SERVICE TAX ON COMMERCIAL RENT - MATRIX OF POSSIBILITIES
While the judgment has been welcomed by most businesses, the Government is expected to prefer an appeal against it to the Supreme Court of India ("SC").
The factual matrix has given rise to interesting discussions on issues inter alia territorial applicability of the DHC judgment; finality; past, present and future tax liabilities; responsibility of landlords and refund of service tax paid.
I. Territorial Applicability:
The judgment does not restrict itself in terms of territorial scope. Notably, the DHC while granting interim stay orders in many petitions, recorded that the stay would operate only within the territory of Delhi. No such qualification is however placed in the final judgment.
In any event, the judgment is on the point of legality, rather illegality, of the Notification No. 24/2007 dated 22nd May 2007 ("Notification") and Circular No.98/1/2008-ST dated 4th May 2008 ("Circular") that sought to levy service tax on commercial rentals of immovable property, the situation would in all likelihood remain the same across India. To dispute applicability of the judgment in any other Indian state, the Service Tax Department would have to perform the herculean task of demonstrating as to how the judgment based on same points of law would not be equally applicable in such other states.
It is noteworthy that Article 226A barred the High Courts from deciding the constitutional validity of any central law, and vice versa Article 32A barred the SC from considering the constitutional validity of any state law unless the constitutionality of any central law was also in question in the proceedings. These Articles, among others with similar objectives, were introduced by the Forty Second Amendment to the Constitution of India. By Forty Third Amendment to the Constitution, these Articles, conferring exclusive jurisdictions, were repealed.
The Supreme Court of India has in a few judgments held that the judgment of an Indian High Court on a Central legislation, as in this case, would have binding effect throughout India.
II. Finality:
The judgment is final in itself, unless stayed or set aside by the SC which is true for every HC judgment. The benefit of the judgment would therefore be available until it is so stayed or set aside. It is for the Government to prefer the appeal. An appeal does not warrant that the DHC judgment will be stayed initially, or set aside finally.
It is also being speculated that the Government may bring out new notification or clarifications in an attempt to secure taxation on commercial rentals on immovable property. The judgment of the DHC, in a nutshell, holds that commercial rental itself is not envisaged to be taxed by the Finance Act and consequently the Notification and the Circular that sought to tax it were held ultra vires. Thus, to tax commercial rentals, the scope of the Finance Act itself would need to be enlarged. That can happen, at the earliest, in the next session of the Parliament, given the variables that the next session would be the first session after formation of the new Government. Even if the Finance Act is amended, the alternative plea of the petitioners, on constitutionality of levy of service tax on rentals, which the DHC has not presently decided, will assume significance.
Without amendment of the Finance Act, any new notifications or circulars by the Government to bridge the gap as regards applicability of service tax "in relation to renting" and "on renting" of immovable property may still be susceptible to a fate similar of the Notification and Circular set aside by the DHC.
A line of argument that the Government may adopt on constitutionality is to try and classify the levy within entry 92C of List I of the Constitution of India i.e. "Taxes on services". However, the respondents may inter alia adopt the argument that the Government had, by way of the Notification set aside by the DHC, permitted exemption on service tax "as is in excess of the service tax calculated on a value which is equivalent to the gross amount charged for renting of such immovable property less taxes on such property, namely property tax, levied and collected by local bodies". In the mind of Government, the tax was equitable (thus adjustable) vis a vis property tax, i.e. under List II, and not List I.
The issue of constitutionality has not been decided by the DHC. To clarify, the issue is not about constitutionality of service tax per se, but constitutionality of service tax on commercial rentals of immovable property. If and whenever, the issue becomes contentious, the respective parties would hopefully bring in many more arguments, and the outcome cannot be predicted as of now.
III. Previous, Current and Future Liabilities:
A debate is on as regards the liability towards service tax if the DHC judgment is reversed by the SC in appeal. The issue may be analyzed with respect to three different periods:
A. Duration within which the service tax was not paid owing to interim stay orders granted by the DHC, or for that matter by any other High Court that disposes off the petitions in view of the DHC's final judgment - say period "A".
B. Duration between the date of delivery of the judgment by the DHC and the stay thereof, if granted by the SC - say period "B"; and
C. Duration during which the SC would decide the matter conclusively - say period "C".
If the SC stays the DHC judgment, the liability would continue during period "C", unless otherwise specified by the SC. The SC is however likely to specify, at the time of admission of the petition or soon thereafter, whether the liability to pay service tax would continue during period "C".
The liability for payment during period "B" is also likely to depend on the language of the stay, if granted by the SC. The Government, in its appeal, may press for payment of tax at least during periods "B" and "C", and consequently one may expect clarity on these issues once the appeal is preferred by the Government. If the Government does not prefer the appeal, the payment obligation would anyway not arise in view of finality of the DHC judgment.
It is also likely that the SC may consider the issue of payments during period "A", if it sets aside the judgment. Notably, benefit of period "A" has been availed only by the parties that have obtained stay orders from any High Court, mostly on undertakings that they would bear the tax and the consequences if the tax is held legal. Though the benefit of periods "B" and "C" are likely to be availed by far more entities, it would be desirable to have clarity from the SC on tax obligations during each period if the DHC judgment is reversed.
