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7 th September 2013

7 th September 2013. Workshop on REAL ESTATE & BUILDERS ----- IMPLICATIONS UNDER DELHI VAT Rakesh Garg , FCA. 1. What is Real Estate Sector. 2. Developer vs . Constructor. 3. 4. Judicial Developments. Builders’ Contracts-K.Raheja (2005)141 STC 298 (SC) Highlights of the Agreement

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7 th September 2013

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  1. 7th September 2013 Workshop on REAL ESTATE & BUILDERS ----- IMPLICATIONS UNDER DELHI VAT RakeshGarg, FCA 1

  2. What is Real Estate Sector 2

  3. Developer vs. Constructor 3

  4. 4

  5. Judicial Developments Builders’ Contracts-K.Raheja (2005)141 STC 298 (SC) • Highlights of the Agreement • K. Raheja enters into development Agreements with owners of lands. After approval of the plans by Raheja, it constructs apartments/ complexes. In most cases, before it constructs the apartments/complexes, it enters into Agreements of Sale with the intended purchasers. The Agreements would provide that on completion of the construction, the residential apartments or the commercial complex would be handed over to the purchasers who would get an undivided interest in the land also. The owners of the land would then transfer the ownership directly to the society which is being formed under the Karnataka Ownership Flats Act, 1974. 5

  6. Judicial Developments Builders’ Contracts-K.Raheja (2005)141 STC 298 (SC) • Highlights of the Agreement • K. Raheja, (as Holders) agrees to sell to the prospective Purchasers an undivided 0.42% share, right, title and interest in the said land for a lump sum agreed and quantified consideration of Rs.3 lacs • K. Raheja, (as Developer) agrees to build the said building named ‘Raheja Towers’, having the specifications and amenities therein for the prospective purchasers, for a lump sum agreed and quantified consideration of Rs. 5 lacs. • Right to management rests with the Developer • Right to forfeit in case of non-payment by purchaser rested with Developer 6

  7. Judicial Developments • Judgment by the SC • Developer has merely lien over property • Right of forfeiture is insignificant • The term “works contract” also includes "any agreement for carrying out the building and construction of any moveable and immoveable property". • Liable to pay tax if developer enters into agreement with prospective purchasers before construction of apartments (even if land is owned by the builder at the time of agreement) • However, not liable to pay tax if builder agreement is entered into after completion of construction. • Judgment referred to larger bench of SC in 2008 – No Stay; Hearing Completed in March 2013; Order Awaited 7

  8. Judicial Developments • Judgment by the Bombay High Court • In the case of Maharashtra Chamber of Housing & Industry vs. State (2012) 51 VST 168, and again on 30.10.2012 (55 VST 504), the Bombay HC observed that works contracts have numerous variations and it is not possible to accept the contention either as a matter of first principle or as a matter of interpretation that a contract for work in the course of which, title is transferred to the flat purchaser, would cease to be a works contract. As noted by the Supreme Court in the case of Builders’ Association vs. U.O.I. (73 STC 370), the doctrine of accretion is itself subject to a contract to the contrary. Analyzing various clauses of the agreement under the Maharashtra Ownership Flats Act, 1963 (MOFA), the High Court held that it is in the nature of works contract. 8

  9. Builders – Whether Dealers Builders’ Agreements Single agreement for sale of flat with pros. buyer Sale of flat after Construction Sale of Land+Cons-truction (Raheja) Sale agreement after completion of construction Two agreements (1) Sale of land (2) construction on behalf of buyer No agreement for sale of land; unoccupied area is of Builder Stamp Duty on full agreement Stamp Duty on land value Stamp Duty on Total value Not liable for VAT; No Input Tax WCT on construc-tion; Input Tax-Yes ? 9

