VIP Road Chartered Accountants Association

Some Controversies

Background

Service tax is a law, which is more administered through circulars than through legal provisions. While circulars are generally expected to clarify the legal provision, at times, one finds that the circulars under service tax do more than just that – they try to lay down the legal position. While doing so, they also transgress on what has been legally laid down and hence do exactly the contrary of what is expected – create more controversies. This article attempts to analyse few such controversies and the author’s opinion on the said controversy. One should however note that the very term "controversy" implies that two opinions are possible!
Statutory position of a circular

As already stated, a circular can clarify the position laid down by the law. It cannot lay down a law.¹ It is well accepted that a Circular cannot take away a benefit granted by the law or levy a tax on something which is not taxable. This position has in fact been accepted by the Board itself.² In the same perspective, in theory, it cannot confer an exemption which is not apparent from the law. In practice, however, such benefits are generally granted. They cannot be protested by the Department as they bind the lower authorities.³ The trade does not protest as it benefits and hence such extra-jurisdictional circulars continue to hold good.

Circulars are at times subject to correction and cannot be taken as sacrosanct. In many situations in the past, the Board has corrected its stand as regards the tax implications conveyed by a circular. Consider for example, the delayed payment surcharge levied by telephone authorities⁴. Also consider the recent example of erection, commissioning and installation activities.⁵

In some cases, though highly undesirable, contrary circulars/clarifications are issued on the same matter. The question whether insurance surveyors were covered under "consulting engineers" was answered in the negative vide Circular No. 34/2001 dated 30-4-2001. However, the FAQs issued by the Department seem to suggest otherwise.⁶

The principle that a circular cannot lay down a law also implies that if a particular Circular states a principle which is unstated in the law or is contrary thereto, such a principle can be applied only to the instance to which it relates and cannot be transported to similar situations elsewhere. Principles/clarifications issued in respect of certain specific service need not apply in similar situations in other services unless a similar clarification is issued in respect of the other service as well.

To elucidate this aspect from a historical perspective, consider the situation of levy of service tax on health clubs and fitness centres w.e.f. 16-8-2002. The CBEC clarified that if the health club receives yearly membership fees in advance, no service tax would be attracted on such membership fees already collected prior to the date on which the new service tax came into force⁷. However, in an analogous situation relating to commercial training and coaching centres, the Board took a diametrically opposite stand by suggesting that if the fees are realized in advance, service tax shall be attracted on amounts attributable to periods after 1-7-2003⁸.

Similarly, the reason attributed for claiming a certain transaction to be non-taxable might also change from service to service. For example, when port services were made taxable, the scope of coverage was only "services in relation to goods or vessels". Therefore, it was clarified that lease rentals would not be taxable as they were not for services in relation to goods or vessels⁹. In the current budget, airport services are made taxable. However, the scope of coverage is "services". The Department clarification now suggests that lease rentals would not be taxable as letting out of premises is not a service!¹⁰
Commercial concern – Whether it excludes individuals (especially in the context of Business Auxiliary Service)

The definitions of the taxable service under many service categories provide that only services provided by "a commercial concern" are taxable. The term "commercial concern" is not defined. The plain meaning of commercial concern would be a business organization operating with a profit motive.

In the context of "commissioning and installation" (C & I) services, a notification grants an exemption for services rendered by agencies other than "commercial concerns"¹¹ This notification has been interpreted by the CBEC to mean that services provided by an individual would be exempted from service tax.¹²

The definition of taxable service for "business auxiliary service (BAS)" specifies that services provided by a commercial concern are taxable.¹³ Since the scope of BAS is very wide, an issue has arisen whether the interpretation rendered in the context of C & I Agency be extended to the BAS and accordingly, whether individual agents would be exempted from the service tax purview. No clarifications have been issued by the CBEC directly on this issue ‘qua’ BAS. The perils of blindly transporting the interpretation in the case of C & I Agency have been already highlighted in para 2 above. Hence this issue should be examined on the merits rather than the existing circular.

The issue here is whether an individual can be considered as a commercial concern. The term "commercial" refers to a profit motive which cannot be denied in the present instance. As such, the issue is whether an individual can be considered as a "concern" or "an organization". The answer to this question will largely depend on facts as the line of demarcation is very thin. In many cases, the individual would be operating under a trade name, would have a number of employees working with him, would be claiming a reasonable proportion of his gross receipts as "business expenses" under the Income Tax. All these factors would point towards the existence of a "concern" or an organization. In the present day context, when most of the business happens through the modern communication methods like internet and mobile phones, it is difficult to negative the argument that an individual can constitute a "commercial concern".

