Moneylife Personal Finance Consumer Interest VAT on sale of under-construction

flats in Maharashtra: All you need to know

VAT on sale of underconstruction flats in

Maharashtra: All you
need to know

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Mohana Nair | 01/11/2012 05:25 PM |

Advocate Mohana Nair explains the Value-Added Tax

(VAT) issue for homeowners and says that developers
should recover tax from customers only after the issues
is finally decided by the Supreme Court. She also points
out that the Bombay High Court order leaves room for
a strong challenge

VAT (Value-Added Tax) is tax levied on sale of goods. The

Maharashtra Value Added Tax Act, 2002, (MVAT Act)
defines sale under Section 2(24). Explanation 6(ii) to
Section 2(24) states that the transfer of goods (whether as
goods or some other form) involved in the execution of a
works contract, would amount to a sale of goods within
Maharashtra state. But there were many further changes
and complications added.
The MVAT Act was amended with effect from 20 June
2006 by inserting the following words at the end of the
Explanation b (ii): namely an agreement for carrying out
for cash, deferred payment or other valuable consideration,
the building, construction, manufacture, processing,
fabrication, erection, installation, fitting out, improvement,
modification, repair or commissioning of any movable or
immovable property. In 2007, in another amendment of
the MVAT Act, the word namely was substituted by the
word including.
Rule 58(1) of the MVAT Act provides that the value of the
goods at the time of transfer of property in goods involved
in the execution of a works contract may be determined by
effecting various deductions from the value of the entire
contract including labour and service charges, amount paid
to sub-contractors, design and architects fees, etc.
Subsequently, a sub-rule (lA) was inserted after Rule 58(1)
to clarify that in the case of construction contracts, the
value of the goods at the time of transfer would be
calculated after making deduction under sub-rule l as well

as deduction under sub-rule 1A being the cost of the land,

from the total agreement value, where the cost of the land
was to be determined in accordance with the guidelines
prepared under the Bombay Stamp Act (Determination of
True Market Value of Property) Rules, 1995, as applicable
on lst January of the year in which the sale of property is
registered and provided that the deduction towards the cost
of land under the said sub-rule would not exceed 70% of
the agreement value.
Meanwhile, the Supreme Court ruled in the case of K
Raheja Development Corporation Vs State of Karnataka
that a contract for construction (development) of a unit is a
works contract within the meaning of the term defined in
Karnataka Sales Tax Act, 1957, so long as the agreement is
entered into before the construction is complete. Based on
this judgement, the Maharashtra government, on 7
February, 2007 issued a trade circular clarifying that the
transfer of property after 20 June, 2006, irrespective of
whether the agreement was signed prior to that date, would
be governed by the amended definition of sale. The
circular also clarified that if the agreement of sale is entered
into after the flat or unit is already constructed, there would
be no works contract and no VAT would be payable.
Then, on 9 July 2010 the Maharashtra government came
out with a composition scheme under VAT would amount
to 1% of the agreement amount, if the agreement was
entered into after 1st April, 2010.

The Maharashtra Chamber of Housing Industry and various

builders associations challenged the constitutional validity
of Section 2(24) of the MVAT Act, 2002, as amended in
2006 and 2007 as well as the rules and trade circulars
issued by the government. Writ petitions were filed in the
Bombay High Court and in a common judgement on 10
April 2012; the court dismissed the petition with no order
as to costs. The courts conclusion was based on various
Supreme Court judgements that held that composite
contracts are permitted to be made divisible by isolating the
sale elements from that of works contract. The Bombay
High Court held that where there is a transfer of property in
goods, whether as goods or in any other form, involved in
the execution of a works contract, even if cost of land is
included in the agreement value, the transaction would be
described as a works contract. Further, that so long as the
contract provides obligation of contract for works and
meets the basic description of a works contract, it must be
described as such, even if it contains sale of land along with
it.
After this judgement, the Maharashtra government issued a
trade circular on 6 August 2012 specifying the time in
which developers should register themselves under the Act
and pay the tax. It also said that a compounding fee of
Rs5,000 only would be payable for the entire period when
the developers were not registered under MVAT and they
could apply for administrative relief from payment of
interest and penalty.

The developers and other petitioners filed Special Leave

Petitions (SLP) in the Supreme Court challenging the
Bombay High Court order. The apex court, while
permitting this and staying coercive recovery of tax,
interest and penalty, had directed that those petitioners
liable to pay tax under the MVAT Act should pay it on or
before 31 October, 2012. The Supreme Court further held
that in case amendment to Section 2(24) of the MVAT Act
is held to be unconstitutional, then the tax deposited/paid
by the developers shall be returned along with interest as
directed by the court. The time for registration of
developers under the MVAT Act was extended from 16th
August to 15 October, 2012 triggering a mad rush by
developers to comply in the past two weeks.
This means that in constructions completed between 20
June 2006 and 31 March 2010, developers would be liable
to pay VAT on the agreement value after making several
deductions therefrom as provided in the MVAT Rules and
from 1 April, 2010 they could also choose to pay VAT @
1% of the agreement value.
Several developers had taken indemnities or commitments
from flat purchasers to pay the VAT liability when it arose.
After the interim order of the Supreme Court they have
been working at recovering it from home buyers before the
31st October deadline. Some developers have even
demanded interest on the VAT liability, claiming that it has
not been stayed under the apex courts interim order.

