The Delhi High Court held that the renting of immovable property is not a service, and accordingly, the levy of service tax on the activity of renting is “ultra vires.” The decision may have significant accounting implications on the entities.
The judgment delivered by the Division Bench of the Delhi High Court in the case of Home Solution Retail India Ltd. & Ors Vs Union of India (UOI) & Ors may have significant financial reporting implications. This article analyzes the key aspects of the court decision and its key implications from a financial reporting perspective.
Issue before the Delhi High Court
In essence, the Delhi High Court considered the legal validity of the levy of service tax on renting of immovable property under the Finance Act.
Petitioners’ contention
The petitioners, challenged the legality, validity and vires of the notification no 24/2007 dated 22 May 2007 (“the Notification”) and the circular no 98/1/2008-ST dated 4 January 2008 (“the Circular”) issued by the Finance Ministry to levy service tax on renting of immovable property.” The following were the major grounds used by petitioners to challenge this levy:
• The petitioners contended that the Finance Act does not envisage the renting of immovable property as a ”taxable service” and the notification/the circular had erroneously interpreted the relevant provisions of the Finance Act to conclude that renting of immovable property is liable to service tax.
• The petitioners contended that the expression ”services in relation to” renting of immovable property means a service, which is distinct and different from the activity of renting of property, though such service should be related to renting.
• Further, referring to the Supreme Court judgment of All India Federation of Tax Practitioners vs. Union of India, the petitioners contended that service tax is a tax on value addition and can be levied only on value-added services. Since renting of immovable property by itself does not provide any value addition, it cannot be treated as a service.
?• alternatively, the petitioners also challenged the constitutional validity of levy of service tax on renting of immovable property. It was contended that such levy of service tax will amount to “tax on land”, which is a state subject covered under the Entry 49 of List II of the Constitution of India. Therefore, only the states have the power to tax such transactions.
Judgment
The High Court accepted the contention of the petitioners and held that the relevant provision of the Finance Act does not intend to levy service tax on renting of immovable property. However, the court held that the services in relation to renting of property, e.g., air conditioning, furnishings etc., will be taxable under the subject category. Accordingly, the notification and the circular purporting to levy service tax on renting per se held by the court as ”ultra vires the Finance Act.” The court, however, did not examine the alternate plea of the petitioner regarding the constitutional validity as it was considered unnecessary because of the view taken by the court that the subject service tax category does not contemplate the levy of service tax on renting.
Further developments
Recently, the Central Government filed a special leave petition with the Supreme Court seeking an interim relief against the order of the Delhi High Court. The Supreme Court heard the matter and ordered notices to be issued to the concerned parties.
Financial reporting impact
Our perspectives on the key accounting/disclosure issues arising from the above mentioned judgment are discussed here.
Accounting by lessee
Since the court has held that levy of service tax is not as per the Finance Act, can a lessee recognize the amount recoverable toward service tax paid in past as an asset?
Response
The recovery of the past payment of service tax is a contingent asset as per AS 29 Provisions, Contingent Liabilities and Contingent Assets. AS 29 prohibits the recognition of a contingent asset as “income” unless its realization is virtually certain. It appears that entities may not satisfy the “virtual certainty” criterion for the recognition of the contingent asset at this stage for the following key reasons:
• It is difficult to predict the future course of this litigation and the final position that may emerge. The Central Government recently filed a special leave petition with the Supreme Court seeking an interim relief against the Delhi High Court order.
• The Central Government may also consider amending the relevant provisions of the Finance Act, possibly with retrospective effect, to overcome this judgment.
• As this is the only high court judgment across India on the issue, it is still to be seen whether other high courts also agree with the same view or not. AS 29 also prohibits the disclosure of the contingent asset in the financial statements. Thus, the lessee cannot disclose the possibility of future recovery of service tax in the notes to accounts. However, the same can be disclosed in the report of the board of directors in the case of a company, and, the corresponding approving authority in the case of any other entity.
Consider that the lessee has a contractual arrangement with the lessor whereby, it is required to bear service tax on rental or there is an indemnity clause with the lessor requiring lessee to refund the actual service tax paid by the lessor. In such a case, should the lessee continue to create a provision toward service tax payable on the current rental, i.e., post the court orders?
Response
As per AS 29, a provision should be recognized when all of the following conditions are met:
a. An entity has a present obligation as a result of a past event.
b. It is probable that an outflow of resources embodying economic benefits will be required to settle the obligation.
c. A reliable estimate can be made of the amount of the obligation.
AS 29 also provides that if these conditions are not met, no provision should be recognized.
In this aspect, a lessee can argue that the Delhi High Court judgment has a strong persuasive value at the moment. Therefore, the criterion for recognition of liability, i.e., the probable outflow of resources embodying economic benefits, is not met. Accordingly, it need not recognize any provision for service tax payable on renting the immovable property, till any further development that may change the view, for example, a decision by the Supreme Court. In case this argument is accepted, the amount of service tax not provided for should be disclosed as a contingent liability. If there are value-added services in addition to renting of the property, service tax on the same should continue to be provided for.
Accounting by lessor
The lessor has collected the service tax on the lease rent, and as per the agreement, it is not obliged to refund the same to the lessee. Can it recognize the same as income without creating provision for the service tax payable to the government?
Response
From perusal of the Finance Act, it appears that the law may not allow the lessor to retain amount collected as service tax. Section 73A of the Finance Act provides as below:
“1. Any person who is liable to pay service tax under the provisions of this Chapter or the rules made thereunder, and has collected any amount in excess of the service tax assessed or determined and paid on any taxable service under the provisions of this Chapter or the rules made thereunder from the recipient of taxable service in any manner as representing service tax, shall forthwith pay the amount so collected to the credit of the Central Government.
2. Where any person who has collected any amount, which is not required to be collected, from any other person, in any manner as representing service tax, such person shall forthwith pay the amount so collected to the credit of the Central Government.” Since the lessor needs to pay the amount collected as service tax to the Central Government, it can not recognize the same as income. Rather, it is shown as an amount payable to the government or refundable to the lessee.
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