IV. Concerns of Landlords:
As is true for every petitioner in any case, the Government may also succeed in obtaining a favorable judgment from the SC.
Understandably, this leaves the landlords as a worried lot, concerning liability of service tax for periods "A", "B" and "C" discussed above, as they are the persons responsible for collection and deposit of the service tax. It is likely for the landlords to, on the one hand, ask the tenants to undertake to bear the service tax in the event of adverse decision by the SC, and on the other hand, wish to be party to the proceedings before the SC to secure their interests. A number of landlords were party to many petitions before the DHC, and are petitioners and respondents in many petitions pending before other High Courts.
Indemnity or undertaking for a tax that is currently held ultra vires would however be viewed by the tenants as undesirable. Such an indemnity would also to a great extent undermine the judgment of the DHC, which per se is not subject to validation by the SC to be effective. The onus is upon the Government to approach the SC promptly if it wishes to secure continued payment of service tax. The judgment of the DHC does not provide benefit only to the tenants, but is rendered and is applicable qua all the parties to the transaction, viz. tenants, landlords, the Union of India and the Service Tax Department. The judgment has taken away the entitlement from the Service Tax Department to claim service tax on commercial rentals of immovable property, and consequently unless the SC expressly reinforces the entitlement, the Government may not demand tax under this head.
For now, it would be reasonable for the landlords to obtain letters from their tenants that the tenants would not pay service tax as it is not payable in view of the judgment of the DHC.
The future course of action may be decided based on how the events unfold, especially in an appeal before the SC. In the event of any unforeseen liability, the landlords would have the remedy of approaching the courts, making the tenant and the Government including the Service Tax Department a party, to seek directions that no tax is payable from the pocket of the landlord as the primary dispute was between the tenants and the Service Tax Department and the tenants have discontinued payment based on the DHC judgment. During the period of operation of the judgment, the landlord cannot recover a tax held ultra vires, and consequently should not be liable to deposit the same afterwards.
V. Composite Agreements:
An interesting case was pleaded by Alpha Future Airport Retail (India) Limited. The Delhi Airport has granted to Alpha, by a single indivisible license agreement, a license to operate duty free shops and the retail space to operate them at the airport. In return, Alpha pays to the airport a fixed fee and a percentage on gross sale proceeds from the duty free shops. As per Alpha, it is impossible to ascertain what part of the payment is towards license and what towards rent, while the license to operate and user of the property are inseparable as the duty free shops cannot be operated at any place except at the airport. The Act does not provide any mechanism to determine the amounts payable for license and for user of real estate respectively.
Alpha's case has not been decided by the DHC by the composite judgment delivered on April 18, though Alpha's submissions are recorded therein. Alpha's case is now coming up before the DHC in May 2009. The judgment in this case is likely to throw light on possibility of attribution of payment towards rental in composite arrangements.
Meanwhile, in cases where the payments can be separately attributed for rental and other services components, but have currently not been so attributed, the parties may amicably decide on splitting the components. Assuming the service tax on commercial rental is not revived, the justification for each component may be subject to scrutiny in future by the Service Tax authorities. Adequate analysis, care and caution are therefore advised while undertaking this exercise.
VI. Other Similar Arrangements:
Section 65(90a), at the center stage of the DHC judgment, applies to arrangements including "renting, letting, leasing, licensing or other similar arrangements of immovable property for use in the course or furtherance of business or commerce ........".
While the judgment clearly applies to arrangements of renting, letting, leasing and licensing, the scope of "other similar arrangements" has neither been restricted in scope and applicability by the Finance Act, nor was it an issue to be determined by the DHC. Arguably, to be covered under the DHC judgment, the payment should have a direct relationship with the use of immovable property. Any arrangements that can qualify as any other taxable service may be a bone of contention with the Government. The judgment in Alpha's case may be of guidance in limiting the exposure.
VII. Possibility of Refund:
Many retailers are also exploring the options, and are keen to seek and secure refund of the service tax paid by them on rentals since its levy. There seems a legal possibility for refund for the past one year, or more. Refusal of refund by the Government may lead to another round of litigation.
VIII. Other Petitions:
Many similar petitions are pending before other High Courts in India, at various stages. While it is likely that many petitioners there may withdraw their petitions in view of the DHC judgment, and a few High Courts may even dispose off these petitions in view of the judgment of the DHC, the possibility of any other High Court opting to independently hear and decide the matter on merits may not be absolutely negated. Any such instances would add multiple dimensions to the issues discussed here and to the proceedings, if any, before the SC.
IX. Transfer Petition:
The Union of India had preferred a Transfer Petition before the SC in 2008 seeking transfer of writ petitions by 20 odd petitioners pending before different High Courts challenging levy of service tax on commercial rentals to the DHC. No final directions have been passed by the SC in the matter till date. Now that the DHC has, in the meantime, disposed off the writ petitions pending before it on the subject, in a manner unfavorable to the Government, it would be interesting to see whether the Government still presses for transfer of these petitions to the DHC. The SC had stayed further proceedings in these writ petitions before the other High Courts.
In all likelihood, the next few months may witness good amount of action on the front.
This article is copyright
About the Author
