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- Preamble
This aspect of the Service Tax law
is quite new and the law itself is evolving. The subject too is very
wide and there are many gray areas, especially in view of the intangible
character of services. The approach adopted in this article is not to
reproduce all the provisions of the law but to give an overview of the
input tax credit mechanism and highlight some of the important issues
and concerns.
- Rationale
The Government has reiterated time and again that Service Tax is
the tax of the future. With increasing globalisation and WTO influence,
we need to bring in Value Added Tax (VAT) in its truest sense. Input
tax credit (ITC) mechanism under the service tax law is a step in that
direction, with the following benefits:
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Reducing cascading impact of
tax
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Increasing competitiveness of
service sector
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Increasing tax compliance level
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Bringing in transparency
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Reducing disputes in administration
of service tax – especially when it is under the siege of peculiar
features like intangible character of services, large groups of
unorganized service providers scattered across the country, intermediate
nature of services, low level of education of service providers
etc.
- Genesis
Many a times one
or more services are received and consumed (i.e., used) in rendering
other services or in manufacturing /selling goods. In a full-fledged
VAT system, full credit is allowed for tax paid on such consumption
of services – be it for manufacture/trading of goods or for rendering
of services.
A road map for a full-fledged VAT
system at the level of the Central Government, was drawn in early
1990’s by the Tax Reforms Committee headed by Dr. Raja Chelliah on
the following lines:
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Indirect taxation at the Central
level should in course of time cover goods and services
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Tax should be levied on services
that enter into the productive process
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As
Central Excise Duties on goods would get gradually transformed
into a Value Added Tax at the manufacturing level (as is the case
under CENVAT1 regime), service tax would get woven
into that system
Task Force on Indirect Taxes headed
by Dr. Kelkar which submitted its recommendations in October 2002, also,
in essence, reiterated this road map.
Modest beginning was made in this direction,
when ITC within same categories of taxable services was allowed for
the first time in the Service Tax regime, with the introduction of the
Service Tax Credit Rules, 2002 with effect from 16th August, 2002. In
less than one year thereafter, with effect from 14th May, 2003, such
ITC was allowed across all categories of taxable services to make the
Service Tax regime a full-fledged VAT system within itself. Also, Finance
Act, 2003, has empowered the Central Government to make rules that may
provide for inter-sectoral credit between service tax and CENVAT.
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Mechanics
of ITC
This is explained in the following simplistic illustration:
ABC provides management consultancy
services (output service) for a fee of Rs. 100 (current applicable
rate of service tax being 8%). ABC consumes other services like services
of other management consultant XYZ, telephone services, courier services
etc. (input services) for rendering its consultancy services. ABC
has paid Rs. 25 for these input services along with Rs. 2 (i.e., 8%
on Rs. 25) as service tax (Input Service Tax). Total Service Tax burden
on ABC would be as under where ITC is allowed to ABC for the Input
Service Tax:
| |
Rs. |
| Value
of Input Services consumed by ABC |
25 |
| Add:
Value of ABC’s own services; i.e., value addition |
75 |
| Total
value of Output Service of ABC |
100 |
| Output
Service Tax @8% on Rs. 100 |
8 |
| Less:
Input Service Tax paid by ABC on input services
|
2 |
| Net
tax payable by ABC on Output Service |
6 |
| Total
Service Tax burden on ABC (Rs. 2 + Rs. 6) |
8 |
In effect, ABC would pay service
tax only on the value added by it viz. Rs. 75 (i.e. Rs.6 = 8% of Rs.
75). In case ITC is not allowed, ABC would pay service tax twice on
the input service of Rs. 25 – once, when it pays Rs. 2 to the input
service providers and again, when it pays Rs. 8 as service tax on
the value of its output service (i.e. Rs. 100). It is to avoid such
cascading effect of taxation that ITC is allowed in a Service Tax
regime.
- Service Tax Credit Rules, 2002
Service Tax Credit Rules, 2002 as amended from time to time deal
with the ITC mechanism under the Service Tax regime. Some of its important
legal provisions are:
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Definition of ‘output service’
and ‘input service’ [Rule 2]
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‘output service’ means
any service (i.e., including a service which is not a taxable
service)2 rendered by the service provider
to a customer, client, subscriber, policy holder or any other
person, as the case may be
Essentially therefore, output service could be any service
– taxable, non-taxable or exempt. But it certainly cannot
be a ‘manufacturing’ or a ‘trading’ activity.
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‘input service’ means any
taxable service received and consumed by a service provider
in relation to rendering of output service.
Essential ingredients of ‘input service’ therefore, are:
– it must be a taxable service
– received and consumed by a service provider
– in relation to rendering of output service
What does ‘received and consumed’ and ‘in relation to’ mean?
‘Received’ should mean ‘taking or accepting’ the service.
‘Consumed’ should mean ‘used’.
However, interpreting ‘in relation to’ raises an issue – to
what extent/degree is the nexus between the input service
and the output service required, keeping in view the phrase
‘received and consumed’?
