Service Tax on Joint Development Agreement vis-a-vis Joint Venture

[Ravi Kumar Somani]

In case of a Real estate and construction industry, where due to various political and economical reasons we have seen that there is a sharp downturn being noted in the sale of residential and commercial construction projects irrespective of fact that the prices of land arestill reaching sky high. Therefore, in a current business and economic conditions where uncertainty prevails over everything it becomes financially not so viable for a developer to acquire and purchase the land from the land owners and then perform the construction activity. However, it is known that every problem comes with a solution. In order to ensure financial and commercial viability of the construction projects, one of the solution is that the developers enter into a “Joint Development Agreement” with land owners whereas the capital, construction and legal work will be carried out by the developerand the land will be provided by the land owner. Ultimately the developer and landownersshare the profit in the any agreed ratio (Generally, it will be in the ratio of 60:40. However, the same may differ based on location, construction cost, development cost etc).It is sometimes also a tripartite agreement between the land owner, builder/developer and a contractor. This article aims at examining whether the “Joint Development Agreement” can be called as “Joint Venture” for bypassing levy of Service Tax.

In order to understand a practical functioning of Joint Development Agreement, lets take an illustration. For instance assume, ABC developers limited enters into a Joint Development Agreement with land owner Mr. XYZ whereas in lieu of this agreement a total of 1000 residential units will be constructed by ABC ltd on the land provided by Mr. XYZ whereas 40% of the units i.e. 400 units shall be given to Mr. XYZ and rest 600 units shall be taken by ABC ltd. Both can commercially sell the units in the open market.Land owner gets 400 units of flats in lieu of the land given and Developer gets 600 units of flats in lieu of the construction work done.In this scenario the following would be required examination

Whether the agreement between developer and landowners is in the nature of joint venture?

CBEC vide circular No. 151/2/2012-ST dated 10^th February, 2012, it has been clarified that applicability of service tax under these joint development models, shall be decided based on the principles enumerated in the transaction of revenue sharing between distributors/sub-distributors and film exhibitors where one supplies film and other exhibits the same in their theatre.

In the said circular, it is held that a joint venture is recognized as legal and juristic entity in the nature of partnership of constituent business entities. Further relied on Supreme Court judgment as to the meaning of joint venture wherein it was held that “the expression ‘joint venture’ connotes a legal entity in the nature of a partnership engaged in the joint undertaking of a particular transaction for mutual profit or an association of persons or companies jointly undertaking some commercial enterprise wherein all contribute assets and share risks. It requires a community of interest in the performance of the subject-matter, a right to direct and govern the policy in connection therewith, and duty, which may be altered by agreement, to share both in profit and losses”.

It is further clarified that two or more entities undertaking a particular activity for mutual benefit will be treated as joint venture only when they are sharing risks and rewards. In other words, where no risks and rewards are shared, they cannot be called as joint venture. In such case, the transactions between them constitute as took place between two separate persons.

In the instant case, land is contributed by Mr. XYZ and the same is developed by ABC ltd. Each of them are sharing built up area and executing the sale of their own share of flats either for a profit or loss accruing to their share, the group risks and rewards are not being shared, which indicate the absence of the mutual risk sharing among the parties.So their association cannot be called as joint venture in the opinion of the paper writer. Since the same is treated as transaction between two parties the service tax implication would be as under

1. From the Landlord prospective, he has forfeited his partial share of land for the constructed area to be received and hence the transaction in the hands of the landlord is mere transfer to title in immovable property, which is excluded from the definition of service under section 65B (44) of the Finance Act, 1994.
2. From the Builder Prospective, he is providing the construction for the landlord’s share for consideration of land transferred to his share, which would be liable for service tax (which needs to be reimburse by the landlord, except of agreed otherwise). This view has been confirmed by the Chennai CESTAT in the case of LCS CITY MAKERS PVT. LTD. Vs.COMMISSIONER OF SERVICE TAX, CHENNAI reported in 2012 (6) TMI 363 - CESTAT, CHENNAI

There is another possible argument that the transaction between the developer and the landlord is a batter of two immovable properties and the same should not be subject to service tax, however such argument lack judicial precedents as on date.

However in case a Joint venture is formed and is assessed as such then it can be considered as a JV and Service Tax implication would be as under, which is with the principle of treating JV and its partners as distinct person given under Circular No. 179/5/2014-ST dated 24.09.2014

1. The combined sale by JV to the customer would be liable to service tax in case the advance has been received prior to completion certificate.
2. The Construction service provided by the builder to JV would be liable for service tax, the value needs to be determined as per Rule 2A of the Service Tax (Determination of Value) Rules, 2006 (Refer Para 4.1.1 of Circular No. 179/5/2014-ST dated 24.09.2014)
3. The Transfer of Land by landlord to JV would not be subject to Service Tax since the transaction is mere transfer to tile in immovable property excluded from definition of service u/s 65B(44) of the Finance Act, 1994.
4. Transfer other than by way of sale to landlord would be subject to service tax. Since the land (non-monetary consideration) is a capital investment/cash call for a future service of construction to be received by the JV. (Refer para 4.1 of Circular No. 179/5/2014-ST dated 24.09.2014)
5. Sale of fully constructed flats/units after the completion certificate by executing a sale deed, would not be liable for service tax

In the opinion of the paper writer none of the Joint Development Agreements are assessed as a Joint Venture as a practice in trade and also there is no any assessment being done as such by the Department to the best of the knowledge of the paper writer. Treating the Joint Development Agreement as a joint Venture and assessing as such may have an advantage as to clarity on point of payment of tax and the value on which the service tax needs to be paid, which otherwise is a area of concern.

(for feedback or queries write to sudhir@hiregange.com or ravikumar@hiregange.com)