In Pursuit of Knowledge

The decision of the Supreme Court in the case of K. Raheja Development Corporation vs. State of Karnataka, (2005) 5 SCC 162, has been treated as an instrument by Tax Departments for levying Sales Tax/Trade Tax and Service Tax on all the Builders/Developers who are engaged in the construction of Multi Storied Group Housing Complexes and Township. The Builders/Developers purchase land either from the farmers or acquire from the various Development Authorities. After the acquisition of land either by way of Sale Deed from the farmers or on 90 years lease from the Development Authorities, the Builders/Developers are making the construction of residential houses/flats, clubs etc. in the Group Housing Complex.

After constructing the houses/flats the same is being sold by the Builders/Developers to the prospective buyers/allottees. The Builders/ Developers are constructing the flats/houses irrespective of the fact whether the Builders/Developers gets a buyer or not.

In spite of it, a Circular dated 15-12-2005 was issued by the Commissioner of Trade Tax, U.P. for imposition of tax by treating the construction of all the flats as works contract merely because the agreement was entered into before the date of completion of the construction and which provide advance payments in instalments to the petitioner by the prospective allottees/purchasers.

Background of Raheja’s decision

The decision of K. Raheja Development Corporation vs. State of Karnataka, (2005) 5 SCC 162 of the Apex Court 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 the before construction.”

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.

Impact of Raheja’s decision

The decision of the Supreme Court will apply to cases where the construction is being done by the builder, who may be the owner of the land, “for and on behalf of” the prospective purchaser. Construction “for and on behalf of” purchaser would be a ‘work contract’ in view of the decision of Supreme Court. Whether the construction is “for and on behalf of” the purchaser is basically a question of fact to be determined having regard to the totality of facts and circumstances of each individual case.

In paragraph 12 of the judgment of Apex Court 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 shows that K. Raheja, as developer had agreed to build the building for the prospective purchaser and they shall built 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 developper 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) only then 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.

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 been sold after its completion.

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 the alleged 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.

Usual facts and planning in residential complex building constructions :

Builders/Developers purchase the land or take it on lease for 90 years from owners. The plan is prepared by the Builders/Developers itself. The lay out and building plans of the residential complex with various flats of different sizes and different dimensions are prepared as decided by the Builders/Developers itself. The entire lay out and building plan for the residential complexes in which the various flats were to be constructed by the Builders/Developers are submitted for approval to the Development Authorities which are duly approved by the said Development Authorities.

Terms of the contract should be clear that the contracts entered into with various prospective purchasers is only for selling the completed flats/ houses as the Builders/Developers continues to be the owner of the flats/ houses till the execution the registered Sale Deed.

The Builders/Developers makes the construction in accordance with the layout and sanctioned map approved by the Development Authorities and the Builders/Developers have the absolute right to alter the layout plan as well as the construction of the houses/ flats on its own.

A clause like the one quoted below can be included :—

“(i) That the Builders/Developers shall have the right to effect suitable alterations in the layout plan, if and when found necessary. Such alterations may include change in location, preferential location, number, increase or decrease in number of apartments, floor, block, or area of the apartment(s).”

The aforesaid clause clearly establishes that the Builders/Developers have right to make alteration in the layout, alteration with location, increase and decrease in number of apartments and make any change.

The prospective purchaser has to adhere to the payment schedule and the Builders/Developers have right to cancel the allotment and forfeit the entire amount of application money deposited by the prospective purchaser.
The contract should clearly provide that common areas and facilities, such as park, parking facilities etc. as approved in the layout plan shall remain the property of the Builders/Developers and the prospective purchaser/ allottees shall have no right, title and interest of any nature except right of ingress and egress in respect of the flat to be sold to the alllottee.

The document of transfer should be executed in respect of the completed flats/ houses to the prospective buyers for which he has to pay the stamp duty, registration charges and other charges as may be levied by the Government for the registration of deed of transfer of flats/ houses.

