Suresh Kumar Bansal & Others vs. Union of India & Others  – Delhi High Court

W.P. (C) 2235/2011 and W.P. (C)  2971/2011 (the judgement was delivered on 3rd June, 2016)

FACTS

Two Writ Petitions were filed before the Delhi High Court in the year 2011 by individual flat buyers who had entered into agreements with builder(s) / developer(s) to buy flats in a housing project at Noida. These petitions challenged:

1. the levy of Service tax on construction services provided by a builder to flat buyers, as introduced vide the Finance Act, 2010 by insertion of Explanation to Section 65(105)(zzzh) of the Finance Act, 1994 (“the Act”); and
2. the levy of Service tax on preferential location charges charged by builders, under Section 65(105)(zzzzu) of the Act.

In the course of arguments, the Petitioners submitted that the challenge mounted by the Petitioners would equally be valid in respect of the statutory provisions under the “negative list” regime of taxation of services introduced w.e.f. July 01, 2012.

DECISION

The High Court upheld the legislative competence of the Parliament to levy Service tax (i) on the service component of a transaction of construction and subsequent sale of immovable property, and, (ii) on preferential location charges collected by developers / builders. The High Court held that the levy of Service tax does not infringe on the legislative field reserved for the States under Entry 49 of List II (State List) under Schedule VII to the Constitution of India – which deals with “Taxes on land and buildings”.

However, the High Court held that no Service tax could be charged on construction contracts involving sale of land (‘immovable property’), on the basis that there are no machinery provisions in the Act or the Valuation Rules for ascertaining the service element specifically in such contracts. It reiterated that Service tax is only a levy on services, and no tax can be levied on the elements representing transfer of goods or immovable property. 

The Hon’ble Court inter-alia held that:

1. The contract between the prospective buyer and the builder is a composite one, which involves not only element of services but also goods and immovable property (land). While Parliament has the legislative competence to tax the element of service involved in such contracts, the levy will fail if it does not provide for the mechanism to ascertain the value of the services component in such contracts, which is the subject matter of the levy of Service tax.
2. In the present case, there is no machinery provision for ascertaining the service element involved in the composite contract. The abatement vide notification to the extent of 75% cannot substitute the lack of statutory (machinery) provisions to ascertain the value of services involved in a composite contract, in view of the law laid down by the Hon’ble Supreme Court in C. C. Ex. vs. Larsen and Toubro  (2016) 1 SCC 170.
3. Reiterating the settled law, it was also held that Circulars or other instructions could not provide the machinery provisions for the levy of tax. The charging provisions as well as the machinery for its computation must be provided in the Parent Act, or the Valuation Rules framed under the Parent Act.
4. Though Rule 2A of the Valuation Rules (introduced w.e.f. July 01, 2012) provides for the mechanism to ascertain the value of services in a composite works contract involving services and goods, the said Rule does not provide for the determination of the value of services in case of a composite contract which also involves transfer and sale of land.

ELP COMMENTS

• This decision which is in the context of a Central legislation (‘Finance Act, 1994 and the rules made thereunder’) will have wide ramifications across India on taxability of all construction contracts which involve sale of goods and land (‘immovable property’) in addition to the provision of services. The Bombay High Court in the case of CIT v. Godavaridevi Saraf, 1978 (2) E.L.T. (J624) (S.C.) had held that in the case of an all India taxing statute (‘Central tax legislation’), the decision of one High Court requires to be followed by the tax authorities in another State in the absence of any other conflicting High Court decision. More recently, the Bombay High Court in Naman Hotels v. UOI 2015 (326) E.L.T. 513 (Bom.) held that while a decision of one High Court may not be binding on another High Court, the binding nature of the decision cannot be questioned by the Central Government especially when the Union of India is party to such decision.
• While there have been certain High Court decision(s) in the past upholding the competence of the legislature to levy Service tax on construction services (which the present decision also upholds), this is the first salient decision which deals with the question as to whether there are  adequate machinery provisions to effectuate the levy of Service tax on construction services. This decision essentially holds that there is no effective machinery provision to tax the service element in composite construction services, as the valuation provisions in their present form refer to exclusion of goods from the value of composite contracts to arrive at the services value, but do not contain any provisions to exclude the value of immovable property while arriving at the value of services in a composite contract having elements of transfer of goods/immovable property and provision of services.
• The decision has reiterated the principle that machinery provisions have to be a part of the enactment or (Valuation) rules made thereunder, and cannot be by way of circulars/abatement notifications, etc. 
• While the decision specifically deals with the provisions of Rule 2A of the Valuation Rules, the decision does not appear to have specifically dealt with the proviso to clause (ii)(A) of Rule 2A of the Valuation Rules, which provides that where the gross amount charged includes the value  of land, the Service tax will be payable on 25% of the total amount. The decision however holds that there is no specific provision to exclude the value of immovable property from a composite contract of sale of goods/immovable property, and, the provision of services, under the Act or the Valuation Rules made thereunder.
• Given the nature of the issue and the impact on industry, the Revenue Department can be expected to agitate the matter before the Supreme Court and may also resort to amendment(s) in the relevant legislation. The last word on this issue has not been written. 

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W.P. (C) 2235/2011 and W.P. (C)  2971/2011 (the judgement was delivered on 3^rd June, 2016)