Renting of Immovable Property - Delhi High Court Judgment analyzed

[Dr. Sanjiv Agarwal]

Delhi High Court while disposing a bunch of over 20 write petitions referred to it by Supreme Court in Home Solutions Retail India Ltd. v Union of India & Others 2009- TMI -33136 (Delhi High Court)  has held that renting of immovable property for furtherance of business or commerce, per se, is not a taxable service falling within the scope of section 65(105) (zzzz) of Finance Act, 1994.

While service providers as well as tenants may argue that renting out involves a transaction of transfer of rights to use the premises and that such an activity may not constitute a service or that mere leasing of premises or property does not constitute a service or that property is a state subject and the union interference is illegal and that state alone can tax such transaction or that there is no voluntary rendering of service by way of a human involvement and so on and so forth. On the other hand, we have statutory definition of taxable service and if the statute stipulates a particular activity as a taxable service or even deemed to be a taxable service, it shall attract service tax.

Finance Act, 2007 had levied service tax on renting of immovable properties for use in the course of or furtherance ob business or commerce w.e.f. 1 June 2007.

W.e.f. 16.5.2008, section 65(90 a) of Finance Act, 1994 defines ' renting of immovable property as follows-

"renting of immovable property" includes renting, letting, leasing, licensing or other similar arrangements of immovable property for use in the course or furtherance of business or commerce but does not include —

(i)    renting of immovable property by a religious body or to a religious body; or

(ii)   renting of immovable property to an educational body, imparting skill or knowledge or lessons on any subject or field, other than a commercial training or coaching centre;

Explanation 1— For the purposes of this clause, "for use in the course or furtherance of business or commerce" includes use of immovable property as factories, office buildings, warehouses, theatres, exhibition halls and multiple-use buildings;

Explanation 2.— For the removal of doubts, it is hereby declared that for the purposes of this clause "renting of immovable property" includes allowing or permitting the use of space in an immovable property, irrespective of the transfer of possession or control of the said immovable property;

Finance Act, 2008 has inserted an explanation to the definition of immovable property to clarify that renting of immovable property shall include allowing or permitting the use of space in an immovable property, irrespective of the transfer of possession or control of such immovable property. The explanation states that the amendment is for removal of doubts. Though as per the definition, these types of renting were otherwise covered in the erstwhile definition, it is now explicitly made clear that provision of space for commercial use such as in malls, cinema theatres, multiplexes, commercial buildings etc. shall be liable to service tax.

Ministry of Finance had vide Circular No. DOF 334/1/2008-TRU dated 29.2.2008 clarified as under -

"Use of immovable property is allowed for placing vending/dispensing machines in malls and other commercial premises and erection of communication towers on buildings. In such cases, there may or may not be transfer of right of possession or control of the immovable property in favour of the person using such property.

Renting of immovable property includes renting, letting, leasing, licensing or other similar arrangements of immovable property for use in the course or furtherance of business or commerce. Transactions mentioned above get covered under the category of other similar arrangement, if not covered under other categories.

What is meant to be an immovable property has been defined in Explanation-I to definition of taxable service in section 65(105)(zzzz). Accordingly, immovable property for this purpose shall include building and part of building, and land appurtenant thereto, land incidental to the use of building or its part, common or shared areas and facilities relating thereto and in respect of buildings in a complex or industrial estate, all common areas and facilities within such complex or estate. The expression, 'for use in course of or furtherance of business or commerce' shall imply actual use in business or commerce as well as intended use for furtherance of business or commerce. The use of such immovable property shall specifically include use as —

   (i)    factories/sheds

   (ii)    office buildings

   (iii)   warehouses/godowns

   (iv)   theatres

   (v)   exhibition halls, and

   (vi)   multiple use buildings

   (vii)  Shopping/commercial complexes

   (viii) Malls

   (ix)   Business/trade centers

   (x)   Open area for use in business

The last two items are wide and shall cover use of buildings for various functions such as sale, exhibition-cum-sale, business meetings, display, product launch, meetings, restaurants (not hotels) etc.

Thus, a transaction to be called a renting of immovable property, following three tests must be satisfied -

   (a)   the transaction should be renting, letting, leasing, licensing or any other similar arrangement.

   (b)   it must be in relation to immovable property except specified exclusions

   (c)   use of such immovable property should be in course of or furtherance of business or commerce.

   (d)   allowing use of space with or without transfer of possession or control will also be covered

What constitutes a taxable service has been defined in section 65(105) (zzzz) of Finance Act, 1994. Accordingly, taxable service has been defined in Section 65(105)(zzzz) of Finance Act, 1994 as under —

Any service provided or to be provided to any person, by any other person in relation to renting of immovable property for use in the course or furtherance of business or commerce.

Explanation 1.— For the purposes of this sub-clause, "immovable property" includes—

   (i)    building and part of a building, and the land appurtenant thereto;

   (ii)   land incidental to the use of such building or part of a building;

   (iii)  the common or shared areas and facilities relating thereto; and

   (iv) in case of a building located in a complex or an industrial estate, all common areas and facilities relating thereto, within such complex or estate, but does not include—

      (a)   vacant land solely used for agriculture, aquaculture, farming, forestry, animal husbandry, mining purposes;

      (b)   vacant land, whether or not having facilities clearly incidental to the use of such vacant land.

