
2 Transitory provisions
Whether service tax will apply only in case of fresh bookings or will apply in case of earlier bookings also?
Date of booking is not relevant. Date of provision of service is relevant as provision of service is the taxable event. Hence, if construction service is provided after 1-7-2010, service tax will be payable.
The Explanation being added to the definition is only a ‘deemed service provision’ and not a valuation provision. It does not link payment received with tax liability.
If the construction is partly complete on 1-7-2010, what would be the service tax liability?
Principally, provision of service is the ‘taxable event’, i.e. services provided after tax is imposed will be taxable. Thus, service tax will apply in respect of services provided or to be provided on or after 1-7-2010. Receipt of payment or advance is not relevant for determining tax liability. Thus, a builder/developer is not liable to pay service tax in respect of services provided upto 1-7-2010. Such bifurcation is possible only if the builder/developer keeps proper accounts and records.
It is highly advisable to issue invoices (running bills) in respect of services provided upto 1-7-2010 and/or obtain certificate from Architect/Chartered Accountant regarding stage of completion of construction as on 1-7-2010.
If construction of residential complex is fully completed before introduction of the new construction service, but completion certificate from local authority has not been granted till 1-7-2010 though applied for, whether service tax will become payable? If so, how to calculate tax liability?
If construction is complete before 1-7-2010, no tax is payable as service tax is on provision of service which is the taxable event. Receipt of payment does not decide tax liability.
What would be position if construction is complete but application for completion certificate is not yet submitted?
Even then, there is no service tax liability if you establish that construction was completed before cut off date of 1-7-2010.
If the customer has paid 100% advance irrespective of completion certificate or possession before the cut off date i.e. 1-7-2010, then service tax will be imposed or not?
As a general principle, tax liability will be on the basis of construction services provided on or after 1-7-2010 and not on the basis of advance received. However, as per Notification No. 36/2010-ST dated 28-6-2010, in respect of service as per amended definition, if any advance payment was received prior to 1-7-2010, for service to be provided after 1-7-2010, service tax will be fully exempted This is a good transitory relief to service providers as well as customers [This provision applies only in respect of services covered under amended definition and not to those services which were already covered under earlier definition].
Thus, if advance payment was received prior to 1-7-2010, service tax will not be payable even if service in respect of that advance is provided after 1-7-2010.
3 When service tax is payable
Whether service tax is charged on advances of customers?
Service tax is payable when advance is received, even if actual service is to be provided later, but that is so only when service is a taxable service. Thus, if advance is received in respect of construction completed upto 1-7-2010, service tax will not be payable.
Whether service tax is payable on completion of construction or in stages?
Service tax is payable on receipt basis and hence as you get payment for construction service from your customer, you have to pay service tax on that amount. If service tax is not shown separately in bill or amount received, the amount received should be taken as inclusive of service tax and then back calculations may be made.
Advance has been received from customer before 1-7-2010 but service is to be provided after 1-7-2010. When service tax should become payable?
As explained above, service tax in relation to such advance has been exempted vide Notification No. 36/2010-ST dated 28-6-2010. Hence, service tax will not apply even if the service is provided after 1-7-2010.
4 Liability of service tax
What is the rate of service tax?
Service tax is payable on gross value of taxable services @ 10.30% (Service tax 10%, plus education cess of 2% plus SAH education cess of 1%).
What will be the basic exemption for service tax to a person coming in service tax net for the first time on 1-7-2010?
The exemption is Rs 10 lakhs in first year of taxable service counting from 1-7-2010, if you are coming in tax net for the first time. If turnover in 2010-11 exceeds Rs 10 lakhs, then there will be no exemption and tax is payable on all services from 1st April 2011 onwards.
We have received land from the land owner and we have agreed to give him some flats/galas (shops) in lieu of the land. Is service tax payable?
The nature of agreement between land owner, builder/developer and customer (service receiver) varies from State to State. In some States (in Western and Northern India), the builder first enters into agreement with landowner and gets development rights and irrevocable power of attorney. The builder then enters into ‘agreement to sale’ with prospective customers. Final sale deed is executed only after building is complete and possession is handed over.
In some States (in Southern India), two separate agreements are executed – one between land owner and customer and other between developer (service provider) and customer. The developer also has separate agreement with land owner where he agrees to give him some flats/galas (shops) free.
In both the cases, issue is whether builder/developer is providing any service to the land owner.
As per section 67(1)(ii) of Finance Act, 1994, envisages consideration ‘not wholly or partly consisting of money’. Thus, ‘consideration’ need not be in money form alone.
