BANGALORE: According to a recent verdict by the Supreme Court, the sale of a property that is under construction would be liable to value-added tax (VAT).
The ruling could have far-reaching ramifications for the real estate industry as well as property buyers. In the case of L&T versus State of Karnataka, the apex court held that the pre-construction agreements for sale of immovable property would qualify as 'works contract' and, therefore, VAT would be payable on the transaction.
It is likely that the judgement will push the states' VAT authorities to tax all transactions for properties that are under construction. This could also include the real estate transactions concluded in the past few years.
The judgement was pronounced by a larger bench of the Supreme Court, so the verdict shall be considered the law of the land until it is overruled by a constitutional bench of the apex court.
Though the case related to real estate operations in the southern and western parts of the country, the principles enunciated in this judgement are likely to impact the real estate industry throughout the country, which, in turn, would result in higher prices of property.
It is pertinent to note that this judge ment is merely an interpretation of an existing law. So, its applicability is likely to be with retrospective effect. The state VAT authorities may cash in on this opportunity and demand tax dues on past transactions from real estate players by invoking the extended period of limitation. While it is not possible to quantify the exact impact of judgement on the real estate industry, if implemented with retrospective effect, the demand for tax and interest is likely to run into thousands of crores of rupees.
Supreme Court ruling on the applicability of VAT to push up property prices
Buy constructed property
What this also means is that buyers may be better off purchasing fully constructed property compared with the one under construction.
Till now, constructed property has attracted only stamp duty, while the one under construction has also invited service tax. Now, the latter will also be subject to VAT.
It would be interesting to see how developers recover the VAT and interest from buyers, especially for past transactions.
While the robust contractual documents signed at the time of sale may empower the developer to recover the additional burden of VAT from the flat buyer, it may not be easy to recover the amount from the buyer if the possession has been handed over. There may also be cases where the original buyer has sold the flat to someone else and moved to another location. Tracking down such buyers will be an additional difficulty.
Besides, the valuation itself will be a challenge. The Supreme Court has specifically held that only goods incorporated by the developer after entering into an 'agreement to sell' the immovable property under construction would be subject to the VAT levy. It will not be easy to compute VAT on such a transaction.
This spells more trouble for an industry reeling from the slowdown in sales, rising inventories and dipping margins. It may be advisable for the real estate industry to engage with the state governments to arrive at a commercially feasible solution to settle the past tax dues, and a workable scheme for the payment of taxes (say, a composition rate of 1% in Maharashtra) in the future. This can help avoid undue litigation.
Setting off the input credit
Another aspect that merits the consideration of the real estate industry would be the manner in which it can set off the input tax credit of VAT paid on the procurement of raw material, against its output VAT liability for the past and the future.
It appears that the Supreme Court has ignored the fact that the sale of flats is already subject to stamp duty on the entire transaction value, as opposed to merely the value of land. Levying VAT on such transactions would now lead to multiplicity of taxes on the same transaction value.
Apart from this, the developers need to brainstorm to analyse the various schemes for payment of taxes available both under the Central and state tax laws, and decide a way forward appropriately.
Given the complexities of the issues, it is likely that the future will witness a series of litigation between the revenue authorities, the developer and the flat buyer. Needless to say, the biggest loser in the entire transaction chain will be the buyer, who will have to bear the burden of the increased cost.