Point of Taxation Draft Rules - Gennie of The Magic Lamp!
AUGUST 22, 2010
By Pradeep Jain CA, Preeti Parihar CA & Ridhi Anchalia CA
"ALLADIN & his magic lamp" - hearing the stories since ages. Gennie fulfilling the desires sound too good, but what if it comes out and becomes uncontrollable… too difficult to put him in again… Now let’s take a look into its latest version – “The Government and drafts rules for determining the point of taxation”. The government has come out proposing new rules namely - Point of Taxation (for Services Provided or Received in India) Rules, 2010 (hereinafter referred as the draft rules). These rules have been drafted in order to provide for certain provisions that do not exist in the current act and rules, as such, forming the backbone of litigations. In order to provide specifically for such essentials, these rules have been drafted. Let’s have an overview of these rules via this piece of article.
The Chapter V of Finance Act, 1994 was introduced in India inter alia just on 3 services which reached to 126 services till date. This has now become a trend of bringing more and more services under the net of taxable services. But till date, there are no expressed provisions in the Finance Act, 1994 regarding the transitional period of a new service, point of taxation of a service, continuous supply of service, interest free security deposit, etc. As such, as and when these issues arise, litigation arises. Though there are Circulars issued by the Board for clarifying these issues, yet a need is always felt for specific provisions in the Act or the rules. To cope up these needs, government has come up with new draft rules namely – “Draft Point of Taxation (for Services Provided or Received in India) Rules, 2010”. These rules are kept open for public comments.
The draft rules propose to levy the service tax on the date the advance is received by the service provider. This step is merely a clarificatory one as the section 67(3) of the Chapter V of the Finance Act, 1994 (hereinafter referred as the Act) already deals with the issue. This section says that the value of advances is to be included in the value of taxable service provided or to be provided. This rule says that the service tax on advances is payable at the time of receipt. Even if this draft rule is not prescribed, there is no ambiguity as the Service tax Rules, 1994 already takes care of it. As per rule 6(1) of the said rules, service provider is required to pay the service tax on the 5th/6th of the next month in which the payment is received. However, since the new draft rule clarifies that the service tax is payable at the time of receipt of payment or issuance of invoice, the service tax so determined at the relevant time would be final and the service provider will not have to review these bills and amend them.
Interest-free deposits:
It is further provided that no service tax is payable on the interest free deposits. This is a well come step. Department has initiated proceedings on the service providers who have received security deposits from the recipients of service. Receipt of interest free deposit is a common practice in the Renting of immovable property service, supply of tangible goods service. The service providers receive an interest free refundable deposit at the time of letting out property/supply of goods. This is done to secure themselves against any loss caused to their property or goods by the recipient of service. This rule will relieve a no. of assessees who are burdened by the show cause notices on this issue.
Change in rate & point of taxation:
Levy and collection of service tax revolves around three aspects – providing of service, raising invoice and payment of consideration. If all the three arise at the same time, there is absolutely no problem. But practically all the three transpire at the different points of time. In such case, the litigation arises if the service tax rate changes in between the chain of these three. Now these draft rules have been proposed to prescribe the point of taxation in such cases. This has been prescribed as follows:-
EVENTS OCCURING BEFORE CHANGE OF RATE | CHANGE IN RATE | EVENTS OCCURING AFTER CHANGE OF RATE | POINT OF TAXATION |
Service provided | SERVICE TAX RATE CHANGES | Invoice raised | Payment received | Date of receipt of payment or issuance of invoice whichever is earlier |
Service provided | Invoice raised | Payment received within 30 days of invoice | Date of raising invoice |
Service provided | Invoice raised | Payment received after 30 days of invoice | Date of payment |
Invoice raised | Service provided | Payment received | Date of payment ** |
Invoice raised | Payment received | Service provided | Date of receipt of payment or issuance of invoice whichever is earlier |
** A supplementary invoice will be issued for recovery of balance service tax.
Transitional provisions for new service:
In case where the service has been provided at the time it was not taxable but the consideration is received after it is brought under the service tax net, whether taxable? No answer in the Act. Due to absence of provisions in this regard, the department used to come up with show cause notices where the amount was received after the levy of service tax.
Now, the draft rules have prescribed in respect of new service that –
- In case the invoice has been raised and the payment is received before the levy, no service tax is payable even if service is provided after it becomes taxable.
- If the payment has been received, and invoice has been issued within 14 days (as prescribed under rule 4A of the Service Tax Rules, 1994); service tax will not be payable.
- In cases where the service has been provided before it becomes taxable, no service tax is payable.
- These steps will resolve the matters lying in the litigation chain and will give foundation to litigation- free transitional provisions for new services.
