The construction industry has for long been harassed by multiple taxation from both the State and the Union Governments. A construction contract was taxed under both the Sales Tax as well as the Service Tax laws and the apportionment provisions were far from precise. The GST regime is a welcome development: Government and taxpayers will not haggle anymore on the question as to whether a particular construction contract constitutes a sale of goods, or a provision of services or a works contract. There is no need to break up a construction contract and apportion it between the goods and services elements.

Through this article, I aim to highlight a few pressing issues facing the construction industry. A caveat: the law is still in its infancy and the drafting of the statute leaves much to be desired. The Government has also not come out with any comprehensive circular on construction industry. The FAQs released by CBEC are very basic: they explain what does not need any explanation and are silent about almost everything else. My views are based on whatever material is available as on date. Readers are advised to form their own independent opinion on the basis of the provisions of the bare Act and the Rules.

Nature of supply

A contract for construction simpliciter is a contract which involves the supply of goods as well as services. A contract for construction of a flat, on the other hand, involves a supply of goods, services as well as an undivided interest in land to the purchaser of the flat. What then is the nature of the supply? Is it a supply of goods or of services? Should the rules of composite and mixed supply be applied to such contract?

Schedule II and construction industry

The CGST Act and the SGST laws pre-empt any enquiry into the nature of supplies involved in a construction contracts by creating irrefutable statutory presumptions in Schedule II. There are two such presumptions contained in that Schedule which are of relevance here:

“5. Supply of services

The following shall be treated as supply of services, namely:—

(b) construction of a complex, building, civil structure or a part thereof, including a complex or building intended for sale to a buyer, wholly or partly, except where the entire consideration has been received after issuance of completion certificate, where required, by the competent authority or after its first occupation, whichever is earlier.

Explanation.— For the purposes of this clause—

(1) The expression “competent authority” means the Government or any authority authorised to issue completion certificate under any law for the time being in force and in case of non-requirement of such certificate from such authority, from any of the following, namely:—

(i) An architect registered with the Council of Architecture constituted under the Architects Act, 1972; or

(ii) A chartered engineer registered with the Institution of Engineers (India); or

(iii) A licensed surveyor of the respective local body of the city or town or village or development or planning authority;

(2) The expression “construction” includes additions, alterations, replacements or remodelling of any existing civil structure.

6. Composite supply

The following composite supplies shall be treated as a supply of services, namely:—

(a) Works contract as defined in clause (119) of section 2”

‘Construction services’ is not defined anywhere in the CGST law. However, the term ‘works contract’ is defined in Section 2(119) to mean:

“’Works contract’ means a contract for building, construction, fabrication, completion, erection, installation, fitting out, improvement, modification, repair, maintenance, renovation, alteration or commissioning of any immovable property wherein transfer of property in goods (whether as goods or in some other form) is involved in the execution of such contract”.

A contract for construction of a bridge or a road will fall within the definition of ‘works contract’, but it will not be covered by the ‘construction services’ clause. Per contra, a contract for construction of flats/building will be covered by both clauses. The tax rates and the input tax credit consequences for construction services are significantly different from the rates and credit consequences for works contract. But in all cases, the services providers rendering construction or works contract services are deemed to be providing supplies of services. As such the time of supply and the place of supply rules relating to services will apply.

Difference between construction services and works contract

Construction services is taxed at 18% on 2/3rds of the agreement value.1 The value of the construction services should be arrived at after deducting the land component which is deemed to be 1/3rd of the flat purchase agreement value. On the balance 2/3rds value, the 18% rate of tax must be applied. Effective rate of tax is, thus, 12%.

On the other hand, a works contract is taxed at a flat rate of 18% of the full agreement value.2

It is my view that a contract for construction of flats, which also involves transfer of property in land or undivided share in land, will be covered by the ‘construction services’ entry, being a specific entry. All other types of works contract will fall within the ‘works contract’ entry, which is a general entry.

