Tuesday, November 21, 2017

Taxzone

GST:  Impact and Implications

 

Real Estate and Construction sector in India has been identified as one of the key sectors by the government. It has even set ambitious targets under the affordable housing segment and has left no stone unturned to incentivise developers and contractors in multiple ways. At the same time the consumers have been empowered by implementation of Real Estate Regulation Act, 2016.

 

GST will no doubt increase the compliance burden of the industry by indirectly tracking all transactions and bringing them in the public domain. It will be very interesting how the government plans to demystify the large maze of data that would now be available to them by way of regular online returns being filed by developers and builders.
India is on the cusp of developing into a country where a lot of things have to be set right. Multiple and complex indirect taxes being one of them. So the paradigm shift from the current mess into a cleaner GST would give way to a better system. At the same time it would see some new issues spawned out of this shift.

CA Sandesh Mundra and Naimesh Padhiar,  from Sandesh Mundra & Associates, assess the impact of GST* on various issues connected with the construction and  real estate sectors.

*Unless otherwise stated “Act” means The Central Goods and Services Tax Act, 2017

 

 

Taxation Clauses under GST Law

Works contract as well as sale of under-construction property have been classified as a ‘service’ under Schedule II to the Act. This is the most positive sign for the construction and real estate sector as this would take care of major valuation related issues dealing with splitting the total agreement into value towards material and labour.

 

As far as construction of complex is concerned a significant change that is now visible is that, apart from the requirement of completion certificate from the competent authority there is also a reference of “first occupation” as an alternative option. This would suggest that the moment first occupation (though may be illegal) is proved by anyone, any subsequent bookings would not be subjected to GST.

 

However the said term has been left undefined under the act leaving a scope for ambiguity and confusion, hence it may be advisable to issue suitable clarification with regard to the same.

 

The government during the discussions at the 14th GST Council Meeting on 19th May, 2017 has released a draft document containing the rates at which services would be taxed under GST. Two relevant entries in the said list are as below:

 

S.No.

Description of Services

GST Rate

1

Construction of a complex, building, civil structure or a part thereof, intended for sale to a buyer, wholly or partly. [The value of land is included in the amount charged from the service recipient]

12per cent  With Full ITC but no refund of overflow of ITC

2

Composite supply of Works contract as defined in clause 119 of section 2 of CGST Act

18per cent  With Full ITC

 

 

One can thus conclude that effectively a 33per cent  abatement has been considered for the purpose of land. The issue that arises is whether the constitutional validity of the rate structure can be challenged just like the several challenges under the current regime. However according to the author the chances of such a situation arising seem to be low mainly on account of two reasons:

  • Wider definition of service under the constitution so as to include everything other than goods,
  • Land and construction when clubbed together may be treated as a mixed supply with land also be subjected to same rate as the construction of complex.

 

Besides what is interesting to note is that 12 per cent rate allows full ITC without any refund of overflow. This would suggest that the government foresees a situation where the developer would be paying Input taxes at 18per cent  and 28 per cent  which may lead to excess Input Tax credit balances. Such taxes would only be available for set off against the future projects. Besides it may also lead to a situation where the restructuring takes place whereby all the purchases at 28 per cent are routed through the contractors in order to avoid payment of higher taxes in Inputs. A contractor when subsumes such purchases would only be charging 18  per cent  on his gross billing.

 

 

VALUATION

Also as far as the valuation is concerned it may be relevant to note the provisions of Section 15(2)(a) of the act which talk about inclusion of any taxes, duties, cesses, fees and charges levied under any other law (other than GST) while discharging the GST liability.   Now the issue is whether stamp duty and registration charges collected from the buyer would also be subjected to GST or not? Looking to the language of the law, such charges are thus bound to be taxed leading to a cascading effect.

 

Inter-branch transfers within the states are out of purview of GST, however, the same shall be subject to GST if transferred in different states. The valuation of such transfers between the related or distinct persons shall be determined based on GST Valuation Rules i.e. the open market value of such supply. These provisions may be challenging to implement with respect to cross-border transactions especially in case of supply of services.

 

 

TIME AND PLACE OF SUPPLY

Developers and contractors would be covered under Continuous Supply of Service, implying that the milestones for payment as decided in the Agreement to sale or the stages of constructions would become the Time of Supply. Utmost care is thus required that the payments are actually received as per the pre-decided milestones.

 

Place of supply for services in relation to immovable property would be the location of the immovable property. There may be possible issues where a single contract is entered into for provision of services related to immovable properties across two or more States.

 

For example, in case of services from an architect, a single contract may be entered into with the vendor, for which consolidated invoices may be raised at one location. Under GST, the place of supply would be each such State where the immovable property is located, and hence, there may be a requirement for the vendor to raise separate invoices.