  10. Works Contract – Meaning in VAT 10

  11. Methods of Computation of Turnover Taxable Turnover=Total Value - Land - Labour/Services Methods of Computation of Labour & Services Composition Basis Standard Percentage Actual Basis Where amount not ascertainable from books of accounts Maintain records for satisfaction of A.A. NIL DVAT-15% to 30%; General-20%; Civil-25% 22

  12. Computation of Turnover Rule 3(1) of DVAT Rules:In case of turnover arising from the execution of the works contract, ……. and shall exclude… • (i) Charges towards labour, services and other like charges; and • (ii) Charges towards cost of land, if any, in civil works contracts; • subject to the dealer’s maintaining proper records such as invoice, voucher, challan or any other document evidencing payment of referred charges to the satisfaction of Commissioner. • Explanation. - Civil works contracts for the purpose of this rule shall include construction of building or complexes - residential or commercial, bridges, flyovers, dams, barriers, canals, diversions and other works of similar nature.

  13. Deduction for Land in Delhi VAT BUILDERS ENGAGED IN CIVIL WORKS • In Delhi, Provisions were incorporated in DVAT Rules w.e.f. 7.9.2006 to levy tax on complex construction and to reduce the value of land ; However, no further change in the definition of works contract. It includes construction. • Reduce the cost of land • If the cost of land is not ascertainable from the books of accounts of the dealer, the amount of such charges shall be calculated - @ 50% of the total value of contract in the case of construction of commercial buildings or complexes - @ 30% of the total value of contract in other cases

  14. Deduction for Labour & Services Reduce Labour & Services (i)Labour charges for execution of works; - means direct labour (ii) Charges for planning and architects fees; (iii) Hire charges for mach./tools used for the works contract; (iv) Cost of CONSUMABLES, e.g.,water, fuel, etc, which get consumed (Enviro Chemicals – Kerala FB) (v) Cost of establishment of the contractor to the extent it is relatable to supply of labour and services; (vi) Other similar expenses relatable to supply of labour & services; (vii) Depreciation – Yes (34 VST 53- Kar); No (41 VST 107- Ker) (viii) Profits earned by the contractor to the extent it is relatable to supply of labour and services

  15. Computation of Output Tax • Calculate amount of tax on taxable turnover applying the rate of tax, i.e. 12.5%. • Declared goods used in the works and transferred in the same form are taxable 5%. • Sale of Malba/Scrap by the builder will be taxable as sale @5% 30

  16. Contractors can claim ITC on following purchases: Raw Material Consumables which do not get destroyed Packing Material Capital Goods other than those specified in Sch. VII, which comprises, inter-alia, Cranes, Earthmovers, JCB, Excavators, Road-Rollers, Concrete-Mixing- Machines and other similar machineries VAT paid on hire charges and consumable which get destroyed can not be claimed as ITC since these are allowable deductions as labour and services and are exempted sales. Input Tax Credit 31

  17. DVAT Composition Schemes - WCT 32

  18. DVAT Composition Schemes - WCT Restrictions: - [Violation may debar from the scheme from first day of the Financial Year + Forfeiture of tax already paid under the scheme] • He shall not purchase or procure goods, other than those specified in the Schedule I appended to the Act, within Delhi, from a person who is not registered under the Act, except to the extent of 2% of his total purchase turnover during the year or Rs. 25 lakhs, whichever is lower. • He shall not be eligible to claim tax credit u/s 9, 14 & 15 of the DVAT Act. He shall not compute his net tax u/s 11 of the Act. • He shall not be entitled to issue ‘Tax Invoice’. • He shall not collect any amount by way of tax. 33

  19. DVAT Composition Schemes - WCT Composition Scheme when beneficial vs. Normal Rate • Contractor is unable to maintain proper books of accounts; • His contractee does not want the benefit of ITC; • His local and /or central purchases are taxable @ 5% or less, so that he is ready to loose the benefit of ITC or Form C; • Local purchase of capital goods are listed in Schedule VII or central purchases are taxable @5%; • Material component is high as compared to labour 34

  20. Tax Deduction at Source • Basic exemption of Rs. 20,000/- per contract; • Contractee (other than individual & HUF) and ALL Contractors are liable to deduct TDS for making any payment for discharge of any liability on account of valuable consideration payable for the transfer of property in goods (whether as goods or in some other form) in pursuance of a works contract. • If payee is registered dealer – Rate of TDS is 4% w.e.f. 16.1.2013 • If payee is unregistered dealer – Rate of TDS is 6% w.e.f. 01.02.2011 • Application can be filed to the Commissioner for lower deduction of TDS, if liability to pay tax under DVAT is less than 2%.

