GST Caselaw

#GSTCase-36-Whether ITC is available for GST on lease/rent paid for land during the construction phase of the immovable property?

#GSTCase-36-Whether ITC is available for GST on lease/rent paid for land during the construction phase of the immovable property-GGL Hotel & Resort Company Ltd., 2019] 101 taxmann.com 138 (AAR-WEST BENGAL)

 

  1. Query

Whether Provisions of Section 17(5) blocks claims of Input Tax Credit for lease rent paid during pre-operative period for the leasehold land on which the resort is being constructed to be used for furtherance of business, when the same is capitalised and treated as capital expenditure.

 

On a conjoint reading of provisions of Section 17(5)(d) of CGST Act, 2017, following wordings emerges :

“input tax credit shall not be available in respect of the following, namely:…..goods or services or both received by a taxable person for construction of an immovable property…”

Explanation.––For the purposes of clauses (c) and (d), the expression “construction” includes re-construction, renovation, additions or alterations or repairs, to the extent of capitalisation, to the said immovable property;

 

  1. Facts:

Bengal Housing Infrastructure Development (hereinafter referred to as ‘WBHIDCL’/Lessor) leased a piece of land measuring 20,039.75 sq meters in New Town Area for a period of 32 years to the Applicant (also referred to, at times, as the Lessee) for a lease premium of Rupees Seventeen Crores Twenty Lakhs only. As per the Indenture of Lease dated 21.08.2013, (hereinafter referred to as “the Agreement) the Applicant is liable to pay annual lease rent at certain percentage of lease premium every year.

 

  1. Contention of the Applicant

Mere capitalization of lease rental cannot make such services as received for the construction of immovable property. Applicant is required to pay the lease rent to the Lessor whether or not the construction has been carried out and shall be paying the lease amount even after the completion of the construction of the immovable property for the balance period of the lease period.  Lease rent for pre-operative period is capitalized under ‘Leasehold Land’ and not under the head ‘Building Block’.  Renting services cannot be said to be received for construction of immovable property as there is no nexus, direct or indirect, between the construction of the hotel and banquet and the rental service availed.

 

  1. Observation by AAR

 

  • Accounting Treatment of Lease Rent: AAR referred to Para 23 of AS10 which provides that cost of a self-constructed asset should be determined using same principles as for an acquired asset, and it is usually the same as the cost of constructing an asset for sale. The property is being constructed on own account and applicant will capitalize lease premium and treat is as fixed asset. Whether the lease rental paid for the pre-operative period is capitalized under the head ‘Leasehold Land’ or ‘Building Block’ is of little significance in this context.

 

When an immovable property like a building is sold the profit is computed after deducting from the sale proceeds the cost of the property, including the land. Therefore, lease rental paid for service of right to use land is an integral part of the cost of the immovable property the and therefore it is a supply for construction of the said property.

 

  • Direct Nexus between Right to use Land and Construction of Property: Restriction from availing input tax credit under section 17(5)(d) of the GST Act extends to immovable property, which includes the supplies received for retaining the right to use and develop the land. Construction of the hotel etc. is impossible unless the applicant enjoys uninterrupted right to use the land. It is clear from the Agreement that the Applicant cannot enjoy that right if he fails to pay the lease rental. The nexus between construction of immovable property and leasing service is therefore, direct and the two are inseparable. The leasing service for right to use the land is, therefore, a supply for construction of the immovable property.

 

  1. Held

 Input Tax Credit is not available to the Applicant for lease rent paid during pre-operative period for the leasehold land on which the resort is being constructed on his own account to be used for furtherance of business, when the same is being capitalised and treated as capital expenditure.

  

  1. Comment

 The judgement is significant in terms of laying down principle on allowability of Input Tax Credit on lease rent paid for the lease hold land during the pre-operative period when the same is capitalized in the books of accounts. The judgement would have a wide ranging impact in cases wherein immovable property like factories or offices are being constructed on leasehold land or rented land. The judgement firstly holds that right to use land has a direct nexus with the construction services and then holds that since the lease rent paid is being capitalized in the books of accounts, therefore Input Tax Credit is restricted as per provisions of Section 17(5)(d) of CGST Act, 2017.

 

  • Direct Nexus between Right to use Land and Construction of Property:

AAR held that leasehold services are having direct relation to construction, therefore Input Tax Credit is not allowed. Another view is that the words “in respect of” used in Section 17(5) attaches them with “goods or services or both” and not with “for construction of immovable property”. Therefore, even though scope of provision of section 17(5)(d) are enlarged when it starts with the words “in respect of goods or services or both” but subsequently it is restricted when the purpose is mentioned i.e. “for the construction of an immovable property”. The goods or services should be “for construction of immoveable property” and not “in respect of construction of immoveable property”.  The leasehold services might be “in respect of” or “in relation” to the construction of immoveable property but are certainly not “for the construction of immovable property”.

 

  • Accounting Treatment of Lease Rent:

Secondly regarding the accounting treatment of the leasehold rent, AAR has referred to Para 23 of AS-10 regarding cost of a self-constructed asset should be determined using same principles as for an acquired asset. However Para 60 and 61 of AS 23 itself recognizes land and building as separate asset which is as follows:

 

60 Land and buildings are separable assets and are accounted for separately, even when they are acquired together. With some exceptions, such as quarries and sites used for landfill, land has an unlimited useful life and therefore is not depreciated. Buildings have a limited useful life and therefore are depreciable assets. An increase in the value of the land on which a building stands does not affect the determination of the depreciable amount of the building.

 

  1. If the cost of land includes the costs of site dismantlement, removal and restoration, that portion of the land asset is depreciated over the period of benefits obtained by incurring those costs. In some cases, the land itself may have a limited useful life, in which case it is depreciated in a manner that reflects the benefits to be derived from it.

 Therefore, to hold that AS 23 Justifies that lease rent is part of cost of the immovable property is correct but then it is not for the purpose of construction of immovable property as AS 23 holds that land and building are separate assets. Provisions of section 17(5)(d) are “for construction of immovable property” and cannot be extended to “immovable property” itself.  This would be stretching the provision.

 

Further AAR Madhya Pradesh in the decision of Jabalpur Entertainment Complex Private Limited  (2018) 97 taxmann.com 587 held that accounting entry in the books of account is not relevant for the purpose of Provisions of Section 17(5)(d) of CGST Act, 2017. It held that

 

“Explanation to the sub-section (5) has defined the term ‘Construction’ to encompass all the activities ‘…. to the extent of capitalization to the said immovable property.’ Mere statement that expenditure is not capitalized cannot come to the rescue of Applicant. Be that as it may, the eligibility of ITC does not depend on the treatment given to the expenditure. If the expenditure is revenue in nature but subsequently capitalized in the books of account it would not make Applicant eligible to ITC on such goods.”

 

Therefore the judgment in the given case might have an alternative view and is not free from further litigation.

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