Rental as a service: More clarity needed

LEGAL EYE

India's transition from the high rate direct tax regime to an aggressive indirect tax one, goes to demonstrate how liberalisation has accelerated growth in the services sector, which accounts for 52 per cent of the nation's GDP.

VAT is in the process of easing out the existing cumbersome sales tax structure. Central excise has been unbelievably rationalised, intended to be replaced by a Goods and Services Tax by 2010, to consolidate and combine excise, service tax and countervailing duty.

Service tax was introduced in India in 1994, in the immediate aftermath of liberalisation, at the rate of 5 per cent on three services. Today it extends to over hundred services, and the effective rate has gone up to 12.5 per cent on the gross amont charged.

The service tax net initially brought in its scope, items whose characterisation as service was unquestionable, such as brokerage, courier, maintenance services in sectors where the incidence of direct tax is minimal. Therefore, in 1997 when the tax was imposed on the activities of real estate agents, it did not evoke much angst, nor did it impact real estate prices significantly.

In real estate, the first inroad was in 2004-2005, when service tax was imposed on construction services, including building repairs and alterations. This leviability was extended to construction activity of all buildings or civil structures used for commercial or industrial purpose.

Government constructions, charitable establishments, residential buildings, except those combining residential and commercial use were exempted.

The builder and contractor lobby, however, were able to negotiate and obtain an abatement of 67 per cent of the tax, in case of composite contracts, where the gross amount charged includes the value of main cost such as cement, steel, fitting, fixtures etc as the standard CENVAT credit facility was not workable.

The tax is applicable to the renting of immovable property, in the course of furtherance of business or commerce.

Expectedly, this has caused substantial stress in landlord-tenant relations, in existing leases and those under negotiation. Again the real estate lobby, even before the law has been passed, has prevailed upon the government to provide a set off of the amount of property tax, payable in respect of the same buildings.

On a plain reading, the service provider as the owner, is liable for paying the tax, though a different question may arise in cases of sub-leases or co-leases. Property tax, statutorily and in practice, in respect as in real estate leases is borne by the lessor/owner, even if the amount is factored into the rent. Of course, in case of non payment, the municipal corporation can recover it from the occupant.

Service tax, like sales tax, is charged to recipients, though the statutory obligation for payment is on the service provider, and irrespective of the above reprieve, leases continue to be negotiated on the basis of the service tax being borne by the tenant.

The problem goes deeper in smaller towns, where buildings combine residential and business activity "� where the residents would find themselves forking out an extra 12 per cent, without reason.

Real estate transactions are perceived in dealing with an asset involving activities such as development, construction, sale, lease, the substantial taxes being imposed as stamp duty and registration fees.

The basis on which service has been extended to dealings in the real estate is based on a definition in the MRTP Act, which is concerned with provision of facilities.

Renting of real estate is a high tax transfer of property and maintenance, the only facilitiy provided is anyway exigible to service tax. There is no clarity on what element in rental can be construed as a service. The rationale of a tax levying lies not in its charging, but also has to satisfy the test of reasonableness.

Kumkum Sen is a partner at Rajinder Narain & Co and can be reached at kumkumsen@rnclegal.com