An insight into Draft Point of Taxation Rules

1.
Introduction :

Given the fact
that frequent change in the rate of tax on services over a period of time has
caused confusion and uncertainty both among tax officers and assessees as to
the criteria based on which the tax may be levied, the Government has decided
to provide framework to determine point of taxation in different situations by
publishing Draft Point of Taxation (for Services Provided or Received in India)
Rules, 2010 (the POT Rules). The said POT Rules are also accompanied by a
preamble letter and Explanatory Notes on the POT Rules. The Government has
clearly expressed that the proposed rules are meant to provide the regulatory
framework and clarity to determine point of taxation whenever there is a change
in the rate of service tax. Similar difficulty is faced in determining point of
tax in the cases of continuous services. The taxable event under the law takes
place on provision of service. However, the liability to pay service tax
currently arises only on the receipt of the payment. In the POT Rules, there is
a shift proposed by providing a link to the payment of tax with raising of
invoice or payment for service provided or to be provided or provision of
service, whichever is occurring earlier. According to the Government, the
current rule allowing payment of tax on receipt basis does not fall in line
with the Central Excise law and the VAT laws of the states of India. In both
these cases, the payment is required to be made on accrual basis i.e., on the
event of clearance of goods in the case of former and issue of invoice in the
case of latter and that Goods and Service Tax (GST) which is in the offing is
likely to follow this practice. Thus, the proposed POT Rules appear to be a
precursor to GST, which is likely to be implemented in April, 2011.

2. Taxable
event and point of taxation :

In any fiscal
legislation, specific provisions exist for charge of tax and collection of tax.
Under the service tax law, the charge of tax is created by S. 66 of the Finance
Act, 1994 (the Act) on prescribed taxable services. ‘Taxable Service’ is
defined as a service provided or to be provided. Therefore when a service is
provided or agreed to be provided, there takes place the taxable event. As
against this, the POT Rules seek to define ‘taxable event’ as the event which
causes the tax liability to arise, namely, the provision of service, issuance
of invoice or the receipt of payment. The events of issuance of invoice and
receipt of payment are deemed as provision of service under a fiction proposed
to be created under the law. When an invoice is issued or payment is received
prior to providing the service by a service provider, the service would be
deemed to be provided at the time the invoice was issued or the payment was
received, whichever occurred earlier and the liability to pay tax would arise
at this point. Referring now to the collection of service tax, currently Rule
6(1) of the Service Tax Rules, 1994 provides that service tax liability arises
when payment for taxable services Is received. In the POT Rules however, ‘Point
of Taxation’ is defined to mean the point of time when the tax becomes payable
to the Government. Thus, the POT Rules have proposed to shift the point of
taxation away from the receipt of payment for the service to either at the time
of provision of service or the issuance of invoice for the service or the receipt
of payment, based on various situations as envisaged in the Rules, but
essentially on the concept of accrual rather than solely on the receipt of
payment.

3. Key
features :

3.1 The POT
Rules essentially provide framework to determine the point of taxation mainly
under the following situations :

à When any advance payment is received towards any
taxable service.

à When there is a change in the rate of tax with regard
to existing taxable service whether exempt or otherwise and there is a
difference in date and timing of provision of
service, raising of invoice and date of receipt of payment.

à When there is a change in the rate of tax with regard
to service which is taxed for the first time.

à When there is a continuous supply of a service or a
service provided on a long-term basis.

à When there is a transaction between associated
enterprises.

à In case of royalty and similar payments.

3.2 Advances
towards taxable services :

Under Rule 4,
the point of tax for advances is dealt with. It provides that service tax is to
be paid on the date of receipt of the advance towards provision of a taxable
service and the rate applicable would be the rate prevailing at the time of
receipt of such advance. Thus, the tax payment under this rule falls in line
with the basic principle underlying the provisions in the POT Rules that the
tax payment is linked to the issuance of invoice or receipt of payment,
whichever is earlier. The Government in its explanatory note in this regard has
clarified that once the tax is charged on the payment, the determination of tax
would be final. Further, it is expressly provided in the rule that no tax is to
be paid on interest-free refundable deposits.

3.3 Change in
rate of tax – Existing services :

Rule 5 seeks to
determine the point of taxation where there is a change in the rate of tax as
regards existing taxable services whether exempt or otherwise and there is a
difference of time between provision of service, raising of invoice and the
time of receipt of payment of taxable service. Table 1 sets out the
determination of point of taxation under the said rule.

 The principle followed in the above rule is that when two points of taxation have occurred, the ear-lier of the two would be the point of taxation.

3.4 Introduction of new services in the tax net :

Table
2

Rule 6 provides for determination of point of taxation when a service is brought in the tax net for the first time. Refer Table 2. This rule however does not apply to services provided on a continuous or long-term basis. (Rule 7 deals with services supplied continuously or for a long duration of time.)

