A senior finance ministry official on Thursday said there was no reason to exempt

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from service tax payments made to builders during the period of construction, a proposal made during the budget for 2010/11.

The Union Budget announced on Friday clarified that realty developers must pay service tax on payments made to them during the period of construction, a move which the developers said would raise home prices and crimp demand. But Revenue Secretary Sunil Mitra said the proposal would not hike prices by more than 3.5 percent, an increase that could be afforded by the customers.

"Construction is a service. As a service, there is no reason why it should not be taxed," Mitra told a business conference. "It is only 3 percent or 3.5 percent that gets added up (for the buyer)."

The new rule, which will take effect when parliament approves the budget, says service tax would be imposed if payments were made before the completion of construction.

Most realtors charge customers in instalments during the construction period, which gives them a steady stream of funds for building and ensures there is no pile-up of unsold houses.