      (c)   land used for educational, sports, circus, entertainment and parking purposes; and

      (d)   building used solely for residential purposes and buildings used for the purposes of accommodation, including hotels, hostels, boarding houses, holiday accommodation, tents, camping facilities.

Explanation 2.—For the purposes of this sub-clause, an immovable property partly for use in the course or furtherance of business or commerce and partly for residential or any other purposes shall be deemed to be immovable property for use in the course or furtherance of business or commerce.

Exemption is allowed in respect of property taxes levied by local bodies from value of property rentals vide Notification No. 24/2007-ST dated 22.5.2007. This notification provides the exemption on the basis of payment only. If the taxes have been accounted for on accrual or due basis but not actually paid, no exemption shall be allowed . These taxes should be only local taxes (not like wealth tax ) paid to local bodies. The exemption shall be available only for taxes and no interest or penalty or any other charge shall be allowed as deduction. In case of advance or due payment of taxes not relating to the period of service in question, only the relevant period amount shall be considered for the purpose of exemption.

 Commercial or industrial construction service or works contract service is an input service for the output namely immovable property. Immovable property is neither subjected to central excise duty nor to service tax. Input credit of service tax can be taken only if the output is a 'service' liable to service tax or a 'goods' liable to excise duty. Since immovable property is neither 'service' or 'goods' as referred to above, input credit cannot be taken.

The petitioners raised the question of whether Finance Act, 1994 envisages the levy of service tax on letting out or renting out of immovable property per se and sought to set aside the Notification No 24/2007 and Circular No 98 dated 4.1.2008. They also had an alterative plea that such a tax  would amount to tax on land and would, therefore be out of the legislative competence  of  the Parliament as it is a case of state legislature . In such an event, levy of service tax on renting of immovable property was sought to be declared as unconstitutional.

Notification No 24/2007 is an exemption notification where in 'taxable service of renting of immovable property' were exempt from amount of service tax as was in excess of service tax calculated on value as reduced by property taxes levied or collected by local bodies. For example, if gross rent is Rs. 10000 and taxes are Rs 2000, service tax would be levied on Rs 8000 only.

Taxable Service and Notification

While section 65(105) (zzzz) states that taxable service shall be any service in relation to renting of immovable property, the notification states 'taxable service of renting of immovable property'. Thus , the basic premise of understanding of taxability service is distorted in the notification. The law envisages that renting of property is not intended to be taxed but services in relation thereto are taxable. The notification proceeds on the basis that renting itself is taxable. This appears to be a gross misunderstanding of the statutory provisions.

So far as Circular No 98 is concerned, it states that right to use immovable property is leviable to service tax under the renting of immovable property service. Again it seeks to levy service tax on renting of immovable property instead of levying service tax on services in relation to renting of immovable property, thus, going beyond what is stated in law.

In relation to

Delhi high court interpreted the words 'in relation to' in the context of taxable service. It observed that while in some other services (eg, dry cleaning), the expression - 'in relation to' itself refers to a service and as such core service plus service in relation to, both are taxable. Contrary to this, in case of renting of property, 'in relation to' would mean service in relation to renting of property as renting by itself can not be considered as a service and only the services which are in relation to renting would be taxable services leaving the actual renting out of service tax ambit.

Service Tax

High court observed that the nature of service tax is that of a value added tax and service tax should be levied on the value addition done by a service provider, provided it is lined to the service. Mere renting does not provide any value addition and as such service tax can not be levied . If there is no addition, there is no service.

Alternative Plea

The court did not considered the alternative plea  of constitutional validity of levy of service tax on renting of immovable property as it deemed it unnecessary because of the view taken on the first plea.

Court's Interpretation

High court's analysis as contained in para 35 and 35 read as under

"34. …….it is apparent that service tax is a value added tax.  It is a tax on value addition provided by a service provider.  It is obvious that it must have connection with a service and, there must be some value addition by that service.  If there is no value addition, then there is no service.  With this in mind, it would be instructive to analyse the provisions of Section 65(105)(zzzz).  It has reference to a service provided or to be provided to any person, by any other person in relation to ¯"renting of immovable property for use in the course or furtherance of business or commerce".  The wordings of the provision are so structured as to entail - a service provided or to be provided to 'A' by 'B' in relation to 'C'.  Here, 'A' is the recipient of the service, 'B' is the service provider and 'C' is the subject matter.  As pointed out above by Mr Ganesh, the expression "in relation to" may be of widest amplitude, but it has been used in the said Act as per its context.  Sometimes, "in relation to" would include the subject matter following it and on other occasions it would not.  As in the case of the service of dry cleaning, the expression "in relation to dry cleaning" also has reference to the very service of dry cleaning.  On the other hand, the service referred to in Section 65(105)(v), which refers to a service provided by a real estate agent "in relation to real estate", does not, obviously, include the subject matter as a service.  This is so because real estate by itself cannot by any stretch of imagination be regarded as a service.  Going back to the structured sentence, i.e.- service provided or to be provided to 'A' by 'B' in relation to 'C', it is obvious that 'C' can either be a service (such as dry cleaning, hair dressing, etc.) or not a service by itself, such as real estate.  The expression "in relation to" would, therefore, have different meanings depending on whether 'C' is a service or is not a service.  If 'C' is a service, then the expression "in relation to" means the service 'C' as well as any other service having connection with the service 'C'.  Where 'C' is not a service, the expression "in relation to" would have reference only to some service which has a connection with 'C'.  But, this would not imply that 'C' itself is a service.