A consulting engineer is defined to ‘mean’ a professionally qualified engineer or an engineering firm.¹⁴ The question whether the term "firm" can include a company was posed before the Karnataka High Court¹⁵. The Court emphasized that the Act aims at levying a tax on services regardless of whether they are provided by a natural or a juristic person. The Court even went ahead to observe as under:

"The question in essence is whether the scheme of the Act makes any distinction between services rendered or provided by individuals and partnership concerns on the one hand and incorporated companies on the other. The answer has to be in the negative. As noticed earlier, the Act aims at levying a tax on the services declared taxable regardless whether the same are provided by a natural or a juristic person. There is no distinction under the Act between the provider of a service, who is an individual, a partnership concern or an incorporated company. The liability to pay tax on the service provided falls uniformly on all the three, provided the service is of a kind that has been declared taxable under section 65(48) of the Act. It is true that the definition of the expression ‘consulting engineer’ could have included the term ‘company’ to set the entire controversy at rest, but the very fact that a company providing technical assistance in any discipline is not included in the definition of the expression ‘consulting engineer’ would not ipso facto mean that service rendered by such company cannot be considered taxable".

To conclude this issue, it is the author’s personal opinion that unless a specific circular is issued for exempting individuals under the BAS, taking a view that they are exempt can lead to substantial litigation.
Sub-contracting principle – Position up to 10-9-2004

Sub-contracting assignments within the same service category are considered outside the purview of service tax as the CBEC interprets the words "client" or "customer" in the definition clause to imply an actual consumer of services. This exemption again stems from circulars rather than any provision of the law or notification.¹⁶

It should also be noted that such a clarification is not given in respect of all the services in the circulars issued by the Central Board of Excise and Customs. However, the Directorate General of Service Tax has clarified that this benefit of sub-contracting shall be applicable in respect of all the services.¹⁷

After the introduction of the input tax credit with effect from 16-8-2002, there were some doubts on the applicability of the abovementioned circulars. These doubts had been raised on the plea that the above circulars attempted to mitigate double taxation. The same seem to be unfounded due to the simple reason that the circulars did not cite such a reason for interpretation. The assessees can also seek shelter from the fact that the Department had reiterated its stand on the exemption for sub-contractors in the Frequently Asked Question Series published by them. Refer the answer to Q. 2.3 in relation to maintenance and repairs services, which has been notified as a taxable service subsequent to the notification of the input tax credit rules.

The above interpretation is also in congruence with the principle of service tax being a destination based consumption tax.¹⁸ It can be equated with the last point single tax concept under sales tax. Thus if A enters into a maintenance contract with B and later on A sub-contracts the same to C, the maintenance services are ‘consumed’ by B and hence the consumption of B (which is the billing of A) should be liable to service tax and all prior transactions should be exempted as being in the nature of sub-contracts. Also, in this situation, A has never consumed the maintenance services rendered by C and hence the transaction between A and C should not attract service tax.
Sub-contracting principle – Position since 10-9-2004

The Finance (No. 2) Act, 2004 has amended the definition of business auxiliary service to include a new sub-category "provision of service on behalf of the client" within the purview of taxable service.¹⁹ Doubts are therefore again raised on the validity of the abovementioned principle of sub-contractor’s liability. While the circulars granting the benefits are not withdrawn, one needs to re-concile the new definition with the existing circulars.

Taking the same example forward, the maintenance services continue to be ‘consumed’ by B with a consequent liability on A. However, now A has also consumed the BAS service of "provision of service on behalf of the client" rendered by C with a consequent liability on C (not as "maintenance service" but as "business auxiliary service"). Of course, this interpretation is mostly revenue neutral as there is CENVAT Credit across the board.

To summarise, the transaction explained above can now be viewed as two distinct transaction flows: A to B and C to A. While the transaction between A & B continues to be taxed as mentioned earlier, it is the author’s opinion that the transaction between C to A can be viewed as "provision of service on behalf of the client" and covered under "Business Auxiliary Service".

The earlier quoted circulars can be of no avail for two reasons: 1) a subsequent legislative amendment takes precedence over a circular and 2) the quoted circulars are issued under the respective service category and not under BAS. The nature of service provided by C to A can be more appropriately characterized as BAS rather than the maintenance service and hence the circular becomes redundant to that extent.

It should be noted that the term used in the definition of BAS is "service" and not "taxable service". Therefore, even transactions of service categories not specifically made taxable, if sub-contracted and provided by some one else on behalf of the principal service provider shall attract service tax.
Abatement for reimbursement of expenses

In many cases, the service provider makes certain payments on behalf of principal and gets the said expenses reimbursed from the principal. No tax can be payable for reimbursement of expenses incurred on behalf of client as they are incurred by the service provider merely for facilitation of the client and not for consumption while rendering the service. For example, octroi paid by Custom House Agent on behalf of principal cannot attract service tax. Several Department Circulars have highlighted this stand. ²⁰

However, in the context of security agencies, the CBEC has clarified that there can be no abatement towards the salaries of the staff or the statutory dues like PF/ESIC from the value of taxable service.21 To properly reconcile this position, one needs to understand the distinction between expenses incurred by the service provider for rendering the service and expenses incurred by the service provider on behalf of the service receiver and later on reimbursed to him. Reimbursements of expenses could be taxable if they are intricately connected with and inseparable part of the services rendered. For example, in case of market research agencies, expenses of field staff are an integral part of market research and therefore cannot be allowed as a deduction even if the same are separately reimbursed. The distinction would be more clear if one considers the example of chartered accountants. If travelling expenses or hotel bills of audit staff are reimbursed, such a reimbursement would not be an integral part of the audit assignment and hence would not be taxable. But if the salaries of audit staff are reimbursed by the client, the said reimbursement would still be taxable as it would be an integral part of the audit service.

