Reverse Charge Mechanism - A Nightmare to service receivers?
AUGUST 09, 2012
S Sivakumar, CA
IT's been more than a month since the new service tax law was introduced… even as the Reverse Charge Mechanism (‘RCM')was already turning out to be a procedural nightmare, the Finance Ministry would seem to have further complicated the RCM by releasing Notifications Nos 44, 45 and 46, all dated August 7, 2012.
Consider these ...
As we know, RCM is attracted in the case of the input services by way of renting or hiring of passenger vehicles, provided by an individual or HUF or Proprietary firm or Partnership Firm (whether registered or not including the association of persons) to any company formed or registered under Companies Act or to a business entity registered as a body corporate. In terms of the RCM provisions, the service receiver is required to discharge 40% of the service tax liability, with a liability also being fastened independently on the service provider depending on whether or not, abatement is taken (by the service provider). In terms of Mega Exemption, services provided by Metered Cabs, Radio Cabs and Auto Rickshaws are exempted from the levy of service tax. In terms of Section65B(32), " Metered cab" is defined to mean any contract carriage on which an automatic device, of the type and make approved under the relevant rules by the State Transport Authority, is fitted which indicates reading of the fare chargeable at any moment and that is charged accordingly under the conditions of its permit issued under the Motor Vehicles Act, 1988 (59 of 1988) and the rules made thereunder.
As is well known, in many practical situations, employees of large companies and especially, IT companies, are allowed to hire cabs for official purposes, pay these bills and claim reimbursements. How would RCM work under these circumstances, assuming that no metered Cabs or Radio Taxis are used? Can a view be taken that the service having initially been rendered to the employee is out of RCM and that this position would not change even when the expense is reimbursed by the employer-company? Or, is the view that, the employer being the ultimate beneficiary of the input service, given the fact that the payout is claimed as an allowable expense under the Income tax law, is still liable to discharge its liability under RCM, more sustainable?
And, what incidentally, is a ‘Radio Taxi'? In the absence of a definition, are we to assume that, a ‘radio taxi' could cover also the case of a driver using a radio to listen to FM songs. What would happen in cases, when the metered cabs refuse to provide bills, a practice widely in vogue. Will this case be covered under RCM, requiring the service receiver to pay service tax?
And… how does the service receiver being a company prove that its employee has used an auto rickshaw and is consequently not covered under RCM, given the fact that, auto rickshaws do not provide bills?And…does RCM cover hiring of taxis or cars with drivers, on a monthly basis by corporates… again, a practice widely used. Under the earlier law, this could have been covered under ‘supply of tangible goods'.
Many of us were taking the view that, "supply of manpower" services, already covered under RCM, would not cover services rendered by security services agencies. The brilliant new FM would seem to have seen this through and has already plugged this, by clubbing security agency services with ‘supply of manpower' services for purposes of RCM, vide Notification No. 45/2012-ST dated August 7, 2012. Despite this amendment, the confusion surrounding the applicability of RCM for ‘supply of manpower' services in unlikely to subside. As per Rule 2(g) of the Service Tax Rules, 1994, "supply of manpower" means supply of manpower temporarily or otherwise, to another person to work under his superintendence or control. T his definition is so restrictive that it could cover most of the services rendered by services providers such as house-keeping services providers. In many cases, CAs also used to provide accounting personnel, which was covered under the Chartered Accountants' services, under the old law. The usage of words ‘superintendence or control' could play hovoc, in as much as, in the case of most service providers involving on-site work, some degree of control and superintendence by the service receiver's employees, is unavoidable, in typical cases such as house-keeping services.
Take the case of individual professionals who work as outsourced employees in software companies, a practice widely followed in the IT sector. Can an individual working as an outsourced employee, on a full time basis in a software company, be covered under RCM? Though, per se, an individual employee offering himself as an outsourced employee/professional cannot be treated as an agency supplying manpower, it would be better to have a clarification from the Board so as to prevent avoidable litigation.
Take the case of works contract services under RCM. This could turn out to be one of the most litigated issues under the new service tax law. As we know… "works contract" is very widely defined to mean a contract wherein transfer of property in goods involved in the execution of such contract is leviable to tax as sale of goods and such contract is for the purpose of carrying out construction, erection, commissioning, installation, completion, fitting out, repair, maintenance, renovation, alteration of any movable or immovable property or for carrying out any other similar activity or a part thereof in relation to such property. What we need to understand is that, for a transaction to be treated as a ‘works contract' under the service tax law, it is not necessary that VAT should actually be levied on the sale portion… it is enough to prove that VAT is leviable, though not levied. With the liability to discharge 50% of the service tax liability being fastened on the service receiver under the RCM, the service receiver could have a procedural nightmare in understanding transactions on which VAT is leviable but not actually levied.
