Supreme Court Judgement - L&T / K Raheja (VAT on Builders)

Supreme Court - L&T / K Raheja

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History…
• Levy of Sales Tax / VAT on Works contract
• Power of states confined to taxes on sale or
purchase of goods
• GDC – I – Five Judge Bench- Theory of
Accretion
• Para 51 of GDC – I – True Interpretation of
the expression of sale of goods
• Constitution’s 46th Amendment

History…
• Five Judge Bench in BAI- Upheld
Constitution’s 46th Amendment
• Five Judge Bench in GDC-II laid down the
valuation norms
• Three Judge Bench in BSNL – Vivesection
• Then came Raheja


Back Ground
• Karnataka, in the early 2000s, the rate of sales
tax used to be rather low at around 4%, while
the stamp duty rate used to be at around 15%.
• Some of the brightest tax brains (in Bangalore)
came out with a plan
• Split the consideration into two agreements,
viz. one, for the sale of the undivided portion of
the land and the second, for the construction of
the apartment

• When the VAT law came into effect from 14-2005, the VAT rate was fixed at 12.5% and
the stamp duty has come down to 5%.

• What was good planning in an era where the
stamp duty rate was high became a disaster,
with the sales/VAT rates climbing up


When is a job established as a Works Contract –
FACTS IN THE CASE OF SUPREME COURT JUDGEMENT
OF K. RAHEJA DEVELOPMENT CORPORATION

• Appellants were carrying on business as real estate
developer.
• They entered into Development agreement with owners
of land.
• The agreement was for carrying out construction on
behalf of somebody else.

Facts Contd….
• The land owner transferred only the ownership of land
to the society and the appellant transferred structure by
a separate agreement for construction.
• The appellants were carrying out construction as
developers for the prospective purchaser.
• Agreement entered into before the completion of the
unit, was considered as Works Contract.

• Agreement entered into after the flat or unit already
constructed would not be within the ambit of works
contract.

• Works Contract - Section 2(1)(v-i) of Karnataka Sales Tax
Act defines a "works contract" as: "works contract"
includes any agreement for carrying out for cash, deferred
payment or other valuable consideration, the building,
construction, manufacture, processing, fabrication,
erection, installation, fitting out, improvement,
modification, repair or commissioning of any moveable or
immovable property.

• Kar HC gave a great regard to the wide definition
of works contract under Karnataka VAT
• Sales Tax -Works Contract - So long as there is no
termination the construction is for and on behalf
of purchaser
• If the agreement is entered into after the flat or
unit is already constructed, then there would be no
works contract-

• On the basis of K Raheja, can we say that all
builders are liable to VAT?

L&T Dev Project
• L & T - contract to develop the property of
Dinesh Ranka- 75:25.
• SCN - Tripartite Agreement is a works
contract.
• No allegation of consideration involved in
the first contract which is the Development
Agreement.


Review……
• However Supreme Court on Aug 19, 2008 had referred
the judgment for reconsideration to a larger bench
considering the Writ Petition filed by L&T on the count
that the judgement has adversely affected the entire
construction industry.


Raheja needs reconsideration
• There would be no difference between
works contract and a contract for sale of
chattel as a chattel.
• Could it be said that petitioner Company
was the contractor for prospective flat
purchaser.
• Observations of Dept, Dev Agr is not works
contract but the Tripartite Agr is works
contract which appears to be fallacious.

Raheja needs reconsideration
• There were 26 appeals for reconsideration
out of which
• 14 appeals were from Karnataka and
• 12 were from Maharashtra.


• While interpreting the Judgement, Lets
appreciate the fact that the definition of
‘works contracts' under the VAT laws of
most States are very similar to Karnataka
and thus this decision will apply to almost,
the whole of the country.


Def’n in Gujarat
• Contract to do any works
• Valuation


Key contentions of the Appellants


• GDC – I still a good law
• Wider definition of works contract not acceptable
• Applicability of Article 366(29-A) read with Entry
54 of List II still cannot apply to an agreement for
sale of immovable property resulting in a
conveyance.
• well-known tests to determine whether a particular
contract is “works contract” or “contract of sale”
have not been adverted to.
• Dominant intention of the agreement was to sell a
flat and not enter into a works contract.

• work undertaken is for joint development of
project as a whole, ie work is undertaken by
developer for himself and the owner; and
not for purchaser;
• the flat is to be sold as a flat and not an
aggregate of its component parts;
• if a suit is filed by flat purchaser, it would be
for conveyance of title and not for
construction of a building.

• Maharashtra - Section 2(24) of MVAT Act and
Rules 58 and 58(1A) - redefine the taxable
event by moving away from theory of accretion
to transfer of immovable property by way of
conveyance and that renders these provisions
unconstitutional;
• State levies stamp duty on agreement of sale
under Entry 25 (as immovable property) and
not under Entry 63 (as works contract) and
hence does not consider agreement for sale to
be works contract.

