Gujarat HC respite to property buyers; Deemed property value only ‘optional’
The taxation of the real estate sector has been the subject of litigation for many years. The controversy over the taxation of construction contracts first arose with the Supreme Court’s decision in Gannon Dunkerley & Co. (Madras) Ltd in 1958, which led to the 46th Constitutional Amendment inserting the article 366 (29A) (b)) according to which the transfer of ownership of property occurring within the framework of the execution of a works contract was assimilated to a sale of property. Subsequently, the Apex Court again answered the question of the valuation of goods in the event of an indivisible works contract in the second Gannon Dunkerley case.
Therefore, before the advent of the GST regime, properties under construction were generally subject to a service tax at the effective rate of 4.50% and state VAT at 1%. An abatement of 1/3 on the land / the undivided share of the land has been authorized for the purpose of calculating the tax payable.
However, since July 1, 2017, a higher GST rate of 12% (effective rate) has been imposed on the real estate sector with the possibility of an input tax credit (ITC). This rate was subsequently reviewed at the 33rd and 34th meetings of the GST Council, whereby a new effective rate of 5% for residential and commercial units was made available from April 1, 2019 subject to compliance with various terms. These conditions included, among others, payment of GST in cash, non-use of ITC, 80% purchases from registered suppliers and related conditions.
It may be relevant to note that even under the new regime the deemed deduction of 33% towards land / undivided land share of the total amount has been maintained, see Notification No. 11/2017-Central Tax (Rates) dated of June 28, 2017.
This posed a challenge to the industry as there was no land value deduction available on an actual basis. Many ratepayers viewed this mandatory fiction as arbitrary and unreasonable in that the actual value of the land could vary depending on its location, size, etc. Court in Munjaal Manishbhai Bhatt v Union of India & Ors.
Recently, the High Court of Gujarat issued an order in favor of the taxpayers while ordering the refund of overpayment of GST to the plaintiff of the writ.
The brief facts of the case and the main submissions of the High Court bench comprising Justice JB Pardiwala and Justice Nisha M. Thakore are summarized below.
1) The plaintiff of the writ, a practicing lawyer, had entered into an agreement with a landlord/developer for the purchase of land and the construction of a bungalow on it.
2) A separate and distinct consideration has been agreed between the parties to the agreement for – (a) the sale of the land and (b) the construction of a bungalow on the land.
3) The plaintiff in the writ believed in good faith that he was liable to pay GST on the consideration payable for the construction of a bungalow. However, the landowner/developer relied on Sr. No. 2 of Notification No. 11/2017-Central Tax (Rates) to collect GST at 18% on all consideration payable for the land as well than the construction of a bungalow after deduction of 1/3. of value to earth.
(4) In these circumstances the petitioner has applied to the High Court to challenge the imposition of a tax on the consideration for the sale of land built under delegated legislation, as ultra vires the provisions of the articles 7 and 9 of the CGST law of 2017 read with entry n° 5 of its appendix III and article 14 of the Constitution.
5) The plaintiff of the writ relied in particular on the minutes of the 14th meeting of the GST Board to demonstrate that the intention to reduce the value of the land by 1/3 was only contemplated in with regard to the sale of apartments and not with regard to transactions where the land was sold separately and the value of the land was specifically available.
6) On the other hand, the respondent Revenue argued that the central government is empowered to decide the rate with applicable conditions, in the public interest based on the recommendation of the GST Board and that the Board of the GST is well within its power to recommend such a reduction with applicable restrictions.
7) Respondents also insisted on the fact that the contractual value of land and construction is decided between the parties and that this might not reflect the real value of the land concerned. Acceptance of the plaintiff’s assertion of the writ can lead to absurd results in which, in an attempt to save tax, the developer and purchaser may mutually decide that 99% of the total consideration would be the value of the land and the balance would be construction.
1) In reviewing the legislative and judicial history of the taxation of construction activities, including the Apex Court decisions in K Raheja Development Corporation and Larsen and Toubro Limited, the High Court noted that where notices have been conceptualized by the GST Board, the Supreme Court decision in Larsen and Toubro Limited was specifically mentioned.
