The taxation of real estate sector has been a subject matter of dispute since many years. The controversy with respect to taxability of construction contracts first erupted with the decision of the Supreme Court in the case of Gannon Dunkerley & Co. (Madras) Ltd back in 1958, which led to the 46th Constitutional amendment inserting Article 366 (29A) (b) whereby the transfer of property in goods involved in the course of execution of a works contract was deemed to be a sale of goods. Thereafter, the Apex Court once again answered the question of valuation of goods in case of indivisible works contract in the second Gannon Dunkerley case.
Therefore, before the advent of GST regime, the under-construction properties typically attracted service tax at effective rate of 4.50% and State VAT @ 1%. An abatement of 1 / 3rd towards land / undivided share of land was allowed for the purpose of calculating the tax liability.
However, wef 1 July 2017, a higher GST rate of 12% (effective rate) was imposed on the real estate sector with availability of input tax credit (ITC). This rate was subsequently reconsidered during the 33rd and 34th GST Council meetings, whereby a new effective rate of 5% for residential and commercial units was made available wef 1 April 2019 subject to fulfillment of various conditions. These conditions included inter alia payment of GST in cash, non-availment of ITC, 80% procurements from registered vendors, and allied conditions.
It may be pertinent to note that even under the new regime, the deemed deduction of 33% towards land / undivided share of land from the total amount was continued, vide Notification No. 11/2017-Central Tax (Rate) dated 28 June 2017.
This posed a challenge to the industry as there was no deduction for land value available on actual basis. Many taxpayers considered such mandatory deeming fiction arbitrary and unreasonable in as much as the actual land value could vary depending on its location, size, etc. Consequently, the constitutional validity of such deemed valuation was challenged in multiple High Courts, including before the Gujarat High Court in the case of Munjaal Manishbhai Bhatt vs. Union of India & Ors.
Recently, the Gujarat High Court passed an order in favor of the taxpayers while directing the refund of excess payment of GST to the writ applicant.
The brief facts of the case and the key observations of the High Court Bench comprising of Justice JB Pardiwala and Justice Nisha M. Thakore are captured hereunder.
1) The writ applicant, a practicing advocate, had entered into an agreement with a landowner / developer for the purchase of a plot of land along with construction of bungalow thereon.
2) Separate and distinct consideration was agreed upon between the parties to the agreement for – (a) the sale of land and (b) construction of bungalow on the land.
3) The writ applicant was under a bona fide belief that he was liable to pay GST on the consideration payable towards construction of bungalow. However, the landowner / developer relied on Sr. Now. 2 of Notification No. 11/2017-Central Tax (Rate) to collect GST at 18% on the entire consideration payable for land as well as construction of bungalow after deducting 1 / 3rd of the value towards land.
4) In such circumstances, the writ applicant approached the High Court assailing the imposition of tax on consideration towards the sale of developed land by virtue of delegated legislation as ultra vires the provisions of Sections 7 and 9 of the CGST Act, 2017 read with Entry Now. 5 of Schedule III thereto, and Article 14 of the Constitution.
5) The writ applicant relied inter alia upon the minutes of the 14th GST Council meeting to demonstrate that the intent of abatement of 1 / 3rd value towards the land was thought only in respect of sale of flats / apartments and not in respect of transactions where land was separately sold, and the value of land was specifically available.
6) On the other hand, the respondent Revenue argued that the Central Government is empowered to decide the rate with conditions as applicable, in public interest on the basis of recommendation of GST Council and GST Council is well within its power to recommend such reduction with restrictions as applicable.
7) The respondents also emphasized on the fact that the agreement value of land and construction is decided between the parties and the same might not reflect the actual value of the land involved. Acceptance of the writ applicant’s contention may lead to absurd results where in an attempt to save tax, the developer and buyer may mutually decide that 99% of the total consideration would be the value of land and the balance would be construction.
1) Perusing the legislative and judicial history of taxation of construction activities, including the Apex Court decisions in the cases of K Raheja Development Corporation and Larsen and Toubro Limited, the High Court noted that when the Notifications came to be conceptualized by the GST Council, the decision of the Supreme Court in Larsen and Toubro Limited was specifically referred to.
