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Analysis of Education Guide 2012- Part II - "Service"

Madhukar N Hiregange 
on 03 December 2012

LinkedIn


Understanding the Educational Guide-2012 Part - II – “Service”

We examine in this article, the guide in detail and have provided our comments in italics. At this stage they represent only thoughts or questions which required to be further examined. Readers are advised to get independent confirmation and then acting as this law is vague and inconsistent.

‘Service’ has been defined in clause (44) of the new section 65B and means –

i. Any activity

ii. For consideration

iii. Carried out by a person for another

iv. And includes a declared service.

The said definition further provides that ‘Service’ does not include –

a. any activity that constitutes only a transfer in title of (i) goods or (ii) immovable property by way of sale, gift or in any other manner

b. (iii) a transfer, delivery or supply of goods which is deemed to be a sale of goods within the meaning of clause (29A) of article 366 of the Constitution

c. a transaction only in (iv) money or (v) actionable claim

d. a service provided by an employee to an employer in the course of the employment.

e. fees payable to a court or a tribunal set up under a law for the time being in force

There are four explanations appended to the definition of ‘service’ which are dealt with in later part of this Guidance Note. Each of the ingredients bulleted above have been explained in the points below.

Comments: The word merely in the provision here has been interpreted as only, which may not be a synonym.

In the context of sale of goods maybe the works contract maybe excluded. Maybe in the sale of immovable property if the eviction of the tenant is agreed to be provided by the buyer then it would not be a mere sale? Or in the sale of the Immovable property the government sanctions for the conversion of land to industrial/ commercial use is also part of the contract then it may not be a mere sale. 

Deemed sale i.e. hiring, works contract, supply of food would also be excluded from the definition of service. Only the value which does not represent sale would be liable for service tax.

It is interesting that the services by the company to its employees could be liable though the vice versa is excluded in the definition. Whole time Directors who are employees [ where their IT return is files under salaries head] would also be covered. Other directors such as independent directors would be said to provide services to the Company.[ Though the same has been covered under reverse charge w.e.f. 7.8.2012.]

2.1 Activity

2.1.1 What does the word ‘activity’ signify?

‘Activity’ has not been defined in the Act. In terms of the common understanding of the word activity would include an act done, a work done, a deed done, an operation carried out, execution of an act, provision of a facility etc. It is a term with very wide connotation.

Activity could be active or passive and would also include forbearance to act. Agreeing to an obligation to refrain from an act or to tolerate an act or a situation has been specifically listed as a declared service under section 66E of the Act.

Comments: Whether an activity can be said to be a passive one is an aspect which maybe questioned in time to come? The definition of “tolerating an act or a situation” whether in line with the Constitutional understanding may require further examination. Whether the social/ personal transactions of such nature would also be covered as there is no exclusion or exemption for the same is the reason the same maybe challenged.  

2.2 Consideration

2.2.1 The phrase ‘consideration’ has not been defined in the Act. What is, therefore, the meaning of ‘consideration’?

As per Explanation (a) to section 67 of the Act “consideration” includes any amount that is payable for the taxable services provided or to be provided.

Since this definition is inclusive it will not be out of place to refer to the definition of ‘consideration’ as given in section 2 (d) of the Indian Contract Act, 1872 as follows-

“When, at the desire of the promisor, the promisee or any other person has done or abstained from doing, or does or abstains from doing, or promises to do or to abstain from doing, something, such act or abstinence or promise is called a consideration for the promise”

Comments: Though the reference to the Contract Act may not be out of place for better understanding, the legal maxim is that when there is a definition provided within the law itself then other laws are not to be referred to. This aspect would also probably emerge once issues reach the court.

In simple terms, ‘consideration’ means everything received or recoverable in return for a provision of service which includes monetary payment and any consideration of non- monetary nature or deferred consideration as well as recharges between establishments located in a non-taxable territory on one hand and taxable territory on the other hand.

Comments: The legal provisions as they exist today have an infirmity in so far as chargeability of service tax on reverse charge basis is concerned. The omission of Section 66A without parallel provisions for the same being enabled could lead to a spate of disputes in regard to the services received from outside India as well as the export of services. Hopefully this lacunae would be resolved soon. Otherwise it is expected that the disputes similar to those from 2004 till 2006 would be re-visited.

2.2.2 What are the implications of the condition that activity should be carried out for

a. ‘Consideration’?

1. To be taxable  an activity should be carried out by a person  for a ‘consideration’

2. Activity carried out without any consideration like donations, gifts or free charities are therefore outside the ambit of service. For example grants given for a research where the researcher is under no obligation to carry out a particular research would not be a consideration for such research.

3. An act by a charity for consideration would be a service and taxable unless otherwise exempted. (for exemptions to charities please see Guidance Note 7)

4. Conditions in a grant stipulating merely proper usage of funds and furnishing of account also will not result in making it a provision of service.

5. Donations to a charitable organization are not consideration unless charity is obligated to provide something in return e.g. display or advertise the name of the donor in a specified manner or such that it gives a desired advantage to the donor.

Comments: The nomenclature therefore would not be as important as the nature of the payment, which is the correct. Specification of end use of charity or donation would not make the same an activity for consideration.

An example could be when an educational institution gets a grant for doing a study/ research and at the end of the exercise, it submits a report on its finding to the funder then there is a quid pro quo and consequently it would be a consideration. Transfer or right to IPR/ sharing of IPR also would be a consideration and liability for service tax could arise.

An important understanding that comes out is that the position of the receiver being an educational/ philanthropic organisation/ Government would not be relevant and only the fact that there is a return or not in some form or the other would be important.

1. What is the meaning of monetary consideration?

Monetary consideration means any consideration received in the form of money. ‘Money’ has been defined in section 65B and includes not only cash but also cheque, promissory note, bill of exchange, letter of credit, draft, pay order, traveler’s cheque, money order, postal or electronic remittance or any such similar instrument.

Comment: The adjustment in accounts by expunging/ reduction in a liability would also be a consideration in cash. This could happen when there are multiple activities carried out between 2 entities. Group companies at times follow this system instead of making and receiving the payments. At times even between the parent company abroad and the subsidiary in India this happens.

