Amidst tremendous resistance from the business community as well as professionals, the Government has expanded the scope of reverse charge mechanism to a significant extent and thereby fastened the onus of paying service tax on the recipients of various services especially by the corporate sector irrespective of whether the service provider is covered by the threshold exemption limit of Rs 10 lakh or he is already discharging the obligation of service tax fully.
History and background:
Reverse charge was first attempted to be introduced in the service tax law as early as in 1997, on the services of clearing and forwarding agents and those of goods transport operators. This was introduced vide section 68(2) of the Finance Act, 1994 (the Act) read with Rule 2(1)(d) of the Service Tax Rules (the Rules). When every person engaging a clearing and forwarding agent and every person paying or liable to pay freight either himself or through his agent for transportation of goods by road in a goods carriage respectively, was responsible for getting registered, discharging the obligation of payment of service tax. However, since the liability on recipients of these two services was fixed merely by introducing the machinery provisions in Rule 2(1)(d) of the Rules, it was challenged. The Readers may recall that the Supreme Court in Laghu Udyog Bharati & Anr. v. UOI & Others 1999 (112) ELT 365 (SC)/2006 (2) STR 276 (SC) ruled that provisions of Service Tax Rules, 1994 viz. Rule 2(d)(xii) and (xvii) of the Rules (as it prevailed then) in so far as it makes the persons other than the clearing and forwarding agents or goods transport operators responsible for collecting service tax were ultra vires the Finance Act, 1994 itself and such sub-rules were accordingly struck down. Later indeed, to overcome the implications of this decision wherein tax collected was ordered to be refunded, the Finance Act, 2000 retrospectively amended these provisions to validate collection of service tax made from recipients of these services. Further, the services of goods transport operators were exempted from 02/06/1998 and later only from 01/01/2005, the Finance (No.2) Act, 2004 reintroduced the services of goods transport agency (GTA). It is to be noted here that enabling provisions under section 68(2) were incorporated with effect from 16/10/1998 vide Finance (No.2) Act, 1998. However, Notification No.36/2004-ST was issued only on 31/12/2004 which notified certain services whereby recipients of notified services were made liable for payment of service tax. In the year 2005, in addition to the recipients of GTA, the liability to register and pay service tax was also fixed on mutual funds for distribution fee paid to mutual fund distributors, insurance companies in respect of commission paid to insurance agents and later on, sponsoring body corporates or firms located in India.
Service tax liability of recipients of services provided from outside India:
In terms of the provisions of Rule 2(1)(d)(iv) of the Rules r.w.s. 68(2) of the Act, the liability of service tax was attempted to be fastened also on the recipient of taxable services provided from a person from a country other than India, with effect from 16/08/2002. In the absence of requisite provision in the Act, the levy on such services was disputed. Even after notifying such services in the Notification No.36/2004-ST referred above, the controversy continued. However, with effect from 18/04/2006 when section 66A was introduced in the Act, creating a charge of service tax on a person receiving taxable services in India provided by a person from a country other than India, the person receiving such services has been liable for service tax. For determining the liability in respect of various taxable services, the Government also prescribed the Taxation of Services (Provided from Outside India and Received in India) Rules, 2006 (Import Rules for short) to come into effect from 19/04/2006. These rules along with section 66A have been in force till 30/06/2012 i.e. till the onset of the newly introduced negative list based taxation of services. A tremendous amount of controversy and consequential litigation occurred for the application of reverse charge on taxable services provided from outside India to a person in India between the period 16/08/2002 and 18/04/2006, i.e. the date on which section 66A was introduced. The controversy however, achieved finality with the Bombay High Court’s decision in the case of Indian National Shipowners’ Association vs. UOI 2009 (13) STR 235 (Bom) and upheld by the Supreme Court in 2010 (17) STR OJ57 (SC). The Court held that only from the date of the introduction of section 66A, service tax liability could be fastened on the recipients located in India, for the services received from outside India.
Reverse Charge: Under the new “negative list” based taxation effective from 1st July, 2012:
Reverse charge as it existed under the erstwhile selective levy of services till 30.06.2012 continues under the new system of taxation also both in case of specified services provided in India and in case of services provided from outside India. As discussed above, section 68(2) of the Act is the applicable provision whereby reverse charge i.e. liability to pay service tax is fastened on the recipient of a service. Section 68 is reproduced below:
“68 (1) Every person providing taxable service to any person shall pay service tax at the rate specified in section 66B in such manner and within such period as may be prescribed.