  21. 38

  22. Builders–Manner of DVAT Assessment 39

  23. Collaboration Agreements Collaboration Agreement - Nature Analyzing the activity in detail in view of Raheja case, it can be fairly stated that Builder (BD) executes works contract for two separate persons, that is, - • (A) Works Contract for the Land owner (LO): where BD constructs the units for a consideration in the form of share in the land (unless treated as Barter –discussed later); and • (B) Works contract for Prospective Buyer (PB), if BD receives payment (or enters into agreement of sale) from PB before completion of the construction. 40

  24. Collaboration Agreements Construction by BD for LO • Consideration is the form of Land • Valuation of land is crucial for ascertainment of value of Works contract; the basis might be- • Actual construction on the basis of books of accounts • Agreement for transfer of land ( to arrive at the value of WC) between BD and LO • Circle rate of Land on the date of agreement between the two • Time of turnover would be incorporation of goods 41

  25. Collaboration Agreements Construction by BD for PB • Total Value (–) Land (–) Services • Valuation of land is crucial for ascertainment of value of Works contract; the basis might be- • DVAT Act - Indexed cost or 30%/50% of total value Alternatively – Risky proposition in the absence of Rules • Agreement for transfer of land between BD and LO • Agreement for transfer of land between BD and PB • Circle rate of Land on the date of agreement between two • Time of turnover would be received or receivable 42

  26. Collaboration – Hypothetical Facts Collaboration Agreement – Hypothetical Facts • Land Owner – LO ; Builder – BD • Construction of 4 flats : 2 flats for LO; and 2 flats for BO • Land Value on the date of agreement: 6 Crores • Value of construction of 4 flats : 4 Crores • Amount to be paid by BD to LO: 1 crore • 2 Flats sold by BD to customers P & Q before completion of construction: 3 crore (x) 2 = 6 crores • Registry of flats sold to P & Q – Directly by LO (it may be even by BD) – Implications of stamp duty ignored 43

  27. Collaboration – Hypothetical Facts SERVICE TAX SALES TAX (VAT) 1. Services Rendered by B to L – Does not involve land - Const. Value for 2 flats is Rs. 2 Cr. - Should be taxable as WCT at actual value or 40% of 2 cr. = 0.80 lacs. (Rule 2A – ST determination Rules) 1. Execution of contract by BD to LO: Rs.2 Crs. taxable in the normal manner. However, it can be argued that since the transaction lacks considera-tion, thus not subject to VAT. Raheja doesn’t have impact 2. Sale by B to P&Q of Rs.6 crs: 2.1) Prospective buyers: If K. Raheja (SC) applies-Taxable as WCT as per DVAT Rule 3 2.2) Sale after Completion : Not Taxable 2. Service by B to P&Q: 2.1) Prospective buyers: Complex Const.; involving land; Tax at 25% of value of Rs.6 Cr 2.2) Sale after Completion: Not Taxable 44

  28. Sale by Land Owner & DVAT SUPPOSE land owner also decides to sell his share, wholly or partly • If sale of flats after completion of construction – not taxable • If sale of flats takes place during construction – If K.Raheja applies, then the Department might allege that liable to pay tax as per Rule 3 of the DVAT Act. Please take care that land value will be decided as per the Rule. However, it can be argued that land-owner is not engaged in any construction activity 45

