Construction cost to come down? Here’s how Orissa HC ruling can help realtors

Source: financialexpress.com

The goods and services tax (GST) regime has been hailed as a panacea to many afflictions plaguing the erstwhile indirect taxation regime. One such affliction GST was meant to address and cure was ridding businesses of tax costs and ensuring seamless flow of tax credits.

To recap, in the pre-GST regime, a business was not allowed to avail credit of excise duty and service tax paid on the construction of an immovable property. Credit of service tax was allowed to the extent an under-construction property was sold upon payment of service tax. Consequently, commercial developments meant for leasing were not eligible for tax credits pertaining to goods and services used for construction. This has been a major cash burner for commercial real estate meant for leasing in the past decade, as these non-creditable taxes added to the cost of construction of malls, office spaces, etc.

It was widely anticipated and lobbied that this restriction should be done away with under GST, at least to the extent of such property being leased upon payment of output tax. The logic being, where GST is paid on the output side, there should be no restriction for credits on the input side.

Against the backdrop of this issue, remaining seemingly unresolved since 2011 (from service tax era), a recent ruling of the Orissa High Court—in a writ petition filed by Safari Retreats Private Limited—is a shot in the arm for the sector. The issue of denial of GST credit to commercial developments for lease was taken up by a developer of malls before the High Court in this case. The question before the High Court was two-fold: (1) Whether restriction of GST credits for development or construction of a property meant for lease is liable to be struck down as unconstitutional, or (2) whether the language of the restriction can be read down to infer a differential interpretation that allows GST credit? Declining to strike down the law, the High Court has categorically read down the restriction to hold that the restriction on construction-related credits shall not be applied to malls developed for lease. The decision, amongst others, articulates a key principle of parity in the taxation of commercial spaces meant for sale and lease, both of which suffer GST on the output side.

Several questions now arise on the timing of this ruling, including its intent and ramifications.

First, why now under GST this has been a legacy issue since the service tax era? While this issue has been under representation/litigation in the past, this is a first-of-its-kind ruling on this issue and hence assumes significance in seeking to address a long-pending demand and concern of the sector.

The second could be about the coverage of this ruling including its applicability to various types of commercial developments. The subject matter of contention before the High Court was a mall that was being developed for being rented out (where a direct nexus of GST payment on lease rentals was identifiable). While the ruling should, therefore, equally apply to other types of commercial properties (such as office spaces, warehouses, hostels and the like), it leads one to a question of whether a similar nexus can be derived for hotels and such other properties where the immovable property is integral to the service being offered; however, the type of revenue earned is not rental of the space per se. More difficult to justify may be a case of construction of a factory that is used to manufacture goods for sale.

Third, can this ruling be said to have a pan-India precedentiary value given it seeks to interpret and read down a central GST law provision that applies across the country? Being a ruling of the High Court, it should have precedentiary value with hopefully other courts following the same in the following weeks/ months. Whether realtors who have rushed to have similar matters heard in other jurisdictional High Court(s) shall be equally successful, remains to be seen. While the possibility of the Revenue challenging the Orissa High Court ruling before the Supreme Court is expected and seems imminent, this decision throws up an opportunity to realtors in the commercial space to re-evaluate their tax positions of the past, present and future, by leveraging on some of the principles laid down by the High Court.

The need of the hour is to see if this ruling can aid in any ongoing litigation on a similar issue under the pre-GST regime and further chalk out a plan to claim GST credits, at least for the go-forward period, if not the past. Options such as writ, refund application, representation, advance ruling, all present varying degrees of opportunity to commercial realtors. These opportunities to stake claim to GST credits need to be carefully weighed in against the time-frame expected for resolution of this issue before the Supreme Court, the chances of an ultimate favourable outcome vis-à-vis the time-frame for depreciation of these costs from an income tax standpoint, as well as potential interest and penalty exposure (on the credits availed), in the event of a negative outcome. Another factor is potential obligations that could arise from an anti-profiteering perspective where credits, hitherto assumed to be locked or lost, are unlocked as a consequence of this ruling.

While these issues are being mulled over and actioned, this could well turn out to be a landmark ruling that paves the way for realtors across the country to claim construction-related input tax credits, resulting in lower cost of construction of leased spaces.