(2) Notwithstanding anything contained in subsection (1), in respect of such taxable services as may be notified by the Central Government in the Official Gazette, the service tax thereon shall be paid by such person and in such manner as may be prescribed at the rate specified in section 66B and all the provisions of this Chapter shall apply to such person, as if he is the person liable for paying the service tax in relation to such service.
Provided that the Central Government may notify the service and the extent of service tax which shall be payable by such person and the provisions of this Chapter shall apply to such person to the extent so specified and the remaining part of the service tax shall be paid by the service provider.”
In exercise of the powers conferred by sub-section (2) of section 68, the Government earlier notified some services vide Notification No.36/2004-ST dated 31/12/2004 (as already discussed above) which now with effect from 01/07/2012 is superseded by a new Notification No.30/2012-ST dated 20/06/2012 whereby in addition to the taxable services provided from outside India and services of insurance agents, goods transport agencies, sponsorship services, leasing services of mutual fund distributors, a few other services are also notified for which recipients are made liable for service tax and in some cases, partial reverse charge is introduced, whereby both service provider and service recipient are jointly responsible for tax payment for the proportion respectively specified for each of them in the said Notification No.30/2012-ST as discussed below:
In case of the following services notified as specified services, the service recipient is held as the person liable for payment of service tax to the Government.
Taxable services provided or agreed to be provided by:
i) An insurance agent to a person carrying on insurance business.
ii) A goods transport agency for transportation of goods by road, where freight is paid by:
(a) a factory registered or governed by the Factories Act;
(b) a registered society;
(c) any co-operative society established by or under any law;
(d) a registered excise dealer;
(e) anybody corporate established by or under any law; or
(f) any registered/unregistered partnership firm including association of persons.
- Services provided by a GTA for transportation of vegetables, eggs, milk, food grains or pulses is exempted vide entry 21(a) and goods where the gross amount charged on a consignment in a single goods carriage does not exceed Rs. 1,500/- or goods for a single consignee does not exceed Rs. 750/-are exempted vide entry 21(b) in Notification No.25/2012-ST dated 20/06/2012.
- It may further be noted that service tax is payable on 25% of freight amount and person paying freight or liable for paying for services of GTA would be treated as the receiver of service for the purpose of reverse charge.
iii) By way of sponsorship to any body corporate or partnership firm located in taxable territory.
Note: The following new services are now added in the said Notification No.30/2012-ST:
iv) Arbitral Tribunal to any business entity located in taxable territory.
- “Business entity” as per section 65B(17) means “any person ordinarily carrying out any activity relating to industry, commerce or any other business or profession”.
v) An advocate whether as individual or a firm of advocates providing legal services to any business entity located in the taxable territory.
- “Legal service” as per Rule 2(cca) of the Service Tax Rules, 1994 (The Rules for short) means “any service provided in relation to advice, consultancy or assistance in any branch of law, in any manner and includes representational services before any Court, Tribunal or authority.”
- Services by arbitral tribunal or by individual advocate or a firm of advocates to any person other than a business entity or business entity with a turnover not exceeding rupees ten lakh are exempted vide entry 6(a) and (b) of Notification No.25/2012-ST.
vi) Government or local authority by way of support services to any business entity located in the taxable territory except in the cases of:
(a) Renting of immovable property by the Government
(b) Speed post expenses, parcel post, life insurance and agency services provided to a person other than Government.
(c) Port and airport in relation to vessel or an aircraft inside/outside the precincts of a port or an airport
(d) Transport of goods or passengers.
- Renting of immovable property for the above purpose as per Rule 2(f) of the Rules means “any service provided or agreed to be provided by renting of immovable property or any other service in relation to such renting.”
Note-1: In case of the three services listed at (viii),
(ix) and (x), the liability to pay service tax is fastened only when the services are provided by any individual, HUF or partnership firm registered or not including association of persons located in a taxable territory to a business entity registered as body corporate located in the taxable territory.
Note-2: Services of director and the words “or security services” along with manpower supply have been inserted only with effect from 07/08/2012 vide Notification No.45/2012-ST.
(xi) Taxable service provided or agreed to be provided by any person who is located in a non-taxable territory and received by any person located in the taxable territory.
- As discussed above, reverse charge mechanism, earlier in terms of the erstwhile section 66A, applied to the services provided or to be provided by a person outside India and received by a person in India. Now with effect from 01/07/2012, to determine the liability of the recipient vis-à-vis various types of services, the Government has prescribed Place of Provision of Services Rules, 2012 (POP Rules for short) in place of Import Rules (as well as Export Rules).
