AAR decision upsets settled law

Builders liable to service tax?

1. Unsettling the settled position

It was more or less settled that builders who are selling ready flats are not liable to service tax. Only contractors who provide service of construction of residential or commercial complex are liable to service tax. This settled position (even accepted by department) has been unsettled by decision of Authority for Advance Ruling, Central Excise, Customs and Service Tax (AAR) in case of Harekrishna Developers v. CST (Ruling No. AAR/03(ST)/2008, delivered on 7-4-2008). In this case, it has been held that activity of booking residential units is a taxable service and is liable to service tax under heading ‘construction of complex’ under section 65(105)(zzzh).

1.1 Background of the case

The proposed activity of applicant (builder) is that he will develop a residential complex on its land at it expense. Builder (applicant) will book residential units in favour of a buyer after taking booking amount. Physical possession of residential unit will be given to the buyer after construction activity is completed and full payment is received. Construction will be carried out as per approved plans. Material will be purchased by builder himself. Construction will be at the cost of builder. Title in land and construction will continue to be with builder until delivery of possession of the residential unit.

In some cases, applicant himself will carry out construction through its own labour and in some cases construction will be carried out by engaging labour contractors who will carry out the work.

As regards situations where work is carried out by contractors, there is no dispute that they are liable to pay service tax. The dispute is only in situation where builder (applicant) himself is constructing the units in residential complex.

AAR held that builder is liable to service tax even if he himself is construction the residential unit.

1.2 Reasons for view of AAR

AAR has given following reasons for its views.

‘In relation to’ widens scope - As per definition in section 65(105)(zzzh), any service provided or to be provided to any person, by any other person, in relation to construction of complex is a taxable service.

In Doypack Systems (P.) Ltd. v. UOI (1988) 2 SCR 962 = (1988) 2 SCC 299 = 65 Comp Cas 1 = 36 ELT 201 = AIR 1988 SC 782, it was observed, ‘The expression ‘in relation to’ (so also ‘pertaining to’) is a very broad expression, which pre-supposes another subject matter. These are words of comprehension which might both have a direct significance as well as an indirect significance depending on the context. -. - ‘Relating to’ is equivalent to or synonymous with as to ‘concerning with’ and ‘pertaining to’. The expression ‘pertaining to’ is an expression of expansion and not of contraction.

The expression ‘in relation to’ is of wide import. Thus, it is not merely the construction part of the activity that matters, the correlated and incidental services are all embraced within the scope of section 65(1005)(xxxh) [para 16 of the order of AAR].

Thus, AAR held that booking flat in advance (which will be constructed and then handed over to buyer) is a service ‘in relation to’ construction of complex and is taxable.

Meaning of service -  In a case under Consumer Protection Act, in Lucknow Development Authority v. M K Gupta (1994) 1 SCC 243=  1994 AIR SCW 97 = AIR 1994 SC 787 = 80 Comp. Cas. 714 (SC) = (1994) 1 Comp LJ 1 (SC), Supreme Court pointed out that concept of service is very wide and how it should be understood and what it means depends on the context in which it has been used in the enactment.

[In this case, Supreme Court had observed that any service which is for consideration and is not a contract of personal service is ‘service’ for purposes of the Consumer Protection Act.].

Activity is not self service - The construction of complex involves provision of host of facilities and amenities. Some or many may be common amenities, but they cannot be dissociated from the construction of the residential unit for benefit of buyer. Even if applicant is constructing the residential unit on its own and not on behalf of buyer, applicant is doing everything to honour his commitment to the buyer. The construction and allied services are referable to agreement with prospective buyer and cannot be viewed in isolation [para 18 of order of AAR].

Thus, activity is not self service [para 19 of the order].

CBE&C circular applies only for sale of ready flat - CBE&C vide it circular Ref Code 079.01/23.8.07 of CBE&C Circular No. 96/7/2007-ST dated 23-8-2007, has stated that if a builder constructs himself, he will not be liable, since service requires two parties. A person cannot give service to himself.

AAR held that this circular applies only to flat which is already constructed and ready for sale [para 20.1 of order of AAR].

2. Nature of contract between buyer and builder

The first and main reason given is that booking flat in advance (which will be constructed and then handed over to buyer) is a service ‘in relation to’ construction of complex and is taxable.  The issue is whether it is a service contract. If it is a service contract, then only the question whether it is in relation to construction of complex can arise.

Distinction between developer model and builder model of contracts – Broadly, there are two modes of entering into contract with intended purchaser of a flat or commercial unit – ‘builder model’ and ‘developer model’.

