This article was originally published in The Euromoney Corporate Tax Handbook 2007. For further information, please visit www.euromoneyyearbooks.com/handbooks
Unlike many countries which have a uniform goods and services tax (GST), India has a separate tax on sale of goods in the form of VAT or sales tax and a separate tax on provision of services in the form of service tax. Service tax was introduced in India under Chapter V of the Finance Act, 19941 (the Act) and still continues to be governed by that Act as amended from time to time by subsequent Finance Acts. There is no separate enactment governing service tax. Service tax is constantly developing in accordance with changing tax rates, the number and scope of services falling within the taxability net, new rules, circulars and notifications being framed and issued. Thus in dealing with service tax, various issues arise at every stage of the determination of service tax liability, for instance, whether a service is taxable, who is liable to pay service tax and which services are exempt. Some of these issues are discussed below.
When is a service taxable?
Although the Act does not define the term service, it provides an exhaustive list of services that are taxable services under section 65(105) of the Act and only these services are subject to the levy of service tax. All other services not included in the list of taxable services are exempt from service tax. Presently there are about 100 services which are chargeable to service tax, many of these having various sub-categories. Most services are taxable, with notable exceptions including legal services, print media, ocean transport, education and medical services. Further, in respect of each taxable service, definitions have been provided elaborating which type of services would come within the ambit of that taxable service and which services are excluded. For instance, in the case of intellectual property service provided by the holder of intellectual property right, the definition of intellectual property right clearly excludes copyright, and services in relation to copyright would therefore not be taxable. Similarly in the case of sponsorship service, sponsorship of sports events is expressly excluded from the scope of the service tax.
Some general exemptions are provided in respect of:
- services provided to the United Nations;
- services to units in and developers of Special Economic Zones;
- services rendered free of cost; and
- services prior to the effective date of the service being included as a taxable service, even if payments are realised later.
If taxable, how is the service classified?
Section 65A of the Act provides the rules for classification of services in cases of both single and multiple supplies and provides that where a taxable service is prima facie taxable under two or more categories, the basic principles of classification are as follows:
- the category which provides the most specific description is preferred to a category providing a more general description;
- composite services consisting of a combination of different services, which cannot be classified as above, are to be classified under the category which gives them their essential character; and
- where the above two methods fail, the classification is to be under the category which occurs first in the statute i.e. which defines taxable service amongst those categories which merit equal consideration. Although the rate of service tax applicable to all taxable services is the same, classification becomes important for various reasons, for example the effective date of the service becoming taxable and the applicability of special notified exemptions.
How are rates and values determined?
The rate of service tax started at 5% and has been gradually increasing over the years. Currently effective from April 18, 2006, service tax is levied at the rate of 12.24% (12% base rate plus 2% education cess) on the value of taxable services. However, since service tax is chargeable on the value of the taxable service, there is no tax payable on a service provided free of cost. Though the value of service is most readily determined in financial terms, it can also be judged where the consideration is in kind or not ascertainable under section 67 of the Act. Rules have been prescribed for the determination of value of the service where the whole or part of the consideration is in kind, called the Service Tax (Determination of Value) Rules, 2006.
Who is liable to and how can you obtain registration?
Although, service tax is an indirect tax, the liability to pay is primarily placed upon the service provider. In practice, the service provider shifts this burden on the service recipient by charging the service tax amount in the invoice raised for the services provided. This liability to pay service tax is reversed towards the service recipient under the reverse charge mechanism, in case of import of service (discussed below), which makes the service recipient liable to pay service tax. The person liable to pay service tax is required to apply for registration to the service tax authorities within 30 days from the date of commencement of the business of providing the taxable service.
When can input tax credit be claimed?
In India, input tax credit is referred to as CENVAT credit and is dealt with under the CENVAT Credit Rules, 2004 (CENVAT Rules). The CENVAT Rules apply to all taxable services, irrespective of the category of taxable services. CENVAT credit is admissible to a manufacturer who produces taxable goods and to a service provider who provides a taxable output service. A service provider is eligible to claim CENVAT credit on the duty paid on inputs and capital goods, and service tax paid on input services used for providing output services. Since the objective of CENVAT credit is to prevent the cascading effect of taxation, there can be no claim of CENVAT credit in cases where the output is exempted i.e. where the service is not a taxable service, or is exempted. Detailed rules have been framed with regard to the time at which CENVAT credit can be used and the amount availed depends on whether the CENVAT credit is claimed for inputs, capital goods or input services and also in cases of composite services i.e. when a taxable service and a non-taxable service are being provided by the same service provider.
What about import service taxes?
Import of services has been made subject to the reverse charge mechanism in certain cases under section 66A of the Act read with the Taxation of Services (provided from outside India and received in India) Rules, 1994 (Import Rules). The reverse charge mechanism would apply to a taxable service if:
- the service is provided by a person who has established a business from which the service is provided, in a country outside India; and
- is received by a person who has his place of business, fixed establishment, permanent address or usual place of residence, in India.
The above taxable service is to be treated as if the service recipient had himself provided the service in India, and accordingly all the provisions of Chapter V of the Act are to apply. Under the Import Rules the services are categorised into three sections and are taxed if the conditions in respect of each category are fulfilled as under:
- in respect of the services provided in relation to immovable property, the property must be situated in India;
- in respect of performance related services, the services must be wholly or partly performed in India; and
- in respect of other services, the services must be received by a recipient located in India for use in relation to business or commerce.
Taxability in case of export of service
There is no tax liability in case of export of service, if it meets the various conditions prescribed under the Export of Services Rules, 2005 (Export Rules) as follows:
- the service must be delivered outside India and used outside India; and
- the payment for the service is received by the service provider in convertible foreign exchange.
In addition to the above, category based conditions have also been laid out:
- in respect of the services provided in relation to immovable property, the property must be situated outside India;
- in respect of performance related services, the services must be wholly or partly performed outside India; and
- in respect of other services provided in relation to business or commerce, the services must be received by a recipient located outside India.
The Export Rules also provide a rebate of the whole of the excise duty paid on excisable inputs, or the whole of service tax and cess paid on all taxable input services used in providing taxable service exported subject to certain conditions.
The service tax provisions are thus not as complex as they may appear to be.
- The Finance Acts are acts which are passed every year to amend or introduce provisions relating to the levy of both direct as well as indirect taxes.
- Duty paid on manufactured goods.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.