 

 

EXEMPTIONS

The government during the discussions at the 14th GST Council Meeting on 19th May, 2017 has released a draft document containing the list of service tax exemptions which are to be continued under GST. Two relevant entries in the said list are as below:

 

S.No.

Description of Services

1

Services provided by way of pure labour contracts of construction, erection, commissioning, installation, completion, fitting out, repair, maintenance, renovation, or alteration of a civil structure or any other original works pertaining to the Beneficiary-led individual house construction / enhancement under the Housing for All (Urban) Mission/Pradhan Mantri Awas Yojana (PMAY);

2

Services by way of pure labour contracts of construction, erection, commissioning, or installation of original works pertaining to a single residential unit otherwise than as a part of a residential complex;

 

 

TRANSITIONAL PROVISIONS

The major impact on implementation of GST would be on the ongoing projects. Ongoing projects are those where completion certificate is not received. There are several issues which may be faced during the transitional period.

 

Government has prescribed a rate of 12per cent  for payment of GST on Real estate projects (construction contracts including land value) and 18per cent  on construction contracts. This rate would apply not only to projects which are launched after the GST implementation date but also those projects which are ongoing as on the implementation date. This would suggest that whatever input tax credit stream that is available to new projects should also be available to ongoing projects.

 

Let’s look at various transitional provisions incorporated to smoothen the availability of past credits. As per Section 140(1) the act, existing tax payers shall be eligible to carry forward credits which are carried forward in the past returns subject to eligibility under the GST regime. Section 140(2) permits carry forward of unavailed capital goods CENVAT credit not carry forwarded in the returns.  Section 140(3) and Section 140(6) are the most critical sections applicable to registered taxable persons availing benefit of service tax abatement in case of construction of complex, building, etc or paying VAT under the simplified composition schemes under the state VAT Act respectively. These provisions however use the words “credit of eligible duties in respect of inputs held in stock and inputs contained in semi-finished or finished goods held in stock on the appointed day”.

 

The doubt that surfaces in the minds based on this clause is whether the stock of Work in Progress of the under-construction property could be termed as a stock of semi-finished goods when construction of complexes have been deemed to be a service under Schedule II of the Act. At this stage it would be noteworthy to refer to the case of ALA Chemicals vs. CCE (2011)-TIOL-940-CESTAT –MUM – Held in CEA, 1944 that where work -in-progress goods and semi-finished goods are not defined – common parlance meaning should be used - goods which do not attain finality are called as work -in-progress/semi-finished goods/intermediate goods.

 

As per section 142(11)(c) the goods and/or services supplied on or after the appointed day in pursuance of a pojects entered into prior to the appointed day shall be liable to tax under the provisions of this Act.  Hence the unexecuted portion of the project would be subjected to GST after the appointed day and no grandfathering mechanism is being followed here. The presumption taken here is that the phrase “extent of supply” as referred in the Section 142(11)(c) would mean the stage of physical construction (Extent of Supply or per cent  Completion). Further Section 142(11)(c) above creates a very interesting situation. The intention of the government seems to be to avoid double taxation. 

 

Let’s study it with an example. M/s. XYZ a developer is in the process of completing a project which has 6 units. Each of these units has achieved a 50 per cent  completion. VAT on full project is paid, however, service tax is paid on 50 per cent  of the project. Under such a case, since 50 per cent  construction is being completed in GST regime, GST (CGST + SGST) shall be applicable on the 50per cent  value of construction. However, as the VAT is already paid on 100per cent , the excess VAT paid i.e. 50 per cent  would be allowed as credit in GST regime.

 

 

ANTI-PROFITEERING CLAUSE

Anti-Profiteering provisions have been introduced in GST in order to ensure that the business passes on the benefits of reduction in tax incidence of goods and services or both to the consumers on account of benefit of input tax credits.

 

The intention of the government is mainly to target the B2C segment catering to the consumer goods to avoid any kind of inflation in the life of a common man after the implementation of GST.

 

Although the author believes, with the kind of competition that exists in the Indian markets, it may not be practical for the industry to keep with itself the benefits arising out of GST. The market will force all the players to offer the best pricing to lure the customers.

 

Section 171 of the Act speaks about passing to the recipient the benefits both on account of Output and Input Taxes by way of commensurate reduction in the prices. Interestingly, the emphasis here is not on profits earned pre-GST or post-GST but on the impact of taxes.

 

In the case of developers, the credit efficiencies can be distributed by passing on these benefits by offer of discounts / credit notes as it may be difficult to reduce the agreement values which are subject to strict watch of the stamp duty authorities unless there are specific circulars from these authorities to cater to this particular issue faced by the real estate sector.