In ‘builder model’ of building contracts, agreement to sale is executed with the intending purchasers. Conveyance is executed by builder only after building is complete and possession is handed over. The conveyance is in respect of land as well as construction.

In ‘developer model’, developer enters into contract with prospective buyers (allottees). After construction, possession is handed over. The owner of land directly transfers the entire land to society or owners of apartment, who become owners of undivided share of land. Separate sale deed is not executed between developer and the purchaser, as the property in goods involved in works contract passes during construction by ‘accession’ during construction (This is to save stamp duty). As discussed below, the agreement in case of K Raheja was on basis of ‘developer model’.

Distinction between ‘contract for sale of immovable property’ and ‘sale of immovable property’ - As per first part of section 54 of Transfer of Property Act, ‘sale’ is a transfer of ownership (of immovable property) in exchange for a price paid or promised or part-paid and part-promised. Sale of tangible immovable property can be made only by a registered document.

As per third part of section 54 of Transfer of Property Act, ‘contract for sale’  for the sale of immovable property is a contract that a sale of such property shall take place on terms settled between the parties. It does not, of itself, create any interest in or charge on such property.

The ‘contract for sale’ is often termed as ‘agreement to sale’. This agreement does not create any interest on the property.

In Shib Lal v. Bhagwan Das (1889) 11 All 245, it was held that ‘sale’ creates a jus in rem, as it passes ownership immediately after it is executed, and a ‘contract for sale’ is a ‘jus ad rem’, for it only creates an obligation attached to the ownership of property, and does not amount to interest therein.

In ‘builder model’, a builder enters into ‘contract for sale’ within the meaning of Transfer of Property Act before construction. After the construction is complete, he executes a contract for ‘sale’ of flat/commercial unit. The contract is not a ‘construction contract’.

In case of ‘developer model’, the developer constructs on behalf of intended purchaser. Thus, it is basically ‘contract for construction’ and not contract for sale of any immovable property.

Illustration of distinction between contract of construction and contract of sale of a flat/commercial unit - In K Raheja Development Corporation v. State of Karnataka AIR 2005 SC 2350 = (2005) 5 SCC 162 = 2 STT 178 = 141 STC 298  (SC), the developer had entered into development agreement with owners of land. Then they got the plans sanctioned and entered into contract with intended purchasers. The agreement provided that on completion of construction of residential apartment or unit in commercial complex, it would be handed over to the purchasers who would get an undivided interest in the land also. Owner of land would then transfer ownership of land directly to society. The agreement of appellant (K Raheja) with intended purchaser was in two capacities - one as holder of land and other as developer land. The agreement was for the following – (a) Sale of undivided share in land as ‘holder of land’ (b) Building of unit as ‘developer’. Cost of land and building was shown separately in the agreement. After construction, there will no conveyance of the immovable property of a flat/residential unit.

The agreement provided for payment of instalments at various stages of construction of flat. The agreement provided that the developer (K Raheja) would not be owners of building, but they would have lien on the property and if purchaser commits a default, the agreement will be terminated and the unit and fractional in the land to other person. The applicant (K Raheja) were never ‘owner’ of the flat or the commercial unit.

The Karnataka Sales Tax Act specifically stated that works contract will cover any agreement relating to construction.

It was held by Supreme Court that it was a ‘works contract’. However, it was clarified by Supreme Court that if the agreement is entered into after the flat or unit is already constructed, there would be no tax on works contract. If the agreement in entered into before construction is complete, it would be a works contract.

As can be seen, the contract of K Raheja with intended purchaser falls under ‘developer model’ of contract.

Agreement before construction does not automatically mean that it is contract for construction – If agreement is entered prior to construction, it does not automatically and necessarily mean that it is contract for construction. It can be a contract for sale of flat in future. In that case, it cannot be said to be a ‘construction contract’ but a ‘contract for sale of immovable property’ and ‘sale’ of immovable property, within the meaning of Transfer of Property Act.

A contract to sell flat when ready is ‘contract for sale’ and not ‘construction contract’. If property in goods involved in works contract passes by accession during process of work, it is a ‘works contract’. In such case, Vat may be payable on material portion while service tax may be payable on service portion.

In K Raheja’s case, they were never owners of the flat/unit. Sale deed was not executed after construction. The property in goods involved passed through accession. Hence, it was rightly held as a works contract.

