friend of mine, Niraj, purchased an apartment in the financial year 2004-05, for which he took a loan.

The bulk of the payment was made to the builder and only 10% is still pending. For which, Niraj has given the builder a post-dated cheque.

The entire purchase and registration of the house was completed in the last financial year (2004-05).

Interestingly, the builder called him the other day to tell him that he has to pay a tax of 3.5% on the outstanding amount.

And what tax would that be? Service tax, of course.

When I was told about this, I was flummoxed.
Is this legal?
Does the buyer have to pay this tax or the builder?

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The new tax

On June 16, 2005, the service tax regime came into force covering (among others) the construction of residential complexes.

This covered houses and apartments in residential complexes having over 12 residential houses or apartments with common areas.

This service tax on residential apartments is to be levied only on the construction services (and the cost of manpower too is included).

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Whose problem is it?

The service tax is payable by a contractor employed by the builder. It is not payable by the builder directly.

But, if the contractor pays the tax, he will in all likelihood recover it from the builder.

The builder will view this as an increase in costs, since this is not a direct tax on him.

He, in turn, will try and recover it from the consumer in the form of increased rates.

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Who does this impact?

First let us talk of contracts already signed before June 16, 2005.

Whether the builder is legally able to recover the money from the consumer or not depends on the terms of the contract between the consumer and the builder.

Most such contracts have a general clause that allows the builder to recover any additional taxes/duties levied after the date of signing of the contract.

However, as already explained above, this is not a tax payable by the builder but by his contractor. So, it very unlikely that such a general clause will enable the builder to claim the additional amount. 

Let's talk of Niraj. 

In his case, it is highly unlikely that the builder is justified in charging anything on account of service tax as the tax has come into effect only from June 16, 2005.

That means it can be levied only for services rendered by the contractor to the builder after that date. And, the construction seems to be already complete since it is the final installment that is being demanded.  

It is quite improbable that any service was provided by the contractor to the builder after June 16 2005. 

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How much is the tax?

The service tax is 10% of the costs incurred.

The tax will not be levied on the full value of the apartment.

Service tax will be charged only on the value of the contract for constructing the block. Land value will be excluded while computing service tax.

Nevertheless, housing costs will increase marginally due to this tax.

It is estimated that the cost of construction will see a rise of around 4% which will eventually be passed on to the consumer.

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Make sure you are not being cheated

Harsh Roongta, CEO, Apnaloan.com, offers some tips.

1. The service tax is only to be charged on the construction costs. It is not levied on the value of the land.

2. For all those who have already made a purchase, take a good look at your contract. Whether or not the builder can recover anything from you depends on the terms of the contract with the builder. You can also take legal advice before making the payment.

Do note, the date of registration of the contract will not have any bearing on the liability for paying such additional cost. 

3. For buyers who have yet to sign the contract, the impact is likely to be in the form of increased prices.

4. New buyers should carefully study the contract before signing it to understand their liability in case the service tax rates are raised in the future.

Illustration: Dominic Xavier