2.2.4 What is non-monetary consideration?

Non-monetary consideration essentially means compensation in kind such as the following:

a. Supply of goods and services in return for provision of service

b. Refraining or forbearing to do an act in return for provision of service

c. Tolerating an act or a situation in return for provision of a service

d. Doing or agreeing to do an act in return for provision of service

Illustrations

If……

And in return…

A agrees to dry clean B’s clothes

B agrees to click A’s photograph

A agrees not to open dry clean shop in

B agrees not to open photography shop in

B’s neighbourhood

A’s neighbourhood

A agrees to design B’s house

B agrees not to object to construction of

A’s house in his neighbourhood

A agrees to construct 3 flats for B on land

B agrees to provide one flat  to A without any

owned by B

monetary consideration

Then

For the services provided by A to B, the acts of B specified in 2nd column are non- monetary consideration provided by B to A. Conversely, for services provided by B to A, similar reasoning will be adopted.

Comments: These situations except for the first one, leads to some very challenging valuation issues such as:

-what is the value of refraining / forbearance

-what is the value of tolerating an act or situation

-what is the value of the doing of an act

It is real that more of these are more perceptions and may lead to impossibility of arriving at a value. Is the value cannot be arrived at could the tax be levied?

2.2.5 Is the value of non-monetary consideration important?

Yes. The non-monetary consideration also needs to be valued for determining the tax payable on the taxable service since service tax is levied on the value of consideration received which includes both monetary consideration and money value of non-monetary consideration.

2.2.6 How is the money value of non-monetary consideration determined?

The value of non-monetary consideration is determined as per section 67 of the Act and the Service Tax (Determination of Value) Rules 2006, which is equivalent money value of such consideration and if not ascertainable, then as follows:-

a. On the basis of gross amount charged for similar service provided to other person in the ordinary course of trade;

b. Where value cannot be so determined, the equivalent money value of such consideration, not less than the cost of provision of service.

For details please refer to point no 8.1.8 and 8.1.9 of this Guide.

Comments: The valuation of services pose a number of challenges as the factors which affect the quote for services could be as under:

1. Whether the service receiver is an old client or new?

2. Whether the service receiver is able to pay, pay normally or able to pay well?

3. Whether the service receiver has too many expectations and also very finicky?

4. Whether the matter is a routine one or complex?

5. Whether the environment is conducive or challenging?

6. Who has referred the client?    

7. Is the client influential/ well known/ look good in the service providers profile?

8. Who would be involved in the work?

9. Many many others.

Even the ascertainment of cost in a service organisation is not easy unless there is a excellent system of cost allocation in place.

Under Central Excise where it relates to goods the Courts have held that different prices due to quantum, location, timing among many other reasons are a valid price and cannot be questioned.

Therefore if the revenue were to question the value based on comparable work it may well nigh be impossible. It is also expected that finally the courts would opine that each value ascertained by the tax payer is valid. This would be especially possible since a service can be given free of cost also unlike goods which have to be valued even if they were for free distribution or donation.  

2.2.7 Are research grant with counter obligation on researcher to provide IPR rights on outcome of a research a consideration?

In case research grant is given with counter obligation on the researcher to provide IPR rights on the outcome of research or activity undertaken with the help of such grants then the grant is a consideration for the provision of service of research. General grants for researches will not amount to a consideration.

Comments: Wherever there is a quid pro quo- something in return the grant would be considered as a consideration. Even providing a report on the finding and giving recommendations based on the study/ research could be considered as something in return. Sharing of IPR also would disentitle the grant for exemption.

2.3 Activity for a consideration

The concept ‘activity for a consideration’ involves an element of contractual relationship wherein the person doing an activity does so at the desire of the person for whom the activity is done in exchange for a consideration. An activity done without such a relationship i.e. without the express or implied contractual reciprocity of a consideration would not be an ‘activity for consideration’ even though such an activity may lead to accrual of gains to the person carrying out the activity.

Thus an award received in consideration for contribution over a life time or even a singular achievement carried out independently or without reciprocity to the amount to be received will not comprise an activity for consideration.

There can be many activities without consideration. An artist performing on a street does an activity without consideration even though passersby may drop some coins in his bowl kept after feeling either rejoiced or merely out of compassion. They are, however, under no obligation to pay any amount for listening to him nor have they engaged him for his services. On the other hand if the same person is called to perform on payment of an amount of money then the performance becomes an activity for a consideration.

Provisions of free tourism information, access to free channels on TV and a large number of governmental activities for citizens are some of the examples of activities without consideration.

Similarly there could be cases of payments without an activity though they cannot be put in words as being “consideration without an activity”. Consideration itself pre-supposes a certain level of reciprocity. Thus grant of pocket money, a gift or reward (which has not been given in terms of reciprocity), amount paid as alimony for divorce would be examples in this category. However a reward given for an activity performed explicitly on the understanding that the winner will receive the specified amount in reciprocity for a service to be rendered by the winner would be a consideration for such service. Thus amount paid in cases where people at large are invited to contribute to open software development (e.g. Linux) and getting an amount if their contribution is finally accepted will be examples of activities for consideration.

Comments: The above explanations do not appear to be reasonable or in order. Many questions can arise- cricketer scoring a century gets an award if paid to play then the award is in relation to the same and therefore could be liable - street artists who know that they would get substantial collections if they perform are no different than those who are called and paid to perform. 

It is difficult to understand as to the reasoning for alimony. Could it not be argued that alimony is an amount paid to ensure that the other person does not disturb/ come in the way [ forbearance] Even dowry which is common in India is to ensure that the daughter is well taken care of in her new household. Could it not be said to be an amount which is payable for ensure that the daughter is well taken care of? Maybe a specific exemption for individual/ within family arrangements and common practices would bring clarity.

Bribe money would certainly be a consideration and would be taxable as and when unearthed as for an activity [ forbearance (overlooking a defect, not making a valid/ frivolous demand ...) or positive action ( speeding up refunds...] it is paid. Of course this would not be available unless there has been a raid. Therefore in the future can we expect that whenever monies [ properties FDs, Shares] are seized in an Income Tax / money laundering / Lok ayukta or search proceedings then the demand under service tax would follow?

