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					Confusion galore on real estate contracts
Source: Business Standard
September 22, 2008

Author: Mukesh Butani, Partner

Raheja’s case poses a challenge for RE Developers the taxation of sale of ‘under construction’ unit
transactions has come up for debate after the judgment of the Supreme Court in the case of K Raheja. The
judgment was delivered in the context of Karnataka Sales Tax Act, which clarified the scope and definition of
“works contract”. The facts of the case suggest that the developer (Raheja) responsible for real estate
development and allied contracts entered into development agreement with the land owners.

In pursuance thereto, the developer obtained plan sanctions and constructed residential apartments and
commercial complexes. The agreements between the landowner and developer provided that upon
completion of the construction, the residential apartment or the commercial complex would be handed over
to the purchasers, who would obtain an undivided interest in the land underlying. The question before the
Court was whether the developer was a ‘dealer’ and hence liable to pay turnover tax (on works contract)
under the Karnataka Sales Tax in relation to agreements entered into with the purchasers.

The Supreme Court held that where a developer sold the flat ‘under construction’, such transactions would
be characterized as works contract, since the act of constructing the flat was performed on behalf of the
purchaser. It, however, clarified that if it were a case of sale of fully-constructed flat, it would not be works
contract and hence, no tax would apply. In summary, whether a contract would comprise as works contract
or not would depend upon the determination if it is sale of an immovable property or transfer of movable
property in goods.

Legislative framework

Under the relevant statutes, sale or transfer of immovable property is governed under the Transfer of
Property Act and sale of movable property is government under the Sale of Goods Act and hence liable to
sales tax. In 1982, the 42nd amendment to the constitution expanded the scope of levy of sales tax to cover
transfer of property (in goods) in the course of execution of works contract. Pursuant to the amendment,
various states enacted laws to levy works contract sales tax on such transactions. Prior to Raheja’s case,
the consideration passing from the buyer of a flat to the developer did not attract VAT. Although the Raheja’s
judgment was in the context of definition of the term ‘works contract’, service tax authorities have acted
rapidly to demand service tax on the labour component of the ‘works contract.’ The Raheja’s decision deems
such sale agreement to be in the nature of works contract, if such flat is under construction. Developers are
faced with a realistic threat of potential double taxation of ‘works contracts’ under the state sales tax/VAT.

Raheja’s decision being reconsidered

Recently in a judgment in Larsen & Toubro’s case, the Apex Court has doubted the law laid down in the
Raheja’s case. In L&T’s case the developer (L&T) is engaged in redevelopment involving construction of
flats and subsequent sale thereof. Revenue Department’s argument is that such sale is liable to tax for the
reason that transaction for construction and sales of flats are in the nature of ‘works contract’.

Development agreement or JV agreement

Typically in real estate transactions, the land-holder contributes the land, the developer constructs the
building and sells the flats. As a result, each owner becomes the owner of an Apartment with corresponding
undivided share in the land and an undivided share in the common areas. The usual feature of such
agreements is that the land-holder will have no say or control in the development. Nor will the land-holder
have any say as to whom and at what cost the developers share of apartments are to be dealt with or
disposed of. Land owners only right is to demand delivery of his share of constructed area. An alternate
contention is that such agreements are neither contracts for construction, nor contracts for sale of
apartments, but are contracts entered for mutual benefit. In a true joint venture agreement between the land-
owner and developer, the land-owner is a partner or co-adventurer where the land owner has a say or
control in the construction and participates in management of the JV. In such situation, the land owner is
neither a consumer nor a service provider. Such JV’s are comparatively rare. What is factually prevalent are
agreements which are a hybrid arrangements for construction, consideration & sale and are at best pseudo
joint-ventures. Ordinarily, a developer is not interested in sharing the control of his business. Except
assuring the land owner a specified constructed area and consideration, the developer ensures absolute
control

Construction is ‘Service’ for consumer grievance purposes

Interestingly, the Supreme Court in F C Gulati’s case has ruled that if the developer is in breach of his
obligation, the land owner has two options. He has the right to enforce specific performance and/or claim
damages under civil remedy. Alternatively, he can approach the Consumer forum; the developer being
classified as a service provider. Can the ratio of interpretation under the consumer protection act be applied
for levy of works contract tax? I guess no. In summary, whereas, the L&T’s decision may have come as a
temporary reprieve for real estate developers, until a larger bench renders its verdict, need of the hour is to
prevent over zealous revenue officials from levy of works contract tax. The recent move of the court to
reconsider principles in Raheja’s case would be closely watched by real estate developers. The court has
hinted that examination has to be made in the context of definition of sale under the Sale of Goods Act and
Transfer of Property Act. Further, it has also observed that if the ratio of decision in Raheja’s case is
accepted, there is no difference between works contract and contract for sale of immovable property!

				
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