Budget 2010 has significant service tax related proposals in store for the Indian real estate sector.

The article addresses the amendments concerning the renting of immovable property. Before that it is imperative to set out first the background relating to the issue. The service in respect of renting of immovable property has been defined under Section 65(105) (zzzz) of the Finance Act, 1994 (‘The Act’) and was introduced w.e.f. June 1, 2007. The relevant portion of the definition reads as follows

“Taxable service” means any service provided, or to be provided to any person, by any other person in relation to renting of immovable property for use in the course or furtherance of business or commerce and the term “service provider” shall be construed accordingly. At the outset, it must be noted that tax applies only on the renting of commercial property and not on residential property. Following the introduction of this taxable service, several writ petitions challenging the levy were filed in various courts. In April 2009, the Delhi High Court, in the case of Home Solution Retail India Ltd & Others vs. UOI & Others (2009 (237) ELT-209), held that the taxable service in respect of renting of immovable property, as defined under the relevant sections of the Finance Act 1994, was with regard to any service in relation to renting of real estate in India and was not on the renting of immovable property as such.

Consequently, the High Court held that the levy of service tax on the renting of immovable Indian property itself, in terms of the relevant notification issued consequent to the introduction of the taxable service, was ultra vires the provisions of the Act. In arriving at its decision, the court relied on the wordings of the definition to hold that since the activity of renting of immovable property was itself not a service, the expression ‘service in relation to renting of immovable property’, could only extend to services which are provided in relation to the renting of immovable property. With regards to the nature of the service tax itself, the High Court had held that it is a value added tax and the tax is a tax on value addition done by the service provider and it must have a connection with the service. Consequently, since the mere renting of immovable property did not entail any value addition, it could not be regard ed as a service for that reason as well.

While upholding the arguments contained in the writ petitions in regard to the above points, the High Court did not examine the alternate argument that the relevant definition, should it be construed as applicable to the activity of renting of immovable property as well, would be violative of the Constitution of India in that the Central Government could not, in terms thereof, impose a tax on land, as it was a State subject. Coming back to Budget 2010, the proposal is to amend the definition of renting of immovable property services, to provide that the activity of “renting” is itself a taxable service. This amendment is proposed to be made with retrospective effect from June 1, 2007. The amendment also now extends the service tax to rent of vacant land where there is an agreement or a contract between the lessor and lessee for undertaking the construction of a building or structures thereon for the purpose of business or commerce. These amendments will come into force from a date to be notified after the enactment of the Finance Bill 2010. Once that happens, the tax will become payable for the period from 1st June 2007 and beyond.

Assuming that the retrospective amendment is constitutionally valid, the point is that the tax becomes payable on and from 1st June 2007. Some key questions need to be answered in this regard. One such question is whether such a tax is chargeable and payable prior to the retrospective amendment coming into force. The legal position is that the tax is not chargeable or payable before this date. This would mean that landlords need to enter into a dialogue with their tenants as to how such back taxes are to be charged for the taxable periods in question and how they would be reimbursed by the tenants, as per contractual terms. Another question is regarding interest on such back taxes. Now, Clause 76 of the Finance Bill 2010 saves actions taken between June 2007 until the date of the retrospective amendments coming into effect on any proceedings for recovery of service tax, interest, penalty, fine or charges related to the renting of immovable property. This could be interpreted to mean that should there be demands from the department to this effect, such demands will continue to have force.

However, should there not be a proceeding at all, and therefore no demand or an order related to the service tax on renting is or was in force, no interest can apply in the matter. In other words, the interpretation is that the savings provisions do not authorise the computation of interest, where no order for interest had earlier been passed. An entirely similar argument could be made with regard to penalty as well. Independent of the above position in law, and to avoid prolonged and vexatious litigation on the point, the Government should seriously consider issuing a clarification that no interest or penalty will be required to be paid, if the service tax were to be paid immediately upon the date of coming into force of the amended provisions. Indeed, this is the only reasonable course to adopt, given that the service tax on renting per se was held not payable by the Delhi High Court and taxpayers had legitimately followed this decision and it is only now that the Government is seeking to undo the decision through the retrospective amendment in question. In such a situation, imposition of interest and/or penalty will be highly inappropriate.

In conclusion, the retrospective imposition of service tax on Indian property rentals will have significant implications, especially where no offset of such taxes is possible, such as in retail sector. The Government needs to be sensitive to this point. It is the expectation in the forthcoming GST, such inability to offset input taxes will be addressed. Until such time however, this matter will continue to pose significant challenges.