2.3.1 Would imposition of a fine or a penalty for violation of a provision of law be a consideration for the activity of breaking the law making such activity a ‘service’?

No. To be a service an activity has to be carried out for a consideration. Therefore fines and penalties which are legal consequences of a person’s actions are not in the nature of consideration for an activity.

Comments: In contracts there are clauses inserted to safeguard the parties against eventualities which are not normally expected. They would be terms as “liquidated damages” or “compensation”. Whether these could be said to be penalties may require to be examined.

2.3.2 Would the payments in the nature as explained in column A of the table below constitute a consideration for provision of service?

Comments: In case of advances not being returned for the supply of goods there would be no liability under this levy. However if it were for services they the liability exists.

In the case of 6 above where in a rental agreement there is a clause that in the unlikely event of the agreement being terminated early the security deposit would be forfeited would be covered. If it was forseen then why would the tenant agree for the forfeiture. Therefore unforeseen also may include not likely / not expected. In case of 7 above the return or non return determining the taxability may be disputed as it appears devoid of any logic.

2.3.3 Can a consideration for service be paid by a person other than the person receiving the benefit of the service?

Yes. The consideration for a service may be provided by a person other than the person receiving the benefit of service as long as there is a link between the provision of service and the consideration. For example, holding company may pay for services that are provided to its associated companies.

2.4 By a person for another

2.4.1 What is the significance of the phrase ‘carried out by a person for another’?

The phrase ‘provided by one person to another’ signifies that services provided by a person to self are outside the ambit of taxable service. Example of such service would include a service provided by one branch of a company to another or to its head office or vice-versa.

2.4.2 Are there any exceptions wherein services provided by a person to oneself are taxable?

Yes. Two exceptions have been carved out to the general rule that only services provided by a person to another are taxable. These exceptions, contained in Explanation 2 of clause (44) of section 65B, are:

a. an establishment of a person located in taxable territory and another establishment of such person located in non-taxable territory are treated as establishments of distinct persons. [Similar provision exists presently in section 66A (2)].

b. an unincorporated association or body of persons and members thereof are also treated as distinct persons. [Also exists presently in part as explanation to section 65].

Implications of these deeming provisions are that inter-se provision of services between such persons, deemed to be separate persons, would be taxable. For example, services provided by a club to its members and services provided by the branch office of a multi-national company to the headquarters of the multi-national company located outside India would be taxable provided other conditions relating to taxability of service are satisfied.

Comments: The matter of mutuality which postulates that one cannot earn an income from oneself or provide service to oneself is being tested by bringing this deeming fiction. Some legal experts opine that the provisions of service tax law cannot go beyond the Constitution of India and the deeming fiction is possible to be successfully challenged. It is expected that the decision in a few years could provide clarity. As on date the Jharkhand High Court in the case of Ranchi Club has held that the Club and its members are not different and therefore there is no service from one to the other inspite of the explanation in the pre negative list regime.  

2.4.3 Are services provided by persons who have formed unincorporated joint ventures or profit-sharing arrangements liable to be taxed?

The services provided, both by the so constituted JV or profit sharing association of persons (AOP), as well as by each of the individual persons constituting the JV/AOP will be liable to be taxed separately, subject of course to the availability of the credit of the tax paid by independent persons to the JV/AOP and as otherwise admissible under Cenvat Rules.

Comments: In case of genuine JVs where the risk and reward is shared and both parties are involved in the transaction, any service provided by them for the JV could not be said to a service. The deeming fiction cannot be extended to such real concerns.

However where the arrangements have been made which clearly go to show that one is the service provider and one a receiver, it would be taxable. Examples of this could be JV between the landlord and builders; revenue share in case of shops in malls. These cases are variation of the services of construction or rental and therefore liable to tax.

The terms of agreement and essence of the contract would determine the taxability.

2.4.4 Who is a ‘person’? Is it only a natural person or includes an artificial or a juridical person?

‘Person’ is not restricted to natural person. ‘Person’ has been defined Section 65 B of the Act.  The following shall be considered as persons for the purposes of the Act:

a. an individual

b. a Hindu undivided family

c. a company

d. a  society

e. a  limited liability partnership

f. a firm

g. an association or body of individuals, whether incorporated or not

h. Government

i. a  local authority,  or

j. every artificial juridical person, not falling within any of the preceding sub-clauses.

Are Government and local authorities also liable to pay tax?

Yes. However, most of the services provided by the Government or local authorities are in the negative list.

2.4.6 What is the rationale behind taxing certain activities of the Government or local authorities?

Only those activities of Government or local authorities are taxed where similar or substitutable services are provided by private entities. The rationale is as follows-

i. to provide a  level  playing  field  to private entities in these areas as exemption  to Government in such activities would lead to competitive inequities; and

ii. to avoid break in Cenvat chain as the support services provided by Government are normally in the nature of intermediary services.

Comments: Even under the earlier positive list regime the statutory [ sovereign] functions of Government were not liable.

It is important now as the exemption provided in areas of public service, education and construction would normally contain conditions which would require to be strictly applied. There is no automatic exemption.

An example could be several Housing Boards who provide/ extend the services which may related infrastructure/ parks/ housing/ land development. Wherever these are with a commercial intent as some of them have started to do, then the same would be liable to tax.

2.4.7 What is the meaning of ‘Government’?

The phrase ‘Government’ has not been defined in the Act. As per clause (23) of section 3 of the General Clauses Act, 1897 ‘Government’ includes both Central Government and any State Government. As per clause (8) of section 3 of the said Act ‘Central Government’, in relation to anything done or to be done after the commencement of the Constitution, mean the President. As per article 53 of the Constitution the executive power of the Union shall be vested in the President and shall be exercised by him either directly or indirectly through officers subordinate to him in accordance with the Constitution. Further, in terms of article 77 of the Constitution all executive actions of the Government of India shall be expressed to be taken in the name of the President. Therefore, the Central Government means the President and the officers subordinate to him while exercising the executive powers of the Union vested in the President and in the name of the President.

