Cross Border Transaction and Service Tax
Service Tax is a value added consumption tax which means that every service shall attract Service Tax each time service is supplied or imported along the commercial chain to its final consumption in India. The destination principle means that Service Tax shall be levied in the country in which services are finally consumed. Thus, when such services are provided in India and received by a person in India, there is no iota of doubt on taxation of such services. Such provision can be called as a pure domestic transaction of provision of services. However, when we speak of “cross-border,” or “multijurisdictional” or “international” transactions, we are referring to transaction which has its source of provision in one country and its consumption in another country. There can be more complex situations involving more than 2 countries. While issues from Service Tax perspective in a domestic transaction primarily revolves around provision of services and its classification, issues involved in a cross-border transaction are more considering the complexities inherent in such transaction such as determination of country of consumption, exchange fluctuations, double taxation, etc. to name a few. The present paper tries to discuss certain important aspects and its taxability in present era of negative list in Indian Service Tax regime.
Concept of Service Tax on Export
The law of no tax on exports, is common for all statues, however, what differs is the manner in which one determines how does such activity or transfer of goods or services qualify as export. It is a trite law that service tax is a destination based consumption tax as held by the Hon’ble Supreme Court in All India Federation of Tax Practitioners v. Union of India [2007] 10 STT 166. It was clarified that it is levied on commercial activities and it is not a charge on the business but on the consumer. The understanding has been affirmed in the case of Association of Leasing & Financial Service Companies v. Union of India [2010] 29 STT 316 (SC) as well. The position has always been upheld in Service Tax regime. Board also issued a clarification vide Circular No. 56/05/2003-ST dated 25-4-2003, where it was clarified that the Service Tax is destination-based consumption tax and it is not applicable on export of services. Determination of export in case of services has always been a contagious issue as unlike goods where crossing of customs barrier can be determined, in case of services, being intangible, such determination becomes tough to prove. In this respects courts have many a times resorted to the law of equivalence between goods and services [Please refer Association of Leasing & Financial Service Companies v. Union of India [2010] 29 STT 316 (SC), Godfrey Phillips India Ltd. v. State of U.P. (2005 (2) SCC 515, Moti Laminates Pvt. Ltd. v. Collector of Central Excise, Ahmedabad – 1995 (76) E.L.T . 241 (S.C.)]. However, applicability of such theory of equivalence in determination of export of services was restricted in the case of Paul Merchants v CCE, Chandigar [[2013] 30 taxmann.com 23 (New Delhi – CESTAT)],wherein Hon’ble Third member observed as follows:
“In my view, the above criteria as to what constitutes the export of goods, or import of goods which is for the purpose of the Customs Act, 1962, where the objective, besides the collection of duties on import of goods into India and export of goods from India, is also regulation of the movement of the goods across the border, cannot be applied for determining what constitutes the export of service, as unlike the movement of the goods across the international border, whether on sale basis or otherwise, where the event of export or import of goods can be easily detected, determining whether a service provided by a person in India is export or a service provided by a person abroad is service import into India, is a much complex question as, as mentioned above the services are intangible and can be provided by various modes and for this purpose one uniform criteria for all the services cannot be adopted.”
Exemption mechanism to Service Tax on exports has been prescribed since FY 1999 by tax authorities. Earlier, the only condition for considering export of services was to receive the payment for the service in convertible foreign exchange. However, with more and more services joining the taxable status, such mechanism became unfeasible and impractical as with increasing participation of India in global service industry, companies could avail such exemption by simply routing payment from company outside India. Thus, the first formal step towards providing proper manner of determination of export of services was made through Export of Services Rules, 2005. However, such Export Rules remained an unsolved mystery for a long time. There had been three categories of services. One determines export in case of services related to immovable properties when such property was located outside India, the other category covered certain services which when performed wholly or partly outside India were considered as export. The last and the most controversial one was services linked to recipient outside India. Such category contained multiple conditions which were amended from time to time. Firstly, it contained the condition of services being ‘delivered outside India’ which cause lot of interpretation issues since services are intangible. Then such phrase was replaced by ‘is provided from India’, which was a case in most scenario and was simpler to interpret. However, the expression ‘used outside India’ continued to create problems for the assesses as authorities took a view that such services could only be used outside India when used exclusively in business outside India. The department also issued Circular No. 111/05/2009-ST dated 24-02-2009 which provided the following clarification:
“In terms of rule 3(2)(a) of the Export of Services Rules 2005, a taxable service shall be treated as export of service if ‘such service is provided from India and used outside India’ Instances have come to notice that certain activities, illustrations of which are given below, are denied the benefit of export of services and the refund of service tax under rule 5 of the Cenvat Credit Rules, 2004 [notification No. 5/2006-CE (NT) dated 14.03.2006] on the ground that these activities do not satisfy the condition ‘used outside India’,-