There is a view that relation between builder and land owner is not of ‘service provider and service receiver’ but that of ‘quasi partner’ or ‘joint venture’. It is difficult to accept this view since in partnership sharing of profit and mutual agency are essential ingredients, while in joint venture, joint control and sharing of profit/loss are essential ingredients. These are totally absent in agreement between builder and land owner.
Hence, in my view, service tax will indeed be payable. In fact, as soon as the builder/developer gets possession of land from land owner, it is ‘advance received’ and service tax will become payable next month.
In fact, land owner himself may be held liable to pay service tax if and when he sells the flat/industrial unit before obtaining completion certificate. Of course, he can argue that all service tax on construction service has already been paid by builder/developer and there is nothing to pay now. He can also argue that he is neither builder nor a person authorised by him to sale the building or part of it.
Valuation can be on basis of value of similar service or on cost plus reasonable profit, as provided in Rule 3 of Service Tax Valuation Rules.
Service tax has been charged to customer and deposited with department. Later, customer surrenders the booking and refund is made to him. What are the implications in service tax?
If you refund the entire amount along with service tax to customer, then you can adjust the service tax in your subsequent payments of service tax . As per rule 6(3) of Service Tax Rules , if excess tax is paid, in respect of service which is not provided either wholly or partially for any reason, the excess service tax paid can be adjusted against service tax payable for subsequent period, if the value of services and tax thereon is refunded to the person from whom it was received.
While giving refund, cancellation charges are usually deducted. These are really in nature of liquidated damages and not on account of service provided. Hence, in my view, entire service tax can be adjusted under rule 6(3) even if cancellation charges are deducted. However, it is a litigation prone issue and one must be ready to fight it out. If quantum is less, it may be economical to pay service tax instead of entering into litigation.
5 Valuation of service
Whether service tax is charged on agreement price of the flat, shop or industrial gala?
Principally, service tax is payable on value of taxable services. This is also clear from the fact that ‘preferential location and development of complex’ has been specified as a different taxable service.
Thus, if a service provider has proper costing records, it is permissible to deduct value of material and land (or calculate value of service on cost plus profit basis) and pay service tax on value of service @ 10.30%.
If this is not feasible, then tax is payable @ 10.30% on 25%/33% of entire value of contract including material (used by builder plus supplied free of cost by customer), but then Cenvat credit is not available, as explained below.
Any person providing taxable service of commercial or industrial construction or construction of residential complex (except completion and finishing services like glazing, plastering, painting, tiling, wood and metal joinery and carpentry, swimming pools, acoustic applications etc.) can opt to pay service tax as follows (w.e.f. 1-7-2010) – (a) on 33% of gross amount charged if the gross amount does not include value of land (b) on 25% of gross amount charged if the gross amount includes value of land (Till 1-7-2010, the 25% scheme was not available. Only 33% scheme was available).
This is at the option of service provider.
The ‘gross amount’ should include value of goods and materials supplied or provided or used. However, he can avail this concession only if - (a) He does not avail Cenvat of duty/service tax paid on inputs, input services and capital goods and (b) He does not avail benefit of Notification No. 12/2003-ST dated 20-6-2003. - Notification No. 1/2006-ST dated 1-3-2006 as amended w.e.f. 1-7-2010.
The partial exemption is available only if the gross amount charged includes value of goods and materials supplied or provided or used for providing such service (Explanation to Notification No. 1/2006-ST]. Thus, if the customer provides some material, its value will have to be added for purpose of payment of service tax.
As per Notification No. 12/2003-ST, no service tax is payable on value of material or goods sold to recipient of service. Thus, if a service provider avails exemption under 12/2003-ST (i.e. claims deduction of value of material or goods from gross value of contract), he cannot avail composition rate of 33%/25% of gross amount charged to customers. The service provider can have benefit either under Notification 12/2003-ST or 1/2006-ST and not both.
This method is not available in case the service provider provides only completion and finishing services (as in such cases, material content will be much less).
This method is also not applicable if service is covered under ‘works contract service’.
In addition to the flat, the builder provides some common services like park, common sewerage and effluent treatment, internal roads, common recreation hall etc. Is its cost includible in value of construction service?
Definition of residential complex covers these elements. Further, in the Budget 2010, a service termed as ‘preferential location or development of complex’ has been introduced w.e.f. 1-7-2010. The definition covers both commercial and residential complex. Thus, value of these amenities would get covered under that head (on pro ratabasis), even if these are excluded from ‘construction service’.
As the construction is nearing completion, the value of flat/commercial unit/shop goes up substantially. Does it mean that service tax payable will also increase?