  29. Consideration under DVAT Transfer of property in goods for Cash or for deferred payment or for other valuable Consideration • Barter transactions, in general, are not subject to VAT • However, where transaction is partly for money and partly for goods, it would be taxable – Madras HC, All HC, SC (exchange of old car, difference in cash) • Based upon facts of the case, even barter or exchange of goods may be considered as sale under the Act, provided there is transfer of property in the goods. (Madras HC) • Supply of molasses in lieu of licence fee, which would be ascertained at the year end – Held as sale by SC – Dhampur Sugar Mills (2006) 147 STC 57 46

  30. Impact on other Builders Agreements Type of Agreements, generally, between Owner & Builder • 1. Construction Agreement: – Builder simply constructs the property for land owner for a consideration. Builder has no right, whatsoever, in constructed property – Simply a works contract service • 2. Land Owner also acts as a builder: - Land-owner develops the plot himself and sells the constructed property either during construction or after completion. Sometimes, the land-owner creates a new entity for the purpose of construction. – Works Contract – K. Raheja applies 47

  31. Impact on other Builders Agreements • 3. Holder of land is different from owner of land : Land is owned by various individuals. The developer holds the land on their behalf and develops the property. He sells the constructed property to the ultimate buyers before completion as holder- Works Contract – K. Raheja applies • 4. Partnership Agreement: - Land-owner and builder enter into partnership agreement, where land-owner introduces his land and builder introduces construction costs as their respective share of capital. Cost and constructed property is divided in a pre-determined ratio. – J.V are not taxable as sale: R.V. Eswaran (1976) 37 VST 543 (Mad). Works Contract – K. Raheja applies if sale to prospective customer 48

  32. Impact on other Builders Agreements • 5. Two separate contracts between builder and prospective customer :- Parties enter into two separate contracts : (a) for sale of land ; and (b) for construction. Stamp duty is paid on sale of land. This situation may take place in any one of the above agreements discussed at Sl. No. (2) to (5).- A works contract in respect of second agreement of construction 49

  33. Precautions & Others

  34. WCT Issues under Litigation • Deduction of turnover of the sub-contractor by the main contractor – L&T, Delhi High Court. • Purchase of Goods against Form C, without paying any VAT locally – Ahluwalia Construction, Delhi HC. • Development Agreements – Emar MGF – Delhi HC • Insufficiency of evidences to substantiate the exemption, and mismatch of taxable turnover – Jitender Mittal – Delhi HC 51

  35. Precautions – To Summarize • Before coming to any conclusion, analyze the impact of all four taxes/duties simultaneously, i.e.- • Income Tax • Service Tax • VAT • Stamp Duty • Treatment in all four taxes should be uniform • Prepare your agreements & contracts accordingly 54

  36. Precautions – To Summarize • Remember, VAT and Service taxes are indirect tax. Try to collect from customer and pay to the Government • Be careful in determining the measure of tax and time of turnover • Your books of accounts should transcribe from the terms of contracts – Account books should not be contradictory – Remember Section 40A • Might have to maintain project wise accounts • Preserve the books of accounts, documents and other evidences in a manner laid down in the Statute 55

  37. Precautions – To Summarize • Reconcile the turnover as per the Returns vis-à-vis Financial Accounts, which have been made as per AS-2, AS-7, AS-9 and other Accounting Standards • Preserve the evidences for labour and services, if calculated on actual basis, otherwise percentage method can be applied- Jatinder Mittal – Delhi HC • Ensure that returns have been prepared and filed correctly because penalty provisions are severe. 56

  38. Precautions – To Summarize • Documents / Contracts should be drafted and maintained in a manner so that there is least confusion and overlapping; • To repeat, be careful in drafting of contracts , and thereafter, maintaining books of accounts in accordance with the contracts, and then, preserving documentary evidences thereof. 57

  39. THANK YOU Rakesh Garg, FCA S S A R & ASSOCIATES Ph: (011) 65960912-13, 9810216270

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