Written by Manav Chakraborty.

The interpretation and application of exemption notifications in fiscal statutes have long been a contentious battleground between the revenue authorities and the taxpayers regarding various aspects. In the realm of Goods and Services Tax (“GST”) or more broadly, indirect taxation, this dispute has increasingly gained a substantial presence in the real estate sector, focusing specifically on the key difference between commercial and residential properties. The fundamental policy impinging taxation statutes with regard to real estate properties has always been to insulate and protect residential dwellings from the onerous burden of consumption taxes governing commercial real estate activities.

The recent Supreme Court (“SC”) judgment in State of Karnataka v. Taghar Vasudeva Ambrish (“Taghar Vasudeva”) adjudicated upon intricate questions concerning the classification of residential dwelling, the activity-centric characterization of supplies under the Goods and Services Tax (GST) regime, and the invocation of the beneficial purpose doctrine. This article undertakes a critical analysis of the legislative response to this judicial development, specifically examining how the amendments introduced in 2022 have effectively attenuated the judgment’s prospective relief. Furthermore, it argues that these regulatory interventions have inadvertently resurrected the cascading effect of taxation, a systemic economic distortion that the enactment of The Central Goods and Services Tax Act, 2017 (“CGST”), was fundamentally designed to expunge.

FACTS AND THE RULING

The genesis of the dispute in this case primarily revolved around the interpretation of Entry 13 of Notification No. 9/2017-Integrated Tax (Rate), (“prior notification”), which exempted “services by way of renting of residential dwelling for use as residence.” The respondent, a co-owner of a substantial property in Bangalore comprising 42 rooms, leased the premises to M/s DTwelve Spaces Private Limited. This lessee, a commercial aggregator, subsequently sub-leased the rooms to students and working professionals for long-term accommodation (3 to 12 months). The Authority for Advance Ruling (“AAR”) and the Appellate Authority (“AAAR”) denied the exemption, reasoning that the lessee was a corporate entity incapable of residing in the property, and that the scale of the operation (42 rooms) rendered it a commercial hostel rather than a residential dwelling.

However, the Apex Court overturned this ruling, holding firstly that Entry 13 is an activity-specific exemption, where the benefit is attached to the nature of the activity rather than the person engaging in the activity. This, in turn, meant that it did not affect whether the entity renting out the property was a lessee rather than the legal owner of that specific real estate. In furtherance of this, the Court also ruled that the ultimate use of the property by the students and working professionals satisfied the condition of use as residence. They held that the interposition of a corporate lessee did not break the chain of residential use and refuted the contention of the Revenue that requiring the lessee itself to reside in the premises was basically reading non-existent conditions into the notification, effectively rewriting the law. At the same time, the Court took note of the 2022 amendments withdrawing the exemption where the recipient is a registered person, but confined its holding to clarifying that this legislative change operated prospectively and could not be relied upon to retrospectively deny the benefit for the pre-amendment period.

THE RESURRECTION OF THE CASCADING EFFECT

While the judgement in Taghar Vasudeva provided much sought after relief to the petitioners and other landlords, its prospective impact has been severely blunted, if not entirely negated, by the legislative amendments introduced by the Government of India in July 2022, modifying some key attributes of the prior notification. This amendment withdrew the exemption for renting residential dwellings when the recipient is a “registered person” under GST, thereby inadvertently resurrecting the “cascading effect”, the very economic distortion that the GST regime was architected to eliminate. The cascading effect refers to the situation where a tax is levied on another tax, increasing the overall tax burden on goods or services. It means the tax is calculated on the price which already includes tax from previous stages, causing “tax on tax”, leading to an eventual inflated price borne primarily by the consumers.

The theoretical premise underpinning GST was to create a seamless flow of Input Tax Credit (ITC) across the supply chain, ensuring that tax is levied only on value addition and that business intermediaries remain tax neutral. However, post the 2022 amendments, the current governance structure for intermediated residential renting suffered a huge structural change as now a hostel operator or aggregator (who is invariably a “registered person”) must pay 18% GST under the Reverse Charge Mechanism (RCM) on the rent paid to the landlord. This constitutes the input leg of the transaction, but it is the output leg when the aggregator rents these units to students does the distortion arise. If the monthly rent is below ₹20,000 per person and for a period exceeding 90 days, the output service is exempt under the newly inserted Entry 12AA of the prior notification. Now herein lies the structural trap: Section 17(2) of the CGST Act mandates that input tax credit cannot be claimed for goods or services used to make exempt supplies.