 

It may be interesting to note what would happen in cases where the customers have made the complete down payment towards the agreement value. In such cases actual payments would have to be made by the developers to the customers by way of refunds to comply with this provision.

 

It will also be interesting to note the manner in which the government goes around to monitor the compliance of this clause looking to huge volume of work involved.

 

In order to ensure that the calculations are done properly the authors have developed an Impact Analysis tool (www.gstbuilder.com) which can serve as a neutral tool from both the customer and contractor’s perspective.

 

 

SECTOR SPECIFIC IMPACT

A.  Impact on Real Estate Sector :

The key basic issues that remains unsolved in the present tax structure leading to intense litigation, especially on issues like transfer of development rights in land, taxability of joint development agreements, taxable value for goods and services, etc. are still not being addressed in GST regime also. However, it is expected that the GST regime is expected to simplify the present Indirect tax structure as it would subsume most of the Indirect tax laws.

 

Joint Development Arrangements:

In the real estate sector, it is a common practice for land owner and developers to come together and develop or redevelop a property. In such a case, the land owner contributes the land and the developer uses his expertise of construction/ development of a project. The constructed property is sold together by the land owner and developer.

 

There can be various revenue sharing options depending on the levels of risks involved. Some of the models along with the taxability under GST regime on developer and land owner is explained herewith:

 

Model

Taxability on Builder

Taxability on Land Owner

1.  Fixed monetary consideration to land owner

The developer pays a fixed consideration for purchase of land. The sale of units by the developer before the completion certificate shall be subject to GST.

Under the development agreement, the landowner firstly transfers the development rights to the developer / builder for development and construction of new property.
Under GST, as per para 5 of Schedule III of the Act, sale of land and sale of building are included under transactions which shall neither be considered as supply of services or supply of goods. There is no mention of rights arising out of land in the said Schedule. And now with a very wide definition of services which includes anything other than goods, department may take a stand that even rights arising out of land like TDR /FSI would be taxable under GST. However in the views of the author such an extended view may not be possible so as to encapsulate all forms of immovable properties within the definition of service just because these rights have not been included in Schedule III. However this shall definitely create some controversy in the industry for applicability of GST under such transactions.

2.  Allotting free units out of constructed space to land owner

In this model, free units are allotted to the land owner in lieu of land consideration. This is a barter transaction between the landowner and the developer where the land owner transfers the land and the developer transfers the part of constructed property to the landowner. The definition of supply under section 7(1) includes all forms of supply such as sale, transfer, barter, exchange, etc. Thus such supplies shall be continued to be taxed under GST regime also.
The complication involved under such barter transactions would be the point of taxation and the valuation. Since the payment under barter transaction i.e. development rights are transferred on the very first day of the contract between developer and landowner, the time of supply shall be the date on which an agreement is executed between the landowner and the developer.

Where the landowner receives the free units from the developer and he further sells these free units before the completion certificate, the same shall again be subject to GST with input credits of the taxes paid by the builder.

3.  Share of profits from the projects

In this model the developer and landowner share the profit from the development of project. Such cases may be treated by the department as an unincorporated JV which is subject to independent taxation. The said risk continues even under GST. Hence drafting of such contract continues to remain very critical.

4.  Fixed per cent  on the consideration charged to buyers of units

In this model developer collects and remits a fixed percentage of consideration charged from the buyers of the units to the landowner towards the land. The authority to sell the units shall rest with the developer at his own responsibility. The consideration received from the sale proceeds before completion certificate shall be subject to GST, however the units sold after completion certificate shall be out of purview of GST. The consideration paid to land owner would be considered for the consideration against the land and will not attract GST.

 

 

 

B.  Impact on EPC Projects :

EPC projects under GST shall be taxed at 18per cent  rate with the full availability of input credits. At a macro level, it is expected that there will be a positive and favourable impact on EPC and infrastructure sector. The incremental rate of GST will be nullified with the availability of increased GST credits of excise duty, CVD and SAD on imports which are presently a cost burden.

 

The major issue involved in the EPC contracts under the present regime was for the free issue of materials by client to contractor and whether the value of such materials are to be included in the valuation. Under GST regime there is no provision within the valuation framework (both act and rules) to cover such issues.  Thus it is expected that such free issues of materials would be out of scope of supply under GST.

 

The BOT projects where, the supply is already effected under the present regime, however the consideration is received in the GST regime. Under such projects, the creditson inputs absorbed in the construction cost shall also be cost in GST regimeand no further mechanism is available for availment of such credit.