Activity done for self is not works contract - In Assotech Realty v. State of UP (2007) 10 STT 36 = 8 VST 738 (All HC DB) and ATS Infrastructure v. State of UP [WP decided on 6-12-2006 – see 9 STT 68 (Mag) (All HC DB)], it has been held that builders booking apartments before completion of construction of the apartments and receiving advance or part payment are not liable to pay Vat/sales tax under Works Contract, if right, title and interest in the construction remains with the builder (and is passed to buyer only after construction is over). It was observed that in case of K Raheja, the developer (K Raheja) was constructing the unit for and on behalf of person who had agreed to purchase the flats. While in present case (of Assotech Realty) he was not constructing flats on behalf if allottees. Activity undertaken by a person for himself is not ‘works contract’.

[This case was actually brought to notice of AAR, but it was observed that the contract is construction contract and not works contract and hence it is not necessary to go into that decision - see para 23 of order of AAR].

Sale of ready flat - If agreement is to sale ready flat, it is contract of sale of immovable property and would not be liable to service tax [View also agreed by AAR]

2.1 The contract is not a service contract

It is true that the contract is ‘in relation to construction’ of complex, but the issue is whether the contract is  ‘service’  in relation to construction of residential complex’. 

The contract is not for providing any service at all. It is a contract on basis of builder model as explained above i.e. contract for sale of immovable property. The question ‘in relation to’ arises only when there is contract for provision of any service.

2.2 Service requires two parties

CBE&C in para 1 of circular No. 332/35/2006-TRU dated 1-8-2006, has stated that if there is no service provider and service recipient relationship, question of providing taxable service to any person by any other person does not arise (view in case of construction services, but principle will apply to all services) [Note that TRU letters have not been withdrawn on 23-8-2007, though all other circulars have been withdrawn].

In Precot Mills Ltd. v. CCE (2006) 186 ELT 54 (CESTAT), it was prima facie held that technical assistance provided to its own constituent (another unit of same company) cannot be subjected to service tax, since consultant-client relationship is absent. Hence, stay was granted – view finally confirmed in Precot Mills Ltd. v. CCE (2006) 5 STT 35  (CESTAT), where it was held that for leviability of service tax, there should be a service provider and service receiver. When one renders service to oneself, there is no question of levy of service tax – same view in Nawanshahr Coop Sugar Mills Ltd. v. CCE (2006) 6 STT 18  (CESTAT).

One cannot render service to oneself - In McKinsey & Co. v. CCE (CESTAT) [para 6(4) – sub-para 2 of the order].

In Rolls Royce Indus Power v. CCE 2004 STT 573 = 6 STT 506 (CESTAT), it was (in effect) held that service tax is attracted when there are two parties. One cannot give service to himself [The issue was relating to consulting engineering services. It was held that the service is not taxable as there are no two parties, one giving advise and other accepting it].

In case of builder model, the buyer has not entered into contract for service at all. Thus, it is not that builder is providing any service to buyer.

He is constructing the flat for himself so that he can sale the flat in future.

CBE&C circular applies only for sale of ready flat - CBE&C vide it circular Ref Code 079.01/23.8.07 of CBE&C Circular No. 96/7/2007-ST dated 23-8-2007, has stated that if a builder constructs himself, he will not be liable, since service requires two parties. A person cannot give service to himself.

AAR held that this circular applies only to flat which is already constructed and ready for sale [para 20.1 of order of AAR].

2.3 CBE&C circular applies only for sale of ready flat?

CBE&C vide it circular Ref Code 079.01/23.8.07 of CBE&C Circular No. 96/7/2007-ST dated 23-8-2007, has stated that if a builder constructs himself, he will not be liable, since service requires two parties. AAR held that this circular applies only to flat which is already constructed and ready for sale [para 20.1 of order of AAR].

Really, CBE&C circular does not say that it applies only to ready to sale flat. As discussed below, if two interpretations are possible, interpretation favouring assessee is required to be adopted.

3. Interpretation favouring assessee when two views are possible

Assuming that two vies are possible, it is established that view favouring assessee should be adopted.