- “Taxable territory” as per section 65B(52) means “the territory to which the provisions of this Chapter apply.”
- Non-taxable territory as per section 65B(35) means “the territory which is outside the taxable territory.”
- ‘India’ as per section 65B(27) means –
(a) the territory of the Union as referred to in clauses (2) and (3) of article 1 of the Constitution;
(b) its territorial waters, continental shelf, exclusive economic zone or any other maritime zone as defined in the Territorial Waters,
Continental Shelf, Exclusive Economic Zone and other Maritime Zones Act, 1976 (80 of 1976);
(c) the seabed and the subsoil underlying the territorial waters;
(d) the air space above its territory and territorial waters; and
(e) the installations, structures and vessels located in the continental shelf of In dia and the exclusive economic zone of
India, for the purposes of prospecting or extraction or production of mineral oil and natural gas and supply thereof.”
- As under the earlier system prevailing till 30/06/2012, an individual recipient receiving any service in relation to any purpose other than commerce or any other business or profession, would not be covered by liability under reverse charge as the same is exempted by entry 34 of the exempted Notification No.25/2012-ST. By this entry, even the Government, a local authority, a Government authority and an entity registered under section 12AA of the Income Tax Act for the purpose of providing charitable activities (as defined in the said Notification 25/2012-ST) also are declared exempt.
Partial Reverse Charge for 3 services only:
Except for the services listed above at (viii), (ix) and (x) viz. services of renting of motor vehicle, supply of manpower or security service and service in execution of works contract, the entire or 100% amount of service tax payment liability vests in the recipient of services. Partial reverse charge i.e. both the service provider and the recipient of services having liability for service tax exists only for 3 services in the following proportion as notified:
An explanation in Notification No.30/2012-ST is provided to clarify that in case of Works Contract services, where both service provider and recipient thereof are the persons liable to pay tax, the service recipient has the option of choosing the valuation method as per choice, independent of valuation method adopted by the provider of service.
Some Issues:
1. Is reverse charge applicable to invoices raised by the vendors in July 2012 or later for the services completed in June, 2012 or when the payment for the invoice is made post 1st July, 2012?
For any service, where point of taxation is determined and liability is fastened prior to 01/07/2012 in terms of Point of Taxation Rules, 2011 (POT Rules for short), the new provisions of reverse charge do not apply. For instance, if service was completed prior to 30th June, 2012 and invoice also was raised before such date, the point of taxation is determined to be the date of the invoice, if the invoice was raised within the stipulated time limit of 30 days in terms of Rule 4A of the Rules. In the scenario, even if the payment is made post 30th June, 2012, reverse charge would not apply to the receiver for such payment.
2. Whether in the following situations, the liability under reverse charge would arise for the recipient?
- When a partnership firm provides works contract services to another partnership firm.
- When manpower supply services are provided by a private limited company to another private limited company.
- A firm of solicitors provides service to a proprietary business concern.
In the first two situations, recipient does not have liability under reverse charge. In the first situation, it is so because except for body corporates, liability is not cast on any other person in case of works contract services. In the second situation, there is no liability because the service provider is a company, the receiving corporate body does not have the liability. In this case, the provider would have to charge service tax and the receiver would pay him as per the invoiced amount unless the provider is covered by threshold exemption under Notification No.33/2012-ST. In the third situation, the liability to pay tax would vest in the recipient as the recipient is a business entity if his turnover is more than Rs.10 lakh i.e. when he is not covered by the threshold exemption limit and provider is a solicitor firm (solicitors are necessarily advocates). However, it may be noted that under Notification No.25/2012-ST, services by Arbitral Tribunal or individual advocate or a firm of advocates provided to any person other than business entity or a business entity with a turnover upto Rs. 10 lakh in the preceding financial year are exempted at entry no.6(b) as discussed above. Therefore, if the proprietary business concern is within the threshold turnover limit, no service tax is payable by such proprietor under reverse charge. The definition of business entity is provided above.
3. When does the liability to pay service tax under partial reverse charge arise both for the provider of service as well as for the receiver?
This is governed by POT Rules. Service provider would have to pay service tax either depending on the date of invoice or the date of receipt of consideration for service whichever is earlier. The recipient as per the said rules would pay, considering the date of payment made for the service. However, if no payment for the invoice is made within six months, point of taxation would be the date of invoice in accordance with Rule 7 of the said POT Rules.
