FEBRUARY 18, 2015

By Lakshmi Ratna K, Advocate

WITH effect from 1st July 2012, there has been a marked departure in the scheme of taxing services from the erstwhile positive list regime. As a consequence, all the allied rules and provisions had been amended.

As bizarre as it may sound, a combined reading of the charging section under the Finance Act and definition of 'exempted service' seems to indicate that the activity of manufacture or production qualifies as an exempted service for the purposes of the CENVAT Credit Rules, 2004.

In this article, an attempt has been made to bring to fore the interplay of these provisions and consequences which flow therefrom.

Scheme of Taxing Services

After the introduction of service tax in 1994, 'service' has been defined only under the negative list regime effective 1 st July 2012. Service has been defined as an activity provided by one person to another for a consideration and includes declared services.

Section 66B of the Finance Act, 1994 ('Finance Act') effective from 01.07.2012, is the charging section for levying service tax. Extract of the same is as under:

"Section 66B. There shall be levied a tax (hereinafter referred to as the service tax) at the rate of twelve percent on the value of all services, other than those services specified in the negative list , provided or agreed to be provided in the taxable territory by one person to another and collected in such manner as may be prescribed."

The wide definition of 'service' makes it imperative that the existing scheme of taxation carves out exclusions from the definition of service, formulates a negative list of services, and grants exemptions for specified activities.

To clarify, the activity of sale of goods and the activity of manufacture have been kept outside the purview of service tax . This has been effected by

- excluding sale of goods from the definition of service itself under Section 65B(44)(i) of the Finance Act and

- including the activity of process amounting to manufacture or production of goods in the negative list under Section 66D(f) of the Finance Act.

The activity of sale and manufacture are already subject matter of Sales tax Act and Central Excise Act respectively.

Process amounting to manufacture or production of goods has been defined under the Finance Act to mean the activity of manufacture on which excise duty is leviable under Section 3 of the Central Excise Act, 1994.

Process amounting to manufacture vis-à-vis Exempted Service under the CENVAT Credit Rules, 2004

The definition of exempted services under the CENVAT Credit Rules, 2004 ('Credit Rules') was also amended in 2012, in order to align it with the charging section of the Finance Act.

'Exempted service' has been defined under Rule 2(e) of the Credit Rules as follows:

"...(e) "exempted service" means a -

i. taxable service which is exempt from the whole of the service tax leviable thereon; or

ii. service, on which no service tax is leviable under section 66B of the Finance Act; or

iii. taxable service whose part of value is exempted on the condition that no credit of inputs and input services, used for providing such taxable service, shall be taken;

but shall not include a service which is exported in terms of rule 6A of the Service Tax Rules, 1994. ..."

A reading of Rule 2(e)(ii) of the Credit Rules indicates that all the services under the negative list would be covered under the ambit of the exempted service. This in turn implies that by virtue of being covered under the negative list even the 'process amounting to manufacture' qualifies as an exempted service.

Unintended Consequences

Once the activity qualifies as "manufacture" under the Central Excise Act, it would be preposterous to conclude that the very same activity is an exempted service.

Treating the activity of manufacture as an exempted service would imply that the manufacturer/service provider would be under an obligation to maintain separate accounts or reverse the proportionate credit availed on inputs and input services as required in terms of Rule 6 of the Credit Rules. Further maintaining separate accounts for the same activity which may result in a dutiable final product and treated as exempted service results in a situation where no credit at all will be available, i.e. the entire credit will be allowed for the manufacturing activity and in the same breath be disallowed treating it as an exempted service. These eventualities would not have been the intention of the legislature because the manufacturer of dutiable final products is entitled to the credit of the inputs/ input services.

A perusal of the negative list and the exemption notifications indicates that the various entries are to keep the activities of certain sectors outside the ambit of service tax (like agriculture, banking etc) or where there had been ambiguity under the erstwhile regime as to whether the activity qualifies as a taxable service (like trading in goods). Hence, it cannot be the intention of the legislature to treat 'manufacture' on a similar footing. The expansive coverage of the definition of 'service' made it imperative to carve out a specific exclusion in this regard.

There is no denying that a bare reading of the provisions does lead to a conclusion that the activities covered under the negative list being outside the ambit of the charging section qualify as an exempted service.

In the light of this, it is to be noted that the provisions of the Finance Act, Excise Act and the Credit Rules have to be read harmoniously and holistically in order to give a purposive interpretation to the statues/Rules.

It is suggested that a suitable clarification be issued in this regard before the current anomaly ensues in another round of litigation on a frivolous issue which had never been the intention of the legislature.

(The author is a Senior Associate, Lakshmikumaran & Sridharan, Bangalore)