Interchange of services between the Associated Enterprise had been a tax avoidance tool in the hands of the various enterprises. A practice was developed in the assessees to make book adjustments and the revenue was only recognized in the books of the companies. No service tax was paid by them on the argument that no amount is being received in actual and these are mere book entries. To have control on such practices, the services provided to the associated enterprises have been brought under the Service Tax net vide Finance Act, 2008. In such cases, service tax will also be payable by the company even if no amount is actually received against services provided to its associated enterprise. Mere book entries will be sufficient to enforce the levy of Service Tax. The amendment has given rise to unique issues which are dealt hereunder.
Associated Enterprise: Meaning:-
The term ‘Associated enterprise’ has been defined in Section 65 (7b) of the Finance Act, 1994 which reads as follows:-
(7b) “associated enterprise” has the meaning assigned to it in section 92A of the Income Tax Act, 1961.
Section 92A (2) of the Income Tax Act specifies various situations under which two enterprises shall be deemed to be associated enterprises. Enterprise means a person who is engaged in the providing any kind of services. The definition under Section 92A of the Income Tax Act, 1961 is reproduced hereunder for ready reference: -
92A. (1) For the purposes of this section and sections 92, 92B, 92C, 92D, 92E and 92F, “associated enterprise”, in relation to another enterprise, means an enterprise—
(a) which participates, directly or indirectly, or through one or more intermediaries, in the management or control or capital of the other enterprise; or
(b) in respect of which one or more persons who participate, directly or indirectly, or through one or more intermediaries, in its management or control or capital, are the same persons who participate, directly or indirectly, or through one or more intermediaries, in the management or control or capital of the other enterprise.
(2) Two enterprises shall be deemed to be associated enterprises if, at any time during the previous year,—
(a) one enterprise holds, directly or indirectly, shares carrying not less than twenty-six percent. of the voting power in the other enterprise; or
(b) any person or enterprise holds, directly or indirectly, shares carrying not less than twenty-six percent. of the voting power in each of such enterprises; or
(c) a loan advanced by one enterprise to the other enterprise constitutes not less than fifty-one per cent. of the book value of the total assets of the other enterprise; or
(d) one enterprise guarantees not less than ten per cent. of the total borrowings of the other enterprise; or
(e) more than half of the board of directors or members of the governing board, or one or more executive directors or executive members of the governing board of one enterprise, are appointed by the other enterprise; or
(f) more than half of the directors or members of the governing board, or one or more of the executive directors or members of the governing board, of each of the two enterprises are appointed by the same person or persons; or
(g) the manufacture or processing of goods or articles or business carried out by one enterprise is wholly dependent on the use of know-how, patents, copyrights, trade-marks, licences, franchises or any other business or commercial rights of similar nature, or any data, documentation, drawing or specification relating to any patent, invention, model, design, secret formula or process, of which the other enterprise is the owner or in respect of which the other enterprise has exclusive rights; or
(h) ninety per cent. or more of the raw materials and consumables required for the manufacture or processing of goods or articles carried out by one enterprise, are supplied by the other enterprise, or by persons specified by the other enterprise, and the prices and other conditions relating to the supply are influenced by such other enterprise; or
(i) the goods or articles manufactured or processed by one enterprise, are sold to the other enterprise or to persons specified by the other enterprise, and the prices and other conditions relating thereto are influenced by such other enterprise; or
(j) where one enterprise is controlled by an individual, the other enterprise is also controlled by such individual or his relative or jointly by such individual and relative of such individual; or
(k) where one enterprise is controlled by a Hindu undivided family, the other enterprise is controlled by a member of such Hindu undivided family, or by a relative of a member of such Hindu undivided family, or jointly by such member and his relative; or
(l) where one enterprise is a firm, association of persons or body of individuals, the other enterprise holds not less than ten per cent. interest in such firm, association of persons or body of individuals; or
(m) there exists between the two enterprises, any relationship of mutual interest, as may be prescribed.
The analysis of this definition makes it clear that it is a wide definition covering almost all the cases through which one enterprise can exercise control on the other. Thus, an enterprise which participates, directly or indirectly, or through one or more intermediaries, in the management or control or capital of the other enterprise is considered as associated enterprise. An enterprise in respect of which one or more persons who participate, directly or indirectly, or through one or more intermediaries, in the management or control or capital of the other enterprise, is also covered under it.
