Web-based Residential Property Marketplace Model – My Recent Interaction With A Start-Up

It’s unbelievable to see the excitement that runs in today’s Indian youth and professionals on the way they see matters relating to start-ups.  With new unicons like SnapDeal there is a hope in almost everyone’s eyes that one should at least give it a shot and try something worthwhile.  Ideas are in abundance and people are willing to risk their careers in search for millions.

It was something similar that happened last week when I got a message from a senior of mine who stays in Australia.  He was the one under whom I did my articleship during my training as a chartered accountant.  One of his friend and an ex-colleague is starting a new venture something on the lines what real estate portals like 99acres.com and housing.com are doing.  She told me that they have thought of doing something different by aggregating people who are willing to let their houses as ‘paying-guest’ (PG) accommodation.  Though the idea is not new because I believe there are few portals that are doing similar activity, I obviously had no reason to say that to her.  May be they have some different tech platform or may be some other unique offering.

So, when our conversation started she wanted to understand whether they should go for a LLP or a private limited company and we discussed the pros and cons of each of the structure.  Then came the discussions on service tax and as expected she had loads of questions to ask.  Primarily, the questions revolved around two things:

  1. Whether service tax is applicable on the services rendered through her web-portal and app;and
  1. If yes, what’s the best way to structure the transactions and achieve maximum tax efficiency?

The transactions were simple.  The website was going to charge PG accommodation owner (‘PG’) a one time fee to list the property on its website.  Thereafter, the website was going to collect the rent from the tenant and pass it on to the PG at the end of the month after deducting its commission.

The issue related to applicability of service tax on listing fee was simple as it was a service for a consideration and consequently, taxable.  The complexity arose whether the amount collected and retained by PG as its commission is taxable or should tax be collected on the entire amount received from the tenant.

This issue wasn’t simple to crack since it first needed to be ascertained whether the underlying transaction of giving property on rent is taxable or not.  Typically, owners of residential dwellings generally provide PG accommodations and these are for a longer stay periods, more than few days.

Since the term ‘residential dwelling’ has not been defined, we relied on the Education Guide issued by the Central Board of Excise and Customs (CBEC) that stated as follows:

4.13.1 What is a ‘residential dwelling’? 

The phrase ‘residential dwelling’ has not been defined in the Act. It has therefore to be interpreted in terms of the normal trade parlance as per which it is any residential accommodation, but does not include hotel, motel, inn, guest house, camp–site, lodge, house boat, or like places meant for temporary stay”.

Thus, the intent of legislation is clear.  Any residential unit that operates as a motel or inn or a guesthouse etc that is meant for a temporary stay is within the purview of service tax.   Further, the Guide also makes it clear that:

“where any furnished flat is given on rent for temporary stay (few days), the same shall not be subject to service tax if the residential dwelling is for the bonafide use of a person or his family for a reasonable period.  However, if the same is given for a short stay for different persons over a period of time, the same would be subject to tax”

It therefore, appears that any residential accommodation provided for a longer stay to a person or a family should be considered as provision of residential dwelling unit, not subject to service tax.  However, if the stay is for shorter periods and is provided to different people over a period of time, the character of the accommodation changes from residential to commercial, subject to service tax.

The questions therefore before the website owners were follows:

  1. Whether the PG accommodation was being provided by owners of independent residential dwellings; and
  1. What was the typical duration of PG accommodation that they intended to have on their website. The challenge though was if the contract is signed for a longer duration but the tenant moves out earlier how would they monitor it?

Thus, if the underlying transaction of renting of PG accommodation was not taxable (being provision of a residential dwelling), the only amount subject to service tax is the commission retained by the website from the rental income.

Separately, if the underlying transaction was subject to service tax, the discussions also revolved around the concept of “aggregator of service” that was introduced by the Finance Act, 2015.  The term “Aggregator” has been defined as follows:

‘Aggregator’ means a person, who owns and manages a web based software application, and by means of the application and a communication device, enables a potential customer to connect with persons providing service of a particular kind under the brand name or trade name of the aggregator

Thus, by virtue of the above definition, a company like Uber that owns a web based software App and which through a mobile device enables a customer to connect with persons providing the service (i.e. cab drivers) and where the service is provided under the brand ‘Uber’, is now obliged to pay service tax on the amounts collected from the cab drivers.  The relevant amendment has been made in the Rules allowing Aggregator to pay such tax under the reverse charge mechanism.

The whole idea to introduce the concept of aggregator of service was to ensure that taxable service which were hitherto not getting taxed since it was not possible to catch hold of individual cab drivers was taxed in the hand of the app aggregator.  However, it was critical that the service was being provided under the brand name of the website.

In our case, we discussed whether the residential dwelling owners who were providing PG accommodation to tenants were doing it under their own brand or were they going to use the brand name of the website.  If the brand was to be the one used by the website then there is a possibility of entire amount collected by the website to be subject to service tax.  This is because the law specifically mandates the aggregator of the service to collect and deposit tax on behalf of the individual service providers.

The questions that were therefore, important for the website provider to consider were:

  1. Whether they intend to use their own brand name and promote the website, something similar to oyorooms.com
  1. Who is going to issue the invoice? Generally, in an aggregator kind of service, the aggregator issues the invoice and not the individual service provider
  1. Does the PG accommodation owner have a brand under which it operates? Because, if they have a brand then technically, the concept of aggregator should not kick in.

These were some of the interesting discussions we had with the website owner and we agreed to meet again once the answers to the above questions were ready.  It is indeed interesting how service tax has got so complicated and this was the tax that was supposed to be the least complicated.

Hopefully, under the GST regime we may have larger clarity.