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Developers’ liability to pay VAT on sale of flat during construction of flat, premises etc.

By Pradeep S. Shah & Mukesh J Bhavsar

I. PRELIMINARY

The Commissioner of Sales tax, Maharashtra, by Circular No 14 T of 2012 dated August 6, 2012 ("the Circular") conveys that VAT is payable on sale of flat during construction by a developer or builder ("the sale of flat") and seeks to induce the developers to pay tax on the sale of flat by providing administrative relief etc.
Subsequent thereto, there were questions about huge liability in the hands of the purchasers.
Apparently, thereafter, on its website Sales tax Department has put up "Basic information in case of tax on developers" and "Frequently asked questions" (hereafter collectively referred as "FAQs") and seeks to explain various matters.

Prima facie, it is felt that the basics and other information set out in the Circular or FAQs do not give a correct picture in accordance with the provisions of law and/or creates certain misunderstanding or misgivings about the inferences and, in particular, in relation to the ultimate cost of VAT embedded in the cost of flat. The objective of this write up is to examine the same.

II. LIABILITY TO VAT
The Circular as well as FAQs start with a basic premise that pursuant to the amendment carried out in VAT laws (in Maharashtra), with effect from June 20, 2006, a builder or developer is liable to tax on the sale of flat. The amendment reads as follows:

"an 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 movable or immovable property".
The above definition, as such, is based on various court decisions to cover various types of activities carried out by a contractor in relation to the movable or immovable property. In other words, the definition does not say anything new. Even otherwise the listed activities carried out by a contractor were treated as works contract.
Further, the definition does not create any fiction to the effect that when a builder undertakes the activity of construction with an intention to sell the premises to intending purchasers, such activity would be considered as a works contract, that is, building or construction of an immovable property under an agreement. For the purposes of levy of service tax, the Central Government did create such a fiction, in service tax law, to levy service tax on the service portion involved in construction of buildings intended for sale.
The amendment was challenged and Bombay High Court in MCHI v State of Maharashtra & Others case held that the amendment was constitutionally valid. However, nowhere the Court held that the sale of flat amounts to a works contract; in fact,it observed that it needs to be determined in assessment.
Prior to the amendment in Maharashtra VAT laws, in various determinations given by the Commissioner of Sales tax, Maharashtra (during the years 1988 to1995) had held that the sale of flat is not liable to tax (or works contract tax, as is commonly known) as if it is a works contract, under the laws in force at that point in time.
As discussed earlier, the amendment in the definition, as such, has not carried out any changes which suggest that the sale of flat amounts to works contract liable to tax.

Hence, the basic premises on which the Circular and FAQs are issued cannot be considered as based on the correct interpretation of law. In other words, presently, “the belief” of the Commissioner that the sale of flat is liable to VAT is the basis and not the law.

III.         OPTIONS FOR PAYMENT
Methods for determining sale price
The Basic information ("FAQs") sets out three options, as specifically stated in the provisions of law.
VAT is payable on the turnover of sales defined to mean the aggregate of sale price, that is, consideration received or receivable for the sale of goods.
Thus, the tax is payable on the sale price on sale of goods.
The law does not provide that the methods stated therein are the only methods and that no other method can be followed, to determine the sale price.
For the purposes of computing tax, what is relevant is "sale price". While prescribing a method, the relevant Rule 58 itself uses the language "may" signifying that it is only a directory and not mandatory. In other words, the said Rule itself recognises that there could be other methods of determining sale price. To illustrate, where the sale price of the goods supplied or used in execution of works contract is determinable on the basis of list of sale price of the ultimate suppliers and/or in the agreement itself, such price can be adopted and the law does not rule out the possibility of adopting such sale price.
To the above extent, the Basic information ("FAQs") does not accord with the specific provisions of law providing for determination of turnover of sales.

Three methods

First: Derived value of goods [as per Rule 58 (1)], that is :
Value of contract                                                                                       xxx
Less :(i) labour charges etc and profit                     
          thereon as specified in Rule 58(1)                xxx
         (ii) Land cost                                                  xxx
Sale Price                                                                                                 xxx
Second: It is a variant of the above method, where labour charges etc cannot be easily ascertained. Derived value of goods [as per Proviso to Rule 58 (1)], that is:
Value of contract                                                                                         xxx
Less: (i) payments to works contractors                         xxx
         (ii) Land cost                                                          xxx
         (iii) 30% of contract value as reduced                   xxx
          by payments to sub-contractors.
SALE PRICE                                                                                              xxx
Third: Composition payment under section 42 (3) @ 5% of the contract value.
While explaining the methods, it mentions about availability of set off and the relevant part reads as follows:
First and second method: "the tax computed as above is reduced after considering the tax paid on the purchases of building material (that is, input tax credit). The tax so determined is required to be finally paid".