| (i) | Call centres engaged by foreign companies who attend to calls from customers or prospective customers from all around the world including from India; | |
| (ii) | Medical transcription where the case history of a patient as dictated by the doctor abroad is typed out in India and forwarded back to him ; |
*** not relevant***
- It is an accepted legal principle that the law has to be read harmoniously so as to avoid contradictions within a legislation . Keeping this principle in view, the meaning of the term ‘used outside India’ has to be understood in the context of the characteristics of a particular category of service as mentioned in sub-rule (1) of rule 3. For example, under Architect service (a Category I service [Rule 3(1)(i)]), even if an Indian architect prepares a design sitting in India for a property located in U.K. and hands it over to the owner of such property having his business and residence in India, it would have to be presumed that service has been used outside India. Similarly, if an Indian event manager (a Category II service [Rule 3(1)(ii)]) arranges a seminar for an Indian company in U.K. the service has to be treated to have been used outside India because the place of performance is U.K. even though the benefit of such a seminar may flow back to the employees serving the company in India. For the services that fall under Category III [Rule 3(1)(iii)], the relevant factor is the location of the service receiver and not the place of performance.In this context, the phrase ‘used outside India’ is to be interpreted to mean that the benefit of the service should accrue outside India. Thus, for Category III services [Rule 3(1)(iii)], it is possible that export of service may take place even when all the relevant activities take place in India so long as the benefits of these services accrue outside India.In all the illustrations mentioned in the opening paragraph, what is accruing outside India is the benefit in terms of promotion of business of a foreign company. Similar would be the treatment for other Category III [Rule 3(1)(iii)] services as well.
Thus, the above clarification tries to put things in right perspective by clarifying that export happens when the benefit of such services arise outside India. The beneficiary or recipient of services is a person who is obliged to make payment for the services provided. In this regard, reliance is placed on Tribunal’s judgment in case of Sumangalam Suiting (P) Ltd. v. CCE [2010] 29 STT 290 (New Delhi – CESTAT). Similar decision has been held by majority in the case of Paul Merchants v CCE, Chandigar [[2013] 30 taxmann.com 23 (New Delhi – CESTAT)]. The Judgement of Paul Merchants is effective in understanding the concept of recipient of services and is very much relevant in present era post enactment of Place of Provision of Services Rules, 2012.
Thus, the position under the erstwhile Export Rules for determination of Export of services now seems to be settled. However, Post July 1, 2012, with the advent of negative list regime in India, the Rules have now been replaced with Place of Provision of Services Rules, 2012, (“POPS”) which determines the place of performance of a service. A service when performed (as determined as per POPS) in taxable territory is taxable under Finance Act, 1994, while if it is performed outside taxable territory, is not taxable. To qualify as Export of service, non taxable service has to satisfy certain more criterions as provided under Rule 6A of Service Tax Rules, 1994. We shall discuss certain important situations and their taxability as provided under POPS in the following paragraphs. While we shall discuss the levy in general circumstances, we shall also discuss certain specific cases. POPS rules have not been replicated for the sake of brevity.
At the outset, it is important to state that the determination of taxability would be guided by a lot factors and is not a scientific formulae. Factors like entities who enter into an agreement, performance etc cause difference in the arrangement. Also, the arrangement context should always override its form and the arrangement should not be one designed to bypass the taxability under the Finance Act, 1994.
Provision of Services outside India
Generally Services shall be decided as non taxable when services are performed in non taxable territory. Such performance is determined to have happed outside India in line with the Rules provided in POPS. The concept is explained by way of the following examples.
Case 1:
Indi Co (an Indian Company) provides audit services to MGS International for all its entities across globe including MGS India which is its Indian arm. While services of audit of MGS International clearly appears to be non taxable, the audit of MGS India can be in troubled waters as services appear to be provided and consumed in India. However, since the person who is beneficiary of services and is obligated to pay for such services (MGS International) is outside India and is consuming the services (Audit report) outside India, the place of performance shall be outside India (Rule 3- location of service recipient). Such services can never be said to be provided to a resident company as he never wanted such audit services and was not under an obligation to pay for such services. However, in case a cross charge of audit cost is obtained from Indian entity, such cross charge cannot be said to sharing of costs but is allocation of cost for Indian services and thus, in such case, cross charge would be taxable as services are performed in India (Rule 3 of POPS). Further, Indian entity would be liable to pay Service Tax under reverse charge being recipient of services from a non resident.
Case 2:
Indi Co (an Indian Company) provides Information technology consultancy services to MGS Tech (UK) which is used by MGS Tech for production of goods. Goods produced by MGS Tech are imported by an Indian entity (PAN India). In this case, services of Indi Co would qualify as non taxable being performed outside taxable territory (Rule 3 – recipient location). Further, PAN India would be required to discharge customs duty on such import.
