MAY 25, 2009

By Dinesh Kumar Agrawal, CA & Ex-IRS

THE Special Economic Zones Act, 2005 was enacted on June 23, 2005 for the establishment, development and management of the Special Economic Zones for promotion of exports and for matters connected therewith or incidental thereto. SEZs are designated duty free enclaves which are considered as deemed foreign territories for the purpose of trade operations, duties and tariffs. Prior to enactment of the SEZ Act, 2005, SEZs were governed under the Customs Act, 1962, the Central Excise Act, 1944 and rules framed thereunder namely the Special Economic Zones Rules, 2003.

Section 26 of the SEZ Act provides several exemption and concessions to SEZ developers and units from various taxes and duties with a view to boost exports and investments. Exemptions from duty includes customs duty under the Customs Act on import or export of goods, excise duty under the Excise Act on goods brought from the domestic tariff area and service tax under Chapter-V of the Finance Act, 1994 on taxable services provided to a Developer or Unit to carry on the authorised operations in a SEZ.

Although exemptions, inter alia , has been provided under all three major indirect tax i.e. Customs, Central Excise and Service Tax, first two duties has not seen as many twist and controversy as the last one i.e. service tax. Way back in 2002, Government vide Notification No. 17/2002-ST dated 21 November 2002 had exempted service tax on taxable services provided to SEZ unit or the SEZ developer if such service was authorised to be rendered by the service provider by a Committee headed by Chief Commissioner of Central Excise having jurisdiction over the said SEZ. Said notification was suppressed by Notification No. 4/2004 S.T., dated 31 March 2004 which provided exemption from service tax on taxable services provided to SEZ unit or the SEZ developer in respect of authorised operation for consumption of the services within such SEZ. Hence, the mandatory requirement was that the services so provided must be consumed within the SEZ. That was prior to enactment of the SEZ Act, 2005 when the SEZs were governed under the Customs and Excise laws.

Section 26 of the SEZ Act and rule 31 of SEZ Rules provides exemption from payment of service tax on all taxable services specified under section 65 of the Finance Act, as amended from time to time, rendered to a developer or unit by any service provider for the authorized operations in SEZs. The SEZ Act has an overriding effect by virtue of section 51 which provides that the said Act shall have effect notwithstanding anything inconsistent therewith contained in any other law for the time being in force or in any instrument having effect by virtue of any law other than this Act.

Section 64 of the Finance Act extend provisions of chapter V thereof to whole of India except J&K, thereby meaning that taxable service provided anywhere in India except J&K will besubject to service tax. However, in view of the express overriding effect of the SEZ Act as declared under section 51 thereof, taxable services covered under Section 26 of the SEZ Act and rule 31 of SEZ Rules remained exempted. On enactment of the SEZ Act, notification No. 4/2004 S.T. became redundant as a levy which is exempted under the statue itself cannot be again exempted by way of an exemption notification. It is well established that neither the powers of legislature can be usurped by the executive nor executives can invalidate legislation by exercising delegated power.

It is interesting to note that in spite of the specific provisions in the SEZ Act for exemption from service tax for provision of taxable services for the authorised operations, revenue authorities continued to scrutinize the eligibility of exemption under the notification No. 4/2004. Nowhere in the SEZ Act or the rules there under, is it provided that the exemption from service tax would be available to SEZ developers or units, only if the taxable services are consumed within the SEZ. As the misperception that the provisions of SEZ Act and the Service Tax legislations are not in consonance with each other persisted in the mind of public, trading community was clamouring for clarification from the executives which never came. The misperception was confounded by the reasons that the customs and excise laws recognised supply of goods from DTA to SEZ as deemed export but no such treatment was accorded to provision of services from DTA to SEZ. It is also interesting to note that the Government has not issued any exemption notification under the customs laws or excise law for exemption on goods as envisaged under the SEZ Act.

Googly was bowled by the Government by issuing notification No. 9/2009-ST dated 3 March 2009 overriding old notification No.4/2004 (which we thought has become redundant on the enactment of SEZ Act) by providing for exemption from the levy of service tax in respect of the taxable services rendered to SEZ Developers and SEZ Units by way of refund. The notification envisaged payment of service tax by the service providers to the SEZ developers/units and subsequent refund of such service tax by the government to the SEZ developers/units. The notification 9/2009 negated automatic exemption from payment of service tax provided in relation to the authorised operations in a SEZ under the SEZ Act. Exemption of service tax under the new notification is subject to the various conditions enumerated therein.

It is interesting to note that under the new notification No. 9/2009, said refund of service tax is available to taxable services which are provided in relation to the authorised operations in a SEZ, and received by a developer or units of a SEZ, whether or not the said taxable services are provided inside the SEZ. In other words, the notification is creating a distinction between "taxable services provided to a Developer or Unit to carry on the authorised operations in a SEZ" and "taxable services provided in relation to the authorised operations in a SEZ whether or not the said taxable services are provided inside the SEZ". It appears that the words "in a SEZ" are misconstrued to mean that taxable service should be provided in the SEZ itself. A bare reading of provisions of the SEZ Act and rules makes it clear that the words "in a SEZ" refers to authorised operations in a SEZ and not the provision of service inside the SEZ.