MERE BOOK ADJUSTMENTS BY ASSOCIATED ENTERPRISE ARE TAXABLE:-
Section 67 of Finance Act, 1994 prescribes for valuation of taxable services for the purpose of charging service tax. CBEC have made changes through Letter D.O.F. No. 334/1/2008-TRU, Dt: 29-2-2008 in this section so as to include the book adjustment in the taxable value of the services. After amendment relevant clause (c) of the Explanation to this section 67 reads as follows:-
“gross amount charged” includes payment by cheque, credit card, deduction from account and any form of payment by issue of credit notes or debit notes and book adjustment, and any amount credited or debited, as the case may be, to any account, whether called “Suspense account” or by any other name, in the books of account of a person liable to pay service tax, where the transaction of taxable service is with any associated enterprise.]
On analysis of above it is ample clear that gross amount charged (on which service tax is payable) includes the debit or credit entries via which any adjustment is made between the associated enterprise.
In other words, any amount debited or credited in the books of accounts of the associated enterprises is now within the scope of the term, 'gross amount charged'. According to this rule Associated Enterprises cannot give an excuse that they are not required to pay service tax as they have not received the payment.
SERVICE TAX BY ASSOCIATED ENTERPRISES – WHEN PAYABLE:-
When an Associate recognizes the amount as revenue/expenditure in accounts than the service tax liability arises. This is an exception to general provision of payment of service tax as given in Rule 6 of the Service Tax Rules, 1994 which says that service tax is required to be paid only after receipt of the payment. This was clarified by the Board in their TRU letter D.O. F. No.334/1/2008-TRU 29th February, 2008. The relevant para is reproduced hereunder for ready reference: -
6.3 As an anti-avoidance measure, it is proposed to clarify that service tax is leviable on taxable services provided by the person liable to pay service tax even if the amount is not actually received, but the amount is credited or debited in the books of account of the service provider. In other words, service tax is required to be paid after receipt of payment or crediting/debiting of the amount in the books of accounts, whichever is earlier. However, this provision is restricted to transaction between associated enterprises. This provision shall also apply to service tax payable under reverse charge method (Section 66A) as taxable services received from associated enterprises. For this purpose section 67 and rule 6(1) are being amended.
It has been clarified in Section 6 of the Service Tax Rules, 1994 which prescribes payment of service tax, that where the transaction of taxable service is with any associated enterprise, any payment received towards the value of taxable service, in such case shall include any amount credited or debited, as the case may be, to any account, whether called ‘Suspense account’ or by any other name, in the books of account of a person liable to pay service tax.
This was inserted in the Service Tax Rules by Service Tax (Second Amendment) Rules, 2008 vide Notification No. 19/2008-ST dated 10.05.08.
SERVICES RECEIVED FROM FOREIGN ASSOCIATED ENTERPRISES:-
This provision of service tax on book adjustment shall also apply in case the associated enterprise is situated in foreign country. By virtue of Section 66A, the service tax will also be payable if the book adjustments are made for the associated enterprise located abroad. In other words, if any service is received from the associated enterprise located abroad and settlement is made via book adjustments, service tax will also be payable under reverse charge method (Section 66A). For this purpose section 67 and rule 6(1) are being amended.
CENVAT CREDIT OF SERVICE TAX PAID BY ASSOCIATED ENTERPRISE:-
Rule 4 of the Cenvat Credit Rules, 2004 prescribes the conditions for allowing Cenvat credit. For taking credit of input service, it provides that: -
(7) The CENVAT credit in respect of input service shall be allowed, on or after the day which payment is made of the value of input service and the service tax paid or payable as is indicated in invoice, bill or, as the case may be, challan referred to in rule 9.
For services of Associated Enterprise, if only a debit entry or credit entry is made in the books of accounts, service tax is payable. But the sub-rule (7) of Rule 4 of Cenvat Credit Rules, 2004 provides that credit of input service is allowed when payment is made of value of input service and the service tax as indicated in invoice, bill or challan is made. As such, until and unless the book adjustments are settled off via payment, the credit of service tax paid on book adjustments will not be allowed. Thus, an anomaly has been created where Cenvat credit cannot be taken by the service recipient even though service tax has been paid on the service of associated enterprise availed by him.
The insertion of concept of service tax on book adjustments is a good step against the enterprises using the book adjustments as a weapon for tax avoidance. But the incomplete amendments in the related rules and provisions have created the anomaly that would break the Cenvat chain. The Cenvat credit facility is allowed to bridge over the cascading effect of service tax/excise duty being paid on both input/output services/products. But in the instant case, the recipient of service who is paying the service tax/excise duty on the output services/products will not be able to take the Cenvat Credit on the input service which had suffered the service tax. The solution to this anomaly would be to amend the Cenvat Credit Rules, 2004 so as to allow availment of Cenvat credit in respect of service tax paid by the associated enterprises on book adjustments. Till then, the biggies of the industries/service sector whose book adjustments involve a huge amount are looking forward to the Board for any clarification in this regard.