The date of “01.07.2012” was a critical date in service tax laws because from this date the service tax laws underwent gigantic change. The concept of “Negative list” and “partial reverse charge” was introduced for the first time to broaden the scope of service tax along with simplifying the service tax laws. Moreover, it was highlighted and asserted that partial reverse charge is a step ahead of reverse charge mechanism and is aimed at controlling service tax evasion as in partial reverse charge/joint charge mechanism, the service provider and service receiver both are jointly and severally liable to discharge service tax. However, till now, we have not come across any case wherein revenue department has taken initiatives for correlating the tax paid by the service provider and that paid by the service receiver so as to check service tax evasion. Moreover, the logic that when the service tax liability is partial, there would be no service tax evasion or say comparatively lesser tax evasion is also not understandable because there is no embargo in following different valuation methods by service provider and service receiver for the same transaction. Accordingly, this article is an attempt to analyse whether the partial reverse charge mechanism has been successful in meeting its objective of simpler and effective tax compliance or has on the contrary, enhanced the complexities in service tax laws.
Genetics of Partial Reverse Charge Mechanism:-
It can be argued that the concept of partial reverse charge or say, reverse charge mechanism has been inherited from the concept of “TDS” in Income Tax Act, 1961. While introducing the concept of “TDS”, the idea of the government was to make the person making payment liable to pay tax to the government. As income tax is a personal tax, whose liability rests on individual, it was thought that the only mechanism to control the evasion of income tax by individuals is to introduce a framework wherein the person making payment to such individuals is made legally liable and under obligation to ensure that the income tax is being paid to the government. Accordingly, the concept of “TDS” was introduced wherein the person making payment is under legal obligation to deduct appropriate income tax that is liable to be paid by the person who is receiving such payment. Hence, by such a mechanism, the government found it easy to have a control on the evasion of income tax and to ensure better tax compliance. On the same lines, the concept of reverse charge mechanism or partial reverse charge mechanism is introduced in the Service Tax Laws. It is well known that service tax being a consumption based tax, the ultimate burden to pay is on the service recipient. However, under service tax laws, the liability to pay service tax to the government exchequer is on the service provider providing services to the service recipient. The service provider is required to charge service tax from the service recipient and deposit the same in the government account. Further, as the share of revenue from service sector is increasing day by day, in order to control the evasion of service tax at the end of service provider, the government has brought a mechanism called as “reverse charge” which is similar to the concept of “TDS” in Income Tax. After observing the services where the leakage of service tax is prominent, the concept of reverse charge or partial reverse charge has been introduced by the government whereby the service recipient has been made liable to pay service tax to the government exchequer. Now, whether this concept of reverse charge/partial reverse charge has been able to attain the objective of simple and easier tax compliance is analysed in the succeeding paragraphs.
Loopholes in the Reverse Charge Framework:-
After analyzing the concept of reverse charge, following ambiguities are worth noting:
Denial of SSI exemption to service recipients paying service tax under reverse charge:-
The service recipient is liable to pay service tax under reverse charge irrespective of the fact that the service provider is falling within the threshold exemption limit. This leads to discrimination among certain services that are covered under reverse charge mechanism as for the said services, service tax is required to be paid by the service recipient as compared to other services wherein benefit of threshold exemption is available. Moreover, in case of partial reverse charge, while the service provider enjoys the threshold exemption for the entire value of services rendered by him, the service receiver is under obligation to discharge service tax liability on the same transaction irrespective of threshold exemption. Hence, even if single rupee is paid for any of the services specified under reverse charge, the service tax is required to be paid by the service recipient.
Service tax to be paid in cash under reverse charge:-
The service recipient cannot pay service tax by utilising cenvat credit balance which is a major drawback for those service recipients that are also service providers/manufacturers and have sufficient cenvat credit balance. The reason for the same is that the defination of “output service” given under Rule 2(p) of Cenvat Credit Rules, 2004 states that output service means any service provided by a provider of service located in the taxable territory but shall not include a service,-
- specified in section 66D of the Finance Act; or
- where the whole of the service tax is liable to be paid by the recipient of service.