4. Whether the service tax liability under reverse charge, partial or full, can be discharged by the recipient of services using balance in the CENVAT credit account?
No. CENVAT credit balance cannot be used for discharging the liability under reverse charge in terms of Rule 3(4) of the CENVAT Credit Rules, 2004 (CCR). CENVAT credit in terms of this rule can be utilised for payment of excise duty or amount payable on removal of inputs or capital goods or amount payable under Rule 16(2) of the Central Excise Rules, 2002 and for payment of service tax on any output service. When a person pays service tax as a receiver of service, it is neither towards output service nor for any excise duty payment or an amount payable as stated above. Further, with effect from 01/07/2012, an express provision vide insertion of an explanation is also made below the said Rule 3(4), providing that CENVAT credit cannot be used for payment of service tax in respect of services where the person liable to pay tax is a service recipient. Also Rule 2(p) of CCR specifically excludes the service where the whole of service tax is liable to be paid by the recipient of service from the definition of output service.
5. When a service provider is located in Jammu and Kashmir and provides taxable service to a receiver located in taxable territory, whether the recipient is liable for service tax?
This is to be determined in terms of the provisions contained in section 66C of the Act read with the rules prescribed in this regard viz. Place of Provision of Services Rules, 2012 (POP Rules, for short) as notified vide Notification No.28/2012-ST dated 20/06/2012. For instance, if the service provided by J&K service provider in the above question is of architect’s service in relation to immovable property situated in Chandigarh, the recipient located anywhere in the taxable territory would be liable to pay service tax under reverse charge as Rule 5 of the said POP Rules provides that place of provision of service is the place where the immovable property is located. Thus, depending on the type of service, the applicable POP Rule would determine the place of provision to determine whether service tax is payable by the recipient located in taxable territory from a person located in non-taxable territory including services received from outside India.
6. (a) When a small service provider is availing benefit of Rs. 10 lakh exemption under Notification No.33/2012-ST dated 20/06/2012 from service tax leviable under section 66B of the Act and has provided services to a body corporate, whether the receiver is liable for service tax?
(b) What would be the answer in case of services for which partial reverse charge is prescribed?
For this purpose, we may refer the Notification No.33/2012-ST. It contains a non-obstante clause which reads as:
“Nothing contained in this Notification shall apply to:
(i) ……………..
(ii) Such value of taxable services in respect of which service tax shall be paid by such person and in such manner as specified under sub-section (2) of section 68 of the said Finance Act read with the Service tax Rules, 1994.”
Section 68(2) referred to in the above clause including proviso therein is reproduced above. Both the provisions read together indicates that the threshold limit does not apply to the service receiver liable for service tax in terms of section 68(2) read with Notification No.30/2012-ST and Rule 2(1)(d) of the Service Tax Rules.
The Government also has clarified in the Guidance Note as follows:
“Liability of the service provider and the service recipient are different and independent of each other. Thus, in case the service provider is availing exemption owing to turnover being less than Rs.10 lakh, he shall not be obliged to pay any tax. However, the service recipient shall have to pay service tax which he is obliged to pay under the partial reverse charge mechanism”
Thus, the clarification answers that in both the situations, whether having full or partial liability, service tax is payable by the recipient irrespective of the threshold exemption availment by the provider. The recipient would discharge the liability of his part.
7. Whether the credit of service tax paid under reverse charge is available to the service recipient? If the recipient is not able to utilise the credit, would the amount paid be refunded?
The availability of credit is subject to provisions of CCR. If the service on which service tax is paid under reverse charge satisfies the definition of “input service” as provided in Rule 2(l) of the CCR and based on GAR-7 challan evidencing payment of service tax, credit can be availed. Rule 5B is introduced in CCR for granting refund to service provider providing services are notified under section 68(2) of the Act and the service provider unable to utilise CENVAT credit availed on inputs and input services for service tax payment on output services subject to procedure, conditions and safeguards to be prescribed.
Comment: In the matter of refund, the above Rule 5B of CCR indicates that the refund would be available to service providers of services notified in section 68(2) and not to recipients liable under reverse charge. Hence, if the recipient corporate body of, say, works contract services and manpower supply services is engaged in pure “trading activity” which is not liable for service tax, such trader cannot claim refund and so would be the manufacturing body corporate manufacturing products which are exempt or have Nil rate of duty. [The newly intro-duced Rule 5A in CCR refers to refund for manufacturers only on inputs].