Continuous Supply of service:
The continuous supply of services has been defined in Rule 2 as a service which continues to be provided for a period exceeding 6 months. The proposed rule prescribes that the rate of tax will be the rate applicable on the date the payment becomes due as per the contract. If the payment is linked to completion of certain events, service tax is payable when those events are completed. If none of the above two conditions is specified in a long term contract, then the service provider is required to pay the service tax at the time of raising of invoice, or receipt of payment, whichever is earlier. Presenting in tabular form:-
Contract clauses | Service tax becomes due on |
Date of payment prescribed | Date of payment as prescribed, whether or not it is actually received. |
Date of payment is NOT prescribed | Payment is linked to achievement of targets | Date of achievement of targets whether or not payment is received on that date. |
Date of payment is NOT prescribed | Payment is NOT linked to achievement of targets | Date of issuance of invoice or receipt of payment whichever is earlier. |
The rule also says that if payment is received before and services are provided afterwards, then they will not be taxable. So the services will only be taxable if payment for the services will be received after the services are taxable. In case of continuous supply it becomes difficult to judge the extent of services received. It has been prescribed that the clauses of the rule shall be read sequentially. If this rule is implemented, this would be the most difficult task to handle for both government as well as the assessees. This rule links payment of service tax to the date of payment prescribed in contract whether or not payment is actually received. This will impose undue hardship on the assessees in case the payment is not received or a reduced payment is received, service tax being already paid. Further, if contract says, the payment is linked to achievement of targets; the service tax becomes due on achieving these targets, irrespective of payment being actually received. What is this – of course neither this is receipt basis, nor billed basis. This is the third thing which, instead of simplifying the things, will make them complicated. Suppose in the year end, the service provider pays the service tax on the basis of targets achieved, how will he keep the records of “targets so achieved for the purpose of service tax”. How will he correlate the payments received alongwith targets achieved and service tax paid. No accounts are being kept for memorizing the targets achieved; of course the payments and raising of invoices are maintained. Even if paid, how will it be traced in the Balance Sheet. The figures of Balance Sheet will not tally anyways. Further, the accounting of service tax paid on the basis of targets achieved; will not commensurate with the general accounting practices. Further, the service provider will have to maintain a database for memorizing about the targets achieved, service tax paid, consideration received, quantum of service tax recovered. Again there will be problem if the consideration is not received in toto, or received at a lower amount. Hence, rising graph of the post-payment issues.
Associated Enterprises:
The associated enterprises have not been left untouched from the new rules. The concept was brought into Finance Act, 1994 during year 2008. At implementation stage, it was prescribed that mere book entries between the associated enterprises will be taxable. These rules do not alter this basic concept. It merely extends it and proposes to levy service tax on the date which is Earliest of the following three dates:-
- Date of payment, or
- Date of debit or credit entry, or
- Date of issue of debit or credit notes.
As per Rule 4(7) of the Cenvat Credit Rules, 2004, credit in respect of input service is allowed after the date of payment of consideration. Initially when the above concept of associated enterprises was implemented, it was demanded that the credit should also be allowed on the date of payment of service tax by the service provider. But this was not done and the same situation will continue even after these draft rules.
Royalties and similar payments:
In the services which involve payment of royalties or any other payment of like nature, the amount of consideration is not known at the time of performance of service. The payment is received in piecemeal in such cases for subsequent use of benefits. In such cases, the rules provide that the service will be deemed to have been provided at the time the payment is received or the invoice is raised. Since such payments may require sufficient time for generation of income, it is very difficult to correlate the rates of service tax changing during this period. In absence of specific provision regarding this, the provisions of the Act were used as they suited to the Department/assessee. These rules will definitely provide a sound basis for proper levy and collection of the service tax on such services.
Before Departing-
The new rules framed out by the government in the veil that these rules will bring clarity in the Chapter V of Finance Act, 1994. But is this the real fact that the government now wants to resolve the old issues. It is for resolving the old issues or preponing the tax liability in the service tax, not clear. If the payment of service tax is linked to the achievement of targets, or provision of service, it would not serve the purpose of aligning the service tax with the VAT or other taxes. Instead, it will be defeating the prime objectives of framing the provisions of receipt basis. Receipt basis was implemented as realisation in service sector is very slow and normally lower than the billed amount. If these draft rules are implemented, this ultimate purpose will be defeated. Moreover, what will be the position of the Cenvat Credit? At present, as per rule 4(7) of the Cenvat Credit Rules, 2004, credit of input services is allowed only after the payment of invoice is made. If this system is followed, whether they will amend the Cenvat Credit Rules, 2004 or will leave them as it is, to add one more issue in the litigation. Further, the accounting aspect of the service tax will be difficult and would not commensurate with the normal accounting practices. It will be difficult to trace out the defaults as there is not set practice system for this type of accounting. Further, it will be almost impossible to tally the figures of service tax records and Balance sheet. Over and above all, the chances of errors – both intentional and unintentional will increase. Further, there is recent trend in the departmental audit teams to make out paras by comparing the figures of Service tax return & records, with the Balance sheet. If these rules are implemented, Balance sheet will not tally with the return in any way. So, what will be the basis of finding the authenticity of the figures shown in the service tax return? Whether government will prescribe new sets of accounts to be maintained for the Service tax purpose or will it go to “Octopus baba”? Not clear. Even otherwise, if the government wants to switch over from receipt basis, there can be a sweat and simple alternative of imposing the service tax on the billed basis. In other words, simply putting the service tax on the raising of invoice will solve many of the above referred problems. Anyhow, if these draft rules are implemented, new controversies will arise which will result into many more audit paras, whether or not understandable. It will complicate the complete system rather than simplifying them. Let’s see, whether the ‘Alladin’ rubs the ‘magic lamp’ or not...