Refund of unutilised Input Tax Credit

The distinction between the content of ‘construction services’ entry and the ‘works contract’ entry is fundamental to the way in which Section 54(3) operates. Under Section 54(3), refund of unutilised input tax credit is allowed where the credit has accumulated on account of rate of tax on inputs being higher than the rate of tax on output supplies (other than nil rated or fully exempt), except supplies of goods or services or both as may be notified by the Government.

A notification has been issued under Section 54(3) with respect to construction services.3 Thus, construction contracts for construction of flats/building involving transfer of property in land or transfer of undivided share in land are not eligible for Section 54(3) benefit.

But refund of unutilised credit under Section 54(3) is available in full in respect of construction contracts which do not pertain to construction of flats/building or do not involve transfer of property in land or transfer of undivided share in land. Such contracts do not fall within the purview of the afore-mentioned notification, since they are classified as ‘works contract services’ and not ‘construction services’.

Redevelopment agreements

A redevelopment agreement involves transfer of development rights by a society to a developer in exchange for flats in the newly developed building. No monetary consideration is charged by the developer in case of the flats which are given to the existing tenants or members. The developer recovers the cost of construction along with profits from the flats sold to outsider purchases. In areas like Mumbai, even a handful of flats sold to outsiders can cover the cost of construction of the entire building and yet yield a reasonably good amount of profit.

Now, there are complicated issues which need to be addressed in order to understand the tax consequences in a redevelopment agreement. I will first deal with the services provided by the developer to the existing and the members in the redevelopment process.

Services provided by developer to existing and new members

The agreements which are entered into between a developer and existing or new members for redevelopment of a building indisputably contain the elements of transfer of property in land or transfer of undivided share in land. However, this is in itself will not lead to the conclusion that services provided to existing as well as new members should be classified as ‘construction services’. There is another crucial distinction between construction services and works contract services, a distinction which is in addition to the land element: ‘construction services’ are confined by black letter to only those contracts where the “building (is) intended for sale to a buyer”4.

The term ‘sale’, in relation to immovable properties, has been interpreted by the Supreme Court to have the same meaning as is given to the term in Section 54 of the Transfer of Property Act, 1882. That is, a sale of immovable property requires the giving of ‘price’ or monetary consideration in return for transfer of immovable property. [See Commissioner of Income Tax v. Motor and General Stores (P) Ltd (1967) 66 ITR 692 (SC)]. The allotment of flats to existing tenants or members in the redeveloped complex in return for development rights is not a contract of sale, but one of ‘barter’ or ‘exchange’. Services of construction provided by a developer to existing members or tenants are thus not classifiable under ‘construction services’, but should be classified as ‘works contract services’.

Paragraph 2 of the Notification No. 11/2017 – Central Tax (Rate) also seems to point towards this legislative intent. The 1/3rd deduction for land is possible only if the agreement for purchase of flats contains consideration expressed in monetary form. Existing tenants or members do not pay any monetary consideration. If the services provided to existing tenants or members in a redevelopment arrangement are classified as ‘construction services’, the valuation mechanism in Paragraph 2 will fail.

On the other hand, services provided by a developer to new members or outside purchasers in a redevelopment scheme are classifiable as ‘construction services’. Such services carry monetary consideration.

Though the plain words of the statute lead to this interpretation, it is absurd and inequitable. Under this interpretation, a developer will give benefit of lower rate of tax under ‘construction service’ to new purchasers by giving the land element deduction (that is, 18% on 2/3rds of agreement value), but a higher rate of tax will be charged for existing tenants or old members under ‘works contract service’ without any land deduction. This discriminatory treatment is in teeth of Article 14 of the Constitution of India. This unequal treatment to existing and new members is not based on any rational or reasonable classification. Indeed, if the affordable housing objective of the Government is considered, particularly in a place like Mumbai where redevelopment is the only resort for many, this interpretation must be avoided.

