Published on Sat, Oct 05,2013 | 18:58, Updated at Sat, Oct 05 at 19:02Source : Moneycontrol.com | Watch Video : 
For the second time, the Supreme Court has upheld the constitutional right of States to levy Value Added Tax or VAT on under-construction property. The apex court had taken a similar view way back in 2005 in Raheja's case. Why then did the principle need a relook and what's the way forward? Payaswini Upadhyay reports.
Contracts for sale and purchase of property vary across India. For instance, in the South, developers or land owners sell an undivided interest in the land to purchasers under a sale deed. A separate contract is signed between the developer and purchaser for the construction of flats.
In Maharashtra and North India, developers and purchasers usually enter into a single contract where flats are sold alongwith the interest in land.
The distinction becomes crucial when looked at from a tax perspective. The Constitution allows State governments to levy tax on goods transfer in a works contract – in this case that be the property being transferred. But it doesn't define what a works contract is.
Bipin Sapra
Partner- Indirect Tax, EY
"When good and services are being supplied simultaneously and when I say goods and services, it means that when a flat is being constructed, there are various stages at which contract is signed. If a developer is signing a contract with a contractor to construct a complex or a building, there he is asking him to provide goods and services - that is a very clear nature of a works contract. However, in the absence of a clear definition of a works contract, when a buyer of a flat comes to a developer and signs and agreement of sale, it is not very clear whether it's a contract for sale or whether it's a works contract."
Rajeev Dimri
Head- Indirect Tax, BMR Advisors
"Historically, many people were of the view that one has to go by the dominant nature of contract- a contract may have many clauses and aspects- one has to look at the dominant nature of the contract. So when you go to a builder, you book an apartment, you choose an apartment and that apartment will then, as part of a larger complex, will g t built and you will be given possession, lets say, 3 years from now. In your mind and in the mind of the seller what is being sold is an apartment which is a real estate transaction not liable for VAT either as sale of goods or as works contract."
In 2005, a division bench of the Supreme Court ruled on this confusion. It ordered - in the Raheja Developers case - that the State has the right to impose VAT on sale of under construction property as it constitutes a works contract. At that time, the apex court had clarified that as long as there is no breach of agreement; the construction would be for and on behalf of the purchaser and would constitute a works contract.
Rajeev Dimri
Head- Indirect Tax, BMR Advisors
"A lot of people, at least in North India, were of the view that the Raheja judgment was very specific to the fact pattern of multiple contracts and not on the specific nature which is usually done in North India where there is a single contract between the builder and the prospective buyer which is inclusive of everything - so while you're right there was explicit judgment, but a lot of people still had this impression that that judgment applied to the facts of the specific case."
And so, 2 years later, several developers including L&T approached the Supreme Court seeking clarity if their contracts would qualify as works contracts. A two member Bench observed that if the Raheja Development precedent is accepted, then there would be no difference between a works contract and a contract for sale. The bench pointed out that an agreement of a sale of flat between a developer and purchaser could be for the sale itself and not necessarily for undertaking construction on behalf of the purchaser. Having taken this varying view - the SC bench referred L&T and several other cases to a larger bench for re-consideration.
Last week, a 3 judge Bench of the SC ruled that irrespective of the model of contract, States can levy VAT on sale of under construction flats…pointing that it involved an element of works contract.
The apex court reasoned that the work is undertaken by the developer for or on behalf of the purchaser and not for himself or for the owner of the land. The SC further clarified that the activity of construction undertaken by the developer would amount to a works contract from the stage when the developer enters into a contract with a purchaser and VAT can be levied only on value addition post the agreement. So the VAT levy on the purchaser of an under-construction flat, will depend on what stage of construction that flat is in at the time of purchase.
Bipin Sapra
Partner- Indirect Tax, EY
"The court has held that when you sign a contract, whatever has been transferred post that contract, would be included in the value of the works contract on which VAT would be levied. Now that's very difficult to distinguish and very difficult for the authorities also to really monitor. So this is the biggest problem which both, the developers and authorities would face in implementing that part of the law. The entire works contract would be liable to VAT and Service Tax for both the elements- the goods and services being transferred- and the entire value would have a Stamp Duty to it. So there will be multiple layers of taxation."
There is also the fear that this interpretation of a works contract may have collateral damage on other sectors.
Rajeev Dimri
Head- Indirect Tax, BMR Advisors
"It could potentially apply to any customized order- so if you to a factory and place and order for goods that are yet to be produced for you and its being produced based on your specific order, is that a contract for sale or works contract. Now in the past that has not been a matter of major debate because one way or the other VAT gets paid on those products and therefore under that law, tax is getting paid. But in real estate – where if there is a completed apartment/project, no VAT can apply but if works contract, the VAT will apply. While it could potentially alter our thinking on many other types of contract, the stakes are high for the real estate sector."
Rajeev further explained it to me that going forward, litigation would be on two fronts- one, the States will go after the developers to collect past VAT based on the period of limitation under the State laws. Two, the developers would seek to bring a contractual claim against flat owners where this possible VAT liability was not accounted for. The success of this claim would depend on the specific terms of the contract. In short, this one Supreme Court order is likely to result in large scale litigation!
In Mumbai, Payaswini Upadhyay
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