Implications of K. Raheja’s Judgment

The decision of Apex Court ultimately settled the concept of Indirect Tax Laws on various issues whether it was Ashok Leyland’s case or the decision of Sunrise Associates delivered on 20-4-2006 regarding tax on sale of lottery tickets or the decision of BSNL’s case (which has reversed the earlier decision of the Apex Court in the case of First Ashok Leyland or State of Uttar Pradesh vs. Union of India and Others) or K. Raheja regarding interpretation of Article 366, (29-A) of the Constitution of India specially with reference to the definition of the word “goods” under section 2(d) of U.P. Act or 2(j) of Tamil Nadu Act.

Basis of Raheja’s Judgment

The decision of K. Raheja (supra) of the Apex Court dated 5-5-2005 arose out of the order of Hon’ble Karnataka High Court, by which the sales tax revision petition was disposed of in accordance with the judgment of the Mittal Investment Corporation decided by Karnataka High Court on 24-9-1999 and a direction was issued to the assessing authority that the matter should be decided in accordance with the observations in the judgment of Hon’ble Karnataka High Court in the case of Mittal Investment Corporation for deciding the question as to “whether the contractor has constructed the building for himself or it was constructed for the prospective buyers with whom the agreements have been entered into even before the construction”. In the decision of Mittal Investment Corporation four questions were raised which were decided on the basis of relevant clauses of the agreement and the relevant laws of Karnataka.

After going through the decision of the Mittal Investment Corporation, it is clear that the said decision is based upon the provisions of Ownership Flats (Regulation of Promotion of Construction, Sale, Management and Transfer) Act, 1972.

In view of the aforesaid provisions in the ownership Act, the Karnataka High Court in the case of Mittal Investment Corporation has held that the ultimate purchaser shall be treated as contractee, and the owner of the land who is constructing the building/flats shall be deemed to be contractor, even though it is not necessary that the contractor should be the owner of the land or he himself have some interest in the land on which the construction is to be made.

The decision of the Mittal Investment Corporation was relied upon by the Karnataka High Court in the case of K. Raheja (supra) by which the matter was remanded to the assessing authority for deciding the question again. The observation of the Karnataka High Court in the case of K. Raheja (supra) was as follows:-

“Whether the petitioner constructed the building for himself or it was constructed for the prospective buyers with whom the agreements have been entered into, even before construction.”

Since this question was examined in Mittal Construction Pvt. Ltd., in accordance with the Ownership Flats (Regulation of Promotion of Construction, Sale, Management and Transfer) Act, 1972, hence the matter was remanded to the assessing authority to decide the issue. However, Hon’ble Supreme Court of India in the case of K. Raheja (supra) has gone only on the relevant clauses of the agreement and has held that the Karnataka Ownership Flats (Regulation of Promotion of Construction, Sale, Management and Transfer) Act, 1972 is not relevant for the purpose of deciding the controversy in view of the specific clause of the agreement.

Implication of Raheja’s decision

Even though in paragraph 12 of the judgment some observations have been made when it was observed by Hon’ble Supreme Court of India that the definition of the works contract is very wide and it is not restricted to a works contract commonly understood and even if the owner of the property enters into an agreement to construct flats and building on behalf of anybody else it shall be treated as works contract and the owner shall be liable to pay the tax.

But these observations has to be read with reference to the contract entered into between prospective purchasers of the flats and the developer. In this connection paragraph 19 of the said judgment is very important in which it has been mentioned as follows:–

“To consider whether the appellants are executing works contract one needs to look at a typical agreement entered into with the purchaser and relevant clauses 1, 5(c) and 7.”

which has been quoted by the Hon’ble Supreme Court of India.

A perusal of sub clause-B of clause 1 of the said agreement clearly showed that K. Raheja, as developper had agreed to build the building for the prospective purchaser and they shall build for and as a unit belonging to the prospective purchasers.

I am of the view that if any construction is made for and on behalf of the prospective purchasers of the flats then the construction activities, according to the judgment in the case of K. Raheja (supra) shall be deemed to be on behalf of the contractee viz., prospective purchaser even though the construction work might have been done either by the owner himself or by the developer who is getting the flats and building constructed not for himself but for the prospective purchaser on his behalf.

In this connection relevant portion of paragraph 20 of the said judgment of K. Raheja (supra) is relevant which is reproduced below:–

“If there is a termination of the agreement and the particular unit is retained by the developer there would be no works contract to that extent. But so long as there is no termination the construction is for and on behalf of purchaser. Therefore, it remains a works contract within the meaning of the term as defined under the said Act. It must be clarified that if the agreement is entered into after the unit is already constructed , then there would be no works contract.……”

From the aforesaid observations, it is clear that if the agreement is entered into after the unit is already constructed then there would be no works contract but if the agreement has been entered into prior to the completion of the building and the construction is made for and on behalf of the prospective purchaser, as was the case in K. Raheja (supra) it shall be treated as works contract and any property which is being transferred under such works contract shall be liable to tax, in accordance with the law provided therein.

