GST on construction services – a brief discussion on time and value of supply

Under GST laws, the most complex set of laws relate to the construction sector. While the industry had just about got to grips with the complexities of law, an entirely new scheme under GST law was introduced from April 2019. In the below discussion, we have attempted to clarify in simple terms, the impact of GST on pre-April 2019 period and post the amendments effective from April 2019.

  • During the pre-GST period, Service Tax / VAT was not paid on execution of Redevelopment Agreement executed with a co-operative housing society for redevelopment of its property. Now, whether GST is applicable on Redevelopment Agreement executed with a co-operative housing society?

The incidence of tax arises at a specific time (point of taxation) which is defined under the MVAT and Service tax law.

Under MVAT laws, based on the agreement date if the liability arises during the pre-GST period, then the applicable MVAT dues can be recovered by the department by initiating assessment proceedings for the relevant period under MVAT act, 2002, i.e., the dues can be recovered as MVAT dues. In respect of the flat sold to non-members (new buyers) the valuation could be made on the basis of works contract as provided under Rule 58 of the MVAT Rules or under the composition scheme which was notified for construction contracts. It has to be seen if composition benefit will be allowed by the department in cases where the developer has not applied/registered for the same.

Similarly, under Service tax law (The Finance Act, 1994) also, if the time of supply arose in the pre-GST period, the service tax dues can be recovered by the department as service tax dues (not GST dues). The valuation in case of construction service provided by the developer to the society members would be arrived at on basis of values of flats sold near the JDA date. In case of development rights provided by the landowner to the developer, under Service tax law, this was treated as sale of land, hence, not covered within its ambit.

The provisions related to construction/re-development project under MVAT and Service tax were quite similar to the existing provisions under GST. If Service tax/MVAT was not paid, the department may treat this as a default.

GST will be applicable on the supplies made after July 01, 2017, i.e., in the GST regime. This is examined in subsequent paragraphs.

  • If yes, what is the rate and how is the valuation done? Whether GST is also payable on the compensation offered to the Society in the form of free area, corpus, rent, shifting charges, etc.?
  • For example, if the plot area is 10,000 sq. ft. and permissible construction is 30,000 sq. ft. The existing Society’s area is 10,000 sq. ft. and Developer has offered 2,500 sq. ft. free additional area to the Society. In above scenario, GST is applicable on total 30,000 sq. ft., or only on the sale area of the Developer, i.e. 17,500 sq. ft.?

Response to 2 and 3 above –

Before answering these two questions, we have to clarify that taxability and valuation would depend on the agreement terms. The response provided hereunder is based on the assumption that the JDA provides simply for delivery of constructed flats and corpus, hardship compensation etc. against development rights. The answer would differ if the JDA terms are different.

As you are aware, there are two separately identifiable transactions in the given case;

  1. Construction service provided by the developer to the Society, and,
  2. The transfer of development rights by the Society to the developer
  • GST on construction service provided by the developer to the Society: 

So far as the question of valuation under GST is concerned, it is clear that the developer has provided construction service, free area and monetary consideration in the form of corpus in return for development rights. Hence, all these components including any area that has been constructed (original area plus additional area) is a part of the supply. The valuation of such supply can be computed based on value of similar flats sold to third persons, near to the JDA date, i.e., first sale to third parties. From the value so arrived at, the value of land (1/3rd) has to be deducted. To state simply, the value of construction service provided by the developer will be –

Corpus + Any other money paid + Hardship compensation + Value of constructed flats given to the Society

So far as when the GST is to be paid is concerned, the time of supply will arise only when the completion certificate is received.

In relation to hardship compensation, there can be two views –

  1. Such hardship compensation is an act tolerated by the individual member or the land owner, hence it is a deemed service provided by the said member or land owner in terms of Schedule II, Clause 5(e) of the CGST Act, 2017. The GST liability, if any, would fall on the said member. However, being a part of the JDA with the society, the Society would have to levy GST on the deemed service.
  2. On the other hand, department may contend that the hardship compensation paid is also a part of the consideration for development rights and it is incumbent on the developer to pay GST on the same.

Referring to the illustration you have provided and taking a conservative view, the developer will have to pay GST as under –

  1. On 12,500 Sq. Ft. given to society – at the valuation discussed above, and,
  2. On 17,500 Sq. Ft. sold to third parties – recovered under forward charge

In the above discussion, we have concluded that;

  1. the developer has to make payment of GST on the construction service provided to the Society,
  2. The valuation of such services will be based on the value of flats sold to third parties nearer to the JDA date,
  3. The GST will have to be paid by the developer at the time of first occupation or receiving of completion certificate whichever is earlier.

Now we look at the tax rate applicable on the construction service which is provided by the developer to the Society. The rate of tax will depend on the JDA date –

  1. JDA date before 01/04/2019: Applicable rate will be 18%. In the present case, the land remains with the Society, hence, the deduction of 1/3rd for the transfer of undivided land will not be available.
  2. JDA date after 01/04/2019: Applicable rate will be 1.50% in case of affordable residential houses and 7.50% in case of other residential houses. Again, the deduction of 1/3rd for the transfer of undivided land will not be available

In case of sale of flats to third parties, the applicable rate of tax will be the same as above, however, the deduction of 1/3rd for transfer of undivided share in land will be available. Hence, the applicable rates will be 12% or 1% and 5%, as the case may be.

