Constitutional validity of deemed deduction of land for construction contracts.

Gujarat High Court in the case of Munjaal Manishbhai Bhatt v Union of India, had an occasion to examine the Constitutional validity of deemed deduction of land for construction contracts.

In this context, we request you to note the following: 1. GST is applicable on supply of goods and / or services. However, sale of land is outside the purview of GST; 2. Sale of under-construction apartments are treated as 'services' for the purpose of GST and the same are liable to tax at the rate of 18% / 7.5%. Additionally, if the consideration for construction services includes sale of land then Para 2 to Notification 11/2017 allows for a deemed deduction of 1/3 of the contract value towards land and tax is required to be discharged on the balance consideration; 3. The writ petitioner challenged the deemed deduction allowed towards land on the ground that the value of land is greater than 1/3 and hence the deemed deduction allowed by the Notification is arbitrary. The writ petitioner also highlighted that in case of plotted development, the value of development is miniscule and majority of the consideration is towards sale of land and deemed deduction of 1/3 indirectly leads to collection of tax on sale of land which is not permissible; 4. The High Court accepted the arguments of the writ petitioner and held that Para 2 of Notification 11/2017 which provides mandatory fixed rate of deduction of 1/3rd of the total consideration towards the value of land is ultra-vires the provisions as well as the scheme of GST; 5. The High Court also observed that the taxpayer can be allowed to pay tax on construction services under any of the following methods a. Deduction Method – Reduce the value of the Land which is agreed between the buyer and seller or use the Stamp Duty Valuation for the purpose of arriving at the value of land and reduce the same from the total consideration agreed for sale of apartment; b. Cost Method – Cost of Construction + 10% Margin should be considered as value of construction services based on the Valuation Mechanism prescribed under CGST Rules; c. Deemed Deduction Method – At the option of the developer, allow them to deduct 1/3rd of the total contract value towards land and treat the balance consideration as construction services. Action Points 1. The above judgement has a huge bearing on the tax implications on sale of apartments, commercial spaces and plotted development. A Developer can opt to deduct the actual value of land from the consideration received from the customers in cases where the actual deduction towards land is greater than 1/3rd of the total consideration; 2. It is suggested that in all the agreements / communications with customers / price list circulated to customers, the Developer specifically provides the bifurcation of the value of construction services and value of land; 3. Few Developers have taken a position that sale of plots is akin to sale of land and hence not liable to GST. The High Court has observed that sale of plots includes some element of service which is subject to GST and hence the developers will have to re-visit their stand in view of this judgement; 4. Is the judgement of Gujarat High Court applicable to States other than Gujarat - Unless a contrary judgement is rendered by the jurisdictional High Court, the judgement of Gujarat High Court will be applicable to the developers located in other States as well; 5. GST liability arising out of Joint Development Contracts might have an impact due to this judgement which will have to be examined based on the facts and circumstances of each case. We are in agreement with the decision of the High Court and believe that Government should amend the laws and allow for deduction of land based on the actual cost method since the current mechanism leads to indirect levy of GST on land which is Constitutionally not allowed. However, given the recent trend, we believe that the revenue authorities will challenge this decision before the Hon’ble Supreme Court. Accordingly, we suggest that developer should exercise caution before deciding on switching over to land deduction based on actual land cost method.