• Main intention remains to buy the flat
• Buyer has no role in conceptualising the
project / design / supervision / material
quality
• Accretion happens in the hands of developer


Key contentions of the Revenue


• View taken in Raheja Development case is
correct and needs no reconsideration.
• After insertion of Article 366 (29-A)(b) in
Constitution, transfer of movable property
in works contract is deemed to be sale even
though it is not sale as per Sale of Goods Act.


• Nothing in Article 366(29-A)(b) limits the
term “works contract”, and ownership of
goods need not pass only by way of
accretion or accession to owner of the
immovable property.


• No question of ascertaining dominant
intention of contract since sale of goods
element is deemed sale under Article
366(29-A)(b) and can be taxed separately.
• A composite contract comprising both
works contract and transfer of immovable
property does not denude it of its character
as works contract.

• Different aspects of same transaction can
involve more than one taxable event.
Transfer of immovable property cannot be
taxed as sale of goods but there is no
constitutional bar to tax only sale of goods
element.


• Explanation b(ii) in section 2(24) of MVAT Act
offers diverse options for valuation which are
methods approved by the SC
– in Gannon Dunkerley& Co and others v State of
Rajasthan and Others (1993-1-SCC-364) (“Gannon
Dunkerley-II”).

• Further, Rule 58A and Rule 58(1A) of the MVAT
Rules are constitutionally valid, as these
provisions are consistent with principles laid
down in Gannon Dunkerley-II.

• As long as there is obligation to construct
under agreement between Developer and
flat purchaser (in case of Maharashtra, being
agreement under MOFA) deemed sale of
goods can be taxed even after incorporation
of goods in works


Ruling of the Supreme Court


• “Tax on sale or purchase of goods” in Entry
54 in List II of Seventh Schedule when read
with definition clause 29-A of Article 366
includes tax on transfer of property in
goods, whether as goods or in some other
form involved in execution of works
contract.


Three conditions :
- there must be a works contract;
- goods should have been involved in
execution of works contract; and,
- property in those goods must be transferred
to third party either as goods or in some
other form.


• For purpose of Article 366 (29-A)(b), in
building contracts or any construction
contracts, if consideration is received, all the
above conditions are satisfied
• As in performance of a contract for
construction of building, goods (chattels)
like cement, concrete, steel, bricks etc are
intended to be incorporated in the structure

• A contract comprising both works contract
and transfer of immovable property, does
not denude it of its character as works
contract.
• The term “works contract” in Article 366
(29-A)(b) is not restricted to contract to
provide for labour and services alone.
• Building contracts are species of works
contract.

• The dominant nature test has no application
• Traditional decisions on substance of
contracts have lost their significance.


• Transfer of property in goods under Article
366 29-A(b) is deemed to be sale of goods
involved in execution of works contract by
person making transfer and purchase of
those goods by person to whom such
transfer is made.
• Purchase Tax


• Value of goods which can constitute the
measure for levy of tax has to be value of
goods at time of incorporation of goods in
works, even though property passes as
between developer and flat purchaser after
incorporation of goods.


• It is thus, not correct to say that work is
undertaken by developer for himself and the
owner and construction is not carried for
and on behalf of purchaser.


Constitutional validity of MVAT provisions, the SC held
that:
• - Amendment in explanation b(ii) to Section 2(24)
was brought because of judgment of SC in Raheja
Development and as the judgment lays down correct
legal position, there is no merit in challenge to
constitutional validity of the provisions.
• - However, wrt rule 58(1A), the SC held that mode of
valuation of goods provided in Rule 58(1A) has to be
read to include value of goods only at the time of
incorporation even though property in goods passes
later.

Consequences


Consequences
• The Apex Court has not overruled its
decision in the case of State of AP and Ors v.
Larsen & Toubro Ltd and Ors
• Impact on Pure developers


Consequences
• As a matter of huge relief, the Apex Court
rejected the contention of the State of
Karnataka that sale of immovable
properties, whether finished or semifinished, are within the purview of VAT.


Consequences- Para 115
• It may, however, be clarified that activity of
construction undertaken by the developer
would be works contract only from the
stage the developer enters into a contract
with the flat purchaser.


• Let us assume that the total value of a flat is Rs 100
lakhs, with Rs 40 lakhs being treated as the value
of the land.
• On the date of the agreement 70% of the work has
already been completed in the flat.
• In terms of the L&T decision, only Rs 18 lakhs
representing 30% of Rs 60 lakhs can be treated as
a works contract.

