TAXATION OF SERVICES BASED ON A NEGATIVE LIST

While presenting the Union Budget for 2011-12, the Finance Minister proposed as under:

“Many experts have argued that it will be desirable to tax services based on a small negative list, so that many untapped sectors are brought into the tax net. Such an approach will be very conducive for a nationwide GST. I propose to initiate an informed public debate on the subject to help us finalise the approach to GST.”

Pursuant to the aforesaid announcement, a public debate on widening the tax base by introducing a negative list of services has been initiated by the Government, through the release of a draft concept paper inviting comments/suggestions from the affected parties.

Revenue implications

Relevant extracts from the draft concept paper are set out below for ready reference:

Para 9.1

Para 9.2

Para 9.3

Shortcomings in the present service tax law

Unlike Central Excise law which clearly defines the basic concept of ‘manufacture’, there is no definition of ‘service’ under the Finance Act, 1994 (‘Act’). Each of the 120 services which are liable to service tax are specified and defined u/s.65(105) of the Act. Taxable services are defined employing a very wide terminology. In the absence of a detailed Tariff (like Central Excise/ Customs) with Interpretative Notes, a large number of interpretation issues have arisen as to the coverage of services liable to service tax, resulting in extensive litigations.

The definitions in regard to each taxable service u/s.65(105) of the Act have been introduced at different points of time. Further, amendments have been made in the scope of definition within a service category from time to time. This has resulted in classification issues as regards date of applicability of levy and coverage under specific exemption Notifications;

A large number of exemption Notifications have been issued over the years, resulting in interpretation issues and disputes between the Department and the taxpayers; and

Issues of overlapping vis-à-vis other indirect taxes like State VAT, Central Excise, etc. resulting in double taxation and consequent increased burden to the end consumer.

The above shortcomings need to be satisfactorily addressed in the proposed service tax policy framework.

The draft concept paper in paras 2, 3 and 4 highlights in detail the issues surrounding the positive and negative lists. While it does accept that the currently existing positive list has certain advantages in terms of definitiveness, it seeks to justify the introduction of the negative list by citing certain limitations of the current mechanism of positive list. According to one school of thinking most of the said limitations can be either removed even in positive list approach or are so inherent that they would continue even in the negative list approach. The same is explained in Table 1

Para 2.6
“The limited experience gained in taxing the services on a selective basis has raised some important issues. The most important of them relates to the basic approach to taxing services. The selective approach to taxation, which has been followed till now, has given rise to many administrative problems arising from selectivity including inadequate coverage and increased litigation, Further, in accordance with the medium-term policy objective of the Government of evolving a manufacturing stage value added tax in respect of goods and services at central level, it is neces-sary to adopt a more general approach.”

Considering the serious shortcomings in the presently adopted selective approach (Positive List) to tax services and the prevailing international practices as regards taxation of services, according to a second school of thinking which is being supported by trade bodies/professional bodies across the country comprehensive approach (Negative List) to tax services may be desirable, more particularly in order to avoid breaking of chain and also to ensure wider coverage from the perspective of proposed GST regime.

However, a serious note of caution is advised while moving towards comprehensive approach (Negative List), keeping in mind that a substantial portion of our economy exists in the form of a large unorganised sector scattered in the different parts of the country and the possible adverse impact on the aam aadmi. Hence, it is essential that the likely con-sequences of adopting a comprehensive approach (Negative List) to tax services are appropriately dealt with.

Introduction of Comprehensive Approach (Negative List)
Introduction should be only with GST to avoid overlaps with State levies
Considering the substantive nature of the proposed legislative amendment which spells out a significant policy perspective of the Government and which is likely to have far-reaching implications, comprehensive approach (Negative List) to tax services should be introduced only as a part of GST Regime, which is being looked upon as the biggest indirect taxation reform in our country post independence.

While mutual overlaps between central levies have been resolved to a large extent, several overlaps remain due to the lack of coordination and uniformity in the approach to indirect taxation by the Centre and the States. GST, in creating a dual but uniform levy on goods and services simultaneously by the Centre and States is expected to resolve many of these issues. The definition of the term ‘service’ has been set out in such broad terms in the draft concept paper that the potential for overlap with the existing State levies (and certain central levies) is very high. Hence, until the State levies are synchronised with the Central levies (which will only happen upon the transition to GST) the introduction of a negative list may be a step in the wrong direction.

In case of introduction of Negative List prior to GST, public debate on amendments in affected legislations necessary Alternatively, if the comprehensive approach (Negative List) to tax service is to be put in place prior to the introduction of GST Regime, a Comprehensive Concept Paper along with drafts of amended legislations likely to be impacted should also be placed for public debate and response by the affected parties so as to fully understand the implications in totality.

