By Chetan Agrawal & Tushar Aggarwal
Court in the case of Larsen & Toubro Limited & Anr
v. State of Karnataka & Anr
.[ see end note 1]
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.
[ 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
Equally complicated will be the task of allowing input tax credit as
only goods incorporated after the agreement is entered into will qualify for
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