Therefore, the construction carried out by the developer which was previously taxable under the VAT/services tax law was now to be taxed under the CGST law of 2017 and, therefore, a deduction was granted for the sale of land.
2) If a three-party agreement is entered into after the land has already been developed by the developer, that development activity has not been undertaken for the prospective purchaser and therefore there is no question of imposing the GST on the landscaped lot.
3) Referring to the provisions of Section 15 of the CGST Act 2017, the High Court observed that where the statutory provision requires a valuation in accordance with the actual price paid and payable for the service and where that actual price is available, then the tax has to be imposed on this real value. The presumption of fiction can only be applied when the real value is not verifiable.
4) In this respect reference has been made to the second Gannon Dunkerley case where the question of the deduction of the real value of work was considered by the Supreme Court, as well as to the judgment in the Wipro Ltd6 case delivered in in connection with the addition of loading/unloading charges for valuation purposes under the Customs Act 1962.
5) Since the deeming fiction is applied uniformly regardless of the size of the land and the construction on it, it leads to arbitrary and discriminatory consequences that are clearly contrary to Section 14 of the Constitution.
6) Such arbitrary fiction by way of delegated legislation has led to a situation where the extent of tax imposed has no connection with the burden of tax, which is the supply of construction services.
7) Even if it is presumed that the government had jurisdiction to fix a deemed value for the supplies, if the presumption of fiction is found to be arbitrary and contrary to the scheme of the law, then it can definitely be considered ultra vires .
8) When a detailed legal mechanism for determining the value is available, the fictional presumption cannot be justified on the grounds that it is intended to curb tax evasion.
9) Further, Schedule II is not intended to define or expand the scope of supply, but only to clarify whether a transaction will be a supply of goods or services if that transaction is deemed to be a supply.
10) In relation to plausible arbitrary valuation of land, the High Court clarified that if in any given case it is found that the value of the building service declared by the supplier is not the correct value to the extent that other consideration was indirectly received, the Income is not irretrievable.
When it is established that this value was not the only consideration for the service, recourse may be had to the valuation rules and the value may be calculated by applying the method of cost plus profits or a reasonable value compatible with the principles and the provisions of the Act.
11) Accordingly, the High Court has read paragraph 2 of Notice No. 11/2017-Central Tax (Rates) and Parallel State Tax Notice to the effect that the Deeming Fiction of 1/3 will only be not mandatory in nature; it will only be available at the option of the taxable person in cases where the real value of the land or joint ownership cannot be verified.
12) Accordingly, he directed the refund of the excess tax deposited with the Treasury directly to the plaintiff of the writ as he had borne the tax burden as beneficiary. The High Court also quashed the ruling appeal order which was based on the contested notification.
Under the blessing of the Prime Minister’s vision which seeks to clear a backlog of land deals and unleash investment to boost local manufacturing and generate millions of jobs to revive an economy that is experiencing its biggest annual contraction since 1952, This High Court judgment comes as a respite to the real estate sector which has been subjected to varied tax levies, as well as valuation complexities due to differing views through advance rulings.
Deducting the actual cost of land, wherever it is verifiable, will help reduce the effective cost of acquiring the property for buyers, especially in Tier I and II cities where land values are higher. This in turn could help stimulate demand for real estate during the current inflationary period.
However, the possibility of an appeal to the Supreme Court or the introduction of a retroactive amendment to the legislation to remedy the anomaly thus pointed out cannot be excluded. Similarly, we could see an increase in litigation challenging the valuation of land and construction costs, and the industry could expect notices challenging the base valuation.
Accordingly, the industry can take note of this aspect while acting on the judgment report, i.e. the review of past, existing or future agreements to take into account the value of the land / undivided share of the land of the total consideration when the same can be established, and/or request reimbursement of the GST already paid on a pro rata basis of the actual value.
By Sanjay Chhabria (Director, Nexdigm) and Aditya Nadkarni (Senior Director, Nexdigm)
Disclaimer: This is the personal opinion of the authors.