The Supreme Court in the case of Larsen & Toubro Limited & Anr v. State of Karnataka & Anr.[ see end note 1] (hereafter referred to as ‘judgment’) has re-affirmed and upheld the legal position earlier taken by the Division Bench of the Supreme Court in the case of K. Raheja Development [ see end note 2 ]. Further, the Supreme Court upheld the Constitutional validity of the expanded Section 2(24) of the Maharashtra Value Added Tax Act, 2002. Consequently, the activities undertaken by builders for construction of flat/building for or on behalf of the customers, for consideration in cash or deferred payment, will qualify as ‘works contract’ chargeable to VAT.
Though the true impact of the above judgment is yet to be completely understood, the uncertainties arising therefrom are spreading like a wildfire within the industry. The judgment has no doubt strengthened the hands of State Governments, in that, certain contrary judgments prohibiting levy of VAT on such construction activities now stand over ruled. However, several issues are still required to be resolved in this context. The objective of this article is to highlight and address some of such issues.
In the judgment the Supreme Court has observed that construction work carried out by the developer is for and on behalf of the purchaser and not for himself or for the land owner. Therefore, in a tripartite (revenue sharing model) agreement involving landowner, developer and customer, it shall be construed that the developer is undertaking construction activity for and on behalf of the customer. However, the implications under tripartite (area sharing model) agreements are yet to be settled. In such arrangements, certain States like Delhi are treating both the developer and landowner as builders and holding the transaction between the developer and the landowner, as also the transaction between the landowner and the customer, as works contract. Therefore, with respect to the sale of landowner's share of flats, will a tripartite agreement involve two works contracts?
In the judgment the Supreme Court took note of and considered the observations of the court in K. Raheja namely, in order to decide whether the developer was executing a works contract or not, it was necessary to examine the relevant recitals and clauses in the agreement. Therefore, it would be interesting to watch whether VAT Authorities will refer to the clauses in the sale /purchase agreements in order to decide whether it qualified as a works contract or will they conclude it as a works contract in all cases.
Interestingly, in the judgment, it has been specifically clarified by the Supreme Court that the construction activity undertaken by the developer will qualify as ‘works contract’ only from the stage the developer enters into a contract with the purchaser. Therefore only that part of the works contract executed after the agreement is entered into with the flat purchaser, can be charged to tax by the State Government. Further, the value of the goods should be the value at the time of incorporation of the goods. Such a stand is bound to create problems in the determination of value. Typically each unit in a project can get sold at different points in time. It is going to be extremely difficult for the VAT Authorities to complete assessments as each individual purchaser can finalize the deal and enter into agreement for a specific unit at any stage of its construction. The Supreme Court has already read down Rule 58(1) of the Maharashtra Value Added Rules, 2005 observing that the Valuation Rules should provide for valuation of goods at the time of incorporation. It is thus indeed going to be a complex valuation exercise frustrating both the tax payer and collector.
Equally complicated will be the task of allowing input tax credit as only goods incorporated after the agreement is entered into will qualify for credit.
The problems that may arise when VAT is leviable as per the judgment do not end here. VAT enactments in most of the States make the contractees responsible for deducting and depositing TDS amount and additionally involve various compliance requirements such as registration, issuing TDS certificate, filing TDS return, etc. The buyers will now certainly face difficulties in complying with such requirements. Even individual buyers who are treated as contractee under a few state VAT enactments will face problem.
The next issue is about who is to bear the burden of this tax. Agreement in respect of ongoing projects may not have provided for such a levy at all or for the occurrence of such contingencies, and therefore the developer will naturally try to pass on the burden of VAT to the ultimate buyer resulting in escalation of costs. For projects already completed but falling within the limitation period, there can be recovery action pushing the developers to collect the tax from the buyers.
The impact of the above judgment may not get restricted to developers and builders only. The definition of ‘works contract’, which is almost the same in the VAT Acts of many States, includes contracts for manufacturing, processing, etc. We have to wait and see whether the department will start treating the contracts for manufacturing goods as per the specifications and standards provided by the buyer as a works contract attracting levy of VAT. Such developments are going to cause a lot of inconvenience both to the industry and the purchasers.
Payment of VAT, service tax and stamp duty, when an agreement to purchase an immovable property is entered into, is going to adversely affect the purchaser. All stakeholders have to bear this fact in mind, while addressing this confused situation. Present day laws on taxation of goods and immovable property in India, which were first promulgated in the later part of 19th century, were essentially aimed at simple and straight forward transactions existing in these areas at that time. Though the law to levy and collect tax on services in India is fairly recent, simple transaction were again perceived to be taxed. But in modern times the character of transactions entered into between parties, in industry and business, started getting complex and complicated, on account of financial, economic and technology factors. Entrepreneurs, financial institutions and consumers started seeing opportunities in these complex transactions as they were profitable to all these stakeholders. But as the present day tax laws were essentially designed to handle simple transactions, confusion gets naturally created when a complex transaction gets caught in the tax net. Even the law settled by courts in the areas of taxation until now does not seem to be adequate to find fair solutions to the problems that these complex transactions today pose.
Transactions having a combination of both service (construction) and sale (immovable property), in the housing industry, involving developers, builders, landowners, financing companies and buyers are today caught in this state of confusion. Intensive research, deep understanding, economic implications, top level expertise and above all a benevolent approach, are required to find proper solutions that will satisfy all parties to the dispute. This for sure is going to take time.
[ The authors are, respectively, Associate and Senior Associate, Tax Practice, Lakshmikumaran & Sridharan, New Delhi ]