It is worth observing that the explanation to Rule 3(4) states that “Cenvat Credit cannot be used for payment of service tax in respect of services where the person liable to pay tax is the service recipient. Accordingly, in view of the explanation, even in case of partial reverse charge, the service recipient is required to pay service tax in cash. It is submitted that the basic purpose of cenvat credit scheme is to avoid cascading effect but the requirement of paying service tax in cash and also credit of some of the specified services such as rent-a-cab services is also not admissible has lead to defeating the crux of the cenvat scheme.
Increased registration and filing of service tax returns:-
It is also worth observing that with the introduction of full/partial reverse charge mechanism, the formalities and administrative tax compliance has increased as now, service recipient is also liable to take registration, file returns etc. This has the effect of increasing the cost of assessee both of routine nature and that pertaining to litigation costs. Moreover, as in case of partial reverse charge, certain specified percentage of service tax is required to be paid by the service provider and certain specified percentage of service tax by the service recipient, the department has the tendency to object full payment by either of them which leads to unnecessary litigation. It is practically observed that the assessees get relief at the stage of Tribunal in such cases on the ground that there cannot be double taxation on the same transaction and the service tax if discharged fully by either the service provider or service recipient is liable to be accepted by the revenue department. But, often huge service tax demands along with interest and penalties are adjudged on the assessees for not discharging the “specified percentage of service tax” under the reverse charge mechanism thereby leading to their harassment even in revenue neutral situations.
Complexities in Valuation Method:-
It is also noted that in some of the services specified under reverse charge, there are more than one option of valuation of services like in the case of works contract service or rent-a-cab service. In case of works contract, ambiguity exists in case of category of works contract i.e. whether the service is original works or whether the same is covered by repair and maintenance. The complicacies increase in case of composite contracts. Further, in case of rent-a-cab, there is benefit of abatement available and it depends on assessee to assessee, which option is chosen by them to be most beneficial to them. Moreover, it has also been specified in the Education Guide released by CBEC that the service provider and service receiver may adopt different valuation methods for discharging their service tax liability. In such a scenario, it is difficult to apprehend how will the government keep a check and control on service tax evasion through adopting the technique of reverse charge mechanism.
Cost benefit analysis: both at Government’s and service recipient’s end:-
Due to introduction of concept of partial reverse charge and denial of threshold exemption on the same, even a single transaction involving a minor amount of service tax is required to be paid off. Also, for this single and non recurring transaction, the service recipient is liable to get himself registered and file the return too. This increases the cost of service recipients. Also, since the specified categories of service recipients covered under partial reverse charge does not prescribe any monetary limit based on turnover, even small entities which fall under specified categories are required to comply with the enormous formalities related to partial reverse charge. All these factors increases the cost of service recipients, particularly, small entities which are de-motivated in such circumstances which is not the intention of the government. If we check the scene at the end of government, there is drastic increase in the number of registrations including those which pertain to non-recurring transactions. People take the registration under particular category and even if the transaction will not take place in future, they fail to amend the registration again and keep on filing the NIL return. Thus, the returns run in number of pages, thereby blocking the official website of government for no use. Also, more interestingly, there are cases where the manufacturer is enjoying the SSI exemption under notification no. 8/2003-CE, however, he is liable to file the ST-3 as a service recipient with negligible amounts which are lost in the pocket of government. Thus, both at the end of government and service recipients, there are some issues which unnecessary increase the cost when compared to benefit derived.
Suggestions to smoothen partial reverse charge:-
The concept of partial reverse charge is no doubt introduced for the sake of betterment in the service tax law. However, the problems discussed in the forgoing paras have hindered the acceptance and growth of this concept. The authors would like to suggest the following measures that can be taken for betterment of partial reverse charge:-
- A threshold limit just like small service providers exemption should be prescribed for the reverse charge including the partial reverse charge. It may not be as high as Rs. 10 lacs, rather the same should be on lower side. This will automatically absolve the small entities from the complex formalities of reverse charge.
- The turnover limit of service recipients as prescribed for the reverse charge on legal services is a welcome step. The same may also be taken as an alternative of the above suggested threshold exemption limit for reverse charge.