Judgment of K. Raheja not applicable in certain cases

According to me the judgment of K. Raheja (supra) will not be applicable where the construction has not been done for an on behalf of prospective purchasers.

The judgment shall also not be applicable in those cases where flats has not been sold and has only been given on lease.

If the company gives the built up area on lease and charge the lease rent in addition to the premium fixed for giving the said premises on lease, the said agreement shall continue to be lease agreement which will not amount to sale.

Where the construction has been made exclusively by the owner himself for himself and not for any prospective purchaser or where the construction has been completed and thereafter the agreement is made for the sale of such constructed building or flat; the judgment of K. Raheja (supra) cannot be a basis for imposition of tax on transfer of property involved in the construction of building.

It is also important that where there is a contract of sale of any flat or building, the judgment of K. Raheja (supra) does not come into the picture at all.

Raheja’s judgment to be understood in the light of contract mentioned therein

It is well established by the various judgments of the Apex Court that every observation cannot be treated as a law declared by the Hon’ble Apex Court under Article 141 of the Constitution of India.

It has held in Union of India vs. Dhanwantari Devi, reported in (1996) 6 SCC 44 at p. 51 and also in Mittal Engineering Works (P) Ltd. vs. CCE, Meerut, (1997) 1 SCC 203, para (8), Vijaylaxmi Cashew Company and Others vs. Deputy Commercial Tax Officer and another, (1996) 100 STC 571 at p. 576 and Ambica Quarry Works vs. State of Gujarat and Others, (1987) 1 SCC at p. 213, that every observation of the judgment has to be read in the context of the facts of the case, question involved, raised and decide in that particular case, and not what logically follows from the judgment.

Hence any observation made in paragraph 12 of the said judgment cannot be treated as the law laid down by Hon’ble Apex Court. The observation made in the judgment of K. Raheja (supra) has to be read in the context of paragraphs 19 and 20 of the said judgment.

The law which has been declared by the Apex Court is the law as mentioned in paragraph 20 of the said judgment, which is based upon the facts and the terms of the contract, as referred to in paragraph 19 when Hon’ble Supreme Court of India has specifically observed as follows:–

“To consider whether the appellants are executing works contract one needs to look at a typical agreement entered into with the purchaser”

I reiterate that where the construction has not been made for and on behalf of the prospective purchaser and the terms of the agreement are entirely different than the agreement referred to in paragraph 19 of the judgment in the case of K. Raheja (supra) the said decision will not be applicable.

Buildings given on term lease or licence

On the flats given on lease for 30 years or 50 years, whether the judgment of K.Raheja is applicable.

Take a case where the contractor is required to make construction for the purposes of giving building/flats on lease.

A condition is provided in the lease deed that the lessee is prohibited to transfer the constructed area except with permission of the owner of the flats.

The building/flats can be given only on lease or licence. Contract for construction of flats is given to a contractor who shall construct the same on a fixed amount. However, steel and cement are supplied by the contractee free of cost.

After the work is completed the constructed area shall be used by the contractee or some part shall be given on lease to other party. The contractor is only making construction for the contractee and not for prospective allottees or lessees with whom the contractee has entered into lease agreement.

There is no transfer of property involved in execution of this work contract vis-a-vis subsequent lessee or allottees are concern.

In spite of K. Raheja’s judgment, there shall be no liability for payment of tax, since construction cannot be deemed to have been made for and on behalf of prospective lessees so far as building or flats are concerned. Contractor will be liable for payment of tax only to with respect to the property transferred to contractee only.

The lease having been given by the contractee the lessee will not become owner of the flats or building even if some premium amount is charged along with rent for such lease.

It is well known fact that when landlord has been given a shop on rent or lease to a tenant, the premium amount is also charged in addition to the rent of the said shop.

Even where the tenant vacates the shop situate in the prime area, the tenant also sometimes demand certain amount for vacating the shop to the landlord. But it does not become price of the shop. The lease can be on monthly, annually or for a fixed period. Hence the nature of transaction of the lease cannot be treated as transaction of sale.

The agreement of lease under which contractee shall be giving building constructed by itself or through its own contractors who have constructed the building for the contractee and not for the prospective lessee, cannot be treated as agreement to sell the building by the contractee to the prospective lessee. The contractee shall not be liable for payment of any tax in respect of such contract which is only applicable in respect of transfer of the ownership of the goods involved in execution of works contract.

The tax will be levied only in respect of materials used by the contractor in the execution of such contract and not on the amount given by the prospective lessees to the Contractor.