Third method: "this tax liability is reduced by the amount of taxes paid on purchases, that is, input tax credit. The balance tax liability so computed is to be discharged".

The above does not explain that :

  • The methods were devised for works contractors and not for the sale of flat in case of developer. The methods were prescribed prior to amendments in law without contemplating a situation like in case of the sale of flat.
  • There is no method specifically prescribed for the sale of flat, save deduction of land cost and 1% composition scheme enacted effective April 1, 2010.
  • The set off may not be available of the entire amount, on account of non-allowance or reduction;
  • the set off is not available in respect of Interstate purchases;
  • the set-off on capital assets or in respect of purchases in which property in goods does not pass; and
  • the set off, in case of the third method, is available only after reduction of 4% of the purchase price; in other words, the entire set off is not available.

Thus, to the extent the set off is not available, it forms part of the cost of VAT embedded in the cost of the builder or developer and obviously in the sale price of the purchaser. The effect of the above is illustrated little later.

Apart from the above, the language extracted above suggests that the effective VAT cost is the final amount required to be paid, which factually and in law is not correct. As per the theory and practice of VAT, the tax is payable on value addition and is collected at each stage of value addition. As per the invoice method followed by Maharashtra government, the tax is collected at each stage and after allowance of set off, the net amount is payable. The net amount does not constitute the cost of VAT; it only reflects the amount payable by a dealer at that stage after set off. The set off is allowed in respect of the VAT already paid to government on the earlier sale. Thus, the amount charged to the ultimate customer is the costs of VAT. This is illustrated little later. To put it differently, in case of Third method, it cannot be said that the cost to the purchaser of the flat is less than 5% on account of set off available inasmuch as the builder collects 5% from the purchaser and after availing the set off (being amount already paid on purchases) pays net amount to the government. In other words, the set off does not reduce the cost of VAT passed on to the purchaser.

Land cost in case of third method

VAT is on the transfer of goods involved in the execution of a works contract. Section 42 (3) contemplates payment of composition amount on the value of works contract and not the agreement value. In spite of that, it is provided that the composition payment needs to be paid on the entire contract value without deducting land cost.

In other words, although, not authorised under the law to levy tax on an item other than goods, through the Circular, tax is sought to be collected also on the value of land. If the builder follows other methods, the land cost is allowed to be deducted.

Even in case of composition payment this cannot be done is recognised by the legislature and, therefore, while specifying the rate of composition, in respect of one percent scheme, the rate of composition was reduced, although, the value of land was included therein. In other words, an adjustment was allowed for the value of land by adjusting the rate of composition.

Illustration
Tax effects of the above methods can be better understood through the following illustration.

To illustrate:

  • Agreement value, say, is Rs 100;
  • Land cost, say, is Rs 20;
  • Material cost is 40% of agreement value (i.e. Rs. 40);
  • 50% of the material used (i.e. Rs. 20) attracts tax at 4%; and
  • The balance 50% of the material used (i.e. Rs. 20) attracts tax at 12.5%.

VAT on purchases would be: Rs 3.30
(4% on Rs 20, that is, 80 paise and 12.5% on Rs 20, that is, Rs 2.50).

As per second method, VAT payable could be:

  • Agreement value Rs 100

less: land value Rs 20
less: Labour etc @ 30% Rs 100, that is, Rs 30

  • Sale price of goods used in construction Rs 50.
  • Tax at 4% on Rs 25 will be Re 1.
  • Tax at 12.5% on Rs 25 will be Rs 3.13.
  • Total tax, which can be charged to the purchaser will be Rs 4.13, that is,

     4.13% of agreement value.

  • Amount of tax to be paid by the builder/developer to government will be Re 0.83 inasmuch as he has already paid Rs 3.30, by way of VAT, on purchases.

As per the third method, the position could be:

To take the benefit of such simplified scheme, the builders or developers may opt for the same, since they would be in a position to recover the amount from the buyer.