Similarly as per clause (60) of section 3 of the General Clauses Act,1897 ‘State Government’, as respects anything done after the commencement of the Constitution, shall be in a State the Governor, and in Union Territory the Central Government. Further as per article 154 of the Constitution the executive power of the State shall be vested in the Governor and shall be exercised by him either directly or indirectly through officers subordinate to him in accordance with the Constitution. Further, as per article 166 of the Constitution all executive actions of the

Government of State shall be expressed to be taken in the name of Governor. Therefore, State Government means the Governor or the officers subordinate to him who exercise the executive power of the State vested in the Governor and in the name of the Governor.

2.4.8 What is a local authority?

Local authority is defined in clause (31) of section 65B and means the following:-

a. A Panchayat as referred to in clause (d) of article 243 of the Constitution

b. A Municipality as referred to in clause (e) of article 243P of the Constitution

c. A Municipal Committee and a District Board, legally entitled to, or entrusted by the

i. Government with, the control or management of a municipal or local fund

ii. A Cantonment Board as defined in section 3 of the Cantonments Act, 2006

d. A regional council or a district council constituted under the Sixth Schedule to the Constitution

e. A development board constituted under article 371 of the Constitution, or

f. A regional council constituted under article 371A of the Constitution.

Are all local bodies constituted by a State or Central Law local authorities?

No. The definition of ‘local authority’ is very specific as explained in point no 2.4.8 above and only those bodies which fall in the definition comprise ‘local authorities’. It would not include other bodies which are merely described as a local body by virtue of a local law.

However it may be noted that services by a governmental authority by way of any activity in relation to any function entrusted to a municipality under article 243W of the Constitution are specifically exempt under the mega exemption. ‘Governmental authority’ has been defined in the said mega exemption as a board, or an authority or any other body established with 90% or more participation by way of equity or control by Government and set up by an Act of the

Parliament or a State Legislature to carry out any function entrusted to a municipality under article 243W of the Constitution. Thus some of these local bodies may comprise governmental authorities.

Comments: The definition of Government authority include those Committees/ Boards:

a. 90% participation by way of equity

b. Or control [ projects require Central/ State Govt clearances- work under budgets set by such govt….]

c. AND set up by an Act of parliament or State Legislature to carry out functions as per Art243W

Art.243W sets out Urban Planning, Roads & Bridges, water supply- domestic, industrial as well as commercial, public health, slum improvement/ upgradation, urban amenities such as parks, gardens and playgrounds, street lighting, parking lots, bus stops and public conveniences among many others.

Therefore the activity carried on by Govt authority needs to be examined as all activities may not be covered.

It maybe noted that the corporations who are wholly owned by the Central or State Government and the PSU would not be covered in the above an therefore would not get any special treatment. Examples could be the State electricity companies / RTO etc where the applicability of concession needs to be clear and specific.

2.4.10 Would various entities like a statutory body, corporation or an authority constituted under an Act passed by the Parliament or any of the State Legislatures be ‘Government’ or “local authority”?

A statutory body, corporation or an authority created by the Parliament or a State Legislature is neither ‘Government’ nor a ‘local authority’ as would be evident from the meaning of these terms explained in point nos. 2.4.7 and 2.4.8 above respectively. Such statutory body, corporation or an authority are normally created by the Parliament or a State Legislature in exercise of the powers conferred under article 53(3)(b) and article 154(2)(b) of the Constitution respectively. It is a settled position of law Government (Agarwal Vs. Hindustan Steel AIR 1970 Supreme Court 1150) that the manpower of such statutory authorities or bodies do not become officers subordinate to the President under article 53(1) of the Constitution and similarly to the Governer under article 154(1). Such a statutory body, corporation or an authority as a juristic entity is separate from the state and cannot be regarded as Central or State

Government and also do not fall in the definition of ‘local authority’.

Thus regulatory bodies and other autonomous entities which attain their entity under an act would not comprise either government or local authority.

2.4.11 Would services provided by one department of the Government to another Department of the Government be taxable?

If services are provided by one department of the Central Government to another department of the Central Government or by a department of a State Government to another department of the same State Government then such service would not be taxable as it would amount to self-service. To be taxable a service has to be provided to another person.

On the other hand if a service is provided by a Central Government department to a State Government department or vice versa or a by a State to another State Government or by a

Government to an autonomous body, the same would be taxable if such service does not fall in the negative list. It is another matter that most of the services provided by the Government are in the negative list. For details please refer to point no. 4.1 of this Guide.

2.4.12 Would taxable services provided by Government or local authorities still be liable to tax if they are covered under any other head of the negative list or are otherwise exempted?

No. For example, transport services provided by Government to passengers by way of a stage carriage would not be taxable as transport of passengers by stage carriage has separately been specified in the negative list of services. The specified services provided by the Government or local authorities are taxable only to the extent they are not covered elsewhere i.e. either in the negative list or in the exemptions.

2.5 Activities specified in the declared list are services.

Declared Services are activities that have been specified in Section 66 E of the Act. When such activities are carried out by one person for another in the taxable territory for a consideration then such activities are taxable services. For guidance on the declared services please refer to Guidance Note 6.

2.6 Activity to be taxable should not constitute only a transfer in title of goods or immovable property by way of sale, gift or in any other manner

Mere transfer of title in goods or immovable property by way of sale, gift or in any other manner for a consideration does not constitute service.

Goods has been defined in section 65B of the Act as ‘every kind of moveable property other than actionable claims and money; and includes securities, growing crops, grass and things attached to or forming part of the land which are agreed to be severed before sale or under contract of sale’.

Immovable property has not been defined in the Act. Therefore the definition of immovable property in the General Clauses Act, 1897 will be applicable which defines immovable property to include land, benefits to arise out of land, and things attached to the earth, or permanently fastened to anything attached to the earth.

2.6.1 What is the significance of the phrase ‘transfer of title’?

‘Transfer of title’ means change in ownership. Mere transfer of custody or possession over goods or immovable property where ownership is not transferred does not amount to transfer of title. For example giving the property on rent or goods for use on hire would not involve a transfer of title.

Comments: The question is what would be the position of agreement to sell [immovable property]. Would it be a transfer of property in immovable property by way of sale, gift or in any other manner? As generally understood, the registration in the name of the transferee would make it so. Therefore there is a possibility that this would not be a transfer of title. This is so even when the custody or possession is transferred.