35. From this analysis, it is clear that we have to understand as to whether renting of immovable property for use in the course or furtherance of business or commerce by itself is a service.  There is no dispute that any service connected with the renting of such immovable property would fall within the ambit of Section 65(105)(zzzz) and would be exigible to service tax.  The question is whether renting of such immovable property by itself constitutes a service and, thereby, a taxable service.  We have already seen that service tax is a value added tax.  It is a tax on the value addition provided by some service provider.  Insofar as renting of immovable property for use in the course or furtherance of business or commerce is concerned, we are unable to discern any value addition.  Consequently, the renting of immovable property for use in the course or furtherance of business of commerce by itself does not entail any value addition and, therefore, cannot be regarded as a service.  Of course, if there is some other service, such as air conditioning service provided alongwith the renting of immovable property, then it would fall within Section 65(105)(zzzz)".

Conclusion

High court has, after an elaborate   analysis concluded that. " Section 65(105)(zzzz) does not in terms entail that the renting out of immovable property for use in the course or furtherance of business of commerce would by itself constitute a taxable service and be exigible to service tax under the said Act.  The obvious consequence of this finding is that the interpretation placed by the impugned notification and circular on the said provision is not correct.  Consequently, the same are ultra vires the said Act and to the extent that they authorize the levy of service tax on renting of immovable property per se, they are set aside".

The court has not given judgment on validity or otherwise of section 65(105) (zzzz) on levy of service tax but has quashed or set aside that operative part of the subject notification and circular, which entails levy of service tax on renting of immovable property. In the nut shell, following outcome is seen-

   a)      Service tax is on services in relation to immovable property for  use in the course or furtherance of business or commerce .

   b)      Service tax can not be levied on actual renting of immovable property.

   c)      Renting would include leasing, letting out etc as defined in section 65(90 a) of Finance Act, 1994.

   d)      Circular No 98 dated 4.1.2008 has been set aside to the extent of clarification provided in para 96.01 that right to use immovable property is leviable to service tax under renting of immovable property service.

   e)      As a result of this, the clarification on Cenvat credit will also not hold good.

   f)       Contents of Notification No 24 dated 22.5.2007 have been quashed / set aside to the extent that it should not interpret that service tax is levied on 'taxable service of renting of immovable property'

   g)      Exemptions in relation to municipal or property taxes shall continue to hold good. As setting aside of notification is only to the extent that it authorizes the levy of service tax on renting of immovable property.

   h)      Renting of immovable property does not provide or offer any value addition by itself.

   i)        Service tax as a value added tax. It is a tax on the value addition provided by service provider.

   j)        What is taxable is the service provided in relation to renting of property (eg, providing air conditioning, property management etc).

   k)      The judgment is applicable to all service providers, landlords and tenants through out the country.

   l)        There is no judgment as to the constitutional validity of levy of service tax.

Future Outlook

While Central Government, in all probability will appeal against the judgment in apex court, we keep our fingers crossed as to whether the high court's landmark judgment is upheld or over ruled. There is also a possibility that apex court may grant interim stay on the judgment. Going by the legislative track record of our Government, possibility of legislative amendment to tax renting of property for use in commerce or business is not ruled out in the forthcoming Budget and it may be made effective from retrospective effect. Till then, we will have to adopt a wait and watch policy .

However, service providers can act in terms of Delhi high court judgment by taking following steps -

   (a)   Enter  into a MOU to have an understanding of not charging service tax till the judgment is operative (ie, no stay is granted or law is amended ).

   (b)   Tenants agreeing on MOU to pay tax if levied in future and landlords to deposit.

   (c)   Seek refund of service tax already paid without waiting for stay / legislative change to avoid limitation issue.

   (d)   Service tax already collected from tenants ought to be deposited with government.

   (e)   Where cenvat credit was availed, refunds may not be applied.

   (f)   All pending adjudications/ appeals will be decided taking into cognizance the   judgment of high court.

 

Addendum

"Before Supreme Court

Central Government had appealed against the Delhi high court judgment and admitted    the SLP, ordering issuance of notice to parties. The apex court declined to grant interim stay (relief) to the Government (SLP Civil No 13850/2009 before the vacation bench of Justice Markandey Katju and Justice Deepak Verma, Order on 2^nd June, 2009)."