An unnamed wit once remarked that taxes and death are both inevitable—but at least death can’t get worse every year! This sentiment was no doubt felt by property owners as well as their prospective tenants when tax was introduced on services rendered “in relation to renting of immovable property" and brought under the service tax net through the Finance Act, 2007, read with notification No. 24/2007 dated 22 May 2007 and circular No. 98/1/2008-ST dated 4 January 2008 by the ministry of finance and department of revenue (by including such services under the taxable services covered under the Finance Act, 1994). It was generally felt that such proposed service tax was unnecessary and onerous as substantial portions of the public’s income is already subject to multiple layers of taxes and levies.

Illustration: Jayachandran / Mint

Expectedly, all concerned (whether property owners/ lessors or tenants/lessees) resisted the imposition of this levy of service tax on services rendered “in relation to the renting of immovable property" quite vehemently and several writ petitions were filed in various courts challenging its constitutional validity, as well as that of the notification and circular, pleading that they are ultra vires (or beyond the powers) in the sense that they impose a burden that is not provided by the Finance Act, 1994.

In order to avoid multiple litigation, the Union of India, pursuant to Article 139A(2) of the Constitution, filed transfer petitions, seeking an order from the Supreme Court for the transfer of some of the pending writ petitions to the Delhi high court for disposal. The Delhi high court, in the case of Home Solutions Retail India Ltd and Others v. Union of India and Others, struck down the said notification and circular as being ultra vires of the service tax legislation in as much as they sought to levy service tax on “renting of immovable property" itself.

The petitioners argued before the Delhi high court that by virtue of the said notification and circular, a completely erroneous interpretation is being placed on section 65 (105) (zzzz) of the Finance Act, 1994 dealing with services rendered “in relation to the renting of immovable property"; the contention being that the renting of immovable property per se is not liable to service tax and what is liable to service tax is only the service “in relation to" the renting of immovable property. The petitioners’ alternate plea was that the levy of service tax on renting of immovable property would amount to a tax on land and would, therefore, fall outside the legislative competence of Parliament, being a state subject under List II of Schedule VII to the Constitution.

The high court has resolved the matter by delving upon the following two key issues:

1. The meaning of the term “in relation to"; and

2. The absence of “value addition" by the service provider.

On the first issue, the court held that the services sought to be taxed were services “in relation to" the renting of immovable property, being distinct and different from the transaction of renting of immovable property. Therefore, the levy was not on “renting of immovable property", but the services provided “in relation to such renting" (for example, provision of facilities such as security, maintenance, air conditioning, among others). The court seems to have agreed with the argument of the petitioners’ counsel that the expression “in relation to" has to be given contextual meaning, and in this view of the matter, have taken a view that service tax is a tax on value addition provided by a service provider. The court has thereby come to a conclusion that the service tax is payable only on the “services" in relation to the renting of immovable property and not on the renting of immovable property per se.

On the second issue, the court held that since there was no “value addition" in the case of renting of immovable property per se, no tax could be levied thereon, since service tax being a value-added tax, the levy could be only on the amount of value addition.

On this point, it appears that the court’s attention was not drawn to the fact that a value-added tax does not imply that only actual value addition is to be taxed, but that what is taxed is the economic value addition. This is ensured by introduction of the concept of “input tax credit" (which was absent in the sales tax regime, for example). In other words, the service provider charges service tax on the entire consideration invoiced by him to his clients and is allowed a credit of service tax paid on the input services.

The observations of the court on the second issue seem to be aimed at ensuring that what is taxed is only the economic value addition. However, this approach may give rise to many contentious and perhaps problematic issues.

Interestingly, the court has made it clear that it has not examined the alternative plea of the petitioners in this matter, concerning the legislative competence of Parliament to levy service tax on renting of immovable property, contrary to some media reports that incorrectly gave the impression that the levy of service tax on renting of immovable property per se has been declared unconstitutional.

The decision of the Delhi high court holding that renting of immovable property per se is not a service and hence cannot attract service tax is a welcome measure for lessees and lessors. However, the Union government has filed a special leave petition before the Supreme Court against the decision. As such, the order of the Delhi high court only provides temporary respite to lessors/lessees—till the Supreme Court delivers its final decision.

The matter was listed before the Supreme Court on 2 June. It is interesting to note that while the apex court issued notices to the parties concerned, it did not grant an interim stay on the operation of the Delhi high court judgement.

The path to civilized society, it is said, is paved with tax receipts—for now, it remains to be seen whether receipts for service tax on rentals of immovable property will join this hallowed paving.

This column is contributed by Deepika Khanna of AZB & Partners, Advocates & Solicitors.

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