The word – merely is understood as only as per this guide.

The intention maybe explained by an example: When a site with a commercial building to be constructed is contracted for, it is not merely a transfer of an immovable property but some activity is required to be done thereto, therefore such transaction would not be excluded. However if a ready plot/ building is sold then it would be excluded from the definition of service.

2.6.2 What is the significance of the word ‘only’ in the said exclusion clause in the definition of ‘service’?

The word ‘only’ signifies that activities which constitute only:

a. transfer of title in goods or immovable property; or

b. transfer , supply or delivery which is deemed to be a deemed sale of goods or constitute; or

c. a transaction in money or an actionable claim-are outside the definition of service.

A transaction which in addition to a transfer of title in goods or immovable property involves an element of another activity carried out or to be carried out by the person transferring the title would not be outrightly excluded from the definition of service. Such transactions are liable to be treated as follows-

If two transactions, although associated, are two discernibly separate transactions then each of the separate transactions would be assessed independently. In other words the discernible portion of the transaction which constitutes, let’s say, a transfer of title in goods, would be excluded from the definition of service by operation of the said exclusion clause while the service portion would be included in the definition of service. For example a builder carrying out an activity for a client wherein a flat is constructed by the builder for the client for which payments are received in instalments and on completion of the construction the title in the flat is transferred to the client involves two elements namely provision of construction service and transfer of title in immovable property. The two activities are discernibly separate. The activity of construction carried out by the builder would, therefore, be a service and the activity of transfer of title in the flat would be outside the ambit of service.

• In cases of composite transactions, i.e. transactions involving an element of provision of service and an element of transfer of title in goods in which various elements are so inextricably linked that they essentially form one composite transaction then the nature of such transaction would be determined by the application of the dominant nature test laid down by the Supreme Court in BSNL’s case. The judgement has been explained in detail in point no 2.6.3. Although the judgement was given in the context of composite transactions involving an element of transfer in title of goods by way of sale and an element of provision of service, the ratio would equally apply to other kind of composite transactions involving a provision of service and transfer in title in immovable property or actionable claim.

Comments: It is important to note that activity of transfer of flat would be outside the levy. It maybe preferable that the value of the immovable property be separated to avoid ST on that part of the value where possible.

• In case the transaction is composite then the dominant nature test would have to be applied. In a transfer of an apartment, some reconditioning/ repair/ repainting is taken up, it would not be liable.

2.6.3 What is the manner of dealing with composite transactions which in addition to a transfer of title in goods involve an element of provision of service?

The manner of treatment of such composite transactions for the purpose of taxation, i.e. are they to be treated as sale of goods or provision of service, has been laid down by the Honorable

Supreme Court in the case of Bharat Sanchar Nigam Limited vs Union of India [2006(2)STR161(SC)]. The relevant paras 42 and 43 of the said judgment are reproduced below -

“42. Of all the different kinds of composite transactions the drafters of the 46th Amendment chose three specific situations, a works contract, a hire purchase contract and a catering contract to bring within the fiction of a deemed sale. Of these three, the first and third involve a kind of service and sale at the same time. Apart from these two cases where splitting of the service and supply has been Constitutionally permitted in Clauses (b) and (g) of Clause 29A of Art. 366, there is no other service which has been permitted to be so split. For example the clauses of Article 366(29A) do not cover hospital services. Therefore, if during the treatment of a patient in a hospital, he or she is given a pill, can the sales tax authorities tax the transaction as a sale? Doctors, lawyers and other professionals render service in the course of which can it be said that there is a sale of goods when a doctor writes out and hands over a prescription or a lawyer drafts a document and delivers it to his/her client? Strictly speaking with the payment of fees, consideration does pass from the patient or client to the doctor or lawyer for the documents in both cases.

43. The reason why these services do not involve a sale for the purposes of Entry 54 of List II is, as we see it, for reasons ultimately attributable to the principles enunciated in Gannon Dunkerley’s case, namely, if there is an instrument of contract which may be composite in form in any case other than the exceptions in Article 366(29-A), unless the transaction in truth represents two distinct and separate contracts and is discernible as such, then the State would not have the power to separate the agreement to sell from the agreement to render service, and impose tax on the sale. The test therefore for composite contracts other than those mentioned in Article 366 (29A) continues to be - did the parties have in mind or intend separate rights arising out of the sale of goods. If there was no such intention there is no sale even if the contract could be disintegrated. The test for deciding whether a contract falls into one category or the other is to as what is the substance of the contract. We will, for the want of a better phrase, call this the dominant nature test.”

The following principles emerge from the said judgment for ascertaining the taxability of composite transactions-

Except in cases of works contracts or catering contracts [exact words in article 366(29A) being – ‘service wherein goods, being food or any other article of human consumption or any drink (whether or not intoxicating) is supplied in any manner as part of the service’] composite transactions cannot be split into contracts of sale and contracts of service.

The test whether a transaction is a ‘composite transaction’ is that did the parties intend or have in mind that separate rights arise out of the constituent contract of sale and contract of service. If no then such transaction is a composite transaction even if the contracts could be disintegrated.

The nature of a composite transaction, except in case of two exceptions carved out by the Constitution, would be determined by the element which determines the ‘dominant nature’ of the transaction.

If the dominant nature of such a transaction is sale of goods or immovable property then such transaction would be treated as such.

If the dominant nature of such a transaction is provision of a service then such transaction would be treated as a service and taxed as such even if the transaction involves an element of sale of goods.

In case of works contracts and ‘service wherein goods, being food or any other article of human consumption or any drink (whether or not intoxicating) is supplied in any manner as part of the service’ the ‘dominant nature test’ does not apply and service portion is taxable as a ‘service’ This has also been declared as a service under section 66E of the Act. For guidance on these two types of composite transactions and the manner of determining the value portion of service portion of such composite transactions please refer to point nos. 5.8 and 5.9 of this Guidance Paper.

If the transaction represents two distinct and separate contracts and is discernible as such then contract of service in such transaction would be segregated and chargeable to service tax if other elements of taxability are present. This would apply even if a single invoice is issued.

The principles explained above would, mutatis mutandis, apply to composite transactions involving an element of transfer of title in immovable property or transaction in money or an actionable claim.