Consequences
• Going forward…


Consequences
• The L&T decision would have retrospective
effect,
• Will the State Governments be flooded with
refund applications from the flat purchasers
/ builders


Consequences
• Possible Loss of revenue
• unless the Constitution is amended, there is
no way the States can get over this historic
decision.
• Reversal of Input Credit


Changes in VAT Legislation
• Madhya Pradesh
• Maharashtra
• Haryana


Consequences on Service Tax


Consequences on service tax?
• Decisions of the High Courts in the Magus
Construction Pvt Ltd Vs Union of India (2008-TIOL-321-HC-GUW-ST) and
Assotech Realty Pvt Ltd Vs State of UP (2007-TIOL-297-HC-ALL-CT), which had
held that, no service is involved when the
Developer enters into an agreement of sale
shall no more be valid


• Most transactions involving construction and sale of flats
would also get covered under Section 66E(b) of the
Finance Act, 1994, which reads as under:• construction of a complex, building, civil structure or a
part thereof, including a complex or building intended for
sale to a buyer, wholly or partly, except where the entire
consideration is received after issuance of completion
certificate by the competent authority.
• Can entry also cover transactions which are not works
contracts ?
• Can this include the value, of the period, prior to the date
of the agreement ?


• Instances where, the construction would be
complete but the CC would not have been
received.
• In these cases, it is perfectly legal to take the
view that, no VAT is applicable, as the
construction is complete. But, the levy of
service tax, in terms of Entry No. (b)of
Section 66E could still survive

• In effect we could have a scenario wherein, a
transaction of construction and sale of a flat
could get treated quite differently, under the
VAT law and the Service tax law.
• Can we challenge the constitutional validity
of levy of service tax ?


• Constitutional validity of Explanations inserted
to the definition of 'commercial or industrial
construction' services and 'construction of
complex' services upheld by the High Courts of
Bombay, Punjab & Haryana and Madras.
• Given further the fact that this entry is under
the 'Declared List', the chances of a challenge to
its legality on constitutional grounds look very
bleak.

• Can pure developers as per law laid down
by the Apex Court in the State of AP v. L & T
case challenge the new law that has taken
effect from 1-7-2012 as well as the old law
with effect from 1-7-2010, in respect of
‘construction services'.


• Do the Developer/Builder would have the
choice to opt for either of the entries under
Section 66E(b) or Section 66E(h) ?


• Section 66E(b) and Section 66E(h) would
indicate that, while services covered under
the earlier entry could cover the services
rendered under the latter entry, the
converse is not true.


• In effect, post L&T decision, the Developer/Builder
would seem to have two choices, viz.
• ++ to classify his service as a 'works contract' in
terms of Section 66E(h) and pay service tax in terms
of the L&T decision, on the balance value of
construction completed on and after the date of the
agreement.
• ++ to classify his service as 'construction service' in
terms of Section 66E(b) and opt for the abatement
scheme under Notification No. 26/2012-ST.


• Can you shift from 66E(h) to 66E(b) and opt
for the abatement scheme under
Notification No. 26/2012-ST.


• The Hon'ble Apex Court makes a strong
statement that the label of payment is not
decisive but the factum of the payment is.
• contentious items like non-refundable
deposits, amounts collected towards
providing water/electricity connections,
etc., may be considered for valuation of the
taxable services.

Joint Development Agreement


• how does the L&T decision affect the levy of
service tax in respect of Joint Development
Agreements?


Joint development Agreements
• This decision in Para 111 makes an
observation that "direct monetary
consideration may not be involved but such
agreement cannot be seen in isolation to the
terms contained therein and following
development agreement, the agreement in the
nature of the tripartite agreement between the
owner of the land, the developer and the flat
purchaser whereunder the developer has
undertaken to construct for the flat purchaser
for monetary consideration”.

• There is a view that, in terms of Para 111,
reproduced above, even Joint Development
Agreements could get treated as works contracts
under the VAT law.
• Karnataka High Court is yet to pronounce its verdict
on the leviability of VAT on joint development
agreements.
• Service tax law on works contract would necessarily
have to follow the VAT law, not-withstanding some
CESTAT decisions, the Board Circular No.
151/2/2012-ST dated February 10, 2012 and the
Education Guide.

Before concluding…
• ramifications arising out of the L&T decision on the Realty
Sector would be far and wide
• It would perhaps take some time for the Realty Sector to
fully digest the impact arising out of the L&T decision
• This decision could have no implications in so far as the
levy of stamp duty by the States is concerned
• It would be interesting to see how the States would react to
this historic decision in general and Para 115 in particular.
• The L&T decision may also impact works like BOT,
maintenance contracts, erection contracts, etc.
• Can we challenge the levy of Stamp Duty now


Message from BAI Judgement
• The Constitutional-Amendment in Article 366(29A) read with the
relevant taxation-entries has enabled the state to exert its taxing power
in an important area of social and economic life of the community. In
exerting this power particularly in relation to transfer of property in
goods involved in the execution of 'works-contracts' in building
activity, in so far as it affects the housing-projects of the
underprivileged and weaker sections of society, the state might
perhaps, be pushing its taxation-power to the peripheries of the social
limits of that power and, perhaps, even of the constitutional limits of
that power in dealing with unequals. In such class of cases 'BuildingActivity' really relates to a basic subsistential necessity. It would be
wise and appropriate for the state to consider whether the requisite
and appropriate classifications should not be made of such buildingactivity attendant with such social purposes for appropriate separate
treatment. These of course are matters for legislative concern and
wisdom.


Supreme Court Judgement - L&T / K Raheja (VAT on Builders)

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