Far From Settled: How the Ruling in Prahitha Judgment Reshapes GST on Joint Development Agreements
[C A P Sai Srinivas is pursuing LL.M. (IBL) from NALSAR University of Law in collaboration with the Indian Institute of Corporate Affairs.]
Real estate, as a sectoral landscape in India, is backed by a demand-driven thrust towards urban-centric and peripheral regions, including residential and commercial spaces, offering a panoptic view of the sectoral growth. Given the scarcity and fragmentation of land parcels, the prolonged gestation periods inherent in land acquisition and superstructure construction impose severe strain on project finance and restrict working capital flow.
The structural evolution of the joint development agreements (JDA) necessitated a syndication between the two resource owners. On one hand, the landowner contributes the scarce real estate parcel and on the other, the developer deploys capital for the conceptualisation, planning and execution of construction of a superstructure. In view of the consideration of the parties based on the agreement, the parties agree to an area sharing ratio as pre-designated and agreed between them upon completion of the superstructure.
For years, the taxation of the Joint Development Agreements under the erstwhile service tax regime governed by Chapter V of Finance Act of 1994 remained a debating ballgame. The developers usually contended that the very nature of “transfer of development rights” constituted a benefit arising out of the land and thus it is explicitly excluded as a taxable event under Section 65B (44) of the Finance Act 1994 The Central Excise and Service Tax Appellate Tribunal, Chandigarh in DLF Commercial Projects Corporation v. Commissioner of Sales Tax, Gurugram (DLF Commercial Projects Case) held that developmental rights constitute an incident of the rights associated with the land and represent a benefit arising out of the land.
The conclusion of the tribunal was premised on Section 3(26) of the General Clauses Act 1897 and the established jurisprudence on legal incidents of land. The principle retains its significance notwithstanding the subsequent introduction of the Central Goods and Services Tax (CGST) Act 2017 regime, on the basis that the developmental rights derive their existence, scope and economic value from the potential development of land and possess a substantive nexus with the land itself. This extends beyond the contours of the tax regime and emphasises the concept of immovable property so as to include not only the land but also the benefits arising from land.
At the same time, the tax treatment as accorded under the erstwhile service tax regime, as held in the DLF Commercial Projects case, does not by itself constitute a conclusive determination under the CGST framework. The relevance therefore lies in the property law characterisation of the development rights falling within the broader conception of interests arising from immovable property. This approach reinforces the substance and legal incidents of rights arising out of the land conferred upon the developer are intertwined with the executed JDA.
The central question that dictates the taxability of the development rights executed in the form of JDA’s under the current GST framework is whether the development rights can be subsumed as an act of benefits accruing from the land. Simultaneously, whether such benefits will be qualified as a sale of land under Entry 5 of Schedule III of the CGST Act 2017, insulating them from the purview of “supply”. A black letter reading of the aforementioned Schedule III leaves no room for the inclusion of the benefits arising out of the immovable property. It reveals a deliberate legislative choice to shift from the non-taxable character of to the taxable event of supply under the current regime with respect to the developmental rights.
This blog examines the ruling of the Hon’ble High Court of Telangana in M/s Prahitha Constructions v. Union of India and Others (Prahitha), which upheld the levy of the service tax on the transfer of development rights and the circumscribed approach as adopted by the court in treating developmental rights as an isolated entity from the underlying land. It also underscores the court’s failure to appreciate the commercial sense of JDAs in revenue-sharing real estate models and assesses the far-reaching implications of the decision on real estate JDAs.
Unlocking TDR: From Land Right to Taxable Service
Transfer of development rights (TDR) under the current regime prescribes the taxable treatment of such transfers in connection with the economic value of the land and the floor space index (FSI) applicable to the project. It places the liability to discharge the tax on the promoter under the reverse charge mechanism and it can be further understood through the notifications governing the taxable event, valuation and time of supply. The first notification, Notification No. 4/2018 Central Tax Rate dated 25 January 2018, addressed that in a transaction where the development rights were supplied in consideration for the construction services, the time of supply is deferred until the possession or the right in constructed project was transferred to the person supplying development rights.
The position was subsequently amended through Notification No. 5/2019-Central Tax Rate, dated 29 March 2019, which bought the transfer of development rights or FSI under the reverse charge mechanism the notification further identifies the supplier as any person and recipient as the developer/ promoter and ultimately shifting the burden on the promoter/ developer. The time of supply was further clarified through Notification No. 6/2019-Central Tax Rate dated 29 March 2019, which specified that the promoter or developer’s tax liability regarding development rights or FSI arises upon the issuance of the completion certificate or first occupation of the project, whichever is earlier.
Where the development rights were received in exchange for construction services, the GST prescribes a specific mechanism for the determination of value, as it does not equate the contractual consideration with the taxable value of development rights for assessment purposes. The treatment of development rights under the established jurisprudence of property law and their characterisation as taxable supply under the CGST Act 2017 poses a potential conflict .The former takes into consideration the legal nature of TDR by examining its connection with the underlying land and the rights associated with it.