Finding an answer to this question
poses a challenge especially in case of input services which are
primarily overhead expenses, like audit fees, security agency’s
services and maintenance or repair services.
Cue for this can be available
from the CENVAT Credit Rules, 2002 where the credit is allowed
for excise duty paid on ‘inputs’ (and capital goods) to a manufacturer
of final products. ‘Inputs’ for this purpose is defined to mean
all goods (except specified goods) ‘used in or in relation to’
the manufacture of final products ‘whether directly or indirectly’
and whether contained in the final product or not and includes
certain specified goods. Also, no one-to-one correlation is required
between the inputs and the final products.
In case of the definition of
‘input service’, the words ‘used in’ and ‘whether directly or
indirectly’ are absent – the only qualifying words being ‘in relation
to’. It is pertinent to note that if the phrase ‘in relation to’
were to be replaced by the word ‘for’, probably, the meaning would
be more restrictive; i.e., the nexus between the input service
and the output service would be required to be closer. Also, the
Supreme Court has interpreted this phrase ‘in relation to’ in
the case of Doypack Systems Pvt. Ltd.3 as under:
"The expression ‘in relation to’
is a very broad expression, which pre-supposes another subject matter.
These are words of comprehensiveness, which might both have a direct
significance as well as an indirect significance depending on
the context"
(emphasis supplied)
In the Service Tax law itself,
the phrases ‘in relation to’ and ‘in connection with’ have been
used at many places, especially while defining various terms in
Section 2. In some cases, further qualifying expressions like ‘in
any manner’, ‘either directly or indirectly’ have also been used
in conjunction with the ‘in relation to’/‘in connection with’.
Keeping all this in view, it appears
that in the context of ITC, ‘in relation to’ may be given neither
too wide nor too narrow a meaning. At the same time, no one-to-one
correlation needs to be established between the input service and
the output service – this is neither intended nor is it practical.
Nevertheless, each individual input service would need specific
examination vis-à-vis the output service, to determine whether to
claim credit for service tax paid on such input service or not.
Common sense practical approach, which would keep the spirit of
the law in mind, rather than a technical, and purely legal approach,
could help arrive at an acceptable solution.
- Input service relating to exempt or
non-taxable output service [Rule 3]
No service tax credit is allowable on input service received
and consumed in relation to rendering of such output service which
is either fully exempt or is not a taxable service, except in the
circumstances mentioned in Rules 3(4) and 3(5).
The exceptions in Rules 3(4)
and 3(5) deal with cases where the output service provider renders
a mix of output services – taxable services chargeable to tax,
exempt services and non-taxable services. In which case, the output
service provider has two options to claim ITC:
- Option 1 [Rule 3(4)] –
to maintain separate accounts for receipt and consumption of
input services meant for consumption in relation to rendering
output services which are chargeable to service tax and those
which are in relation to exempt or non-taxable services.
In this case, ITC will be available only on that portion of
input service which is intended for use in relation to output
service chargeable to service tax. Hence, no ITC would be available
on that portion of input service, which is intended for use
in relation to output services, which are exempt or non-taxable.
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Option 2 [Rule 3(5)]
– not to maintain such separate accounts
In this case, ITC will be available at the lower of the actual
input tax or 35% of the service tax payable on the output
service chargeable to tax. An issue that needs examination
in this context is, if there is unutilised balance of ITC
after exercising Option 2, can the same be carried forward?
If yes, up to what period? One view could be that such carry
forward is permissible for an indefinite period considering
the provisions of the Rules and the prescribed Form for ITC.
A combined reading of Rules 3(3),
3(4) and 3(5) indicates that in essence, the intent and spirit
of the law appears not to allow credit where an input service
is clearly identifiable with an exempt or non-taxable output service.
However, where such identification is not possible, Option 2 can
be exercised and the service provider can claim ITC on such input
service. At times, exercising Option 2 may be more beneficial
than Option 1. This decision would primarily depend on the nature
of input services and the costs and efforts involved in maintaining
separate accounts as required under Option 1.
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ITC not available on
mobile phones [Rule 3(6)]
ITC on telephone services received and consumed is allowable
only for telephone connections installed in the premises from
where output service is provided. CBEC has clarified4 that
service tax paid on mobile phones would not be eligible for ITC.
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ITC concerning non-resident
service providers
Where a service provider is non-resident or from outside India
and he does not have any office in India, the obligation to pay
service tax on taxable service rendered by such service provider
is on the service recipient. CBEC has clarified4 that
such service tax paid by the service recipient can be claimed
by him as ITC on the basis of document/bill/invoice under which
he has paid the same.