The Indian government plans to charge a service tax on sale of homes Indian real estate under construction. This will have a major impact and will raise costs for buyers.

The levy on Indian real estate under construction may increase costs for home buyers by as much as 5 percent, the Confederation of Real Estate Developers’ Associations of India said on Feb. 26. India plans to levy service tax on several real estate-related activities, among other activities.

This is expected to have an effect on investment in Indian real estate, with investors becoming cautious of investing in Indian commercial real estate assets, especially income generating assets, since purchasing such properties on a fixed return basis will now yield significantly lower returns.

A property owner may earn different types of incomes from his Indian property . This depends on the nature of the property and the purpose of its holding according to Ashish Gupta, ETBureau. Broadly, a property may either be residential or commercial.

In case one owns residential property, it may either be self-occupied or rented out. If one rents out his residential property , income as rent can be earned. The income earned as rent is taxable in the hands of the recipient. It is taxable under the head “Income from House Property”.

The tax liability is calculated according to the provisions of Sections 22 to 27, after allowing for the admissible deductions. No deductions other than those specified under the Income Tax Act are permissible.

What is taxed under the head ‘Income from House Property’ is the inherent capacity of the property to earn income called the ‘annual value’ of the property . This is taxed in the hands of the owner of the property. Gross annual value is the higher of rent received or receivable , and fair market value or municipal valuation. If however , the Rent Control Act is applicable , the gross annual value is the standard rent or rent received, whichever is higher.

In case a let-out property was vacant for a whole year or any part of the previous year, and owning to such vacancy the actual rent received or receivable is less than the sums mentioned , the amount actually received or receivable will be taken into account while computing the gross annual value.

Net annual value is the gross annual value minus the municipal taxes paid by the owner. This is provided the taxes were paid during the year. Annual value is the net annual value minus the deductions available under Section 24.

The Delhi High Court in India has pronounced its judgement with regard to several writ petitions which had challenged the applicability of the levy of service tax on renting of immovable property.
The High Court has held that the taxable service in respect of renting of immovable property, as defined under the relevant Section 65(105)(zzzz) of the Finance Act 1994 thereof, was with regard to any service in relation to renting of property and was not on the renting of immovable property as such.

Consequently, the High Court has held that the levy of service tax on the renting of immovable property itself, in terms of the relevant notification issued consequent to the introduction of the taxable service, was ultra vires the provisions of the Act.
In arriving at its decision, the court has relied on the wordings of the particular taxable service in order to hold that since the activity of renting of immovable property was itself not a service, the expression ‘service in relation to renting of immovable property’, occurring in the definition of the taxable service, can only extend to services which are provided in relation to the renting of immovable property.

Accordingly, the Court distinguished the particular definition of service in relation to renting of immovable property from several other definitions in service tax law which were similarly worded and held that in those other definitions, the expression ‘in relation to’ itself referred to a service and consequently not only was the core service taxable but also the allied and ancillary services in relation thereto were also taxable.

The court illustrated this distinction by referring to the taxable service of dry cleaning where the expression was a service in relation to dry cleaning and held the activity of dry cleaning was itself also a service which was taxable therein. As opposed to this situation, the taxable service provided by a real estate agent, for instance, was a service in relation to real estate and since real estate was not a service, the definition could only extend to services in relation thereto.

On a similar analogy, the court came to the conclusion that in the present case, the renting of immovable property could not be construed as a service by itself and hence the taxable service in question could only extend to services in relation to renting of immovable property and not to the activity of renting itself.

In arriving at the aforesaid finding, the court has relied on the decision of the Supreme Court in T N Kalyana Mandapam Association Vs. UOI (2004) 5 SCC 632) which, interestingly enough, was relied upon both by the appellants, who had challenged the legality of the levy, as well as by the respondents i.e. Government of India. Based on a detailed consideration of the aforesaid judgement, the Delhi High Court has come to a determination that the decision of the Supreme Court supported the argument of the appellants and not that of the respondents.

With regard to the nature of the service tax itself, the High Court has held that it is a value added tax and the tax is a tax on value addition done by the service provider and it must have a connection with the service. Consequently, since the mere renting of immovable property does not entail any value addition, it could not be regarded as a service for that reason as well.