Really, even if value (selling price) goes up, that does not mean that cost of construction has gone up to that extent. The value goes up because of demand/supply situation and customer is willing to pay higher price when there is ready possession or construction is nearing completion.
In such cases, payment of service tax only on value of service will result is substantial reduction of service tax liability, instead of going in for composition scheme. Hence, it is advisable to calculate value of service and pay service tax on that @ 10.3%.
This can also be justified from the fact that ‘preferential location and development of complex’ has been specified as a different taxable service. Thus, any charge over and above value of construction service cannot be subjected to tax.
A builder/developer has agreed to provide some flats/shops free of cost to the landowner who has given the land for construction. Is service tax payable in respect of these three flats/shops?
Really, the flats/shops are not given free but are in lieu of land cost. In such case, value of service will have to be found out on basis of value of service of identical or similar flat/shop or on basis of cost of construction plus reasonable profit.
Two methods are available – (a) Value of similar service (b) If value of similar service is not available, then cost plus reasonable profit [Rule 3 of Service Tax Valuation Rules].
In fact, land owner himself may be held liable to pay service tax when he sells the flat/industrial unit before obtaining completion certificate. Of course, he can argue that all service tax on construction service has already been paid by builder/developer and there is nothing to pay now.
Valuation can be on basis of value of similar service or on cost plus reasonable profit, as provided in Rule 3 of Service Tax Valuation Rules.
For extra items, i.e. items not covered in the agreement of sale, builder charges extra amounts. Whether service tax is payable on such extra items and whether the deduction of material purchased for such extra work would be given?
Service tax is payable on actual value of taxable services provided and not on basis of mere written agreement. Thus, service tax will be payable on extra services. Deduction of material is obviously available since service tax is payable only on value of services.
Which method of valuation should we adopt?
The 25%/33% scheme is simple but the liability of service tax will be high, particularly at places where land costs are very high. Further, if you are getting the work done through contractors/sub-contractors, you cannot take Cenvat credit of service tax paid by contractor/sub-contractor. This will further add to the cost.
Hence, in such cases, it is advisable to pay service tax on value of services @ 10.30%.
Value of services can be calculated either on cost plus profit basis or by reducing value of land and material from the total contract value.
If the contract is small, 25%/33% scheme may be opted since it is simple.
Can we adopt different valuation methods for different contracts?.
Each contract can be treated as separate contract and valued differently.
6 Cenvat Credit
Whether there is a provision of claiming deduction (setoff) on service tax paid to professionals, contractors, etc.
This is termed as Cenvat credit. You can get and utilise Cenvat credit of all your input services and capital goods only if you are paying service tax on the value of services @ 10.30%. If you are paying service tax under simplified scheme on 25%/33% of total value, you cannot avail any Cenvat credit at all.
We are providing both taxable and exempt services. How can we avail Cenvat credit?
If service provider is providing both taxable and exempt service, then it is advisable to avail Cenvat credit only in respect of input services directly attributable to taxable services. If Cenvat credit is availed of common input services, then rigors of proportionate reversal or payment of 6% ‘amount’ on exempted services, as contained in rule 6 will apply.
Can Cenvat credit on construction activities of one project be allowed towards output service tax on sale of another project?
Though Cenvat credit Rules do not require one to one relationship, as per rule 6 of Cenvat Credit Rules, Cenvat credit is not available if output service is exempt from service tax. Subject to this restriction, Cenvat credit among various projects is indeed inter-changeable, particularly if you opt for centralised registration.
We avail various input services like telephone, courier, mobile, bank charges, audit, security, catering etc. as Head Office. Can we utilise that credit for service tax payable on construction services?
Indeed you can do so, but you have to be careful if you are providing both taxable and exempt services and/or trading in goods. In that case, rule 6 of Cenvat Credit Rules will apply.
7 Other aspects
Can a builder or should a builder have separate service tax registration for each project?
A builder can either take separate service tax registration for each project or have centralised registration after studying pros and cons. If proper records etc. are kept, centralised registration will be OK. It may be advisable to register each project separately in following cases – (a) If some services are exempt and some taxable or (b) valuation basis for each project is expected to be different,.
What happens if only part land or a plot of a larger development is sold to the prospective purchaser, whereby no construction over the said plot is to be done by the seller/ developer?
This is not ‘construction service’ and hence question of service tax cannot arise.
A customer who has purchased a flat/commercial unit/industrial gala/shop from builder/developer is selling the same before Completion Certificate is obtained. Is he liable to pay service tax?
