Input tax credits on vehicle warranties

Of the various changes in the CENVAT Credit Rules,2004 that were effected in Budget 2011, an intriguing one relates to the disallowance of input tax credits on warranty services relating to motor vehicles.

By way of context, the relevant definition of input service, as it stood prior to the aforesaid change, read as follows:-

(l) “input service” means any service,-

i) used by a provider of taxable service for providing an output service, or

ii) used by the manufacturer, whether directly or indirectly, in or in relation to the manufacture of final products and clearance of final products upto the place of removal, and includes ………………… activities relating to business,……………………. Thus, activities relating to business were eligible for the offset and there were no exclusions to the definition, as it stood prior to the amendments of 2011.

Post the changes, the definition reads as follows:-

(l) “input service” means any service,-

i) used by a provider of taxable service for providing an output service, or

ii) used by a manufacturer, whether directly or indirectly, in or in relation to the manufacture of final products and clearance of final product upto the place of removal.

and includes……………………..

but excludes……………………..

(A) ……………………………..

(B) specified in sub clauses ……………………….., (zo) of Clause (105) of Section 65 of the Finance Act, 1994 insofar as they relate to motor vehicles, except when used for the provision of taxable services for which the credit on motor vehicle is available as capital goods; Or

(C) …………………………..

It can thus be seen that the revised definition does not any longer contain the expression “activities relating to business”.

More importantly, it also excludes several services specified in Clauses (A), (B) and (C). All such exclusions pertain to services used by manufacturers and hence such exclusions do not relate to service providers. Further, one of the excluded services is as defined in Clause (105) (zo) of Section 65 insofar as it relates to motor vehicles.

Now, Section 65(105(zo) relates to taxable services provided by authorized service stations and the aforesaid exclusion means that such services are not eligible for input tax credits in the hands of manufacturers.

Interestingly, the definition of authorized service station services has itself undergone a change. The erstwhile definition stood as follows:-

“Taxable service means any service provided or to be provided to a customer by an authorized service station in relation to any service, repair, reconditioning or restoration of motor vehicles, light motor vehicles or two wheelers motor vehicles in any manner.

On the other hand, the revised definition reads as follows:-

“Taxable service means any service provided or to be provided to any person by any other person in relation to any service or repair, reconditioning, restoration or decoration or any other similar services, of any motor vehicles other than three wheelers, scooters and auto rickshaw and motor vehicles meant for goods carriage”. The import of the aforesaid changes to the definitions of ‘input service’ and ‘authorized service station’ service is that services provided by authorized dealers of motor vehicles to customers ‘free of charge’, under the warranties given by such motor vehicle manufacturers, are no longer eligible input services for these manufacturers.

Thus, the service tax charged on such services, for which consideration is received from the motor vehicle manufacturers by the dealers, are no longer eligible as an offset in the hands of such manufacturers. Under the erstwhile definitions, the service tax so paid was available as an offset to the manufacturer.

It appears from the very specific changes that have been effected in the relevant definitions as described above that the intent of the Government is clearly to disallow the credit of the service tax on such services provided by the authorized dealers of motor vehicles.

It is moot as to whether this intent is in line with the overall philosophy of the CENVAT Credit Scheme, as also the overall Service Tax Scheme, which is to enable an offset for all services legitimately used by manufacturers in the course of their business. In the present instance, it could be argued that such services are indeed used by the manufacturers of motor vehicles in relation to the manufacture of such vehicles, in that the manufacturers have provided warranties to the customers purchasing their products.

If it is agreed that such warranties are indeed legitimate business activities, then the services provided by the authorized dealers, for which they receive consideration from the manufacturers, ought also to qualify as legitimate input services.

It is interesting to note that the amended definitions have the effect of disallowing input tax credits on such services provided on all motor vehicles other than three wheelers, scooters, auto rickshaw and goods transport motor vehicles.

Thus, the manufacturers of two wheelers other than scooters, i.e. motorcycles, as well as motor car manufacturers, have been negatively impacted as a result of this apparently deliberate exclusion from input tax credits.

An equally interesting point to note is that while the aforesaid exclusions relating to the input service tax credit have been brought in, at the same time the definition of ‘input’ goods has been amended to extend the benefit of credit on goods used for providing free warranties for final products.

The explanation to this definition defines ‘free warranty’ as the warranty provided by the manufacturers, the value of which is included in the price of the final products and is not charged separately from the customers. Thus, input tax credit has now been extended to input goods which are used in the provision of warranty services on all final products, including motor vehicles. This benefit was not available earlier.

It is thus the case that as a result of all of these changes in Budget 2011, motor vehicle manufacturers are now precluded from available input tax credit on the service taxes charged to them by their authorized dealers, on the provision of services on motor vehicles in terms of the warranties (free services) provided by such manufacturers to customers, whereas the parts which are supplied by such manufacturers to such dealers as warranty replacements of defective parts, would now qualify for credit, towards payment of the excise duty of the motor vehicles.

Since the product warranties relating to motor vehicles typically require that such vehicles be serviced at the authorized service stations at appropriately defined intervals, it would have stood to reason if the above service tax was also admissible for credit. In other words, it could be argued that the aforesaid distinction in the input tax credit provisions relating to motor vehicle warranties is unwarranted and should be removed. It will be interesting to see whether this distinction is maintained or removed under the provisions of the forthcoming GST.

The author is Executive Director, PricewaterhouseCoopers Pvt. Ltd. pwctls.nd@in.pwc.com  

Supported by Nikhil Aggarwal and Krishnan Agarwal