Now, once again the Government has bowled a bouncer by issuing notification No. 15/2009-ST dated 20 May 2009 amending the notification No. 9/2009. The notification No. 15/2009 has substituted clause (c) in the notification No. 9/2009. Earlier clause (c) read as "the exemption claimed by the developer or units of SEZ shall be provided by way of refund of service tax paid on the specified services used in relation to the authorised operations in the SEZ" and now after amendment read as "the exemption claimed by the developer or units of SEZ shall be provided by way of refund of service tax paid on the specified services used in relation to the authorised operations in the SEZ except for services consumed wholly within the SEZ".

The Board vide circular No. 114/08/2009-ST dated 20 May 2009 has clarified that:

"Notification No. 15/2009-Service Tax, dated 20.05.2009 has been issued to amend the aforesaid Notification 9/200-ST dated 3.3.2009 to provide unconditional exemption to services consumed within the SEZ without following the refund route thus dispensing with the requirement of first paying the tax by the service provider and then claiming the refund thereof by developer/unit. The exemption by way of refund would be limited to situations only when taxable services provided to SEZ are consumed partially or wholly outside SEZ."

Now by the latest amendment in the notification, Government has denied refund of service tax paid on services consumed wholly within the SEZ by clarifying that service tax is unconditionally exempt if taxable services are wholly consumed within the SEZ. A bare reading of the amending notification suggest that refund of service tax is denied on the services consumed wholly within the SEZ and no where it suggest that service tax is exempt on such services. To properly decipher the notification, one has to fall on the circular. I am afraid whether an exemption can be provided by a clarification if we consider that exemptions provided under the SEZ Act was not good enough in the first place necessitating the Government to issue notification 9/2009.

The service sector is growing rapidly and has contributed around 55 percent to India's GDP during 2006-07. Budgeted collection of service tax in year 2008-09 was Rs 64460 crores. However, in spite of huge contribution to the economy and exchequer, service industry has been given step motherly treatment.

Rule 2(d) of the CENVAT Credit Rules, 2004 define "exempted services" to mean taxable services which are exempt from the whole of the service tax leviable thereon, and includes services on which no service tax is leviable under section 66 of the Finance Act. Service tax is not payable on provision of taxable service to SEZ developer/unit which is consumed wholly within the SEZ. Hence, this service will be considered as exempted service. Rule 6 of the Credit Rules prescribes certain conditions for availment and utilisation of credit in the case of manufacturers who manufacture dutiable as well as exempted goods and service providers who provide exempted as well as taxable services. The Credit rules don't permit availment and utilisation of CENVAT credit on inputs or input services exclusively used for providing exempted services. A service provider who is providing taxable as well as exemptedservices is required to maintain separate records for taxable and exempted services in respect of receipt and utilisation of input/input services.

Further, a service provider not maintaining separate accounts for exempted and taxable services, has two options. He either (i) pay an amount equal to 8% of the value of exempted service; or (ii) avail proportionate credit attributable to the value of taxable service computed as per the formula prescribed in Rule 6(3A). Sub-rule (6) to Rule 6 provides certain exceptions to the above. In terms of the said sub-rule, the provisions of sub-rule (1), (2), (3) and (4) shall not be applicable in case where the excisable goods are cleared to a unit in SEZ. It is pertinent to note here that the said sub-rule mentions only about the exempted goods and not the exempted services. In view of the above, it transpires that:

++ a DTA service provider exclusively providing taxable services to SEZ unit/developer which is consumed wholly within the SEZ is not eligible for the CENVAT credit on input/input services as output service is exempt

++ a DTA service provider also providing taxable services to SEZ unit/developer which is consumed wholly within the SEZ is either liable to reverse the proportionate credit or pay 8% amount

++ If DTA service provider charges service tax on the taxable services provided to SEZ unit/developer which is consumed wholly within the SEZ, SEZ unit/developer will not be able to claim refund

++ On the other hand, DTA service provider providing taxable services to SEZ unit/developer consumed partially within the SEZ will be eligible for the CENVAT credit on input/input services as output service will be taxable and SEZ unit/developer will be able to claim refund. Hence services partially consumed within SEZ will be cheaper than services fully consumed within SEZ.

In contrast, no service tax will be leviable if same services are imported by the SEZ unit/developer and consumed wholly within the SEZ. Certainly, above scenario is a heart burn for the Indian service industry. I don't understand why the Indian service industry should celebrate for the new notification.

The above situation can be rectified by simple amendment in the Sub-rule (6) to Rule 6 of the Credit Rules by including therein provision of service to SEZ. In such case, supply of goods and provision of service to SEZ developer/units will be at par and service providers will not be liable to pay 8% amount or reverse the proportionate credit. However, mandarins in the north block have their own ways and there may not be any wakeup calls till the political bosses step in. No doubt, "Doing Business 2009 Report" released by the World Bank rank India at 122 for the Ease of Doing Business Rank below neighbouring nations such as Pakistan (77), Bangladesh (110) and even Nepal (121).

(The author is associated with Khaitan & Co)