Liability of builder or developer in relation to construction contract

The decision of the Supreme Court in K. Raheja Development Corporation case has created tremendous confusion as in regards to applicability of VAT and Service Tax on builders and developers in case of a construction contract. The article attempts to clear the confusion and explains the liability of builder or developer in relation to construction contracts.

1. Liability of builder or developer in relation to construction contract

Types of contracts

There are two modes of entering into a contract with the intended purchaser of a flat or a commercial unit.

Builder model contract: According to this model, a builder enters into an "agreement to sell" with the intending purchasers before construction. The contract is not a construction contract. The builder executes conveyance only after building is complete and the possession is handed over. Stamp duty also, is paid after the building is complete. The conveyance is in respect of land as well as construction.

Developer model contract: According to this model, a developer enters into a contract with the prospective buyers to construct a building on their behalf. The possession is handed over only after the construction is completed. The owner of the land directly transfers the ownership to the society. The developer is not the owner but has a lien over the property. Hence if a purchaser commits default, the developer can terminate the agreement. The contract is a construction contraction and not a contract for sale. Stamp duty is not payable since the property in goods involved in works contract passes to the buyer through accession.

Test of service provider- service recipient relationship

If a builder, promoter, developer builds a residential complex with the services of its own staff, it will not attract service tax, as there is no service provider-service recipient relationship. However, if a builder, promoter, developer engages a sub-contractor, contractor to do the construction, such a contractor, sub contractor will be liable to tax. This is also clarified vide Circular No. 96/7/2007-ST, dated August 23, 2007. The clarification is reproduced hereunder:

Reference Code	Issue	Clarification
079.01/23.08.07	Whether service tax is liable under construction of complex service [section 65(105)(zzzh)] on builder, promoter, developer or any such person,- (a) who gets the complex built by engaging the services of a separate contractor, and (b) who builds the residential complex on his own by employing complex’ direct labour?	(a) In a case where the builder, promoter, developer or any such person builds a residential complex, having more than 12 residential units, by engaging a contractor for construction of the said residential complex, the contractor in his capacity as a taxable service provider (to the builder / promoter / developer / any such person) shall be liable to pay service tax on the gross amount charged for the construction services under ‘construction of service [section 65(105)(zzzh)]. (b) If no other person is engaged for construction work and the builder / promoter / developer / any such person undertakes construction work on his own without engaging the services of any other person, then in such cases,- (i) service provider and service recipient relationship does not exist, (ii) services provided are in the nature of self-supply of services. Hence, in the absence of service provider and service recipient relationship and the services provided are in the nature of self-supply of services, the question of providing taxable service to any person by any other person does not arise.

Conclusion

A contract to sell a ready flat is a ‘contract for sale’ and not a construction contract. In case of activity rendered based on a Builder model contract, there will be no liability of service tax since it is not a construction contract.

Further, such ‘contract for sale’ will also not attract VAT liability as held by Hon'ble High Court in case of Assotech Realty (P.) Ltd. vs. State of U.P [2007] 10 STT 36 (All.). The court held that where construction of flats was not for and on behalf of prospective allottees and right, title and interest in construction continues to remain with the petitioner, no tax could be imposed upon such construction treating it to be works contract.

The activity rendered based on Developer model contract will attract service tax liability in our opinion as it is a construction contract and these exist a clear service provider and service receiver relationship in such contract.

In the activity rendered the property in goods involved in works contract passes to the buyer through accession. Thus, such a contract can to be said to be a construction contract and will attract VAT.