Delhi HC ruling on service tax a precedent for home buyers seeking refund

The Delhi High Court (HC) recently heard a writ petition filed by individual buyers challenging the applicability of service tax on the sale of under-construction residential apartments (where the agreement for sale is entered into during the construction phase).

While the HC held that though the central government is entitled to impose service tax on the service portion of construction contracts, no service tax could be imposed on such sale of under-construction residential units as no mechanism is prescribed to compute service tax on such contracts. The HC acknowledged the established judicial principle that, for a levy to survive, the legislation should provide for the following key elements namely – (i) the measure of tax (ii) who is liable to pay tax and the (iii) aspect that is being taxed. The HC observed that the valuation rules prescribed under the service tax legislation are inadequate in case of construction contracts related to under-construction residential units, in as much as, the rules do not allow deduction of the value apportioned to the transfer of the undivided share of land to the buyer of such units. It was held that in absence of a specific machinery for computing applicable service tax, the levy of service tax on such contracts is liable to fail.

What to expect

The big question is whether buyers of under-construction residential units would get an immediate reprieve from service tax on future installments and whether a refund of the service tax charged and collected by the builders in the past would be available.

In my view, the answer is the negative. There are several reasons for this.

For one the said HC judgement may not be considered as final, since it is likely to be appealed against, in the Supreme Court by the government. Further the HC judgement is applicable in Delhi alone, and has only a persuasive value in other states. Given the unfortunate likelihood of the continuing litigation, most builders may continue charging service tax on future installments at least on a provision basis.

Further, the law requires that the builders deposit any amount collected as service tax with the government regardless of whether the same is correctly collected or paid. The only exception to this broad principle is if the law itself has been considered invalid. The debate therefore on refunds of the tax already deposited is likely to be extremely tortuous. Builders may initiate process of obtaining refunds from the government in relation to the service tax paid on past installment payments but refund the money to buyers only once the tax refunds are received by them.

In addition to this, it is pertinent to note that the levy of service tax has been held to be within the constitutional vires of the central government. Given this, the government may need to only amend the valuation rules to plug the shortcomings observed by the HC to enable imposition and collection of the tax. The amendment to the valuation rules does not really require a parliamentary approval and can be easily be done by issuing a notification.

The government should be expected to do so sooner than later.

Further in similar cases where the levy of service tax has been considered to have failed on technicalities such as the one pointed out by the HC – the central government has resorted to make amendments on a retrospective basis. While the government should ideally resist this temptation in line with their declared policy of abhorring retrospective taxation, such a move may not be entirely ruled out. Builders may not want to take this risk.

In this regard, individual buyers may also choose to approach high courts in their respective states seeking refunds of the service tax collected from them in the past and also challenging levy of service tax on future installments. The persuasive value of the Delhi HC judgement has increased the probability of getting a favourable ruling in the matter.

The writer is tax partner, EY India