Service Tax Planning: Options for real estate players

MUCH has been talked and written about the newly introduced Composition Scheme for works Contractors, with effect from June 1, 2007. Most of the players in the Real Estate industry have started to believe that the Composition Scheme is the best option that could be available to them. This article is an attempt to understand the various options that are still available to the players in the industry by using which, there could be an overall optimization of the service tax payments.

Various Options Available

Before we get into this discussion, let"s understand the various options that are available to the players in the industry, under the service tax law. They can opt for any of the following schemes…

Regular Scheme, under which, the works Contractor would have to pay service tax at the applicable rate of 12.36% and would be entitled to cenvat credit in respect of inputs, capital goods and input services.

2.The works Contractor can opt for the benefit of Notification No. 12/2003 dated June 20, 2003, as amended from time to time read with Rule 2A of the Service Tax (Determination of Value) Rules, 2006 which has come into effect from June 1, 2007, whereby, he would be entitled for an exclusion of the extent of the value of goods and materials used while computing the value of taxable services and would still be entitled for cenvat credit in respect of service tax paid on input services, subject to condition that there is documentary proof specifically indicating the value of the said goods and materials. This exemption will apply only in such cases where (i) no Cenvat Credit on such goods and materials had been taken by the service provider, or (ii) if such Cenvat Credit had been taken by the service provider on such goods and materials, such service provider had paid the amount equal to such credit availed before the sale of such goods and materials. In other words, either the service provider should not have taken Cenvat Credit on such goods and materials, or, if he had taken such credit, he must reverse the credit before the sale of such goods and materials.

3.Abatement Scheme, under Notification No 1/2006 dated March 1, 2006, as amended from time to time, whereby, the works Contractor is entitled to claim abatement to the extent of 67% of the value of services rendered by him. In effect, the works Contractor would have to pay service tax @ 4.08% and would not be entitled for any cenvat credit on inputs, capital goods and input services.

4.The newly introduced Composition Scheme, effective June 1, 2007, under which the works Contractor would be required to collect service tax @ 2.06% on the value of services rendered and would be entitled for cenvat credit in respect of input services and input capital goods.

Various Players

When we talk of a works Contractor, we normally mean one of the following players, viz.
- A pure Developer/Builder, who might have outsourced or contracted out the construction activities to a Contractor, in the case of a civil works contract.
- A Developer/Builder cum Contractor, who undertakes the construction himself and consequently doubles as a Contractor.
- A Contractor, who does work for the Developer/Builder.
- A Sub-Contractor who does work for a Contractor.

Possible Planning Models

Having armed ourselves with the information relevant to the civil construction industry, let us now proceed to see how the various players in the industry can optimize their service tax liability under the parameters of the law.

Let"s first take the case of a pure Developer/Builder, who develops and sells residential units to his customers and who wants to opt for the Composition Scheme, pay service tax at minimal levels and buy sleep. Since the service tax paid by him to his contractors is available as cenvat credit, the quantum of service tax paid by him would not perhaps matter. Given this logic, the pure Developer/ Builder should look at ways of optimizing the overall service tax payments related to his project, by having his contractor select the most appropriate scheme, which could be either the Regular Scheme or the scheme covered by Notification No. 12/2003. The Contractor, by choosing to pay service tax under either the Regular Scheme or the Notification No. 12/2003, can avail of cenvat credit on inputs in addition to input services and input capital goods. In typical cases, we find that the Contractor buys most of the inputs like cement, steel, etc., and if he were to be under the Composition Scheme, the cenvat availability on inputs would be lost, resulting in an overall increase in the project costs. On the other hand, by opting for the Regular Scheme of the Notification No. 12/2003, the Contractor could avail of higher cenvat credit, arising out of the duties paid on inputs. Though the Contractor would be charging service tax at higher levels to the pure Developer/Builder, these higher service tax payments could in turn be utilized as cenvat credit by the pure Developer/Builder, resulting in an overall lesser cash payments to the Government on account of service tax.

Take the case of the Developer/Builder who also undertakes the construction activity by himself and consequently and doubles as a Contractor (Developer/Builder cum Contractor). He would be entitled to opt for the Regular Scheme or for the scheme under Notification No.12/2003 or the Composition Scheme. What is good for this Developer/Builder cum Contractor would depend on the facts of his case. However, it would look like the choice would be essentially between the Regular Scheme and the Composition Scheme, as the cenvat benefits are available under both the Schemes. If the materials / goods like steel and cement (“inputs") were to form a very high percentage of the overall costs of the project, it might turn out that the Developer/Builder cum Contractor would better off opting for the Regular Scheme and pay service tax at the full rate of 12.36%, as the benefits arising out of availment of cenvat credit might work out quite high and the consequent service tax payment (net of cenvat) working out to be lower under the Regular Scheme, as compared to the corresponding figure under the Composition Scheme.

Taking this discussion further, into the realm of commercial construction, players in the commercial space renting (who develop these commercial complexes or parks which are let out to companies) who are liable for service tax payments in respect of commercial rentals would do well to plan for the scheme in which their Contractors should fall. The planning that is applicable to pure Developers / Builders in the residential construction space is very much applicable to Developers of commercial complexes, as well and they could reduce the overall costs of the project by having their Contractors choose the most appropriate scheme. In many cases, Developers of commercial complexes would find it much more profitable to ask their Contractors to opt for the Regular Scheme and charge them (i.e. the Developers) service tax at the full rates (rather than under the Composition Scheme) and adjust their service tax payments to their Contractors against their service tax collections arising out of commercial rentals. There is no legal bar for both the parties (i.e. the Developer of the commercial complex and the Contractor) to share the benefit arising out of the cenvat availment by the Contractor, in respect of inputs and input capital goods, as between the Contractor and the Developer.

There could be cases where the Developer could be involved both in commercial space as well in residential space. This kind of a situation provides enormous opportunities for legal planning. Either the Developer can consider the part of the turnover pertaining to the residential space, in which he is only acting as a pure developer, as exempt from service tax or alternatively, he can opt for the Composition Scheme and pay service tax @ 2.06%. In the overall scheme of things, this kind of a player might find it better placed to avail of cenvat credit to his overall benefit.

It is needless to say that the same logic would work as between the Contractor and his Sub-Contractors. Based on our experience, we have seen that most Contractors and Builders have opted for the benefit of Notification No. 1/2006. It needs to be seen here that this Notification does not, per se, prohibit utilization of cenvat credit vis-À-vis payment of service tax. In my opinion, a Contractor opting for 1/2006 can keep accumulating cenvat credit and adjust the same against service tax liability on any other service other than construction service.

It is very obvious then that a good strategy for service tax should take into consideration, the various schemes that are available for the different players, with a view to optimize the overall service tax payments by all of these players combined, rather than to take a stand alone view.

Undoubtedly, the prevailing situation in respect of service tax applicability on the players of the Real Estate Sector, is very complex and confusing. But, let"s not forget that the present confusion and chaos can give rise to tremendous opportunities for legal planning aimed at minimization of the overall service tax liability, by the industry players.