Indirect Tax: Banking on Service Tax

Budget 2006 has come at a time when the Indian economy has grown substantially and at a brisk pace, especially over the past two to three years. The markets are showing irreprehensible exuberance, and India has suddenly been elevated to the pedestal and is being considered as one of the most promising economies in the world.

The primary need of the hour is to sustain this buoyancy and momentum. Given this, it was expected that the budget would spur consumption and investment, especially in infrastructure sectors like power, oil and gas, etc. This calls for increased government expenditure with a conflicting need to stick to the fiscal prudence regime.

To this end, the present budget seeks to do the following:

• Increase tax collections;
• Spur investment in infrastructure;
• Rationalise tax administration (especially in relation to the service tax levy); and
• Rationalise duties

With respect to indirect taxes, the government has sought to increase the tax base in relation to service tax and rationalise duties with respect to customs and excise duties.

Service Tax: The service tax rate has been increased from 10% to 12%. The effective rate of service tax would therefore work out to 12.24% (including the education cess).

Further to the above, the ambit of service tax has been widened to include the following new services:

• International travel (other than economy class);
• Rail transport of goods (other than government railways);
• Sponsorship (excluding sponsorship of sports events): Based on clarifications, the Ministry of Finance has proposed to introduce a reverse charge for taxing these services whereby the sponsor would be liable to pay the tax (and not the service provider);
• Sale of space or time for advertisement;
• Auction services;
• Public relation services;
• Cruise Travel;
• Credit card and other similar payment card services: While credit card services were taxable earlier also, this new service category seeks to tax all services in relation to any cards as also all players in a plastic money transaction such as merchant establishments;
• Internet telephony services: It has been clarified that Internet telephony services is already taxable and the present budget merely seeks to include a specific category for taxing the said services. This issue would need to be evaluated;
• Business support services i.e. services in relation to telemarketing transaction process, and infrastructural support have also been made liable to service tax;
• Other new services that have been made taxable include services of a recovery agent, share transfer agent services and a service provided by registrars to an issue.

In addition to the new services, the scope of existing taxable service categories has been expanded.

The key expansions are outlined below.

In case of banking services, money transfer services and bankers' services in relation to issue of securities have now been made taxable;

Currently promotional marketing as also processing services and auxiliary services related to the above activities are covered under the category of taxable services category business auxiliary service.

However, computerised data processing services and maintenance of computer software were specifically excluded from the ambit of the said service category. This exclusion has been withdrawn. Given this now computerised data processing service or computer software maintenance services which are in the nature of business auxiliary services would be taxable;

• Erection, commissioning and installation services in relation to structures whether prefabricated or otherwise have now been made taxable;
• Clinical testing of drugs and formulations would be taxable under the taxable service category of technical testing and analysis services;
• Further, the reference to commercial concern in the definition of taxable services has been replaced by 'any person'. On account of this amendment, any entity, including an individual providing these services, would now be liable to service tax.

In line with broad basing this levy, several exemptions have been withdrawn. These withdrawals are effective from March 1, 2006. The following exemptions have been withdrawn:

- Exemptions related to reinsurance premium and premiums booked outside India have been withdrawn;

- Exemptions to call centre services and medical transcription services have been removed;

- In case of chartered accountants, in the past only specified services primarily related to audits, certification or advisory works were liable to tax. Services other than these specified services were exempted. These exemptions have been withdrawn.

- Further to the above, in case of normal lending activity, service tax was not applicable on the interest component. However, in the case of lending activity there was an anomaly whereby only the interest component of a rental that was received was taxable based on clarifications issued by the government. The Finance Minister has sought to somewhat rationalise this anomaly by exempting 90% of the interest component from the levy of tax.

The government has also expressed its intention to introduce valuation provisions in line with those under the excise and customs legislations. This amendment is in with the intention to plug any loss of revenue on account of low valuation of intra group company services etc.

As the Finance Minister announced in his speech, the ministry proposes to issue draft valuation rules after inputs from the industry and the public at large.

While a reverse charge mechanism already exists in relation to import of services (whereby the service recipient pays tax and not the service provider), it is triggered only in cases where the service provider does not have the establishment in India.

Budget 2006 proposes to introduce specific rules in relation to define an 'import of services' and the applicability of a reverse charge on all services 'imported' into India. In addition to the above, several other procedural and administrative changes have been made.

Customs duty: In line with the on-going trend of rationalising customs duty as also with the overall objective of reaching ASEAN levels of tariff barriers, the Finance Minister has reduced the peak rate of basic customs duty (of goods other than agricultural products) from the existing 15% to 12.5%. However, to give a level playing field to indigenous manufacturers, a special additional customs duty of 4% has been made applicable on most products.

The special additional customs duty is in lieu of sales/VAT applicable on sale of goods within India given that similar imported goods are otherwise not liable to this tax. It should be noted that local manufacturers importing raw material etc would be eligible to claim Cenvat credit of this special additional customs duties. Thus, the special additional customs duty would not be an additional cost for these manufacturers (traders and service providers who are not eligible to claim credit of this duty would have to pay more for imports).

Excise duty: In relation to the excise duty, as had been expected, excise duty rate on small cars was reduced to 16%. Small cars for this purpose have been defined as cars which are less than 4,000 mm long and which have a engine capacity of less than 1.2 litres in case of petrol cars and 1.5 litres in case of diesel cars. Pursuant to this reduction in excise duty, manufacturers have announced reductions in prices of around Rs 12,000 "� 20,000 (depending upon the model).

Excise duty has been introduced on computers and computer software. However, the Finance Minister has clarified that excise duty would only be applicable on packaged software and not customised software or on software which is downloaded from the Internet. The introduction of excise duties on software would result in imports of software (not downloads) being liable to customs duties.

Excise duty has been reduced on cheap footwear, certain foodstuffs such as ice cream, dosa/ idli premixes, pasta.

CST: The Finance Minister reiterated the intention to phase out CST in the short / medium term. In this connection, contentious issues in relation to determining compensation formula as also modes of compensation to the states on account of loss of revenue on the CST being phased out are being sorted out.

It is expected that the Finance Ministry would come back to the Parliament with relevant proposals upon reaching consensus with the state governments. In light of this, the expected reduction of tax rate of 4% to 2% applicable on purchase against Declaration Form 'C' has been deferred with a promise that a review would be done shortly. Further, with a view to reducing cost of LPG, it has been included in the list of declared goods, thereby making it incumbent on the state governments to reduce sales tax/VAT rates to 4%.

Goods and Services Tax: Endorsing the suggestion of the Kelkar Task Force, the Finance Minister announced the intention of the government to introduce a unified Goods and Services Tax (GST) and replace our existing archaic system of taxation. The Finance Minister indicated that April 1, 2010 is being considered as the date for implementing a unified GST subject to all the states implementing VAT in the interim.

(Courtesy: Ernst &Young)