3.5 Continuous supply of services :

Continuous supply of services is defined to mean services supplied under a contract for a period exceeding six months or services as specified by the Government to be in continuous supply. The proposed Rule 7 provides that the rate of tax would be the rate applicable on the date of payment becoming due in terms of the contract irrespective of whether or not payment is received or invoice is raised. If the payment becomes due on completion of any milestone in terms of the contract, the date of completion of such milestone is the point of taxation. If the contract does not contain any clause for date of payment or mile-stone, the service tax is required to be paid on raising of invoice or receipt of payment, which occurs earlier.

It is further provided that when the service supplied continuously is covered under this rule is introduced for the first time in law, no service tax is required to be paid on payments received prior to service becoming taxable, even if the service is provided subsequently. The Government has clarified that in case of ongoing contracts of construction, the tax is liable to be paid on the basis of raising of invoice or the date provided for payment in the contract or the actual date of payment, as the case may be. When payment for construction is received prior to applicability of service tax and commencement of construction occurs after the levy coming into force, no service tax would be levied on such payments made prior to the applicable date.

3.6 Services provided to associated enterprises:

In case of transactions with associated enterprises, Rule 8 has provided that the relevant date is the date of debit or credit in the books of account or issuance of debit or credit note or the date of payment, which is earlier.

3.7  Royalty and similar payments:

As regards royalties and similar payments where the whole amount of consideration for service is not ascertainable at the time of performance of service and subsequently the use or the benefit of these services by a person other than the supplier gives rise to any payment of consideration, Rule 9 has provided that the service would be deemed to be provided at the time of each payment is made or invoice is raised, which is earlier.

    At the end:

While the attempt of the Government to introduce framework of POT Rules should be regarded as a welcome step since it is done with the basic objective of addressing some of the prevailing certainty and open issues under the current dispensations of law, there exists certain aspects which appear to add to complexity and difficulty of implementation. For instance :

    As aforesaid, currently the charging S. 66 of the Act determines the taxable event and which is ‘provision of a service’. To redefine this rudimentary aspect of the fiscal statute under the rules proposed to be issued in exercise of the powers conferred u/s.94(2) of the Act seem to be going beyond the Finance Act, 1994 and to this extent, re-consideration of this very fundamental aspect appears necessary.

    The objective of the Government as indicated in the preamble letter and Explanatory Notes is to specify point of taxation as the date of raising of invoice, provision of service or receipt of payment, whichever is earlier, whereas the POT Rules have dealt with only specific conflicting situations and not the remaining or residuary situation/s. If the point at which the service provider should pay tax is changed, it is not indicated whether the existing Rule 6(1) of the Service Tax Rules, 1994 would be amended consequent upon the proposed POT Rules coming into force. Or else, is it to be contended that the point of taxation except in the case of specified situations, would be still the time of receipt of payment? In any case, the proposed rules should be consistent with the provisions of the Service Tax Rules 1994, existing or suitably amended.

    Provision of multiple parameters under different situations if introduced without modification, is likely to pose a serious challenge in implementation as Rules 5, 6 and 7 are complex and keeping a track of all the three events viz. provisions of service, raising of invoice and receipt of payment under any of these rules is a huge task for businesses after understanding and interpreting the said rules.

    The POT Rules have not dealt with a situation when services are provided from outside India i.e., when reverse charge mechanism operates u/s.66A of the Act. Specific consideration for this also appears necessary.

    Rule 4 provides that interest-free refundable deposit would not attract service tax. Does this mean that when interest is payable on a refundable deposit, the tax is payable? If intention is not so, suitable change is required on this issue.

    The class of service providers in India is not analogical to that of manufacturing units or VAT dealers. There could be tremendous cash flow issue for a number of service providers when one is required to pay at the point of raising of invoice or provision of service which may result in delay in compliance of law followed by penal action and litigation. Further, the POT Rules as proposed are silent over the treatment of non-payment for services or bad debts, cancellation of invoice, discounts, etc. Similarly, in the current scenario also, there already exists the issue of availability of CENVAT credit (in terms of existing CENVAT Credit Rules) when service tax is paid on advances. If multiple taxable events as proposed are introduced, well-thought out consequential amendments in CENVAT Credit Rules, 2004 also would be required. Further, one could envisage a chaotic condition while taking CENVAT credit as complexity in record maintenance would also arise again resulting in litigation.

Since the Government has invited public comments on the Draft POT Rules before September 01, 2010, it can be hoped that major creases would be ironed out if the Government is keen on notifying the Rules. As a matter of fact, since GST is soon likely to be a reality, it would be a better proposition to implement broad-based rules along with GST rather than half-baked rules as precursor to GST, which may only worsen the already uncertain scenario.