On composition basis, the builder or developer will charge Rs 5 as tax on Rs 100, which he would recover from the purchaser.
While making payment, he would get set off of about Rs 1.70 (out of total VAT paid Rs. 3.30 on its purchases, set off @ 4% of its purchase price would not be allowed and, therefore, make net payment to government of Rs 3.30.)
Thus, the aggregate VAT cost would be Rs 6.60 (i.e. aggregate of disallowed set-off Re. 0.80 on purchases attracting 4% VAT plus Re.0.80 on purchases attracting 12.5% VAT plus 5% composition tax) and would form part of cost of developer and sale price to the purchaser.
Now, when the matter was in dispute, by and large, a builder may have built in the cost of VAT in the purchase price of flat. Thus, in the above example, Rs. 3.30 was recovered and included in the sale price. In addition thereto, now, Rs 5 would be recovered by way of tax. On the top of that, interest3 at 15% per annum, in terms of the contract, may be recovered from the buyer. Suppose, the buyer had purchased the flat sometime in August 2008; the builder decides to pay the tax in August 2012. Thus, the builder will have to pay 60% by way of interest on the amount of VAT payable (Rs 3.30); however, in terms of the agreement, a builder may be able to recover interest on Rs 5, which would work out to Rs 3. Thus the aggregate cost to the buyer would be about Rs 11.30 that is 11.3%.

It may not be out of place to mention that even in case of purchase of goods, the retailer or the supplier charges VAT at applicable rate, that is, 5% or 12.5%, as the case may be, on the entire amount, and while paying VAT collected, considers the set off available to him. In other words, the set off is not passed on to the ultimate purchaser.

IV         CERTAIN OTHER MATTERS

One percent composition scheme

The Basic information (“FAQs”) states that pursuant to various Developers Associations’ representations, 1% composition scheme was evolved and is applicable with effect from April 1, 2010. In case of 1% composition scheme, broadly stated, subject to fulfilment of conditions:

  • 1% is payable on agreement value or stamp duty value (which includes land value), whichever is higher; and
  • no set off is allowed.

Thus, even under 1% composition scheme, based on the above illustration, it is clear that VAT cost, in case of the sale of flat would be about 4.3%.

It is learnt that the builders or developers had represented that 1% scheme may be applied even in respect of past transactions. However, for whatever reasons, the representations were not accepted.

Collections by Builders

After June 20, 2006, on account of uncertain position, apparently, the industry evolved a practice of collecting amounts, in respect of VAT liability, if any, in escrow accounts or in a manner which safeguards the interests of both the builders and/or the purchasers.

They were advised that such collections, by way of deposit and in the like manner, do not amount to collection of VAT. Thus the amounts were collected to meet any contingency.

In the circumstances, it is not clear as to how the Basic information states that the builders have failed to discharge their tax liability by depositing the collected tax (except in a case where the amounts were actually collected as VAT).

Replies to various questions

In that, a reference to one reply, pervading throughout the FAQs, is necessary. The liability is linked to the agreement value or the amounts received or receivable under the agreement value. The receipt of value is not the taxable event. The taxable event is the transfer of property in goods in the course of execution of Works contract.

Having regard to the above, it is felt, the Circular and/or FAQs, it appears, are like built-up area or super built-up area or carpet area or actual available area confusion in the minds of the purchasers. They do not reflect the position in law which would be applicable to the sale of flat for determining whether it is liable to VAT and, if yes, what could be the amount thereof.

Way forward
Would it not be advisable for the Government to adopt 1 % composition scheme even for the period 20.06.2006 to 31.03.2010? It would save a lot of efforts on the part of Government; Builders; and Purchasers. Effectively, the Government would collect 4 % or more by way of VAT -1% on agreement value and about 3.3% being VAT paid on purchases, which would not be available as set off.


M/s Bhadani Associates, M/s Unit Arsens Developers,M/s Paranjape Builders Pvt Ltd- DDQ-          1088/C/40/Adm-  12 Dated: 10.03.1988
   M/s K. E. Builders-DDQ-WC-1492/43/Adm-12 Dated: 18.02.1993
   M/s D. S. Kulkarni and Associates-DDQ-WC-1489/88/Adm-12 Dated:13.06.1994
   M/s D. S. Kulkarni and Associates-DDQ-WC-1489/87/Adm-12 Dated: 31.03.1995

(Derived value as explained earlier)

3 Presently, it is not waived and it may be inferred that Supreme Court has not barred the levy of interest.

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