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Time limit for claiming
and utilising ITC
No time limit is prescribed within which ITC should be ‘claimed’
(i.e. ‘availed’) and ‘utilised’. However, so far as
time limit for ‘claiming’ ITC is concerned, one view is that it
should be claimed within a reasonable period. This view is based
on the decision of CEGAT (now known as CESTAT) in the case of
Mysore Lac and Paint Works Ltd.5, where it was held
that in the absence of any specific provision in the Central Excise
Rules for short MODVAT credit taken by an assessee, such credit
can be taken within a reasonable time, and such reasonable time
could be six months, in view of the provisions of refund under
section 11B of the Central Excise Act, 1944. Since then, this
period of six months stands amended to one year. Hence, one year
appears to be reasonable period to ‘claim’ ITC. In any event,
as far as ‘utilisation’ of such ITC is concerned, it can be done
at any time.
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Obligation of output
service provider to ensure service tax is paid by input service
provider
Rule 5(2) provides that output service provider availing (i.e.,
claiming) ITC (person claiming ITC) should take reasonable steps
to ensure that input service provider has paid the service tax
indicated in the document on the basis of which output service
provider claims ITC. It further provides that if the person claiming
ITC has satisfied himself about the identity and address of the
input service provider and that details regarding description
and value of the input service have been correctly furnished in
the documents, the person claiming ITC would be deemed to have
taken resonable steps.
However, there is no specific
relief available to such person even if such reasonable steps
are deemed to have been taken and service tax not paid by the
input service provider would still be recoverable with interest
from the person claiming ITC (Rule 6). This provision seems to
be unfair. How can output service provider who has paid the value
of the service to the input service provider be held responsible
for paying the service tax liability of the latter if the latter
has not discharged the same? So long as the output service provider
is in possession of a document issued by the input service provider
giving the prescribed particulars, output service provider should
not be penalised for the default of the input service provider.
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Other important provisions
Some of the other important provisions concerning ITC are:
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Invoice or bill or challan
issued by the input service provider must clearly indicate
its serial number, date of issue, description and value of
input service, service tax paid/payable, service tax registration
number and address of input service provider
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ITC is available only after
payment is made for value of input service
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No refund of ITC is allowed
under any circumstances
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A return in the prescribed
Form [Rule 5(4)] should be filed in respect of ITC along with
half-yearly service tax return in Form ST-3.
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Output service provider should
maintain proper records containing prescribed particulars,
viz. serial number and date of document on which ITC is availed,
service tax registration number and name of input service
provider, description and value of input service, ITC availed
and ITC utilised for payment of service tax on output service.
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Burden of proof regarding
admissibility of ITC lies on the person taking such credit
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Balance ITC lying unutilised
with a service provider can be transferred to the successor,
if the output service provider shifts his establishment to
another site or his establishment is transferred on account
of change in ownership on account of sale, merger, amalgamation,
lease or transfer of establishment to a joint venture subject
to certain conditions.
- Exempt services and
ITC
Certain services are currently exempt from Service Tax6.
Also, there is a move not to charge service tax on services which
are exported. In the absence of refund mechanism under the current
ITC regime, providers of such services will end up paying service
tax on input services. This may affect their competitiveness vis-à-vis
output service providers who are able to claim ITC. There is therefore,
a need to prescribe ‘zero rate’ of service tax for these services
instead of making them ‘exempt’ or ‘free from tax’ and allow them
ITC with consequential provisions allowing claim for refund.
- Some other teasers
Some of the other crucial issues concerning ITC that need to
be resolved or clarified are:
- Do earlier dispensations of the service
tax authorities7 to the effect that a sub-service
provider who is within the same category as the main service
provider need not charge service tax to the main service provider,
still remain valid after 14th May, 2003?
- Can an output service provider opt for Option
1 for some time and then for Option 2? If yes, when and under
what circumstances can he switch over?
- Whether an assessee who has a manufacturing
/trading division as also a service division can claim ITC on
common input services received and consumed by both the divisions
if it does not maintain separate accounts? If yes, how?
- When payment for an input service is made
by a person other than the service recipient (for example, Head
Office making payment on behalf of Branch Office), will service
recipient be eligible to claim ITC?
- Can an output service provider selecting
Option 2, decide to claim ITC selectively by leaving out certain
input services altogether?
- Future scenario
The way Service Tax regime is evolving, it appears that time is
not far when excise duty paid on goods used for providing a taxable
service would also be allowed as ITC against service tax liability.
When this happens, at least at the Central level, burden of indirect
taxation on service consumers would get mitigated with removal of cascading
effect of Central level indirect taxation. This may however, be coupled
with differential service tax rate structure or higher rates of service
tax.
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Central Value Added Tax - erstwhile
Central Excise Duty, levied on manufacture of goods
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With effect from 14 May, 2003,
in view of Service Tax Credit (Second Amendment) Rules, 2003
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Doypack Systems Pvt. Ltd. vs.
Union of India [1988 (36) ELT 201 (SC)]
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Circular No. 59/8/2003 dated 20
June 2003
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Collector of Central Excise vs.
Mysore Lac and Paint Works Ltd. [1991 (52) ELT 590 – Trib]
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For example, services for which
payments are received in convertible foreign exchange, software development
services, services provided to SEZ units/developers, services provided
to UN/international organisations
- In the context of courier service, custom house
agent’s service, market research agency’s service, architect’s service,
interior decorator’s service etc.
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