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Indirect Tax Alert - Gujarat High Court holds ad hoc one third deduction towards land value ultra vires GST law and unconstitutional

09 May 2022

Background and facts of the case

In India, under the Goods and Services Tax (‘GST’) law, the sale of land is not liable to be subjected to GST. At the same time, the sale of under-construction property by a real estate developer is treated as a supply of a taxable service. Since the sale of the under-construction property would also include the sale of the underlying land, either as land or as an undivided share in the land, the valuation of such services poses a challenge.  To exclude the value of land from the value of an under-construction property, the Government allowed an ad hoc deduction of one-third of value from the total amount vide notification no. 11/2017-Central Tax (Rate) dated 28 June 2017, thus levying GST on the balance two-third value, for under-construction property. Many assesses considered such Ad hoc deduction as arbitrary and unreasonable as the provision disregards the actual value of land, which would vary depending on various factors such as location, size, etc. and approached Courts to strike down such ad hoc deduction.

In one of such cases, the Gujarat High Court has pronounced its judgment in the case Munjaal Manishbhai Bhatt (‘the Petitioner’) vs Union of India, where the brief facts are as under:

  • Petitioner entered into an agreement with Navratna Organisers & Developers Pvt. Ltd (‘Taxpayer’/ ‘developer’) with respect to a purchase of plot of land.
  • The said agreement also encompassed construction of a bungalow on the said plot of land by the developer.
  • It pointed out that separate consideration has been agreed upon between the parties to the agree, i.e. (i) sale of land and (ii) construction of bungalow on the land.
  • notification No. 11/2017-Central Tax (Rate) dated 28 June 2017 was challenged as the petitioner was liable to pay tax at the rate of 9% CGST plus 9% SGST under the GST on the consideration payable for land as well as construction of bungalow after payment of 1/3rd value of the land.
  • Because of the impugned notification, the entire consideration towards the sale of land was not excluded for the purpose of computing the tax liability under the GST Act. In other words, only 1/3rd of the total consideration was deemed to be the value of the land as per para-2 of the impugned notification.
  • It argued that the impugned entry referred to above in the notification is ultra vires section 7(2) of the GST read with entry No.5 of the Schedule-III to the GST Act.
  • It also argued that the deeming fiction introduced under para-2 of the impugned notification was contrary to Section 15 of the GST Act.

Key take-aways from the judgement

  • If a tripartite agreement is entered into after the land is developed, then such development activity was not undertaken for the prospective buyer and therefore there is no question of imposition of GST on the developed land. The deduction for the sale of land is also available for sale of developed as well as undeveloped land.
  • The Application of such a mandatory uniform rate of deduction is discriminatory, arbitrary, and violative of Article 14 of the Constitution of India. The deeming fiction of one - third of agreement value towards deduction for land also leads to a situation where the measure of tax imposed has no nexus with the charge of tax on the supply of construction services.
  • The High Court held that while maintaining the mandatory deduction of 1/3rd for the value of land is not sustainable in cases where the value of land is clearly ascertainable or where the value of construction service can be derived with the aid of valuation rules, such deduction can be permitted at the option of a taxable person, particularly in cases where the value of land or undivided share of land is not ascertainable.
  • The High court has directed the concerned GST authority to refund the excess amount of tax along with the interest at the rate of 6% per annum which is to be calculated from the date of excess payment of tax till the date of refund to the petitioner which has been collected by the taxpayer and deposited with the Government treasury within 12 weeks from the date of receipt of this order.

BDO comments

The Judgement effectively reduced the overall GST burden, especially relating to properties in the large cities, where the land cost can be higher than one third of the agreement value. It will help the property buyers as the effective acquisition cost of the property may be reduced and aid the real estate industry to spur demand.

The judgment of Gujarat High Court has sought to address the inherent anomaly in grant of flat one third deduction towards value of land, disregarding the location, size or type of property involved (e.g., flat vs. a villa or land in metro city or other towns, etc.) and decided the issue in favour of the taxpayers. The observation of the Court, particularly relating to calculation of construction service value on a cost-plus basis or the comments for taxability of the plot development would need to be studied closely on case-to-case basis.

One cannot rule out the possibility of the Government escalating the matter in the Supreme Court or amending the GST Act to address the fall-out in this judgment. The industry may reckon with this aspect while revisiting its plan to implement the ratio contained in this judgment or seek a refund of the excess tax burden as in the present case.

[Munjaal Manishbhai Bhatt Vs Union of India order dated 06 May 2022]