Comments: The arriving at the dominant nature of the transaction would be very important. If the intention of the parties is to sell the goods then it would be sale.  Other than WC and catering contracts in all other contract this rule would apply.

Where however the transaction represents 2 distinct and separate contracts then the contract of service in such transaction would be liable. This would not be affected by the fact that a single invoice is issued.

The transaction such as rerubberisation of rollers, revarnishingof printers and mounting films, retreading of tyres, photography studios among others are disputed across India for the past several years, but clarity on the same is not available. That should have provided in this guide.

2.6.4 Why has notification 12/2003-ST been deleted?

Notification 12/2003 – ST exempted so much of the value of all taxable services as was equal to the value of goods and materials sold (emphasis supplied) by the service provider to the service recipient subject to condition that there is documentary proof of such value of goods and materials. This was necessary under the regime of taxation of services based on specified descriptions as some of the specified descriptions could include an element of transfer of title in goods.

On the other hand, under the negative list scheme, specified descriptions of taxable services have been done away with and transactions that involve transfer of title in goods or are ‘deemed to be sale of goods’ under the Constitution are excluded from the ambit of service by the very definition of service. Therefore if, in the course of providing a service, goods are also being sold by a service provider for which there is such documentary proof as to make the sale a distinct and a separate transaction then the activity of sale of such goods gets excluded from the definition of service itself. The essence and intent of notification no 12/2003 has, therefore, been fully captured in the definition of service itself.

Comments: The understanding of Not. 12/2003 is important from the stand point that the essence and intent is captured in the definition of service. The case laws in this regard would be important to be followed. The fact that there are many composite activities under the VAT law which are not covered in the definition of works contract under the service tax provisions continues to cause much doubt and disputes abound in the same. The omission leads to situations where in the same transaction one would pay VAT on 100% and service tax also on 100% [ software] or VAT on 100% and service tax on 70% [ repair] These are issues which have not been addressed which should have been.

Therefore Notification 12/2003 needs to be reintroduced to provide reasonable collection of taxes by Centre and State.

2.6.5 Will the goods portion in transactions like annual maintenance contracts or erection and commissioning or construction be includible in the value of services consequent to the deletion of Notification 12/2003-ST?

All the examples given in the question now comprise “works contracts” and only the service portion of such contracts comprise service. By the express provisions contained in the definition of service (which is mandated by constitutional provisions) it is not possible to tax the goods portion of works contracts. However the principles of segregation of the value of goods are provided in Rule 2A of the Valuation Rules. Thus there is no basis for the taxation of goods in such contracts even after the deletion of the stated notification.

Even for the sale of any equipment for which a separate contract for warranty or after sales services or maintenance is entered the discernible sales portion is not to be included in the discernible portion of the value of service. For all practical purposes these will be two separate contracts. However for artificial segregation of value between goods and services, to save either of the taxes on goods or services, the benefit was neither available earlier under the stated notification and the position continues to be the same under the new regime.

Comments: This understanding seems to be incorrect in the light of the decision in Shilpa Color Labs – 2007 where the deduction was available on production of documentary proof of materials consumed. However a Larger bench decision in 2011 of Agarwal Color labs holds a contrary view. We understand that the same is under challenge. However Tribunal are following 2011 decision. It would have been ideal that the intention of the constitution should have been considered. By allowing deduction of value offered to State/ Centre, the fairness in the law would be restored.

If the gross amount is includible in other contracts then the credit on the inputs used/ consumed should also be available, which maybe an important aspect which would alleviate the impact to the extent of goods procured by paying the Central Excise duty. This has also been restricted in the cenvat credit rules which is quite unreasonable and palpably indicates the revenue collection zeal of the drafted of the law.

2.6.6 “Securities” have been included as goods. What are securities?

Securities have been defined in section 65B of the Act as having the same meaning assigned to it in clause (h) of section 2 of the Securities Contract (Regulation) Act, 1956 (42 0f 1956) in terms of which ‘securities’ includes–

a. Shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate.

b. Derivative.

c. Security receipt as defined in clause (zg) of section 2 of the Securitisation and

Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002.

• Units or any other such instrument issued to the investors under any mutual fund scheme.

• Any certificate or instrument (by whichever name called), issued to any investor by any issuer being a special purpose distinct entity which possesses any debt or receivable, including mortgage debt, assigned to such entity, and acknowledging beneficial interest of such investor in such debt or receivable, including mortgage debt, as the case may be;

• Government securities;

• Such other instruments as may be declared by the Central Government to be securities.

• Rights or interest in securities.

1. What are the implications of inclusion of ‘securities’ as ‘goods’?

The definition of ‘goods’ has essentially been borrowed from the Sale of Goods Act, 1930 with the only variation that in the inclusion clause of the said definition the phrase ‘stocks and shares’ been replaced with ‘securities’. In effect, therefore, activities that are in the nature of only transfer of title by way of sale, redemption, purchase or acquisition of securities on principal-to-principal basis, excluding services of dealers, brokers or agents in relation to such transactions, are outside the ambit of ‘services. However activities which are not in the nature of transfer of title in securities (for example a person agreeing not to exercise his right in a security for a given period of time for a consideration) would not be included in this exclusion clause to the definition of ‘service.

2.6.8 What is a derivative?

As per in clause (ac) of section 2 of the Securities Contract (Regulation) Act, 1956 (42 0f

1956) “derivative” includes—

A. a security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument or contract for differences or any other form of security;

B. a contract which derives its value from the prices, or index of prices, of underlying securities.

The definition of ‘derivatives’ in the said Act is an inclusive definition. Moreover, it may be noticed that as per the said definition ‘derivative’ includes security derived from a ‘contract of difference’ which is of a very wide ambit.

It would thus be prudent to keep in mind definition of derivatives as contained in Clause (a) of Section 45U of the RBI Act, 1935 as per which a ‘derivates’ means an instrument, to be settled at a future date, whose value is derived from change in interest rate, foreign exchange rate, credit rating from credit index, price of securities (also called “underlying”) , or a combination of a more than one of them and includes interest rates swaps, forward rate agreements, foreign currency swaps, foreign currency-rupee swaps, foreign currency options, foreign currency–rupee options or such other instruments as may be specified by the Bank from time-to- time. Transactions, including over the counter transactions, in such securities would therefore be out of the ambit of definition of ‘service’.