B. GST on transfer of development rights by the Society to the developer:

It must be noted that there is an argument that the transfer of development rights arising out of land is nothing but transfer of land itself, hence, the same would be out of the ambit of GST. However, the government has issued Notification 4/2018-Central Tax (Rate) clarifying the transfer of such development rights as taxable under GST. The contention that such rights are not covered under GST will be tested in court. It is relevant to note that Chandigarh Bench of CESTAT held in DLF Commercial Projects Corporations Vs Commissioner of Service Tax that Service tax was not payable on transfer of development rights. The bench observed –

“As the Hon’ble High Court observed in the case of Sadoday Builders Private Ltd. and Ors. (supra) that transferrable development right is immovable property, therefore, the transfer of development rights in the case in hand is termed as immovable property in terms of Section 3 (26) of General Clauses Act, 1897 and no service tax is payable as per the exclusion in terms of Section 65B(44) of the Finance Act, 1994. “
(there are many other similar judicial precedents)

While the above ruling pertains to Service tax period, the basic principles apply in the GST regime also. However, leaving the above argument aside, we examine this second part of the transaction.

  1. JDA before 01/04/2019 – In respect of the development rights transferred by the Society to the developer, the valuation can be arrived at by considering the open market value of such development right as mandated under Rule 27 (open market value) or Rule 30 (110% of the cost plus monetary consideration if any) of The CGST Rules, 2017. The GST on the value so arrived at has to be paid at the time of allotment of flats or conveyance of the units to the Society. The Society would have to register and levy GST to the developer, who could have taken the ITC of such GST charged by the Society.
  2. JDA on or after 01/04/2019 – Development right given by the society to the developer is exempt to the extent of flats sold by the developer before completion certificate is received, i.e. as long as GST is paid on the sale of flats under construction, the development rights remain exempt. In case there are any unsold units (from developer’s share of flats) when the completion certificate or first occupation happens the proportionate value of development rights has to be worked out based on the last sale and GST is to be paid by the developer under reverse charge. The applicable rate of GST will be 18%, however, restricted to 1% or 5% of the value of such unsold units, i.e., lower of 18% or 1% / 5%, as the case may be. The GST paid under reverse charge becomes a cost to the developer as ITC will not be available.

The time of payment of GST on development rights related to unsold units will arise when the completion certificate is received or first occupation, whichever is earlier. [For this calculation, the sold/unsold units are to be reckoned with only from the developer’s share of units]

Issues in valuation method prescribed under GST law :   

From A and B above, we find that the approach of law in respect of valuation needs to be more rationalised. The fact remains that the transaction is a barter transaction. In such a case, the value of development rights given by the Society and the construction service provided by the developer has to be the same. Two different values for the same barter transaction seems illogical.  

Revenue neutrality under old provisions (before 01/04/2019) –

As we have seen that the tax liability on construction services provided to Society arises in hands of the developer. Similarly, tax liability on development rights arises in hands of society. This may end up being revenue neutral for the developer as well as for the Society see table hereunder –

StageService providerService recipientType of serviceTime of supplyITC Impact (old provisions)
Stage 1SocietyDeveloperDevelopment rightAllotment letterSociety levies GST on developer.ITC available to Developer
Stage 2DeveloperSocietyConstruction Services of Society’s share of flatsCompletion certificate or first occupationDeveloper has to charge GST on his servicesThe ITC available in stage 1 can be utilised.
  • When is the liability due and payable by whom, the Developer or the Society?

This aspect is already covered in the paragraphs 2 and 3 above. However, for the sake of clarity –

  1. GST on development right given by the society to the developer will become due at the time of conveyance or issue of allotment letter [Stage 1 in above table]
  2. GST on construction service provided by the developer to the society will become due at the time of first occupation or receiving the completion certificate from local authority, whichever is earlier. [Stage 2 in above table]  
  • From 1st April 2019, GST has been revised to 5% on sale flats and Input Tax Credit is not permitted. GST was made applicable on TDR and redevelopment agreement as Input Tax Credit was also permitted prior to 1st April 2019. Now since ITC is unavailable, whether GST is still applicable on TDR and redevelopment agreement?

In respect of ongoing projects, in April 2019, option was given to the developer to opt for new scheme without ITC or continue with the old scheme where ITC was available. If the option to continue with the old scheme was exercised by the developer, then ITC would continue to be available. If the option was not exercised, the new scheme without ITC would be compulsorily applicable to the developer.

Also, as discussed in paragraphs 2 and 3, if the new scheme of no ITC and 1% and 5% rates is opted for, the transfer of development right by the society to the developer has been made exempt from 01/04/2019. Accordingly, while development right will be exempt, the construction service provided to the Society by the developer will remain taxable.

This brief discussion merely touches the tip of the iceberg in this complex set of laws for construction services. We hope it provides some clarity to the reader on time of supply and valuation aspects in case of redevelopment projects. Questions or comments of readers on this article are welcome.

Dipen Lathi,
Chartered Accountant
www.Lathico.com

DISCLAIMER : No assurance is given that the revenue authorities/ appellate authorities/ courts would concur with the views expressed herein. Our views are based on the existing provisions of law and our interpretation thereof. We do not assume responsibility to update the views consequent upon such changes, if any. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.

All rights reserved. No part of this material may be reproduced, without the prior written permission of the author. Fair use of the content is permitted provided credit is given to the author.

© Dipen Lathi

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