If clauses are mentioned in the contract that the specification, plan, price, payment schedule, layout plan as proposed by the Builders/Developers have to be agreed by the proposed purchasers and the Builders/Developers shall have the right to raise finances from any bank, financial institutions, body corporate and the Builders/Developers and for this purpose Builders/Developers can create equitable mortgage in favour of one or more financial institutions and the prospective purchaser/allottee shall not have any objection for creation of such charge during the construction of the flats then the construction cannot be said to have been made for and on behalf of prospective purchaser.

However, at the time of execution of the Sale Deed of the flat/ house it should be given free of all encumbrances for which a suitable clause be added in the contract, which may be as follows:–

“That the Builders/Developers have the right to raise finance from any Bank/ Financial Institution/ Body Corporate and for this purpose create equitable mortgage of the land and construction in favour of one or more such institutions and for such an act the allottee(s) shall not have any objection for creation of such charge during the construction/ development of the Complex. Notwithstanding the foregoing, the Developer will ensure that any such charge, if created is vacated before execution of the deed of conveyance in favour of the allottee(s).”

It will clearly establish that no construction has been made by the Builders/Developers for and on behalf of the purchasers/ allottees and all the constructions were made by the Builders/Developers on its own account in accordance with the layout and sanctioned map approved by the authorities.

The title in the flats/apartments constructed by the Builders/Developers shall pass to the purchaser only upon the execution of the Sale Deed and its registration and till such time the Sale Deed is not executed, the right, title, interest, including the ownership and title in the construction so made remains with the Builders/Developers.

Inasmuch as right, title, interest and ownership and possession in the construction vests with the Builders/Developers till such time the Sale Deed is executed and registered in favour of the prospective allottees, the prospective allottees do not get any right, title or interest in any construction whatsoever.

Allahabad High Court’s judgment considering Raheja’s decision

Hon’ble Allahabad High Court in Writ Petition No. 996 of 2006– Assotech Reality (P) Ltd. vs. State of U.P. which was allowed on 23-3-2007 has considered various clauses of the agreement and has held as under :—

“From a conjoint reading of clause (m) of section 2 and section 3F of the Act, it is seen that to be a works contract under the Act, the activities mentioned therein ought to have been undertaken by means of an agreement, either implied or written, for cash, deferred payment, or other valuable consideration. If the activity is being undertaken by a person for himself, then it would not be a works contract under the Act and consequently, there will be no liability for payment of tax under section 3F of the Act.”

Clauses 3, 8, 19, 20 and 27 which were relevant for deciding the issues involved were as under :—

“3. The specification, unit plan, price, payment schedule and the layout plan of the complex are as proposed in the respective product brochure and its accompanying price list signed by a duly authorized representative of ASSOTECH.

8. It is hereby agreed, understood and declared by and between the parties that the ASSOTECH may take construction finance/demand loan for the construction of the above Complex from the Banks/Financial Institutions after mortgaging the land apartments of the said complex, however the sale deed in respect of the said apartment in favour of allottee(s) will be executed & registered free from all encumbrances at the time of registration of the same.

19. The allottee shall strictly adhere to the payment schedule. For delay in payments a written request must be made to ASSOTECH and at the discretion of the management of ASSOTECH the same could be entertained on payment of interest @ 1.5% per month or part of the month. Further the extension can be allowed for a maximum of two installments and up to a maximum period of 45 days. And after that the management reserves the right to cancel the allotment and forfeit the amount deposited.

20. The allottee agrees that no right will accrue in favour of the allottee in the apartment until a sale deed is executed & registered, and the ASSOTECH shall continue to be the owner of the apartment and also the construction thereon and this allotment shall not give to the allottee (s) any rights or title or interest therein even though all payment have been received by the ASSOTECH. The ASSOTECH shall have the first lien and charge on the apartment for all its dues that may become due and payable by the allottee(s) to the Assotech.
27. The possession of the respective apartment shall be made only on the payment o the entire amount stipulated and only on receipt of the completion/occupation certificate from the statutory and other authorities.”