The claim for reimbursement of expenses will have to be documented through necessary evidences. In case there is no suitable evidence or in cases where the reimbursement is charged at a lump-sum or after including a markup, the assessees may face difficulties in the claim of exemption from valuation.

In certain sectors especially the financial service sector, the agent receives the commission from the seller and passes on sub-commissions to either the purchaser or the sub-agent. In such cases, the agent will be liable for service tax on gross amount and cannot claim an abatement on the ‘real income theory’
Extra-territorial scope of service tax provisions

Section 64 of the Finance Act, 1994 applies to the whole of India (excluding Jammu & Kashmir). Service tax is a tax on services provided²². As such, services rendered within the Indian territories (including the designated areas in the continental shelf²³) would be liable for service tax whereas services rendered outside Indian territories would be exempt. It should be noted that there are no deeming provisions granting extra-territorial jurisdiction to the Finance Act, 1994²⁴

Notification 6/1999 granted an exemption for services realized in convertible foreign exchange. The said notification was withdrawn w.e.f. 1-3-2003. Following the withdrawal, there were widespread apprehensions on the tax implications of service exporters. This prompted the CBEC to clarify that service tax is a destination based consumption tax and hence export of services continue to be exempt.²⁵

The CBEC interpretation of service tax being a destination based consumption tax brings to light the controversy in cases where services are provided outside India but consumed in India. It should be noted that the Finance Act, 1994 at no place emphasizes the importance of consumption but talks of rendering/ providing the services²⁶. Therefore such transactions cannot be taxed in India as the rendering of services is outside India.
Conclusion

It may not be possible to discuss all the controversies arising out of circulars in a single article. The analysis can be viewed as a tip of the iceberg. It is therefore time that the principles of interpretation and legal positions be clearly laid down in the Finance Act, 1994 itself.

Refer para 7 of the Madras High Court decision in Adwise Advertising Private Limited vs. Union of India 2001 (131) ELT 529 (Mad)
Circular No. 62/11/2003 dated 21-8-2003
K P Varghese vs. ITO 131 ITR 592 (SC) as followed in Laxminarayan Sharma vs. Superintendent of Central Excise 1996 (87) ELT 345 (Raj)
Earlier clarified to be taxable vide Circular 29/1999 dated 15-7-1999 but later to be non taxable vide Circular
32/2000 dated 20-12-2000
Earlier clarified to be covered under "consulting engineers" vide Circular 49/2002 dated 18-12-2002 but later said to be not so covered vide Circular 79/2004 dated 13-5-2004
Refer Answer to Q. 16 of the FAQ relating to "Consulting Engineers"
Circular B11/1/2002-TRU dated 1-8-2002
Circular 65/2003 dated 5-11-2003
Circular B-II/I/2000-TRU dated 9-7-2001
Circular 80/2004 dated 10-9-2004
Notification 18/2003-ST dated 21-8-2003
Circular 62/2003 dated 21-8-2003
Section 65(105)(zzb) of the Finance Act, 1994
Section 65(31) of the Finance Act, 1994
Tata Consultancy Services vs. Union of India 2001 (130) ELT 726 (Kar)
Trade Notice 1/96-ST dated 31-10-1996 for Advertising, Trade Notice CE/20/Air Travel/97 dated 27-8-1997 in respect of air travel agents, Trade Notice 7/98-ST dated 13-10-1998 in respect of architects/interior decorators & so on.
Letter No. V/DGST/Misc-7/98/Mumbai dated 11-2-1999
As interpreted by the CBEC in Circular 56/2003 dated 25-4-2003
sub-clause (vi) of section 65(19)
Trade Notice 7/97-ST dated 4-7-1997 issued in the context of consulting engineers, B-11/I/2000-TRU dated 9-7-2001 in case of insurance auxiliary services and so on…
Trade Notice 7/98-ST dated 13-10-1998
Section 64(3) of the Finance Act, 1994
As notified by Notification 1/2002-ST dated 1-3-2002
Provisions equivalent to sections 5 to 9 of the Income-tax Act, 1961 are blatantly missing in the Finance Act, 1994
Circular 56/5/2003 dated 25-4-2003
Refer sections 64(3), 65(105), 66 & 67 of the Finance Act, 1994

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