Making Services Pay

* To an investor, by a stockbroker in connection with sale or purchase of securities registered in recognised stock exchange;

* To a subscriber by the telephone authority in relation to a telephone connection; and

* To a policy holder by an insurer carrying on general insurance business. The following year it further levied tax on advertising, couriering and paging services.

However, as recommended by the National Institute of Public Finance and Policy (NIPFP) Report on Reform of Domestic Trade Taxes in India, it is essential in the interest of the sound federal structure of the country, to have a rational distribution of power to tax services in such a way that the services that fall within the purview of states are assigned to them. Under the present system of administration, it is recommended that the following services are assigned to the states for inclusion under their tax net, possibly on the pattern of the assigned tax, as is presently done in the case of the Central Sales tax.

Transport: Transport of goods is at present taxed by the state governments, under the Motor Vehicle tax and Passenger and Goods tax. Since most of the state governments are at present levying passengers and goods tax through compounded levies, this source has not been tapped properly. As the number of vehicles has increased considerably from three lakh in 1950-51 to over nineteen lakh by 1989-90, this source has great potential for raising resources. In view of this, it is important that the services provided by the transport companies are distinguishable from the vehicles plying on the road. Accordingly, a tax on services provided by the transporters should be separately taxed in the form of a service tax.

Private nursing homes: Although medical services are treated as merit goods and, therefore, get tax exemption, the trend of rapid expansion of private hospitals over time suggests that these need not necessarily be treated as merit goods any more. In fact, a new concept of high-tech and corporate hospitals has emerged. Through this, most nursing homes tie-up with the corporate sector and take deposits from the clients ranging into lakhs. The room rent for the service is also exorbitant. It is, therefore, recommended that all private nursing homes whose total receipt exceed Rs 2 lakh per annum and/or charge room rent of Rs 300 and above are brought under the purview of a service tax on their room rent.

Automobile repair and services: Automobile repair and its service are the other important bases on which a service tax could be levied by the states. As there has been a tremendous increase in the number of show-rooms and large repair shops, most of which do maintain proper accounts, a small service tax could yield considerable revenue to the states.

Rentals from leasing: Leasing is an activity related to sales. Its exemption, therefore, creates loopholes in the taxation of sales. Many sales transactions could be camouflaged as leasing to avoid any payment of tax. For example, the film producers avoid sales tax by resorting to hiring instead of a sale. In the case of A P Meiyappan vs CTO, the film producerwho entered into an agreement with the distributor to distribute films for 49 years, could not be taxed. Since the films have a few years of useful life, selling or hiring makes no difference to the seller (lessor) or the buyer (lessee) from the commercial angle. Non-taxation of leasing, therefore, simply encourages tax avoidance. Similarly, in recent years, leasing of heavy plants and machinery as well as cars has become very common. It is, therefore, a good source of taxation as well as a means of checking avoidance of tax.

Works contract : As is the case with leasing, in works contract too, sale of goods and services is part of the same transaction, and it is easy to tax them together. In the supply of food and drinks in hotels and restaurants, as per the legal interpretation, the term service is included in sub-clause (f) of clause (29-A) of Article366. Accordingly, a tax on sale or purchase is authorised to be levied on the service. However, in the case of works contract, the service element is excluded; no tax is authorised to be levied on the service component. The exclusion of the service from the workscontract makes the levy of tax on such transactions ambiguous and difficult to administer.

The numerous cases pending before various high courts and also in the Supreme Court challenging the levy of tax on works contract are a result of the ambiguity in excluding the service element from the levy of tax. This is the consequence of the decision by the Supreme Court in the State of Madras vs Gannon Dunkerly and Co (Madras) Limited (1958) 9 STC, 353, which held that the labour portion as not taxable. Also, in Builders Association of India vs Union of India (1989) 73 STC, 370,(SC), while adjudging the constitutional validity of sub-clause (b) of clause (29-A) of Article 366, the Supreme Court held that by the 46th Amendment of the Constitution, the powers to levy tax enjoyed by the states prior to Gannon Dunkerly's Case (1958) 9 STC, 353 (SC), is restored. It would, therefore, be useful to allow the states to levy tax on the service component of the works contract. Since, the legal position of other types of contracts where goods of substantial value (like

fumigation, chemical treatment etc.) are used up in the process, are also not at all different, all such contracts should be brought under the tax net through taxation of services, as already done in the case of service of food and drinks.

Financial services: Financial services are generally exempt from value added tax. This is because of various measurement problems of value added in these services. The price of services are generally inclusive of tax on inputs. There cannot be any subtraction method to estimate value added to levy a tax on the financial services. Instead, value added has to be calculated directly, by adding wages, salaries, and profits. This method was introduced in Israel from 1976 through 1979. However, since 1979, the tax on the financial sector has been designated as a separate and distinct tax even in Israel. Most countries do not tax these services because it may drive financing underground. Also, these services being provided by a financial institution may be more accurately measured by the spread between the earnings from lending and the cost of borrowing. However, in practice it is found impossible to determine the margin. Consequently, most of the countries exempt core financial

services.

To conclude, under the present provisions of the Constitution both under the excises and sales taxes, only goods are taxed. Services have been left out of the tax net. However, the government, of late, has started levying tax on a few select services by invoking the powers resting with it under the residuary entry. This would not finally lead to a rational tax system in the Indian federal structure. It is, therefore, essential that some of the services that primarily belong to the states are given to them through tax assignment, as already done in the case of the Central Sales Tax. Let us hope the Union Budget 1997-98 does the needful.

(The author is a Professor at the National Institute of Public Finance and Policy, New Delhi. The views expressed in this article are his personnel views.)