On April 18, 2009, the Division Chamber of the Delhi High Court, consisting of Mr. Justice Badar Durrez Ahmed and Mr. Justice Rajiv Shakdher, admitted twenty-six writs challenging the levy of service tax on the commercial rentals. The summary of the dispute, the arguments raised by both parties and the observations of the Delhi High Court are provided below.

I. Background:

“Real property leasing service” was introduced by the Finance Act 2007, amending the Finance Act 1994 (collectively and effectively “the Act”), whereby the definition of “taxable service” included, as of June 1, 2007:

“service rendered or to be rendered to any person by any other person in connection with the rental of real property for use in the course or promotion of business or commerce”

Subsequently, the Secretary, Ministry of Finance, Department of Revenue, Government of India issued a Notice No. 24/2007 dated 22 May 2007 (“Notice”) and Circular No.98/1/2008-ST dated May 4, 2008 (“Circular”) by which an interpretation of Section 65(90a) and 65(105)(zzzz) of the Law to levy the service tax “on the rental of real estate” was introduced. rather than on services rendered “in connection with the leasing of real property.”

The amendment, read with the Notification and Circular in force, introduced the rental, rent, lease, licensing or other similar arrangements of real property, for use in the course or promotion of business and commerce, within the net of the tax about services. This new levy severely affected business models across India as most rental agreements did not even stipulate this up front.

II. DISPUTE:

Several tenants/licensees/lessees questioned the legality, validity, and vires of the Notice and Circular on the interpretation of Section 65(90a) and 65(105)(zzzz) of the Act.

The main question raised was “Does the 1994 Finance Law provide for the imposition of a service tax on the rental/leasing of immovable property per se?”

third ARGUMENTS OF THE PETITIONERS [TENANTS/LICENSEES/LESSEES]

The petitioners noted that the Notification established the taxed service as a “taxed real estate rental service.” Similarly, the Circular, while clarifying with respect to the commercial and industrial construction service, purportedly clarified that the “right to use real estate is subject to service tax by virtue of the real estate leasing service.”

The petitioners argued that:

– under the provisions of the Law, the service tax applies only to a service that is provided or to be provided to any person by any other person “in connection with” the rental of immovable property for use in the course or development of business or trade ;

– in the Law, the reference is not to the “taxable service of leasing of immovable property” but to the taxable service “in connection with” the leasing of immovable property;

– by virtue of the Notification and the Circular, a misinterpretation of the relevant section of the Law is being given, and it is intended to levy the service tax “on the lease of immovable property” instead of the service tax on the services provided “in connection with rental of real property”;

– the statements of the Union of India given in the Notification and Circular go beyond the provisions of the Act;

– the rental of real estate as such cannot be considered a service on which a service tax can be charged under the provisions of the Law;

– the contested Notice and Circular proceed from the inconsistent assumption that the leasing of real estate is itself a service;

– the service tax is a value added tax and can only tax the added value provided by some service provider;

– property-based services are different from performance-based services. In the case of property-based services, the value added in terms of improvement/improvement of the property may be taxable. However, in the pure rental regime, there can be no service tax in the absence of any improvements/improvements.

The petitioners also adopted the alternative contention that “if it is held that such a tax is contemplated, the provisions of Section 65(90a), 65(105)(zzzz) and Section 66 of the Act to the extent that they relate to with the levy of the service tax on the rental of immovable property would be equivalent to a tax on land and would therefore fall outside the legislative jurisdiction of Parliament to the extent that such subject is covered by Entry 49 Schedule II of the Constitution of India and would fall within the exclusive domain of the State Legislative Assembly, for which reason said provision would have to be declared unconstitutional”.

IV. DEFENDANTS’ ARGUMENTS [UNION OF INDIA]

The Government maintained that:

– the user of the land/building itself is a service;

– the transfer of the right to use the property for commercial or business purposes is itself a service;

– the mere rental of real estate is itself a service;

– the mere provision of temporary premises for the organization of a financial, social or business function would also include other facilities in connection therewith and would therefore constitute a taxable service; Y

– the expression “in connection with the leasing of immovable property” has a broad scope and also covers the act of leasing immovable property.

V. DECISION OF THE COURT

The Court held that:

– any services related to the rental of immovable property would be subject to service tax under the Law;

– the rental of the immovable property by itself does not constitute a service;

– the service tax is a value-added tax and therefore levies the added value provided by some service provider;

– the leasing of immovable property for use in the course or promotion of business or trade does not imply any added value and therefore cannot be considered a service;

– the interpretations made by the Notification and the Circular on the provisions of the Law are not correct;

– The Notification and the Circular are repealed, to the extent that they authorize the application of the service tax on the lease of real estate itself;

– the petitioners’ alternative claim regarding the legislative competence of Parliament in the context of Entry 49 Schedule II of the Constitution of India was not considered due to the opinion taken on the petitioners’ main claim.

As a result, no service tax is paid on the commercial rental of real property. It is up to the Government to apply to the Supreme Court of India within 90 days from the date of the judgment, if it intends to overturn the judgment.