If a provision is capable of two meanings, construction beneficial to citizen (assessee) should be adopted - CIT v. Vegetable Products Ltd. (1973) 88 ITR 192 (SC). * CIT, Punjab v. Kulu Valley Transport Co. (P.) Ltd. - AIR 1970 SC 1734 = (1970) 77 ITR 518 * State of Punjab v. Jullundur Vegetables Syndicate - (1966) 17 STC 326 (SC) = AIR 1966 SC 1295 * CIT v. Shahzada Nand and Sons - (1966) 60 ITR 392 (SC) = AIR 1966 SC 1342. Same view was expressed in State of Maharashtra v. Mishri Lal Tarachand (1964) 5 SCR 230 = AIR 1964 SC 457. * CCE v. Parle Exports (P.) Ltd. - 1988 (38) ELT 741 (SC) = 20 ECR 1 = AIR 1989 SC 644 = (1989) 75 STC 105 (SC) = (1989) 1 SCC 345 * CIT UP v. J K Hosiery - AIR 1990 SC 2190 = 1986 (159) ITR 85 (SC) = 25 Taxman 80A = 1991 (55) ELT 393* Hindustan Lever Ltd. v. Municipal Corporation - (1995) 3 SCC 716. * CIT v. Madho Jatra - (1976) 4 SCC 92 = 105 ITR 179 (SC) * N V Shanmugham & Co. v. CIT - (1971) 81 ITR 310 (SC) *  CIT v. Podar Cement P Ltd. 92 Taxman 541 (SC) = 1997 AIR SCW 2466 = (1997) 5 SCC 482 = AIR 1997 SC 2523 = 226 ITR 625 (SC 3 member bench) * Mysore Minerals v. CIT 1999 AIR SCW 3146 = AIR 1999 SC 3185 = 239 ITR 775 = 106 Taxman 166 (SC).

When two interpretations are possible, the Court ordinarily would interpret the provision in favour of a tax-payer and against the revenue - Sneh Enterprises v. CC (2006) 7 SCC 714 = 202 ELT 7 (SC) * Mahim Patram P Ltd. v. UOI (2007) 7 STT 136 = 6 VST 248 (SC) * State of Karnataka v. Balaji Computers (2007) 5 VST 120 (SC).

If two interpretations are possible, one in favor of the assessee should be adopted – G K Choksi & Co. v. CIT (2007) 165 Taxman 299 (SC 3 member bench)

In Diwan Brothers v. Central Bank of India AIR 1976 SC 1503 = (1976) 3 SCC 800 (SC 3 member bench), it was held that benefit of doubt in fiscal statute should be given to the subject to lighten the burden. If one interpretation is onerous and other liberal, the Court would apply that provision which was beneficial to the litigant. Same view in UOI v. Kanunga Industries - AIR 1990 SC 2190 = 178 ELT 19 = (1992) Suppl (1) SCC 35 * J K Steel Ltd. v. UOI - (1969) 2 SCR 481 = 1978 (2) ELT (J355) SC = AIR 1970 SC 1173 * Hansraj and Sons v. State of J&K (2002) 6 SCC 227 = AIR 2002 SC 2692 = 2002 AIR SCW 3029 =  128 STC 203 (SC).

When two opinions are possible, the assessee should be given the benefit of doubt and the opinion which is in its favour should be given effect to. - Poulose & Mathen v. CCE 1997 AIR SCW 905 = AIR 1997 SC 965 = 90 ELT 264 = (1997) 3 SCC 50. * CIT v. Shaan Finance P Ltd. 97 Taxman 435 = 1998 AIR SCW 1250 = 231 ITR 308 = AIR 1998 SC 1372 * Federation of Andhra Pradesh Chambers v. State of Andhra Pradesh  2000(6) SCC 550 =  247 ITR 36 = 115 Taxman 143 (SC 3 member bench) * UOI v. Onkar S Kanwar 2002 AIR SCW 4179 = AIR 2002 SC 3563 = 2002(7) SCC 591 = 125 Taxman 121 * 145 ELT 266 (SC) * Cemento Corporation v. CCE 2002 AIR SCW 4332 = 129 STC 313.

4. Department cannot take stand against its own circular

In CCE v. Eswaran & Sons Engineers AIR 2005 SC 613 = 179 ELT 272 (SC 3 member bench), following views of Calcutta High Court [reported in Birla Jute v. ACCE (1992) 57 ELT 674 (Cal HC)] were endorsed – (1) Instructions of Board u/s 37B of Central Excise Act cannot be binding upon a quasi judicial authority under the Act, but the departmental officers conducting the lis before such quasi-judicial authority cannot take a stand contrary to directive/instruction issued (2) The instructions which may be binding on Central Excise Officers are not binding on assessee, who may question the correctness of the same before a quasi-judicial authority and before a Court. Both the quasi-judicial authority and a fortiori, the Court, can question the correctness of the instructions (3) An assessee has right to claim and the Court may compel compliance with such instructions as are for benefit of the assessee, by the Central Excise Officer.