Consequently, as a result of this provision, the 18% tax paid by the aggregator to the landlord becomes a blocked credit which ceases to act as a pass-through tax and transforms into a burdensome cost for the businesses. Thereby, as a result of these increased prices, the operator in order to ensure economic viability, is forced to embed this 18% cost into the rent charged to the student. Therefore, the student or the working professional ends up paying an inflated amount on their rent charge due to the cascading effect, which directly runs counter to the legislative intent of the exemption, something recognised in the Taghar Vasudeva judgement also.

While the Supreme Court in Taghar Vasudeva acknowledged the legislative pivot introduced by the 2022 amendment, the judgment remained conspicuously silent on the resultant economic distortions, most notably the cascading effect and its future impacts. The bench confined its judicial scrutiny strictly to the temporal applicability of the notification, ruling that the withdrawal of the exemption for registered persons could not be enforced retrospectively to the prejudice of the taxpayer, as argued by the Revenue.

COMPARATIVE VIEWPOINTS

To remedy this structural anomaly, Indian policymakers can look to other foreign VAT/GST jurisdictions that have successfully managed to harmonize the taxation of residential intermediaries in their system by implementing mechanisms that preserve the input tax credit chain while shielding the ultimate consumer.

The Australian New Tax System (Goods and Services Tax) Act 1999 offers a very robust solution through its distinction between ‘Residential Premises’ and ‘Commercial Residential Premises.’ Under this particular legislation, premises that function as hostels, boarding houses, or student accommodation are classified as Commercial Residential Premises. The supply of such premises, even on a lease basis, is taxable, which basically allows the operator to claim full input tax credits on the rent paid to the landlord and on construction costs. Further, to protect long term residents from the burden of high taxes, a concessional treatment is granted where GST is levied on only 50% of the value for stays exceeding 28 days. Such a model is successful in achieving the dual goal of maintaining the credit chain for the business while reducing the tax burden for the resident.

The United Kingdom offers another interesting approach through its Value Added Tax (VAT) system, which addresses this issue through the “Option to Tax” mechanism. Under this system, residential renting is generally exempted, however, a landlord of a commercial or mixed-use property can choose to “opt to tax,” thereby waiving the exemption. By doing so, the landlord charges VAT on the rent, which allows them to recover the input VAT incurred on construction and maintenance charges. Furthermore, in cases involving Rent-to-Rent schemes similar to the facts in Taghar, the UK tribunals and Courts have focused in on whether the service has been materially altered. If an intermediary transforms a passive residential lease into a serviced accommodation business, the supply becomes taxable, which ensures that the business pays tax on its value addition, and credit flows seamlessly through the chain.

Both the approaches demonstrate that the core weakness in the Indian GST framework lies not in taxing residential intermediaries per se, but in the absence of a mechanism that links taxability to functional commercial use while preserving the input tax credit chain. The Australian model would be more viable in India because its rule-based, categorical treatment of commercial residential premises offers certainty, limits discretion, particularly valuable in a high-litigation, compliance-heavy system like India’s. By contrast, while the UK’s option-to-tax and substance-over-form jurisprudence effectively targets value addition, its reliance on elective taxation and intensive factual adjudication may exacerbate inconsistency and disputes if transplanted into the Indian context.

CONCLUSION

Accordingly, while the judgement correctly affirms the activity-centric nature of residential renting exemption, the 2022 amendment has substantially neutralised this judicial relief by reintroducing input tax blockage for registered intermediaries. Remedying these structural distortions arising from the current framework must become a legislative priority for our lawmakers. The GST regime was envisaged as a decisive departure from the fragmented and cascading tax architecture that characterised the pre-GST regime, and the resurgence of this issue would only create new economic inefficiencies and defeat the protective policy objective underlying the exemption for residential dwellings. Comparative experiences from foreign jurisdictions show that carefully calibrated classifications and valuation models can preserve credit neutrality for businesses while insulating end-users from regressive tax incidence.