Moreover, in terms of Explanation-II to Notification No. 30/2012, the service recipient has the option to choose a valuation method that is independent of the valuation method adopted by the service provider. Take a typical case of a works contract involving the realty sector. With ‘original works' being loosely defined, assume that, the service provider treats a particular transaction as ‘original works' and charges 50% service tax on 40% of the value. If, in case, the service provider feels that the transaction is not covered under the definition of ‘original works', is he required to discharge his part of the service tax liability, i.e 50% on 60% of the value? In other words…. is the requirement to follow a different valuation method, an option or a requirement vis-à-vis the service receiver, especially considering the fact that, the service receiver's liability to discharge service tax liability under RCM, is independent of the service provider's liability.
Take the case of annual maintenance contracts… in some cases, a view is taken that no goods is involved and the entire transaction is treated as one of providing services, as is the situation in most software AMCs. Is the service receiver independently required to go into the substance of the transaction and discharge his part of the liability under RCM, if he feels that the transaction is a works contract, not-withstanding the fact that the service provider could still treat this as a transaction of pure service? I have no answers for questions like this, which would arise, under RCM.
And… what would happen if the service provider makes a mistake and applies a wrong valuation method? Is the service receiver required to follow his own method and discharge his liability, irrespective of the valuation method followed by the service method, which could be incorrect, as assumed in this example?
There could be some cases where, there could be a dispute between the service provider and the service receiver, in terms of classification of a service as a, manpower supply services, let's say. In this case, it is possible that, the service provider would charge 100% service tax, while the service receiver could also pay up service tax on 75% of the value, being his part of the liability. Will cenvat credit be allowed on the entire quantum of service tax paid by the service receiver to the service provider? I do hope so, as this kind of an issue is sure to come up, under RCM.
And… in terms of Notifications Nos.45/2012-ST dated August 7, 2012, the service recipient (being the Company) is liable to pay 100% service tax under the reverse charge mechanism, in respect services provided or agreed to be provided by Directors. This Notification, unfortunately, does not distinguish between Managing and Whole-time Directors and Non-Managing/Whole-time Directors. Managing and Whole-time Directors are employees of the company and are consequently governed by the exclusion clause contained in the definition of ‘service' contained in Section 65B(44)(b) and consequently, the said Notification would need to be amended to exclude ‘services' rendered by Managing and Whole-time Directors from the RCM.
Before concluding ...
Talking of works contracts….. photocopying/xeroxing has been held to be a works contract. In effect, most small scale body corporates using xeroxing services would be covered under RCM. Even a casual transaction involving xeroxing of a document could bring them under RCM.
In the manufacturing sector…. factories use casual labor who are referred to hamalis. All of these services could get covered under RCM and these corporates could be required to discharge their service tax liability under RCM, not-withstanding the position that, these transactions are normally concluded in cash.
RCM would be particularly unfair to trading companies and small scale service receivers…. these entities would be denied the benefit of cenvat credit and would also not be able to claim refund of cenvat credit, unlike, the service providers, who are allowed the benefit of refund of the unutilzed cenvat credit under the newly introduced Rule 5B.
In many cases and especially in cases involving services provided by small scale services providers, no invoice might get issued. How is the service receiver expected to discharge his part of the service tax liability, under RCM, in these cases?
The cost of compliance vis-à-vis RCM is going to be high. The service receiver is required to understand every business transaction from the RCM perspective and ensure that, his liability is discharged under RCM. In many cases, the service receiver's employees would need to call up the service provider, to get a better understanding of the transaction, apart from the need to go through the agreements, etc. From the service tax audit perspective…. keeping records under RCM would be a very big challenge. Most software packages available today, do not distinguish between corporate service providers and non-corporate service providers. A lot of manual effort would be required to compute the service tax liability under RCM, for sure.
Under RCM – while a service rendered by a foreign branch of an Indian company to the Head Office would be treated as import of service, the same transaction when rendered by the Indian company's Head Office to its foreign branch is not treated as an export of service. Can anything be more unjust, Sir?
From a purely practical perspective …. in many cases, the service receivers could feel that, it would make better practical sense to pay up the service tax under RCM and avail the same as cenvat credit rather than take a litigating stand.
Mr P Chidambaram has stated, after taking over as FM that, "clarity in tax laws, a stable tax regime, a non-adversarial tax administration, a fair mechanism for dispute resolution, and an independent judiciary will provide great assurance to investors". This objective cannot be met if there is a constant tinkering of the service tax provisions, which in any, are a few weeks old. One hopes that the Finance Minister would allow the service tax law to settle for at least, a year, before any further amendments are introduced.
(The Author is Director, S3 Solutions Pvt Ltd, Bangalore)