1. Overview
In the past decade, the country has been witness to mushrooming of tall residential skyscrapers in the metropolis as well as satellite townships, primarily to cater to the rising demand from the urban population. A typical transaction in this business will entail three parties, namelya builder (or developer), land owning party and flat buyer. The developer enters into a development agreement with landowner, whereby the developer acquires the development rights with respect to the land. The development right entitles the developer to obtain licenses and approvals from the government authorities, construct the building on the land as per its own design and architecture, determine the price of the units, negotiate and enter into flat buyers agreements and execute sale deeds with buyers.
The agreement for transfer of development rights executed between developers and landowners involve payment of consideration by the developers to the landowners for transfer/acquisition of development rights. Such consideration may be in monetary terms or by way of ownership rights of certain percentage of the developed area.
Recently, Service Tax authorities have carried out search operations against various developers and landowners to demand Service Tax on the consideration received by landowners for granting development rights to developers. The Service Tax authorities are of the view that the payment of consideration by developers to landowners is subject to Service Tax.
Payment of Service Tax on consideration payable for transfer of development rights can result into huge Service Tax cost in cases where no Cenvat credit can be claimed (e.g., where the developer is engaged in the activity of sale of plots which does not attract Service Tax liability). Even in cases where Cenvat credit can be claimed, there are working capital issues as the period between utilization of Cenvat credit and the payment of Service Tax is long in the construction industry. Therefore, in this article we have discussed in detail the nature of ‘development rights’ and analyzed the taxability of such transactions under the Service Tax law.
2. What are development rights?
In order to determine the taxability of the transfer of development rights, it is important to first analyze the legal nature of development rights.
A landowner enjoys various rights with respect to the land, such as cultivation rights, easement rights etc. One of such rights is the right to develop such land into an agricultural, industrial, commercial, residential or for any other purpose.
In other words, these are rights to modify an immovable property by carrying out improvements, constructing building thereon etc.
3. Modus-operandi for transfer of development rights
It is also relevant to discuss modus-operandi generally followed with respect to the transfer of development rights by landowners to developers.
In the real estate sector, generally, following steps are undertaken with respect to transfer of development rights:
– Developer enters into an agreement with a landowner, wherein the right to develop the land is permanently and irrevocably transferred by the landowner to the developer;
– Developer is given permission to enter the land for the purpose of carrying out the development activity. However, ownership in land continues with the landowner;
– As a consideration for sale of development right, a fixed consideration or a share in sales proceeds or ownership of certain developed area is given by the developer to the landowner;
– Accordingly, the developer acquires exclusive, permanent and irrevocable rights for development and subsequently transfer (by way of sale, lease, license, etc. to end customers) the entire or certain percentage of the developed area (i.e. apartment, units, plots etc.)
– The developer is allowed to further assign the development rights to any other person, but the landowner is precluded from doing so.
4. Relevant provisions under Service Tax law prior to 1 July 2012*
With respect to ‘immovable property’, as per the Service Tax law during the relevant period (i.e. prior to 1 July 2012), the taxable service category of ‘Renting of Immovable Property’ was relevant.
‘Renting of Immovable Property Service’ included renting of vacant land, given either on lease or license for construction of building, under section 65