International trade in services has expanded rapidly as a result of globalisation, aided significantly by the revolution in communication technology. This expansion has coincided with the global spread of Value Added Tax (VAT), with some 140 countries now using such a tax as their primary or only consumption tax. VAT systems are designed to tax final consumption and therefore the intent is to tax consumers who actually consume goods and services.
However, although this basic intent of VAT is the common aim, there is a great deal of variation in the manner different countries around the world have adopted/implemented VAT.
Significant differences can be found in terms of the structure, the substantive provisions as well as coverage of the tax. While countries like Australia, New Zealand and European countries have adopted a single unified VAT as a common tax on goods and services, countries like Canada and Brazil have adopted a dual VAT in that the tax is levied and collected by both the Central and the State or Provincial Governments. Other countries have adopted dissimilar provisions for taxing goods and services and consequently services taxation is addressed in qualitatively different terms.
Due to this heterogeneous approach towards VAT, its application on international or cross-border transactions has become complex. This has given rise to tax disputes with particular reference to the international trade in services.
In relation to cross border trade in goods, the internationally accepted principle that goods should be effectively zero-rated on exports and taxed in the country of import works well in practice.
However, the principle works less effectively in relation to services, almost certainly because of their intangible nature, which leads to the problem of double taxation or double non-taxation. There are several approaches adopted by different countries to tax cross border trade in services with the aforesaid principle in mind but with mixed results in terms of preventing the problems mentioned above.
As a result, businesses and governments have had to face difficulties. Many studies have been conducted by organisations like the OECD and the EC in order to identify the VAT issues in international trade in services and to suggest measures to resolve such issues. The remedy perhaps lies in internationally agreed approaches to VAT on cross border trade in services. The challenge is to identify the neutrality producing VAT principles and ensuring acceptance of such principles by all countries.
The following discussion briefly illustrates the approaches to taxing the international trade in services, the significant VAT issues arising as a result and the possible measures to address these issues, with a brief reference to the Indian service tax provisions relevant to the discussion.
Globally, the approaches to taxing international trade in services have been origin based taxation, destination based taxation or a mixture of the two. Under the ‘origin’ model, services are taxed in the country where the supplier is based unless they are specifically defined to be taxed somewhere else.
Other countries use a ‘destination’ model under which services are taxed where the customer is based. The hybrid model would be one where some services would be taxed at origin and some others on a destination basis.
Further, different jurisdictions would define differently the expressions ‘place of consumption’, ‘use of service’, ‘rendering of service’, all of which are commonly used to ascertain the event and the incidence of export or import of services, for the purpose of taxation of cross border services.
Other terms, which are also relevant and whose definitions can cause variations in the tax effect, intended or unintentional, include the ‘supplier’s or recipient’s residence’, ‘permanent/fixed establishment’, the physical place of performance’ and ‘ the place of use and enjoyment’.
These proxies, and they are such, when applied differently by different countries, have the potential to create conflict, especially given that there are also uncertainties as to their interpretation and application. Therefore, there are significant practical difficulties in establishing the situs of taxation, based on either the origin or the destination principle in place in those jurisdictions, which can cause the problem of double taxation or non-taxation. In addition, there are difficulties in relation to definitions of the underlying services themselves and in relation to bundled supplies, to name just two. These uncertainties in the application of consumption taxes may dissuade businesses from making investments or postpone trading decisions, leading to sub-optimal economic results.
For their part, tax administrations struggle with revenue generation and revenue sharing concerns, in relation to these transactions. Consumption taxes are normally predicated on the basis that businesses are responsible for the proper collection and remittance of such taxes, as ‘unpaid tax collectors’, so to speak.
Hence, complex, unclear or inconsistent rules across jurisdictions are difficult to manage for tax administrations and create uncertainties and a high administrative burden for business, which can lead to reduced compliance levels.
In addition, such an environment may also possibly favour tax evasion as well. These issues are critical to global trade and need resolution in a manner so as to be seen and actually operate as a ‘win-win’ model for both businesses and governments.
The Indian perspective
Indian service tax law is at a nascent stage. India’s dual VAT system, in terms of separate tax laws for goods and services, can create complexity and unintended tax consequences. The relevant provisions are both difficult and ambiguous, so as to give rise to the possibility of double taxation not only in cross border trade but in domestic trade as well, where a single transaction can potentially be taxed as both a sale of goods and a provision of services.
The basic approach adopted by India is to tax services on the destination principle, which is in line with international norms. However, the provisions to establish the incidence of exports and imports are susceptible to varied interpretations and need review. For example, to qualify as export, one of the conditions required to be satisfied by a service is that it should be ‘provided from India and used outside India.’ This expression is not defined in law and this causes considerable uncertainty in relation to treatment of specific transactions.
This brings a potential double tax implication into focus, in that the service could potentially be taxed in both the exporting & importing jurisdiction.
Similarly, under the Import of Services Rules, the provisions are unclear as to whether services received in India should be subject to the tax, or should the consumption of the service in India be a necessary precondition for the tax to apply. This lack of clarity again creates a potential double taxation situation. There are other illustrations as to how the present service tax law creates difficulties in achieving the desired effect; which is to tax consumption of services on a destination basis.
To conclude therefore, the international situation in relation to the application of VAT on cross border trade in services is unsettled and what needs to be done is that clear and transparent taxation principles must be brought into effect across jurisdictions in order to ensure that services are taxed once and not twice or more, based on global agreement as to where the taxing jurisdiction ought to lie.
India’s service tax law is increasingly based on global principles and accordingly India needs to work closely with the OECD, the EC and other multi country institutions in order to bring about a fair and transparent scheme of taxation of cross border services.
The writer is leader, Indirect Tax Practice, PricewaterhouseCoopers
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