The problem is that there is lack of clarity about the amount

of VAT payable because the calculation is complicated.
There are three methods of computing the liability for the
period 20 June 2006 to 31March 2010; and one more
method is available thereafter. Neither the developers nor
flat purchasers are clear about the exact liability. The
Builders Association of India and others filed a writ
petition in the Bombay High Court seeking clarity, but the
petitions were dismissed and the trade circulars issued by
the government were held to be valid and binding. The high
court also ruled that the assessing officer in each case
would decide if a particular agreement for sale is a works
contract or not, and VAT would not be payable if it is not a
works contract.
It would, therefore, appear that even after the 31st October
deadline for paying VAT, the actual amount that is finally
payable is still to be decided. This means that the flatowners liability to reimburse developers will arise only
after the Supreme Courts final ruling. And, in any
circumstances, this cannot be more than what the
developers themselves have paid as VAT by 31 October,
2012. If the Supreme Court sets aside relevant provisions
of MVAT Act or modifies or reduces the VAT, developers
need to commit to return the money collected from home
buyers before the courts final decision.
The Supreme Court will now have to decide whether the
Agreement for Sale of a flat on which instalments are due
after 20 June, 2006 (irrespective of whether the agreement
was signed prior to that date) is a works contract or is a

contract for the purchase of an immovable property (flat).

The following facts suggest that the Bombay High Court
order holding such an agreement is a works contract, is
incorrect for the following reasons:
(a) The flat purchaser has no say in the purchase of land,
the structural design, building plan or amenities provided
by the developer. S/he has only selected a particular flat,
signed the purchase agreement in the format provided by
the developer and paid for it in instalments as set out in the
agreement. Just because the instalments were based on the
stages of construction of the building, it would not convert
the agreement for purchase of a flat into a works contract.
(b) The Maharashtra governments decision to levy VAT
on under-constructions flats was based on the Supreme
Court Judgement in K Raheja Development Corporation Vs
State of Karnataka. However, the major difference in the
case before the Supreme Court then and that before the
Bombay High Court, was that in Karnataka and other
southern states, (unlike Maharashtra), the developer or land
owners sells an undivided interest in land to prospective
purchasers under a sale deed on which stamp duty is paid.
Thereafter, the developer and flat purchaser enter into an
agreement for construction of the flat. In such a case, the
agreement is in fact a works contract. This is not the case in
Maharashtra, where the flat is sold along with right to land
and the agreement for such sale of flat is a sale of
immovable property and not a works contract by any
stretch of the imagination.

(c) Another pertinent point is that in Maharashtra, stamp

duty is paid on the entire agreement value for the sale of
flat. If this agreement is to be treated as a works contract it
must be split into a contract for sale of goods used in
construction, contract for services of labour, etc and
contract for sale of land. VAT would be payable on the
portion attributed to sale of goods, service tax would be
payable on contract for service and stamp duty on land
value alone. By now calling upon developers (and
indirectly flat purchasers) to pay VAT and Service-tax
(which has been levied by Central Government and is
presently stayed by court) on certain portions of the
agreement value and stamp duty on the entire agreement
value, the flat purchases have been taxed twice over for the
same property/services.
(d) Bombay High Court itself has held (and the same has
been upheld by the Supreme Court) that an agreement for
sale of a flat under MoFA is an agreement under which
immovable property is transferred and so is liable for
payment of stamp duty on agreement value. Having held
that it is sale of immovable property, it cannot now be held
to be a works contract and, therefore, divisible into three
parts as has been done under the present Bombay High
Court judgement merely because the sale consideration is
payable in instalments based on stages of construction of
the building in which the flat is situated.
Thus there is a very high possibility of Supreme Court
setting aside the Bombay High Court judgement and
striking down the provisions of MVAT Act by which VAT is

levied on flats under construction. Further several queries

remain as to the calculation of VAT payable. It is,
therefore, advisable that till all these issues are resolved and
the amount payable by each flat purchaser if at all, is
decided finally by the Supreme Court, the flat purchasers
do call upon the developers to pay the amount due as the
developers deem correct before 31 October 2012 and claim
the same from the flat owners after the Supreme Court has
passed the final order as to whether the VAT is payable and
if yes, to what extent.
The three ways in which VAT payable could be determined
for the period 20th June 2006 to 31st March 2010 are:
OPTION 1: As per rule 58 of the Maharashtra Value Added Tax Rules, 2005 the sale price may be
determined after deducting from the agreement value, the value of land, labour, charges for planning,
designing, architects fees, hire charges of machinery, etc. The tax is computed on the value arrived as above.
The tax computed as above is reduced after considering the tax paid on the purchases of building material
(i.e. input tax credit). The tax so determined is required to be finally paid.

OPTION 2: The rule 58 also provides for the standard deduction at 30%. The deduction towards the land
value is taken from the total agreement value, the sales price is computed by further taking standard
deductions (@ 30%) as provided in sub-rule 1. The tax is computed after applying the schedule rate of tax on
sales price so arrived. The tax computed as above is reduced after considering the tax paid on the purchases
of building material (i.e. input tax credit). The tax so determined is required to be finally paid.
OPTION 3: The Section 42(3) of the Maharashtra Value Added Tax Act provides for tax at the rate of 5%
on the entire contract value. The developer may opt for this and calculate the tax liability at the rate of 5%.
This tax liability is reduced by the amount of taxes paid on purchases i.e. Input Tax Credit subject to
maximum of 4%. The balance tax liability so computed is to be discharged.

(Mohana Nair is an Advocate practicing in the Bombay

High Court. She is a Partner at JMB Partners, Advocates
& Notaries and is known for her willingness to take up

socially relevant issues and causes on behalf of NGOs on a

pro bono basis)