A developer has two options in this scenario. The first option is to give the term ‘sale’ a wider meaning to include exchange and barter and take land deduction by using comparable pricing method. This method is complicated and fraught with difficulties.5 It is quite possible that the Assessing Officer will not accept this interpretation and will want to stick to the “plain language of the statute”. The second option would entail challenging the Notification No. 11/2017 in Court on the grounds of violation of Article 14 and to get the Court to read the word ‘sale’ as including an exchange or barter. The Court can then be asked to direct the Government to evolve a suitable valuation mechanism for the land deduction or the Court may give any other suitable directions with respect to the same.

Transfer of development rights by existing members to the developer

A society transfers development rights to the developer in return for flats being allotted to the existing members or tenants in the new building without any of those members or tenants having to shell out money consideration for the same. Such transfer of development rights is not in the course or furtherance of business. A housing society is not in the business of granting development rights. Though the definition of ‘business’ in Section 2(17) covers isolated transactions without profit motive, the entirety of the definition seems to require some kind of commercial character to be present in a transaction before it can be said to be a business. If every isolated transaction or activity without any commercial character is elevated to the status of business, every transaction or activity will automatically become a supply in the course of business. Had this been the intention of the Legislature, it could have simply levied the tax on all transactions and activities instead of going out of the way to restrict the concept of supply to a transaction “in the course or furtherance of business” and then defining the term ‘business’. As such, no tax is leviable on transfer of development rights by the society to the developer.

Anti-profiteering Clause

Section 171 of the CGST Act directs every supplier to pass on the benefit of rate reduction or the benefit of input tax credit to customers. However, no one seems to be very sure of how this benefit is to be computed in the first place. There is no formula or guidelines in the statute to help the taxpayer in this regard.

It is my view that Section 171 is unenforceable till appropriate criteria is laid down in the statute. Its mandate is overbroad and thoroughly vague. A taxpayer cannot be expected to keep guessing as to what is the real meaning and effect of a statutory provision and how to comply with statutory dictates.

One must note that even Parliament is unsure of the formula which is needed to make these calculations. In fact, even the rule-making authority is not able to come out with a formula. The rule-making authority has simply shrugged off its responsibility and passed on the burden to some committee of bureaucrats which has not been formed till date, though the anti-profiteering clause has been brought into effect from 1st July, 2017 itself.

In my view, Section 171 impairs the freedom of trade and occupation guaranteed by Article 19(1)(g). Whether the anti-profiteering mechanism theoretically constitutes a reasonable restriction which is saved by Article 19(6) or not is a separate issue, but it is my view that Section 171 is not reasonable at least till sufficient guidelines are prescribed by the proper authority.

There are many such issues which need resolution by the Government. Ideally, it is for Parliament to clarify the law. Circulars and other clarifications have become an untrustworthy source of law nowadays with the Revenue regularly challenging its own circulars as being contrary to the statute. Much less reliable are the twitter updates by the Government of India or the many press releases which are being released almost daily. Neither the twitter updates nor the press releases have any legal sanction. Certainly, these informal clarifications, even if they are held to be binding on the Central Government in future, will not bind the State Governments. In our system of tax administration, it is not possible to say that SGST officers will always give any credence to Central Government clarifications.



1 That is, 9% CGST and 9% SGST on 2/3rds of the agreement value – See Entry No.3(i) of the Notification No. 11/2017 – Central Tax (Rate) and Paragraph 2 of that notification.

2 That is, 9% CGST and 9% SGST – See Entry No.3(ii) of the Notification No. 11/2017 – Central Tax (Rate).

3 Notification No. 15/2017 – Central Tax (Rate).

4 See Clause 5(b) of Schedule II to the CGST Act.

5 Comparable agreements can be those which are entered into with new purchasers of the same complex. However, in many cases there is a considerable time gap between agreement with new purchasers and the agreement with existing members or tenants. In such cases, the comparable pricing method will not always work properly.

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