Hence, the construction carried out by the developer which was previously taxable under VAT / Service Tax law was now sought to be taxed under the CGST Act, 2017 and therefore, deduction was given for sale of land.
2) If a tripartite agreement has entered into after the land is already developed by the developer, then such development activity was not undertaken for the prospective buyer and therefore, there is no question of imposition of GST on the developed land.
3) Referring to the provisions of Section 15 of the CGST Act, 2017, the High Court observed that when the statutory provision requires valuation in accordance with the actual price paid and payable for the service and where such actual price is available, then tax has to be imposed on such actual value. Deeming fiction can be applied only where the actual value is not ascertainable.
4) In this regard, reliance was placed on the second Gannon Dunkerley case where the question of deducting actual value of labor had been considered by the Apex Court, as well as the judgment in the case of Wipro Ltd6 rendered in the context of addition of loading / unloading charges for the purpose of valuation under the Customs Act, 1962.
5) Since the deeming fiction is uniformly applied irrespective of the size of the plot of land and construction therein, same leads to arbitrary and discriminatory consequences which are clearly violative of Article 14 of the Constitution.
6) Such arbitrary deeming fiction by way of delegated legislation has led to a situation whereby the measure of tax imposed has no nexus with the charge of tax, which is supply of construction service.
7) Even if it is presumed that the Government had the competence to fix a deemed value for supplies, if the deeming fiction is found arbitrary and contrary to the scheme of the statute, then it can definitely be held to be ultra vires.
8) When a detailed statutory mechanism for determination of value is available, then the deeming fiction cannot be justified on the basis that it is meant to curb avoidance of tax.
9) Moreover, Schedule II is not meant to define or expand the scope of supply but only to clarify whether a transaction will be supply of goods or service if such transaction qualifies as supply.
10) As regards the plausible arbitrary valuation of land, the High Court clarified, if in a given case it is found that the value of construction service which is declared by the supplier is not the correct value inasmuch as other consideration has been indirectly received, the Revenue is not remediless.
Where it is established that such value was not the sole consideration for the service, then resort can be had to the valuation rules and value can be derived by applying the cost-plus profit method or a reasonable value consistent with the principles and provisions of the Statute.
11) Consequently, the High Court read down para 2 of Notification No. 11/2017-Central Tax (Rate) and the parallel State Tax Notification to the effect that the deeming fiction of 1 / 3rd will not be mandatory in nature; it will only be available at the option of the taxable person in cases where the actual value of land or undivided shared in land is not ascertainable.
12) Accordingly, it directed the refund of excess tax deposited with the Government treasury directly to the writ applicant as he had borne the burden of tax as a recipient. The High Court also quashed the advance ruling appellate order which was based on the impugned Notification.
Under the benediction of the Prime Minister’s vision which seeks to clear a backlog of land cases and unleash investment to boost local manufacturing and generate millions of jobs to lift an economy set for its biggest annual contraction since 1952, this High Court judgment comes as a respite to the real estate sector which has been subject to varied levies of taxes, as well as complexities in valuation due to divergent views through advance rulings.
The deduction of the actual cost of land, wherever it is ascertainable, will help reduce the effective cost of acquisition of property for the buyers, particularly in Tier I & II cities where the value of land is on the higher side. This in turn could help boost the demand for real estate during the present inflationary times.
However, one cannot rule out the possibility of matter being taken up before the Apex Court or introduction of a retrospective amendment to the legislation to address the anomaly so pointed out. Similarly, we could witness an increase in litigation challenging the valuation of land and construction cost, and the industry could expect notices challenging the base valuation.
Accordingly, the industry may take a note of this aspect while acting upon the ratio of the judgment, ie, review of past, existing or future agreements to take abatement basis the value of land / undivided share of land from the total consideration where the same can be established, and / or seeking refund of GST already paid proportionate to actual value.
By Sanjay Chhabria (Director, Nexdigm) and Aditya Nadkarni (Senior Manager, Nexdigm)
Disclaimer: This is the personal view of the authors.