 

Major exemptions which were available under service tax are also withdrawn and are restricted to an extent. This will have an adverse effect on Renewable Energy projects. These projects are presently enjoying VAT and entry tax exemptions in some states, excise duty concession and fiscal incentives.

 

Overall, the model GST law comes across as a mixed bag for infrastructure projects depending on the kind of the project and procurements. However, the issues on credit blockages shall still be observed under GST regime also.

 

 

C.  Impact on Logistics and Warehousing Sector:

Transportation alone holds 60per cent  share of the logistic industry and rest 40per cent  is contributed by warehousing, freight forwarding, value-added logistics, etc. Presently the services by goods transport operators are included in negative list and has put out of purview of service tax. Under GST regime the same shall continue to enjoy a similar treatment.

 

However, since petroleum products are kept outside the scope of GST currently, and since nearly 50per cent  of all goods transported is motor spirit, some of the benefits of GST may not reach the end customers and thus all the duties and taxes paid on the petroleum products shall be cost. Further the reverse charge mechanism applicable to GTA (Goods Transport Agencies) would continue under GST regime also. GST at 5per cent  shall be levied on GTA services with no ITC as notified by the council. However, it will always be tough to define the place of services under GST regime also.

 

Section 12(8) states that the  place of supply of services by way of transportation of goods, including by mail or courier to a registered person, shall be the location of such person and for a person other than a registered person, shall be the location at which such goods are handed over for their transportation i.e. the place of destination.

 

The other disadvantage of current tax regime to the industry is State-border checkpoint, which are tasked with location based compliances.The same will be simplified in GST regime as there will be no cross border check post and there by will reduce the compliances burden.

 

Since GST would bring a uniform common market for Goods and services, breaking state barriers and borders, it would lead to re-construct warehouse strategy by various manufacturers and principal companies. Presently for supplying goods in different states, manufacturers are forced to set up warehouses in each such states in order to save themselves from payment of excise duty which is presently levied on removal of such goods. Under GST regime since tax shall be levied on supply of goods, a new strategy shall have to be defined by the manufacturers thereby reducing the number of warehouses and thus reducing the cost of operating such warehouses.

 

It is also important to note that inter-state transfers between branches shall be liable to GST. However, the credit of such transfers shall be available at a later stage. This would also lead to initial increase in working capital requirements. Furthermore, since there is smoothest flow of credit with less restrictions, there would be no blockage of credit within the supply chain and thereby would reduce the operating cost of warehouses.

 

It is also worth noting that in case of warehousing the credit for GST paid on construction of warehouse building i.e. on works contract services shall not be allowed as the same are not for further supply of works contract services as per section 17(5)(c). Therefore, GST at 18per cent  paid on construction of building shall still remain cost. Thus it is expected that the logistics and warehousing sector will have a positive impact under GST regime, by increasing overall efficiency and thereby resulting in more organised stages in supply chain. However in the near term there could be some  inflation, but, the impact should be transitory.

 

D.  Construction, Earthmoving and Mining Equipment:

Almost 50 percent of earth-moving and construction equipments used by infrastructure  sector are taxed as luxury items under present regime. The overall rate of taxes are worked out at 18per cent .

 

Under GST regime earth-moving and construction equipment such as bulldozers, angle dozers, wheeled-loaders, backhoe loaders, soil compactors, and excavators, graders, levellers, scrapers, mechanical shovels, excavators, shovel loaders, tamping machines, road roller, grading, levelling, scraping, excavating, tamping, compacting, extracting or boring machinery, for earth, minerals or ores, piledrivers and pileextractors, etc. shall be taxed at 28per cent  slab rate as notified by GST council.Around 50 per cent of the equipment will fall under the 28 per cent bracket which will definitely have a negative impact.

 

The availability of credits would also depend on the status of the said equipment as a motor vehicle under the prescribed definition of the act.

 

Since these equipments would be taxed at higher rate, it is anticipated that there would be an overall price hike under GST regime on these equipments. It would also have effects on the cash flow of contractors, where output is taxed at 12 per cent  or 18per cent , while the input tax is 28 per cent  and hence the balance credit will be blocked for a point of time and thereby increase in capital investment.

CA Sandesh Mundra  & Naimesh Padhiar, Sandesh Mundra & Associates,  Ahmedabad

The authors are currently engaged in doing several impact analysis assignments for the construction sector. They have also developed their own in house tool named GST Builder for doing multi state impact analysis. They have also authored a book titled “GST – Quick Connect with Construction Sector” available on

www.consultconstruction.com

Besides, CA Sandesh Mundra as Chairman -GST Committee of the Builders’ Association of India, has been actively involved in giving several representations to the government on issues connected to the construction and infrastructure sector.




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