CESTAT Hyderabad Rules Out Service Tax on Personal Use Residential Construction by Builder

The decision in Modi Ventures Vs Commissioner of Central Tax (CESTAT Hyderabad) provides important judicial guidance on how service tax applies to builders executing residential projects, particularly where flats are intended for the personal residential use of individual purchasers and where construction is undertaken under composite contracts.

The Tribunal analysed the constitutional backdrop of works contracts, the evolution of the service tax law, and the specific statutory provisions governing “works contract service” and “construction of complex service”. Ultimately, it set aside the entire service tax demand raised on the assessee-builder in relation to a residential project, holding that the services in question were not liable to tax for the entire period covered by the show cause notice.

Factual Background and Proceedings

Project Structure and Business Model

The assessee, Modi Ventures, was engaged in development of a residential project titled “Gulmohar Gardens”. The business arrangement followed a two-agreement structure with each purchaser:

  1. Sale deed

    • Transfer of undivided share in land along with an incomplete built structure.
    • Appropriate stamp duty was paid on this instrument as per applicable law.

  2. Construction agreement

    • A separate contract for finishing and completing the flat in line with the individual specifications and requirements of each customer.

Initially, the assessee obtained registration under the category of “construction of complex service” and paid service tax on receipts relating to the project. Subsequently, after referring to CBEC Circular No. 108/2/2009-ST dated 29.01.2009, the assessee took a view that its activities were not taxable and stopped paying service tax.

Show Cause Notice and Adjudication

A show cause notice dated 24.10.2011 was issued proposing:

  • Demand of service tax (including cess) amounting to Rs 1,38,13,576/- for the period 01.06.2007 to 31.12.2010.
  • Levy of interest.
  • Imposition of penalties under Section 78 and Section 77(2) of the Finance Act, 1994.

The adjudicating authority confirmed:

  • The full tax demand of Rs 1,38,13,576/- with interest.
  • Penalties as proposed under Section 78 and Section 77(2).

The assessee challenged this order before the CESTAT, Hyderabad.

Grounds of Appeal by the Assessee

The assessee raised, among others, the following key grounds:

  • No service tax was chargeable on its activities prior to 01.07.2010.
  • Construction done for personal residential use falls outside the scope of “construction of residential complex service” due to the exclusion built into Section 65(91a).
  • Certain charges were improperly included in the taxable value, such as:
    • Corpus fund
    • Electricity charges
    • Stamp duty
    • Registration charges
    • VAT
  • Invocation of the extended period of limitation was not justified.
  • Interest and penalties were not sustainable on the facts and law.

The Departmental Representative supported the order in original and argued that the demand and penalties had been correctly imposed.

Constitutional and Legislative Framework for Works Contracts

Pre-46th Amendment Position: Gannon Dunkerly

Under the scheme of the Constitution of India, legislative fields are allocated between the Union and States through three lists in the Seventh Schedule. While:

  • Service tax was levied by the Union under its residuary power (Article 265 read with entry 97 of List I),
  • Tax on sale or purchase of goods fell within the authority of the States under List II.

Originally, neither the Constitution nor the Government of India Act, 1935 expressly provided for taxation of the value of goods involved in the execution of indivisible works contracts. When the then Province of Madras sought to treat the transfer of property in goods in such contracts as a deemed sale and levy sales tax, this attempt was struck down by the Constitution Bench of the Supreme Court in:

  • State of Madras Vs Gannon Dunkerly & Company Madras Ltd [1959(SCR)379)] / [2015(330)ELT 11 SC]

The Court held that indivisible works contracts could not be artificially split to tax the material component as a “sale” in the absence of a specific constitutional provision enabling such treatment.

46th Constitutional Amendment and Article 366(29A)

Following Gannon Dunkerly, the Law Commission of India recommended amendments to empower States to tax the transfer of property in goods involved in works contracts.