The words used in the ‘Explanation’ are ‘by the builder or a person authorised by the builder’. A customer is not a person authorised by builder to enter into contract for construction. Hence, a customer cannot fall within that definition. Even otherwise, service tax is payable on value of taxable service which has already been paid by builder/developer. Even if the customer sales the flat or unit or shop at higher price, it does not mean that cost of construction has increased.
8 Preferential location and development of complex service
What is definition of ‘preferential location and development of complex’ service?
As per section 65(105)(zzzzu) of Finance Act, 1994 (inserted w.e.f. 1-7-2010), any service provided or to be provided, to a buyer, by a builder of a residential complex, or a commercial complex, or any other person authorised by such builder, for providing preferential location or development of such complex but does not include services covered under sub-clauses (zzg), (zzq), (zzzh) and in relation to parking place, is a ‘taxable service’.Explanation.— For the purposes of this sub-clause, ‘‘preferential location’’ means any location having extra advantage which attracts extra payment over and above the basic sale price.
What is taxable under this head?
CBE&C, has clarified as follows – (Annexure- A to JS (TRU-II) D.O. letter F. No.334/1/2010-TRU dated 26-2-2010)
It has been reported that in addition to these activities, the builders of residential or commercial complexes provide other facilities and charge separately for them and these charges do not form part of the taxable value for charging tax on construction. These facilities include,- (a) prime/preferential location charges for allotting a flat/commercial space according to the choice of the buyer (i.e. Direction- sea facing, park facing, corner flat; Floor- first floor, top floor, Vastu- having the bed room in a particular direction; Number- lucky numbers); (b) internal or external development charges which are collected for developing/maintaining parks, laying of sewerage and water pipelines, providing access roads and common lighting etc; (c) fire-fighting installation charges; and (d) power back up charges etc.
Since these charges are in the nature of service provided by the builder to the buyer of the property over and above the construction service, such charges are being brought under the new service. Charges for providing parking space have been specifically excluded from the scope of this service. Development charges, to the extent they are paid to State Government or local bodies, will be excluded from the taxable value levy. Further, any service provided by Resident Welfare Associations or Cooperative Group Housing Societies consisting of residents/owners as their members would not be taxable under this service.
Agreement was entered for PLC before 1-7-2010 and payment was received. Is service tax payable, if construction is completed after 1-7-2010?
Service tax will not be applicable in such case as per transitory relief given vide Notification No. 36/2010-ST dated 28-6-2010.
Will the abatement of 25%/33% abatement available if PLC is charged separately in the agreement?
9. Agreement for sale/construction of a single flat directly with builder/developer
Department had clarified that agreement with builder/developer for an individual flat will not be subject to service tax. Is that clarification still valid?
As per section 65(91a) of Finance Act, 1994, “residential complex” does not include a complex which is constructed by a person directly engaging any other person for designing or planning of the layout, and the construction of such complex is intended for personal use as residence by such person.
As per CBE&C circular No. 108/02/2009-ST dated 29-1-2009, if the ultimate owner enters into a contract for construction of a residential complex with a promoter/builder/developer, who himself provides service of design, planning and construction, and after such construction the ultimate owner receives such property for his personal use, then such activity would not be subjected to service tax, because this case would fall under the exclusion provided in the definition of residential complex. However, if service of contractor, designer or similar services are received, then such person will be liable to service tax.
Really, this clarification should be valid even after amendment to definition of ‘construction complex’.
However, the word used in exclusion clause is ‘complex’, while any individual does not enter into contract for construction of entire ‘complex’ but only a part of it.
The issue is litigation prone and ultimate result is unpredictable.
Clarification in this regard is available here issued on 10.02.2012
Clarification in this regard is available here issued on 10.02.2012
What immediate steps a builder/developer should take?
He should apply for registration within 30 days. Further, he should prepare and submit running Bills till cut off date i.e. 1-7-2010. If this is not possible, at least take Architect and CA certificate about stage of completion and cost of completion upto 1-7-2010 so that there is no service tax liability on that portion.
Would you like to give any general suggestion or caution?
Whatever I have stated above is on my understanding of the law. It is possible that some of the views may not be accepted by department (In fact, even you may be having some different view on some of the issues discussed above).
Hence, you have to take policy decision on basis of your final conclusions. In service tax, full disclosure is key to safety. Thus, wherever in doubt, your view, your understanding and what you are going to do should be fully disclosed to department by writing a letter. Asking clarification is not generally advisable. Seeking permission is normally not advisable at all, as you will almost never get the permission and you will be falling in a trap.
Full disclosure to department has following advantages – (a) Penalty cannot be imposed and (b) Demand beyond one year is not sustainable. However, interest @ 13% is mandatory if by chance your understanding is not accepted by Tribunal or High Court or Supreme Court.