The Supreme Court, in the case of Larsen & Toubro, recently upheld the constitutional validity of VAT levied by State governments on the sale of under-construction flats. It mentioned that the concept of “works contract” applies to agreements entered between builders and buyers for under-construction flats. The verdict has worsened the already low sentiment in the real-estate sector.

The industry (as indeed the end-consumer) should evaluate the implications for transactions.

IMPLICATIONS FOR BUILDERS

Builders will have to charge and pay VAT on sale of under-construction flats. It is likely that State governments (particularly Maharashtra and Karnataka) may approach builders to recover VAT for past years. For builders who have already deposited VAT dues (whether during regular assessment or “under protest” pending the verdict), the demand for pending dues may not possibly result in significant interest or penalty burden.

However, the builders who have not charged or deposited VAT are likely to be especially sensitive to this verdict. Several real-estate developers had taken shelter under the Special Leave Petition to avoid VAT payments until now. The VAT demand is likely to be significant for them. Their ability to pay, and the extent to which such payment might strain the industry’s working capital requirement remain to be seen.

On the other hand, certain features available under State-VAT provisions may assist the builders. One obvious relief is the possibility of claiming State-VAT input credits to reduce or offset the gross VAT liability arising from the verdict. Additionally, several State-VAT laws provide composition schemes to compute and pay VAT dues.

IMPLICATIONS FOR FLAT BUYERS

As State-VAT is an indirect tax, generally passed on to the buyer, the flat buyer would now bear an additional tax. For buyers who were already charged VAT, the judgment now assures them that it is payable. But the buyers who were not charged VAT should check whether the builder has inserted appropriate tax clauses in the under-construction agreement to recover VAT dues. Generally, builders have been prudent to insert such clauses. Thus, buyers who were not charged VAT on under-construction flats may now have to bear the additional cost (which was not considered at the time of financing the purchase through banks/ financial institutions).

IMPLICATIONS FOR HOUSING

In the recent past, State and Central Government departments have been attempting to provide affordable housing to the lower middle-class urban population, especially in high-priced locations such as Mumbai and Delhi. The Delhi Development Authority (DDA) and the Maharashtra Housing and Development Authority (MHADA) are among them. The implications of the Supreme Court verdict may likely apply to under-construction flats sold to the lower middle-class group. A dilemma may arise over whether the State governments should award concessions or exemptions to certain types of residential projects to ensure VAT is not onerously passed on to the buyers.

IMPLICATIONS FOR TAX REGIME

India is on the cusp of introducing the Goods and Services Tax (GST) to replace its indirect tax system. GST policymakers have hinted that real-estate transactions (buy-sell of residential properties) may not form a part of the initial GST framework. However, the Supreme Court verdict may enable GST to cover agreements for sale of under-construction properties. Thus, the related concerns may continue into future tax regimes as well.

As Supreme Court verdicts go, especially with regard to taxes, this judgment does have far-reaching implications. In addition to the problems related to compliance (such as impact on past VAT dues, cascading impact through interest and penalty proceedings, and so on), there may be associated indirect taxes such as service tax and stamp duties involved. Consequently, the challenges for a real-estate player in managing funds in today’s business environment are likely to compound.