However if some service charges or service fees or documentation fees or broking charges or such like fees or charges are charged, the same would be considerations for provision of service and chargeable to service tax.

2.6.9 Would buying or selling of mutual funds or debentures be a ‘service’?

No. buying or selling of mutual funds or debentures would not be a service as the same would be a transaction in securities.

2.6.10 Whether the service tax would be chargeable on the ‘entry and exit load’ amount charged by a mutual fund to the investor?

As per the definition of ‘service’ only activities which are in the nature of transfer of title in goods (which includes securities) are excluded. As a consideration for the transfer of title in mutual funds the investors pay amounts equal to NAV of the mutual fund. Entry or exit loads are in the nature of consideration for documentation, covering initial expenses, asset management etc. Hence service tax would be leviable on such entry and exit loads.

Service tax would also be leviable on fund management activity undertaken by an asset management company (AMC) for which an AMC charges the mutual fund an ‘investment and advisory fee’, in accordance with provisions contained in the SEBI regulation.

2.6.11 What is the meaning of ‘immoveable property’?

‘Immoveable property’ has not been defined in the Act. Therefore, the definition of ‘immoveable property as given in clause (26) of the General Clauses Act, 1897 has to be taken as per which “immovable property” shall include land, benefits to arise out of land, and things attached to the earth, or permanently fastened to anything attached to the earth.

2.7 Activity to be taxable should not constitute merely a transfer, delivery or supply of goods which is deemed to be a sale of goods within the meaning of clause (29A) of article 366 of the Constitution.

2.7.1 What are ‘deemed sales’ defined in article 366(29A)?

The six categories of deemed sales as defined in article 366(29A) of the Constitution are –

• transfer, otherwise than in pursuance of a contract, of property in any goods for cash, deferred payment or other valuable consideration

• transfer of property in goods (whether as goods or in some other form) involved in the execution of a works contract

• delivery of goods on hire-purchase or any system of payment by installments

• transfer of the right to use any goods for any purpose (whether or not for a specified period) for cash, deferred payment or other valuable consideration

• supply of goods by any unincorporated association or body of persons to a member thereof for cash, deferred payment or other valuable consideration

• supply, by way of or as part of any service or in any other manner whatsoever, of goods, being food or any other article for human consumption or any drink (whether or not intoxicating), where such supply or service, is for cash, deferred payment or other valuable consideration.

Once transfer of title by way of sale of goods is specifically excluded, what is the need to exclude deemed sales specifically?

Some categories of deemed sales do not involve transfer of title in goods like transfer of goods on hire-purchase or transfer of right to use goods. Accordingly, deemed sales have been specifically excluded.

2.7.3 Is there a possible conflict between exclusion of transactions covered under Article 366 (29A) and activities that have been declared as services under section 66E?

No. Activities specified under section 66E, which are related to transactions that are deemed as sales under article 366 (29A), have been carefully specified to ensure that there is no conflict. This would be evident from the following illustrations-

Transfer of property in goods (whether as goods or in some other form) involved in the execution of a works contract is a category of deemed sales. On the other hand the declared list entry is limited to the service portion in execution of a works contract.

Delivery of goods on hire-purchase or any system of payment by installments is deemed to be a sale under article 366 (29A), while the related declared service list entry is limited to activities related to delivery of goods on hire-purchase or any system of payment by installments

Transfer of the right to use any goods for any purpose (whether or not for a specified period) for cash, deferred payment or other valuable consideration is again a specified category of deemed sales. The declared list entry in clause (f) of section 66E specifies transfer of goods by way of hiring, leasing or licensing or in any such manner without involving transfer of right to use goods as a declared service.

Supply, by way of or as part of any service or in any other manner whatsoever, of goods, being food or any other article for human consumption or any drink (whether or not intoxicating), where such supply or service, is for cash, deferred payment or other valuable consideration is a deemed sale of goods. Such supply takes place in restaurants or in catering. On the other hand clause (i) of section 66E restricts the declared service to service portion in an activity where such supply of food or drinks takes place.

It is thus evident that the activities specified as declared services in section 66E do not encroach upon the area of deemed sales. In fact most of the declared services have been specified with the intent of clarifying the distinction between deemed sales and activities related thereto which are outside the realm of deemed sales but qualify as a service.

Comments: The possibility of bifurcation by way of applying costing principles and standards maybe examined to avoid the overlap on the value under VAT and service tax. In many hotels  the VAT is charged on the total value and the service tax on 50% which appears to be unreasonable method of payment of taxes as per the decision in BSNL case wherein it was held that on the value of services no sales tax should be charged and vice versa.    

2.8 Transactions only in money or actionable claims do not constitute service

What kind of activities would come under ‘transaction only in money’?

• The principal amount of deposits in or withdrawals from a bank account.

• Advancing or repayment of principal sum on loan to someone.

• Conversion of Rs 1,000 currency note into one rupee coins to the extent amount is received in money form.

Would a business chit fund comes under ‘transaction only in money’?

In business chit fund since certain commission received from members is retained by the promoters as consideration for providing services in relation to the chit fund it is not a transaction only in money. The consideration received for such services is therefore chargeable to service tax.

2.8.3 Would the making of a draft or a pay order by a bank be a transaction only in money?

No. Since the bank charges a commission for preparation of a bank draft or a pay order it is not a transaction only in money. However, for a draft or a pay order made by bank the service provided would be only to the extent of commission charged for the bank draft or pay order. The money received for the face value of such instrument would not be consideration for a service since to the extent of face value of the instrument it is only a transaction in money.

2.8.4 Would an investment be transaction only in money?

Investment of funds by a person with another for which the return on such investment is returned or repatriated to the investors without retaining any portion of the return on such investment of funds is a transaction only in money. Thus a partner being admitted in a partnership against his share will be a transaction in money. However, if a commission is charged or a portion of the return is retained as service charges, then such commission or portion of return is out of the purview of transaction only in money and hence taxable. Also, if a service is received in lieu of an investment it would cease to be a transaction only in money to the extent the investment represents the consideration for the service received.