Department itself cannot go against the circular - In CCE v. Usha Martin Industries 1997 AIR SCW 3795 = (1997) 7 SCC 47 = 111 STC 254 = 1997 (94) ELT 460 = AIR 1997 SC 3871 (SC 3 member bench), it was observed – “Through a catena of decisions, this Court (Supreme Court) has pronounced that Revenue cannot be permitted to take a stand contrary to the instructions issued by the Board. It is a different matter that an assessee can contest the validity or legality of a departmental instruction, but that right cannot be conceded to department, more so when others have acted according to such instructions. - . - Of course appellate authority is not bound by the instructions given by the Board but the Assessing Officer cannot take a view contrary to the Board's instructions”.

In CCE v. Dhiren Chemical Industries 139 ELT 3 = (2002) 2 SCC 127 = 126 STC 122 = 254 ITR 554 = 2001 AIR SCW 5073 (SC 5 member bench), the Court ordered, ‘Regardless of the interpretation that we have placed on the said phrase, if there are circulars which have been issued by the Central Board of Excise and Customs, which place a different interpretation upon the said phrase, that interpretation will be binding on the revenue’. [In this case, the departmental circular was favouring the assessee, while SC judgment was against the assessee, and hence probably this specific order was made]. This was followed in CCE v. Maruti Foam  2004 (6) SCC 722 = 144 STC 1161 = 164 ELT 394 (SC), where it was held that even if there is contrary order of Supreme Court, departmental circular will be binding on department, unless it is withdrawn.

5. Binding nature of decision of AAR

The advance ruling is binding on the applicant. It is binding on Commissioner only in respect of the applicant (i.e. not in respect of others). The advance ruling will continue to be binding unless there is change in law or facts on the basis of which advance ruling was given. [Section 23E of CEA,  section 28J of Customs Act and section 96E of Finance Act, 1994 (Service Tax Provisions)].

In A Tex (India) P Ltd. In re 2005 (179) ELT 540 (AAR), it was held that advance ruling is binding only on appellant and Commissioner. It does not bind others – same view in Zee Telefilms Ltd. v. CCE (2006) 5 STT 182 (CESTAT).

Though legally, opinion in other case will not be binding on department,  the opinion given in other case will have persuasive value and cannot be discarded by department or by assessee without valid reasons.

6. Construction of individual unit in a complex is taxable

AAR gave another decision on the same day in case of same party - Harekrishna Developers v. CST (Ruling No. AAR/04(ST)/2008, delivered on 7-4-2008) [This decision will be reported in Service tax Today (STT) in forthcoming issue.

Here, the issue was that applicant will be selling sub-plot of land to buyer. The buyer will then enter into works contract (for construction of individual residential house) with the applicant (builder).

Applicant (builder) argued tat the contract is for construction of an individual house and not for construction of complex. If such residential house is located on an individual stand-alone plot, the service will not be taxable. The works contract service cannot be subjected to tax simply because the residential building is situated within the residential complex and not on a stand-alone plot.

As per section 65(105)(zzzza), any service provided or to be provided; to any person, by any other person in relation to the execution of a works contract, excluding works contract in respect of roads, airports, railways, transport terminals, bridges, tunnels and dams, is a taxable service.

Explanation - For the purposes of this sub-clause, “works contract” means a contract wherein, –

(i)                 transfer of property in goods involved in the execution of such contract is leviable to tax as sale of goods, and

(ii)               such contract is for the purposes of carrying out,-

(a)    - - (not applicable)

(b)    - -

(c)    construction of a new residential complex or a part thereof; or

It was rightly held by AAR that the service contract falls within the meaning of ‘part thereof’ as per explanation (c) to section 65(105)(zzzza), and hence is taxable [para 7 of order of AAR] The applicant will be liable to service tax even if construction is done by sub-contractor, who is also liable to service tax [para 10 of the order].

In view of the words ‘or a part thereof’, the decision of AAR seems to be correct.

7. Conclusion

The basic issue was whether contract with builder is a service contract at all. If it is service contract, then the further issue whether it is in relation to construction arises. As explained earlier, in builders model, it is not a service contract at all.

Even assuming that there is some ambiguity (though there seems to be none), interpretation in favour of tax payer is required to be adopted.

Further, department cannot be allowed to take a stand against its own circular.

It is true that decision of AAR is not binding on others but it has persuasive value and has potential to create problems to many builders.