Joint Ventures
A Joint Venture (JV) (when not incorporated as separate company) requires the parties to contribute their goods and services located in multiple jurisdictions to the functioning of that Joint Venture. Such arrangements usually when undertaken as a single entity (with no separate obligations of JV partners require determination of liability of JV as a whole, and its taxability is distinct from that of its JV partners. The situation is explained as under:
|
|
PAN India (resident) and MGS Tech (non resident) enters into an arrangement with Con Asia to provide EPC services in India. The scope of their work is collective. Accordingly, the entire contract is agreed to be performed by their unincorporated JV – Indi JV. Thus, services provided by Indi JV to Con India would be taxable being services by a resident to another resident (Rule 8 of POPS). Similarly any charge for services from JV (by whatever name called – profit etc.) would be tested for taxability in India.
Alternatively, if MGS Tech and PAN India enters into an arrangement for performance of a contract where their services are distinct and separable, though under a single arrangement, it can be contested that services of MGS Tech is not taxable.
Employee transfers
There can be multiple arrangements for taking services of expatriates who work in country other than their resident state in multi national companies. The arrangements vary from direct employment into a foreign company to secondment by home country to other country. There can also be cost sharing of high end employees by group companies situated across different countries. From the perspective of Service Tax, each of the above arrangement requires proper examination of facts, agreement and understanding. While a transfer to a group company in another country would entail no Service Tax implication, a secondment would fall under provision of manpower. In former case, if the employment contract is transferred to the Indian company by the foreign company in relation to the expat, then such services would be that of employment between Indian company and expat and shall be outside the ambit of Service Tax. However, if such employment continues to subsist with the foreign company, such provision of expat would qualify as service and would be taxable in India (Rule 3 of POPS). The same is the case vice- versa. There can also be making available of man hours of persons situated in India. Such cases also shall be non-taxable when provided to recipient outside India.
Further, under such scenario, usually the companies forget to add up the portion of salary paid in the home country to the employees and consider only the amounts paid to them in foreign country. Similarly if company is paying any other costs relating to such provision of manpower, then such costs would add up to increase the liability of the company to whom such employee is seconded. To complicate things further, there can be arrangements having ESOPs from home country which require special attention on a case to case basis.
Business Process Outsourcing
Business Process Outsourcing Industry had been one of key movers of the Indian economy in the last decade. The possibility of Information technology shrinking the world and creating employment opportunities in respect of work in country in another continent became a reality. Calls from call centres situated in India handling customer complaints for US and UK brought income to the youth and also, tax worries for big corporate. The question as to whether such services would qualify as export had always been contended by the tax authorities in Service Tax regime prior to July 1, 2012. Such BPO services were contested to have been provided in India and thus, benefits of such services being export were denied to the companies. However, such services were clarified to be export vide Circular No. 111/05/2009-ST dated 24-02-2009 (provided earlier). The situation remains same in present context post enactment of POPS. Such services would be export when provided to recipient outside India (Rule 3 of POPS).
Relevance of Transfer Pricing Report under Income Tax Act, 1961
There is no transfer pricing rules prescribed under Finance Act, 1994. The valuation in Finance Act, 1994 is determined in accordance with Service Tax (determination of Value) Rules, 2006 (“Value Rules”). The Rules provides the manner for determination of value of services in different cases. However, no specific rule is provided for determination of value in case of associated enterprises (as provided in Excise and Income Tax). Since Excise valuation shall cover valuation of only goods, the Transfer pricing provisions under Income Tax provides arms length pricing for both goods and services. Thus, the question arises as to whether transfer pricing report can be relevant in any manner from Service Tax perspective. The question can be answered in affirmative (not all cases but many). Rule 4 of the Value Rules provides powers to Central Excise Officer to question the valuation of services (not limited to associated enterprises). The Rule provides that where the Central Excise Officer is satisfied that the value so determined by the service provider is not in accordance with the provisions of the Act or these rules, he shall issue a notice to such service provider to show cause why the value of such taxable service for the purpose of charging service tax should not be fixed at the amount specified in the notice. Thus, for determining the arms length prices (specifically incases when there is no recipient other than related parties), derivation of valuation can be based on transfer pricing report.
Conclusion:
The complications in cross border transactions is multifold and it should be the aim of the government to provide clear guidelines on all such possible situations. The concept of providing clarification in case of cross border transaction is prominent in all developed economies as they understand that such ignorance can cost heavily to their foreign investors. Indian laws are considered as one of the most complicated ones, and thus, all foreign investors shall always like to factor all tax costs so that they can conceive their profits and break even in a closer to certain manner.