2.8.5 What is the significance of Explanation 2 to the definition of service in clause (44) of section 65B of the Act?

The said Explanation 2 clarifies that transaction in money does not include any activity in relation to money by way of its use or conversion by cash or by any other mode, from one form, currency or denomination to another form, currency or denomination for which a separate consideration is charged. The implications of this explanation are that while mere transactions in money are outside the ambit of service, any activity related to a transaction in money by way of its use or conversion by cash or by any other mode, from one form, currency or denomination to another form, currency or denomination would not be treated as a transaction in money if a separate consideration is charged for such an activity. While the transaction in money, per-se, would be outside the ambit of service the related activity, for which a separate consideration is charged, would not be treated as a transaction of money and would be chargeable to service tax if other elements of taxability are present. For example a foreign exchange dealer while exchanging one currency for another also charges a commission (often inbuilt in the difference between the purchase price and selling price of forex). The activity of exchange of currency, per-se, would be a transaction only in money, the related activity of providing the services of conversion of forex, documentation and other services for which a commission is charged separately or built in the margins would be very much a ‘service’.

Comments: Was there a special exemption later?

2.8.6 Would debt collection services or credit control services be considered to be transaction only in money?

No. Such services provided for consideration are taxable.

2.8.7 What are actionable claims?

As per section 3 of the Transfer of Property Act, 1893 actionable claims means a claim to any debt, other than a debt secured by mortgage of immovable property or by hypothecation or pledge of movable property or to any beneficial interest in movable property not in the possession, either actual or constructive, of the claimant, which the Civil Courts recognize as affording grounds for relief, whether such debt or beneficial interest be existent, accruing, conditional or contingent.

Illustrations of actionable claims are -

• Unsecured debts

• Right to participate in the draw to be held in a lottery.

If an unsecured debt is transferred to a third person for a consideration would this activity be treated as service?

No. Since unsecured debt is an actionable claim, a transaction only in such actionable claim is outside the ambit of service. However if a service fee or processing fee or any other charge is collected in the course of transfer or assignment of a debt then the same would be chargeable to service tax.

2.8.9 Would sale, purchase, acquisition or assignment of a secured debt like a mortgage also constitute a transaction in money?

Yes. However if a service fee or processing fee or any other charge is collected in the course of transfer or assignment of a debt then the same would be chargeable to service tax.

2.8.10 What is the scope of ‘beneficial interest in moveable property’ in the definition of actionable claim?

Black’s Law Dictionary defines ‘beneficial interest’ as follows-

“A right or expectancy in something (such as a trust or an estate), as opposed to legal title to that thing. For example, a person with a beneficial interest in a trust receives income from the trust but does not hold legal title to the trust property”

Therefore ‘beneficial interest in moveable property’ is a right or expectancy in a moveable property like right to receive income accruing from a moveable property. It may be noted that accrual of income from a moveable property could be in the nature of a consideration for a taxable service, e.g. a hiring fees or a license fee accruing on hiring or licensing of a moveable property. In such a situation the service being provided in relation to such moveable property would not be covered in the exclusion clause. It is only if the beneficial interest in such property is transferred to another person for a consideration that the activity of transferring the beneficial interest would be covered.

2.8.11 Would vouchers that entitle a person to enjoy a service, for example a health club, be an actionable claim?

No. Such a voucher does not create a ‘beneficial interest’ in a moveable property but only entitles a person to enjoy a particular service for a single or specified number of times.

2.8.12 Would recharge vouchers issued by service companies for enabling clients/ consumers to avail services like mobile phone communication, satellite TV broadcasts, DTH broadcasts etc be ‘actionable claims?

No. Such recharge vouchers do not create a ‘beneficial interest’ in a moveable property but only enable a person to enjoy a particular service.

2.9 Provision of service by an employee to the employer is outside the ambit of service

2.9.1 Are all services provided by an employer to the employee outside the ambit of services?

No. Only services that are provided by the employee to the employer in the course of employment are outside the ambit of services. Services provided outside the ambit of employment for a consideration would be a service. For example, if an employee provides his services on contract basis to an associate company of the employer, then this would be treated as provision of service.

2.9.2 Would services provided on contract basis by a person to another be treated as services in the course of employment?

No. Services provided on contract basis i.e. principal-to-principal basis are not services provided in the course of employment.

2.9.3 Would amounts received by an employee from the employer on premature termination of contract of employment be chargeable to service tax?

No. Such amounts paid by the employer to the employee for premature termination of a contract of employment are treatable as amounts paid in relation to services provided by the employee to the employer in the course of employment. Hence, amounts so paid would not be chargeable to service tax. However any amount paid for not joining a competing business would be liable to be taxed being paid for providing the service of forbearance to act.

2.9.4 What is the status of services provided by casual workers or contract labour?

Explanations to the definition of ‘service’

• Explanation 1 clarifies that ‘service’ does not cover functions or duties performed by Members of Parliament, State Legislatures, Panchayat, Municipalities or any other local authority, any person who holds any post in pursuance of the provisions of the Constitution or any person as a Chairperson or a Member or a Director in a body established by the Central or State Governments or local authority and who is not deemed as an employee.

• Explanation 2 clarifies that transaction in money does not include any activity in relation to money by way of its use or conversion by cash or by any other mode ,from one form, currency or denomination to another form, currency or denomination for which a separate consideration is charged.’(please refer to point no 2.8.5 for further guidance on this)

• Explanation 3 creates two exceptions, by way of a deeming provision, to the general rule that only services provided by a person to another are taxable. As per these deeming provisions establishment of a person located in taxable territory and establishment of such person located in non-taxable territory are deemed to be establishments of distinct persons. Further an unincorporated association or body of persons and members thereof are also deemed as separate persons. For implications please see point no 2.4.2 of this Guide.

• Explanation 4 explains that a branch or an agency of a person through which the person carries out business is also an establishment of such person.

This article needs to have much more discussion and many aspects would see clarifications from the revenue. The comments indicate merely an initial view. For doubts readers may host their queries on the question answer of this forum or pdicai.org.




Category Service Tax
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Madhukar N Hiregange 

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