Here again, the High Court has relied upon another decision of the Supreme Court, in All India Federation of Chartered Accountants Vs. UOI (2007) 7 SCC 527), which had held that just as excise duty was a tax on value addition in regard to goods, the service tax was a tax on value addition by rendition of services.

Accordingly, the Supreme Court, in that case, had distinguished property-based services and performance-based services and had arrived at a conclusion that the expression ‘in relation’, occurring in the various relevant definitions, needed to be construed in accordance with this principle of value addition.

The High Court has, relying on the above decision, consequently come to the conclusion that the levy of service tax on the activity of renting of immovable property was ultra vires the relevant definition of the taxable service, as contained in the Finance Act, 1994.

While upholding the arguments contained in the writ petitions in regard to the above points, the High Court has held that it has therefore not been required to examine the alternate argument as contained in the petitions that the relevant definition, should it be construed as applicable to the activity of renting of immovable property as well, would be violative of the Constitution of India in that the Central Government could not, in terms thereof, impose a tax on land, as it was a State subject.
Hence, the decision is limited to the point that the taxable service as understood and interpreted through the relevant impugned notification and hence the tax so collected, was not in accordance with the statute and hence without basis in law and the decision is not with regard to whether or not the definition of taxable service itself is unconstitutional.

This judgement is applicable on an all India basis, as it is on a point of legality, and would have far reaching consequences for all and in particular for those who carry on business in rented premises and who do not have an output excise or a service tax liability so as to be able to offset this tax on rentals. The Retail Sector is thus a very major beneficiary, as the service tax on rentals is a very significant unrecovered tax cost for the sector. Further, the judgement has ramifications with regard to other taxable services as well since these are also similarly worded.

The Central Government is almost certain to file an appeal against the aforesaid judgement with the Supreme Court. It remains to be seen whether it will request a stay of the judgment in the interim and whether such a request would be granted. It is also possible that the Government may consider amending the provisions of the Finance Act, 1994, possibly with retrospective effect, in order to overcome the above judgement of the Delhi High Court. The picture will become clear in this regard in the near future.

However, until such time as these eventualities do not occur, taxpayers can take effective steps to avail the benefit of non payment of service tax on renting of immovable property. Several issues such as discontinuance of payment of tax for future period, filing of refund claims for past taxes paid on such rentals, for the period of one year and beyond, availment of CENVAT credits on such taxes, payment of such taxes to the Government, if already collected as such, the person entitled to file such claims will need to be addressed in detail, in order for the benefits to flow to tax payers.

The Indian revenue department have completed a u-turn on its proposed reform of Indian property stamp duty announced over a month ago.

The Congress minister Patangrao Kadam, has dropped the plan after the revenue department studied the pros and cons of the proposal which sought to change the “ready reckoner” rates and move to a more sophisticated system.
The proposed new system was to calculate stamp duty on Indian property taking into account other key constraints.

It was proposed to value a properties stamp duty liability in terms of it’s real value taking into consideration its proximity to amenities, its distance from the railway stations, the scope for further development, status of title and floor-space index. The rates of stamp duty charged would therefore differ on the same type of property in different locations.

The government have now decided that the system does not need to be changed and have rejected this proposal for now. It is thought that this decision is based more on the governments own resource crunch with stamp duty on Indian property delivering important receipts. Pressure however is still being applied by real estate players in India who are looking for ways to increase stimulate demand.

The age-old system of charging stamp duty on property in India based on the “ready reckoner” will be obsolete in a matter of months according a report by the Times of India.

Instead of this system the inspector-general of stamps and registration has proposed a draft where the value of a property will now be calculated using a number of different criteria. These include locational advantages and disadvantages which actually decide the true value of real estate in India.

Ramrao Shingare, who drafted this new system using the assistance of a Geographic Information System, said,

“No scientific methodology was available so far to decide a property’s real value. We felt the value of a piece of property should be based on the availability of amenities, its distance from the railway station, the scope for further development, status of title and floor-space index, among other factors. If we take all these aspects into consideration and modify the rules accordingly”

This new system will use over a dozen issues which will decide the real value of property, with those close to less attractive facilities even paying less stamp duty.

However although some property owners in India could see their stamp duty bills fall, the changes are mainly designed to lead to increasing the state’s income from stamp duty so buyers should not get too excited yet!

“If we are able to decide the real market value of the property, it will help add revenue to the state exchequer. With this aim in view, we have drafted the new microplanning project to ensure that all properties are valued properly and stamp duty charged accordingly” Mr Shingare said.