J K Mittal: The mystery of Cenvat credit

On March 1, 13 separate notifications providing partial exemption (abatement) from service tax leviable on 10 specified taxable services were consolidated into a single notification and re-issued vide notification no. 1/2006-ST. However, in the consolidated abatement notification, the government made a significant change, and in addition to Cenvat credit of excise duty paid on inputs or capital goods, Cenvat credit of service tax paid on various input services was also disallowed.

Earlier, while availing the benefit of abatement, a service provider was only disallowed to take Cenvat credit of excise duty paid on inputs or capital goods, but there was no bar for availing Cenvat credit of service tax paid on the various input services.

Under service tax, there are many taxable services, which involve supply of materials/goods (such as commercial and residential construction contract) and abatement was primarily provided for the material portion under some selected taxable services. Therefore, the denial of Cenvat credit of service tax paid on the various input services, to a service provider who is availing the benefit of abatement, is not justifiable.

Therefore, now, a service provider, availing the abatement benefit, cannot avail Cenvat credit of service tax paid on various input services, including the service tax paid to a sub-contractor. Take the case of ABC Ltd company, which gets a construction contract of Rs 1 crore and sub-contracts the part of work, say, Rs 25 lakh. In this case, the sub-contractor will charge a service tax of Rs 82,500 (10 per cent, excluding education cess) on Rs 8,25,000 (that is, 33 per cent of Rs 25 lakh after abatement of 67 per cent) and the principal contractor will charge a service tax of Rs 3,30,000 on Rs 33 lakh (33 per cent of Rs 1 crore). However, the principal contractor will not be allowed to avail Cenvat credit of service tax paid on the various input services, including the service tax paid to the sub-contractor, that is, Rs 82,500.

Thus, due to part of the work being given on sub-contract, in addition to Rs 3,30,00 of service tax paid by the principal contractor, an additional service tax of Rs 82,500 is also paid to the government account by the sub-contractor. Whereas, in case if there is no sub-contract, the amount of service tax liable to be paid will only be Rs 3,30,00. Thus, disallowing the Cenvat credit of service tax paid on input service to a service provider who is availing the benefit of abatement under notification no. 1/2006-ST is not justified as it will lead to double taxation. This is also against the spirit of the finance minister's Budget speech that "service tax paid can be credited against service tax payable".

The author is a service tax expert and can be reached at jkmittal@vsnl.net.