After consideration the above clauses, Hon’ble Allahabad High Court has held as follows :—

“From a reading of the aforesaid clauses, we find that the specification, plan, price payment, schedule and layout plan as has been proposed by the petitioner is to be agreed by the parties. Further, the petitioner has been empowered to mortgage the land and apartments of the said complex to raise construction/finance/demand loan for the construction of the complex, from the Banks/ Financial Institutions. The only stipulation is that the sale deed would be executed and registered free from all encumbrances. The allottees are to strictly adhere to payment schedule failing which liability for payment of interest accrues. The allottees do not get any right in the apartment until a sale deed is executed and registered and the petitioner continues to remain the owner of the apartment as also the construction thereon, even though full payment has been received by the petitioner. The petitioner is empowered to make variations/ modifications in the plan, design and specification and possession is to be handed only upon payment of the entire amount. Taking into consideration, the terms and conditions of the letter of allotment which have been reproduced above, we are of the considered opinion that the petitioner continues to remain the owner of the apartments/ flats including all constructions till such time the sale deed is executed and registered in favour of the prospective allottees/purchasers. The payment of instalments by the prospective allottees/ purchasers do not transfer any right, title or interest in the construction undertaken by the petitioner. Thus, the constructions undertaken by the petitioner cannot be said to have been undertaken by it for and on behalf of the prospective allottees/ purchasers.”

The Hon’ble High Court in the aforesaid case has also considered the judgment of K. Raheja Development Corporation (supra) and after considering the aforesaid judgment it was found that in the case of K. Raheja Development Corporation constructions were being made for and on behalf of the persons who had agreed to purchase the flat.

The Hon’ble High Court has noticed the various clauses of the agreement in the case of K. Raheja Development Corporation and after considering the various clauses of the agreement in the case of K. Raheja it has been held by the Hon’ble Allahabad High Court as follows:–

“In the aforesaid case, K. Raheja Development Corporation were constructing the unit for and on behalf of the person who had agreed to purchase the flats. In the present case, we find that the petitioner is constructing the flats/ apartments not for and on behalf of the prospective allottees but otherwise. The payment schedule would not alter the transaction. The right, title and interest in the construction continue to remain with the petitioner. It cannot be said that the constructions were undertaken for and on behalf of the prospective allottees and, therefore, the constructions in question undertaken by the petitioner would not fall under clause (n) of section 2 read with section 3F of the Act and are outside the purview of the provisions of the Act. In other words, they cannot be subjected to tax under the Act and the action in imposing tax on such constructions treating them to be works contract, is wholly without jurisdiction.”

Binding effect of Apex Court decision

It is well established by the various judgments of the Apex Court that every observations 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.

CONCLUSION

In view of the aforesaid facts and legal position I am of the view that the decision of the Supreme Court will apply to cases where the construction is being done by the builder, who may be the owner of the land, “for and on behalf of” the prospective purchaser. Construction “for and on behalf of” purchaser would be a `work contract’ in view of the decision of Supreme Court. Whether the construction is “for and on behalf of” the purchaser is basically a question of fact to be determined having regard to the totality of facts and circumstances of each individual case.

The mere fact that the agreement for sale of the flat as a completed unit has been entered into before the date of actual completion, by itself is not the conclusive factor. Further, the mere fact that the agreement between the Builders/Developers and the prospective purchaser provides that if the prospective purchaser backs out and does not get the sale deed executed ultimately, the advance instalments or its part or the earnest money or security will stand forfeited is also not by itself a conclusive factor. The reason is that this kind of an agreement providing for future sale and charging advance sale consideration or charging earnest money or security could also be entered into after the completion of the construction and if such agreement entered into after the completion of construction provides for forfeiture of the earnest money or security or the advance sale consideration or its part, it would not make the transaction of ‘work contract’.

Therefore, the only factor which is left and which can be said to be a conclusive factor as to whether agreement between the Builders/Developers and the prospective purchaser, when entered into before the completion of the construction, and whether charging advance sale consideration or not, and whether providing for forfeiture or not will amount to a ‘work contract’ only if the entirety of facts show that throughout the process of construction, the title to the superstructure or its various parts at various stages of construction continues with the prospective purchaser.

If the facts and circumstances show that the title to the superstructure does not vest at all in the prospective purchaser till the superstructure is transferred by a registered sale deed to the prospective purchaser, in that event, the transaction would not be a ‘work contract’.