8. (a) In case of services provided by a director of the company to the company, now that Notification No.45/2012-ST has introduced reverse charge with effect from August 07, 2012, if a director receives sitting fees from more than one company, whether all the companies where a person provides service as a director would separately pay service tax on his sitting fees?
(b) How about remuneration to managing director, whole-time directors or executive directors?
In principle, all the companies in which a person is a director would independently pay service tax as a recipient, in respect of services received from all its directors. As regards the payment made to the managing director, whole-time director or executive director, the liability under reverse charge would be determined, based on facts of each case. If there is an employment contract with such a director and the amount paid is as ‘salary’, there will not be any service tax liability since employment contracts or an employee providing services to an employer are specifically excluded from the definition of ‘service’ in section 65B(44) of the Act. Manner of tax deduction at source under the Income Tax Act i.e. whether deduction is made u/s 192 or section 194J may also help indicate (although not conclusive) whether the amount paid is in the nature of salary or remuneration. If a director is paid some fixed amount as salary and other or additional amount as remuneration and if this is not part of the employment contract with the director, reverse charge would apply to such amount paid additionally and not forming part of the employment contract. However, independent directors on the Board act in a fiduciary capacity and therefore the consideration for the service rendered by the director to the company would be liable for reverse charge.
9. In case of works contract service, in terms of Notification No.24/2012-ST depending on the nature of works contract, different valuation rate viz. 40%, 70% or 60% is applicable. How would the recipient body corporate know whether the provider has applied/paid service tax at the correct rate?
In terms of Explanation II to Notification No.30/2012-ST, the service recipient has the option of choosing the valuation method, independent of the valuation method adopted by the provider of service. Consider an instance, when a provider has charged and paid 50% of the service tax on 40% of the value of an invoice, considering the works contract as one of “original works” whereas if the recipient holds a view that the contract/transaction is not covered by the definition of “original works” and therefore, service tax would be attracted on 60% value. In such a case, whether the recipient is “mandatorily required” to independently determine the substance of the contract by virtue of the above explanation or not, is not clear. The explanation refers only to having an option in reflecting “valuation method”. Therefore, it appears that the recipient along with the provider runs a risk of dispute over ‘valuation’ option if a lower rate in place of a higher one is selected.
Conclusion:
The intention of the Government in introducing the above complicated procedure of reverse charge and especially partial reverse charge for various services provided predominantly in semi-organized sector, can be understood and appreciated as the compliance is poor and undue advantage of threshold exemption also may have been taken by some. However, certain fall-outs of the clumsy system cannot be ignored when it is introduced at the cost of hardship that would be faced by small entities including trading outfits and even the law firms as enumerated below:
- Large law firms would not be able to avail any CENVAT credit of service tax paid on various taxable services used by them, as they are not required to collect and pay service tax for their services. This indeed means a substantial cost addition for them.
- In case of partial reverse charge, a number of compliance issues are likely to emerge. For instance, if a manpower supply agency has already discharged service tax obligation, as in the past, of 100% liability, and if no service tax is paid by the recipient to the Government, as he has inadvertently paid 100% service tax to the provider.
- Whether CENVAT credit of service tax paid to the vendor would be allowed?
- Whether or not service tax demand would be raised against the receiver and consequently whether excess service tax paid as the provider would be refunded to the provider?
There are no definite answers to the above issues without going through the litigating process. However, it may be noted here that in the past, considering the basic cannons of taxation that no transaction can be taxed twice, in Invincible Security Services vs. CCE (2009) 13 STR 185 (Tri.-Del) and in Navyug Alloys (P) Ltd. vs. CCE&C (2008) 17 STT 362 (Ahd-CESTAT), liberal view was taken by the Tribunals and even on receiving service tax without authority of law, it was held that it was not open to the department to confirm the same again in respect of the same service and the appeals were allowed.
Since the above illustrations are only a small part of various issues and difficulties that are likely to be faced on account of partial reverse charge, it is recommended that the same should be done away with at the earliest and instead the Government may consider introduction of transaction threshold. A private limited company paying barely Rs.1,500/-as sitting fees to each director for every meeting also is required to register and pay service tax of an insignificant amount. Transaction threshold can relieve such hardships as well as administration costs of the corporate sector as well as that of the department. A pragmatic approach is required on the part of the Government in this matter.
