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‘Good’ Tax!

A unified Goods and Service Tax augurs well for the construction industry, writes Harishanker Subramaniam, tax partner, Ernst & Young, India.

The importance of infrastructure in a nation’s sustained economic development is well recognised. An inadequate and inefficient infrastructure results in high transaction costs proving to be an impediment in realising the full potential of an economy.

Infrastructure in India still remains a major problem area. As per the World Competitiveness Yearbook brought out by the International Institute for Management Development, India’s rank declined from 49th in 2008 to 57th in 2009.

In his budget speech, the FM this year has reiterated the Government’s commitment towards implementation of a unified Goods and Service tax (GST) by April 2010. Implementation of the proposed GST would entail a paradigm shift in the levy and administration of indirect taxes.

A unified GST would mean integration of the Central levies, namely excise duty and service tax (with the elimination of Central Sales Tax) and merging of multiple State specific levies such as Value Added Tax (VAT), octroi, entry tax, luxury tax, entertainment tax based on public domain information.

The idea of uniform tax rules for the flow of goods and services across the country is highly attractive for the industry. Instead of paying multiple taxes at different levels of a transaction (with cascading), the concept of paying tax at a uniform rate for the whole transaction with credit of input taxes and reduction in the requirement of compliance appears encouraging.

Currently, the Empowered Committee (EC) of State Finance Ministers, along with the Joint Working Group is expected to shortly commence the drafting of GST legislation and finalising the framework for its implementation.

The FM has clarified that a Dual GST model, where tax would be concurrently levied by both Central and State Government, would be implemented across the nation. However, the essential details such as mechanics, draft legislation, tax rates are still not known.

Both Central and State GST may be applicable to all transactions of goods and services. However, there would be separate legislation for Central GST and State GST, which would be mutually exclusive to each other and would be implemented separately.

Accordingly, credit of taxes paid on inputs/ procurements against Central GST may only be allowed to be utilised against payment of Central GST.

The same principle should also be applicable for the State GST. The dual GST model hopefully should result in reduction of burden of administrative pro-cedures and reduction in effective tax.

It is expected that there would be substantial harmonisation of administration, wherein there would be single window to deal with both GSTs.

For example, uniform tax collection procedures,uniform returns to be submitted with the authorities, simplified compliance requirements and a system of single taxpayer identification number could be proposed under the dual GST regime.

With respect to the tax rates, based on the recommendation of the EC, it appears that there could be a standard rate of GST for goods and services, a lower rate (for goods like precious metals) and a zero rate (for certain specified goods).

However, there are various issues which would need to be kept in mind while, drafting the legislation such as treatment of exemption schemes applicable under different VAT, service tax regimes and so on.

One of the industries, which could see a radical change in the applicable indirect tax structure under the proposed dual GST model would be the Construction/Real estate industry.

The introduction of GST is expected to have a significant impact on the existing indirect tax costs and compliance requirements for the construction industry.

The Construction and Real estate industry is essential to country’s infrastructural development and is one of the primary drivers of our economy. In his budget speech also, the Finance Minister has emphasised on the importance of revival of the real estate industry and infrastructure sector as a whole.

The Finance Minister has indicated that the Government aims to increase its infrastructural spending to about 9% of the GDP by 2014. Keeping in view of the current downturn, proper implementation of the GST will lead to a stimulus in the
industry and increase in the overall GDP growth.

Under the current indirect tax regime, sale of immovable property (residential unit/ land) has been kept outside the scope of levy of State VAT, Central Sales Tax and Service tax.

Only state stamp duty is applicable on such transactions, the rate of which varies from one State to another.

The contractor constructing/developing the property is liable to applicable VAT/ Service tax and passes on the burden of tax to the owner. The owner is unable to take credit of the tax amount charged by the contractor as the sale of the immovable
property is not liable to any of the above taxes.

Such taxes become a cost for the developer. Under the current scheme of taxes, there exists a significant uncertainty, whether preconstruction sale of real estate property amounts to works contract and subject to VAT and Service tax.

While the law and the court have clearly established that VAT cannot be applied on value of services and Service tax cannot be applied on value of goods, there is still a potential for dispute on value to ascribed to goods (liable to VAT) and services (liable to Service tax).

Additionally, there remains an exposure of duplication of taxes on the same trans-action. The industry has been constantly interacting with the Government at different levels to remove these distortions which lead increases the total project cost.

However, there has been no significant move to address these issues in entirety. Construction activity undertaken by the contractor qualifies as ‘works contract’ (generally, composite scope of work which entails supply of both goods and services) for the purposes of VAT and Service Tax.

Both the legislations provide for composition scheme for works contract wherein lower rate of tax (generally 4% each) is required to be paid by the contractor on the total contract value.

Also, abatement from levy of tax is provided under the Service Tax legislation with respect to construction related services. The above schemes help in reducing the net indirect tax cost for the contractors engaged in construction activity.

At present it is not clear whether sale of real estate would be brought within the scope of dual GST model and whether the stamp duty would be merged or not. The Empowered Committee’s paper on Road Map for GST is silent on application of GST to the construction industry.

Under the current Constitutional structure, both Union and the States have been given exclusive powers to levy tax in their specified areas. States do not have the power to levy tax on services but land is a State subject.

Therefore, one of the major and significant requisites for implementing the dual GST model is to allow both Centre and States to levy tax on goods and services which would require a Constitutional amendment.

Taking a cue from the GST/VAT laws implemented in other nations across the world such as Australia, New Zealand, Canada,USA and South Africa, sale of newly developed real estate property/ commercial buildings are subject to levy of GST/ VAT.

Such GST is levied on full selling price, which includes cost of land, building materials and construction services. Similarly, GST is also levied on rental charges for leasing of industrial/ commercial undertakings.

However, exemption is provided on resale of used residential property and renting of dwellings because the tax is already collected at the time of their first purchase, especially for homes acquired post implementation of GST regime.

If the sale were to be made taxable, credit would need to be given for the tax paid on the original purchase and on any renovations and additions after the purchase.

This would be complex and would make the system difficult to monitor. Also, except where the prices have gone up, the net incremental tax on resale may not be significant.

Further, credit of GST paid on inputs and inputs services used in construction can be utilised towards payment of GST on sale of such property to reduce tax cascading. 

Residential rentals are also exempted for the same reason. If rents were to be made taxable, credit would need to be allowed on the purchase of the dwelling and on repairs and maintenance.

Over the life of the dwelling, the present value of tax on the rents would be approximately the same as the tax paid on the purchase of the dwelling and on any renovation, repair, and maintenance costs.

In effect, payment of tax on the full purchase price at acquisition is a prepayment of all the tax due on the consumption services that the house will yield over its full lifetime.

In case the above system is incorporated in the design of GST in India as well, there would be significant positive implications.

Unnecessary classification disputes regarding sale of immovable property would also be resolved.

Applicability of GST on sale of the real estate property would reduce tax cascading effect as it would eliminate the blockage of input taxes on construction materials and services.

Besides, extending GST to sale of real estate properties, including construction materials and services, would simplify the tax structure.

Another important aspect needing attention is as to how the real estate property would be defined under GST (whether the same would include residential dwelling, mixed used properties such as residential units with business office and so on).

It remains to be seen how the GST deals with the concessional schemes provided under the current VAT and Service Tax regime such as composition scheme, abatement in order to ensure that there is no additional tax cost burden on the contractors/ developers undertaking construction activity for others.

Any increase in tax cost would be a big blow to the whole industry specifically in the current economic conditions. The construction industry would be looking for a simplified GST regime, which would provide solutions to their current tax problems rather than further complicating them.

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