- Payment of service tax should also be allowed from Cenvat Credit. For government, payment from Cenvat is as good as payment in cash, particularly in case where the same is ultimately refunded to the assessees (like in case of exports). There have been a number of judicial pronouncements wherein it has been held that the payment from Cenvat is as good as payment in cash. Thus, in our view, there should not be any discrimination between service tax payment by service provider and service recipient and the cash payment should not be made mandatory for the later. The government may also prescribe particular cases where the cash payment is mandatory or it may also prescribe vice versa, i.e. where the payment from Cenvat is allowed, like the units in BIFR or exporters (who have abundant Cenvat Credit which is ultimately refunded), etc.
- If any service recipient is taking registration for payment of service tax under reverse charge on non-recurring transactions, there should be auto-cancellation of registration taken for the said purpose. This can be done by amending the form of registration. There can be option to be filled by the service recipient regarding the nature of transaction – whether the same is of recurring or non-recurring. Also, if possible time period after which auto-cancellation is sought can also be filled in by the recipient of service. This would reduce the efforts and time taken in procedural formalities.
- A special cell may be constituted at service tax division, if not possible, at Commissionerate level; which is dedicated to resolve the issues pertaining to valuation and other miscellaneous issues under reverse charge. This will bring uniformity in approach as followed at a particular area, thereby reducing the litigation as well as the cost of assessees. Also, this will reduce the mistakes occurring in ST-3 returns leading to unnecessary and non-fruitful departmental queries; thereby reducing the work load at service tax department.
- The mega exemption notification provides service tax exemption for carrying out an intermediate production process as job work in relation to any goods on which appropriate duty is payable by the principal manufacturer. The reason for the same being that even if the service tax is paid by the service provider to the government, its credit would be available to manufacturer thereby leading to “revenue neutral” situation. This approach is beneficial also as it is futile exercise that one should pay first and then take credit and it results in no additional revenue to the Government. The same analogy was adopted for the service tax payment on services of GTA and foreign sales commission by exporters. Earlier the service tax was required to be paid by exporter himself and refund was to be sought from the department. However, the introduction of Notification number 31/2012-ST dated 29/06/2012 and 42/2012-ST dated 20/06/2012 respectively has changed the situation and the service tax has been exempted. The analogy is the same i.e. why to pay the service tax first and then to take the refund.
On similar lines, provision should be introduced that if certain services that are input service for the service recipient and where the credit of service tax paid for such input service is admissible to the service recipient, and the service recipient is liable to pay tax (even the partial reverse charge) the service should be exempted from the levy of service tax following the analogy of revenue neutrality as stated above. Every service recipient pays the service tax and then takes the service tax credit immediately. Thereafter, the service tax credit is used for payment of his excise or output service tax liability. Hence, where the service tax credit is available to the assessee then the exemption from service tax should be given so that unnecessary formalities and compliances are avoided.
If we compare the TDS framework launched by the government in contrast with the reverse charge mechanism of service tax, it is found that the TDS framework is comparatively much stable and has been able to achieve the object of ensuring minimum tax leakage with minimum procedural formalities. On the contrary, the introduction of reverse charge mechanism, whether full or partial has lead to increase in controversies, doubts and ambiguities indicating adverse tax environment instead of conducive tax environment. Moreover, the conditions of applicability of reverse charge mechanism for different services in different situations like legal services of advocate are covered under reverse charge if provided by individual or firm and received by business entity having turnover exceeding Rs. 10 Lakhs per annum located in taxable territory has made the entire framework complicated. There remains ambiguity in classification, valuation, application, implementation and quantification of service tax. Moreover, unlike TDS framework, where Form 26 AS is automatically generated thereby providing authentic details of TDS credit admissible to the assessee, there is no mechanism under service tax law for eligibility of service tax credit.
Before parting, it is only submitted that in order to use the reverse charge mechanism as a tool to control service tax evasion, it is necessary that the service tax law itself should be free from any doubt and ambiguity because if the assessee and government are themselves do not have consensus and concurrent findings on the basic issues of taxability, the tax evasion cannot be controlled.
An article by:-
CA. Pradeep Jain
CA. Preeti Parihar
CA. Neetu Sukhwani