While the latter separately determines the consequences of how the transfer of such rights is to be taxed, discharge of liability, valuation and time of supply, the jurisprudential approach of rights associated with the land needs to reconcile with the taxable treatment under the CGST framework. It is essential to therefore guide the applicability of CGST on the development rights by inferring from the context and the nature of rights transferred. However, the treatment under the property law does not decisively conclude the taxability of TDR under the CGST regime.
Land ownership is traditionally perceived to be a bundle of rights, encompassing the rights not only of possession and alienation but also of taking profits, using and enjoying, and other associated rights. The High Court’s ruling in Prahitha overlooks the essential element of the developmental rights as an integral and indivisible component attached to the land; the compartmentalisation of development rights as a service for taxation renders the judicial interpretation indefensible. It departs from already well-settled jurisprudence established in DLF Commercial Projects case that recognised development rights are proprietary interests in land rather than a taxable service.
More importantly the ruling in Prahitha leaves unresolved several border questions for consideration at the intersection of property law and GST regime. In particular the judgement does not adequately address how a proprietary character of development rights is to be situated within the statutory scope of supply under Section 7 of the CGST Act 2017. In also whether the reciprocal obligations under a development agreement constitute a separate taxable supply or form part of a single integrated transaction. Also, how the exchange of developmental rights for the constructed area is characterised when the consideration is determined in accordance with the development of the underlying land.
This becomes particularly significant under the real estate GST framework that separately determines the point at which such transactions become taxable and the manner in which their value is to be ascertained. The judgment leaves open the larger question whether the contractual nature of a development agreement can by itself determine its GST treatment, without first assessing the legal incidents and proprietary character of rights involved.
Looking Beyond Development Rights: The Ultimate Conveyance of Land in JDAs
The JDA prima facie is intended as an executory contract conferring the permissive license to enter upon the land for the development. The developmental rights are categorised as a derivative asset; it possesses no intrinsic utility. The valuation depends on market price, floor space index, monetisation potential, and expected cash flow projections. The question is whether a clause containing the transfer of an undivided share in a JDA can translate into the transaction of a true sale?
The court has answered it negatively, holding that to effectuate a valid transfer of the undivided share of land to the developer, a separate independent deed of conveyance is mandatory. In the absence of the registered conveyance deed, the mere execution of the JDA is ineligible to serve as a surrogate for or substitute for the sale deed. The court has outrightly rejected the contention of the petitioner by affirming the aforementioned reasoning and ruled that a JDA in any circumstances would not be tantamount to a sale of land.
However, the judgment fails to appreciate the commercial reality in real estate transactions that in almost all JDAs, the area sharing ratio corresponding to the undivided share on land stands predetermined. Every prudent builder optimises the plan to maximise his entitlement under the agreed terms, in accordance with the requisite statutory and municipal approvals.
A significant aspect of the court’s reasoning was that in the absence of a conveyance deed upon completion of the project or upon handing over possession of the building by the developer to the landowner, it formed the foundation for the court’s conclusion on the taxability of development rights. This leads to an important question: if the landowner were to execute the conveyance deed transferring the undivided share of the land in favour of the developer contemporaneously with or immediately upon the completion of the construction or the delivery of the possession, would such a transfer nonetheless retain the character of a taxable supply under the Telangana Goods and Service Tax Act 2017.
This question assumes significance because the moment the landowner transfers the undivided share of the land to the developer, it essentially culminates in the transfer of title of immovable property. In substance, such transfer assumes the character of a sale of land prima facie falls within Entry 5 of Schedule III of the CGST Act 2017. The incidence of the transaction cannot be made upon the form or mere existence of a conveyance deed, where the substance and the legal effect of the JDAs lie not only in the transfer of developmental rights but also in the transfer of proprietary interest.
Conclusion
The legal character of the JDAs was fundamentally embedded in the commercial objectives they are designed to achieve. Subsequently, the material clauses governing the creation, transfer and exercise of development rights must be examined in the context of economic and contractual interdependence underlying the development agreement. The court’s resort to supply-by-supply analysis overlooks the manner in which the rights, reciprocal obligations, consideration and development activities operate together to give effect to the executed JDA. The court in Prahitha Constructions adopted a differentiated view by formally segregating each transaction forming part of the land owner and the developer under the JDA into independent taxable supplies. This approach effectively places the developer within a multi-tiered and complex tax structure, mandating the obligation to discharge the tax at multiple levels in accordance with the circumstances as prescribed under the notifications.
The petitioner has filed a special leave petition before the Supreme Court of India on 12 May 2024, challenging the decision. Notwithstanding the pendency of the appeal, the apex court refused to stay the applicability of the decision, and it remains operative until the final appeal is decided. The court can redefine and expand the commercial sense of the JDA’s by adopting a substance-over-form approach, giving due weight to the economic realities of the emerging real estate transactions.