An illustrative list of rules/regulations which could be impacted are as under:

•     Service Tax Rules, 1994

•     CENVAT Credit Rules, 2004

•     Criteria-based Export of Services Rules, 2005

•     Criteria-based Taxation of Services (Provided from Outside India and Received in India) Rules, 2006

•     Service Tax (Determination of Value) Rules, 2006

•     Works Contract (Composition Scheme for Payment of Service Tax) Rules, 2007

    Point of Taxation Rules, 2011

•     Service-specific exemption Notifications issued from time to time granting exemptions/abatements either fully or partially

In relation to the aforesaid, it should be ensured that the existing substantive and established principles are continued upon in the negative list approach as well.

Time for preparation
Introduction of a comprehensive approach (Negative List) of taxing services with several consequential amendments in existing rules & regulations will undoubtedly require businesses to make innumerable changes in their current IT systems, processes, documentation, record management, etc. Therefore, businesses should be given a minimum of 6 months’ time after all the legislative amendments (including the Rules referred to above) are announced, but before they are made effective.

Important issues requiring consideration before adopting comprehensive approach (Negative List) to tax services
While moving towards comprehensive approach (Negative List) to tax services, the important and significant aspects which need to be considered are set out below.

Definition of ‘Service’
The term ‘service’ needs to be appropriately defined whereby the shortcomings of the present service tax law are taken care of and at the same time unintended transactions do not get taxed by ensuring the following, in particular:

•     The terminology in definition employing words such as ‘anything’ should be done away with so as to minimise interpretation issues.

•     In line with prevalent international practices, the scope of ‘service’ should explicitly cover only those transactions which are carried out with a commercial/economic objective & intent.

•     In the absence of harmonious approach be-tween the Centre and States at present, there are already instances of various transactions like supply of software, enjoyment of IPR, franchise, recharge vouchers for telecommunication services and DTH services, etc. which are currently treated by the Centre as services liable to service tax and by States as sale of ‘goods’/ ‘deemed sale of goods’ liable to VAT. Once the term ‘service’ is defined for the purpose of taxing services based on a negative list and if there is no consensus between the Centre and States on such definition, instances of dual taxation of various transactions, both by Centre and States, will only increase. Therefore, approval of all the States governments should also be taken on the definition of the term ‘service’ to be adopted by the Centre. In order that the end beneficiary (aam aadmi) is not burdened by cascading effect of dual taxation, it should be ensured that services which are liable to service tax by the Centre do not also suffer VAT under the State VAT Laws.

•     Transactions which are in the nature of ‘self-supply’ within a legal entity are excluded.

•     Transactions which are per se not in the nature of ‘service’ (e.g., donations/voluntary contributions, gifts, subsidies/grants, security deposits, damages and compensations, etc.) should be kept out of service tax.

•     Transactions arising from shifting or transfer of factory/premises on account of change in ownership or on account of sale, merger, de-merger, amalgamation, lease, conversion to LLP, transfer to joint venture or any other mode of business reorganisation with specific provision for transfer of liabilities of such factory/premises/business to the transferee should be excluded from the purview of ‘service’.

l Exclude activities that are specifically notified from time to time for exemption/exclusion from the levy of service tax.

Threshold exemption

Under the comprehensive approach (Negative List) to tax services, a large section of the country’s unorganised economy is likely to get covered under the service tax, which could have adverse impact on the aam aadmi. In order to ensure that a large number of small taxpayers are kept out and administration efforts of the Government are focussed on large taxpayers the following is suggested:

•     A high threshold limit in the range of Rs.50 lakh (on an optional basis) should be prescribed.

•     Alternatively, a simple composition scheme of taxation (with no CENVAT benefit), may be prescribed for small taxpayers where taxable value of services exceeds a specified amount during a financial year.

Input services eligible for CENVAT credit
It is an established cardinal principle of any VAT/ GST system prevalent worldwide that taxes paid on all services availed for the purpose of business are eligible for input tax credit. If services are to be taxed comprehensively, there cannot be any justification for breaking the input tax credit chain. Hence, simultaneously with introduction of negative list of services, definition of ‘input service’ under the Cenvat Credit Rules, 2004 must be amended, whereby all services availed for the purpose of business qualify as input services eligible for CENVAT credit.

•     There are certain key sectors (Refer to Table 2) of our economy, which need to be specified as ‘Zero-rated Services’ (i.e., while there would be no output tax payable, benefit of input tax credit would be available, through a refund mechanism).

•     In order to avoid issues and disputes as to classification and consequential eligibility to benefit, coverage of services should be clearly defined with detailed Interpretative Notes on lines with Central Excise/Customs Tariff.

Negative List of services

•     The Government has identified certain services (Refer Table 3 below) to be kept out of the service tax. In case of such services, benefit of CENVAT credit would not be available to the service provider. The following services should be considered for inclusion/wider coverage in the negative list.

•     In order to avoid issues and disputes as to classification and consequential eligibility to benefit, coverage of services should be clearly defined with detailed interpretative notes on lines with Central Excise/Customs Tariff.