Will SC Ruling on Works Contract Tax open Pandora's Box?

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Larger Bench of SC has recently upheld levy of sales tax / VAT on construction and sale of flats, holding building contracts to be species of "works contract". Larger Bench has, thereby, approved the ratio laid down by 2-Judge Bench of SC in Raheja Development.  However, it has clarified that construction activity undertaken by the developer would be "works contract" only from the stage when developer enters into a contract with the flat purchaser. 
 
Tax Experts analyse the impact of this ruling on Real-Estate Industry.


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Ms. Bhavna Doshi

Pronounced on 26 September 2013, the Judgement of Supreme Court (SC) in the case of Larsen and Toubro , changes the concept of “works contract” and significantly expands scope of taxation of transactions involving transfer of property in goods involved in execution of “works contracts”. It will have significant bearing on the manner of its implementation going forward.
 
Hitherto, at least till the decision of SC in the case of Raheja Developers (which was believed to be differentiable on facts and in law), “works contracts” as referred to in Article 366(29A)(b) of the Constitution were generally, understood to be those transactions where the work was performed on the property of the customer/buyer and the property in the goods, in any form, passed to the customer by theory of accretion/accession; where the customer had proprietary interest in the works whether it was repair or modification or renovation of goods/immovable property or construction of building on customer’s land.
 
The interpretation adopted by the SC has, in essence, done away with this aspect of proprietary interest. SC has now explained “works contract” to mean a transaction where, as a result, “work(s)” is/are created irrespective of whether the property on which the work is carried out belongs to the customer or not and even if the property in the resulting movable or immovable property passes to the customer subsequent to the completion of the “works”.
 
Effectively, therefore, transactions where goods are made to order will need to be carefully examined for applicability of works contract tax. The same will also be true of service contracts involving transfer of property in goods, even if such transfer is incidental or ancillary to the execution of the works contract.
 
It will be interesting to see how State Governments formulate rules for determining taxable value in case of contracts involving sale of flats in under construction buildings as value, in each case, could be different based on the stage of completion of the work at the point of time when the agreement is entered into. Supreme Court has clearly held that the taxability, as works contract, arises only after the agreement is entered into. This means, in each case, taxable value will need to be determined based on the proportion of the consideration allocable to the work carried out after the date of entering into the agreement.
 
An important implication of this judgment is that the VAT chain will now get extended, to some extent, to the ultimate buyer of the under construction properties. Developers pay works contract tax to the contractors and they, in turn, will charge works contract tax to the customers. This will require State Governments to work out appropriate mechanism to enable credit flow to avoid double taxation. It will also be interesting to see whether this chain is further extended (completed) by allowing input tax credit to the buyers of properties who use it for business purposes and are paying output VAT. That would be the true VAT – a complete pass through for businesses!!!