Controversy Regarding Rental Services - An analysis

[This article appeared in “Service Tax Today” Vol. 12 Part 7 Page 101 dt. 15-2-2008]

Controversy Regarding Rental Services – An analysis

By CA. Pradip R Shah

e-mail: pradip_shah@vsnl.com

Introduction

1.0   The Board of Direct and Indirect Taxes has developed a unique art of generating controversies by issuing clarifications in the form of circulars. While a circular is supposed to clarify the issue, at times now a day, it operates the other way round, for rather than clarifying the issue, it creates controversies. This particularly happens when the process of interpretation of the statute goes topsy-turvy i.e. when statutory provisions are interpreted keeping in mind the final outcome. A judicial mind will not look at the final outcome or implications and will read the statutory provisions as they are. However, it is not the case with a bureaucrat. Off late it has been observed that interpretation by a bureaucrat is more focused on implications of the interpretation on achieving the revenue target. In the process, the losers are the taxpayers at large, although there are beneficiaries to the same as well viz. advocates, chartered accountants, tax practitioners and publishers of tax literature. This kind of circulars help advocates, chartered accountants and tax practitioners in keeping their dull and dreary life worth living. The circular in debate off late is the Circular No. 98/1/2008-ST issued by The Tax Research Unit (TRU) of the Department of Revenue, Ministry of Finance. In order to appreciate the controversy, read its text carefully.

Ref. Code: 096.01 / 04.01.08         

Issue:

Commercial or industrial construction service or works contract service is used for construction of an immovable property. Renting of an immovable property is leviable to service tax.

Whether or not, commercial or industrial construction service or works contract service used for construction of an immovable property, could be treated as input service for the output service namely renting of immovable property service under the CENVAT Credit Rules, 2004?   

Clarification:

Right to use immovable property is leviable to service tax under renting of immovable property service.

Commercial or industrial construction service or works contract service is an input service for the output namely immovable property. Immovable property is neither subjected to central excise duty nor to service tax.

Input credit of service tax can be taken only if the output is a ‘service’ liable to service tax or a ‘goods’ liable to excise duty. Since immovable property is neither ‘service’ or ‘goods’ as referred to above, input credit cannot be taken.

(for better reading references to various sections in the text has been deleted)

Core Issue

2.0   In terms of provisions of S. 65(105)(zzzz) of the Finance Act, any service provided or to be provided in relation to renting of immovable property (IP) for use in the course of business or commerce is subject to Service Tax (ST). As in the case of other services, Cenvat Credit Rules (CCR) are applicable herein as well, as the landlord is entitled for credit of taxes paid in respect of input services (IS). The issue here is whether the ST paid on IS, at the time of construction of the IP which has been given on rent, can be claimed as input credit and can set-off be claimed from ST on rent received.

2.1   Apparently, and even at the close reading of the provisions of CCR will reveal that there should not be any problem in claiming the credit. However, then what is the issue? Let us examine the circular in question in various aspects and see how it has tried to achieve (or has mislead) its objective in convoluted manner.

2.2   Let us look at the issue raised. It is very clear and in no uncertain terms asks about

“Whether or not, commercial/industrial construction service/works contract service used for construction of an immovable property, could be treated as input service for the output service”

The querier is very clear in his mind. However, see how the clarification starts.

Fallacy No.1

3.0         Right to use immovable property is leviable to service tax under renting of immovable property service.

3.1   Firstly, the query nowhere refers to the legality of the taxing of the renting services. Assuming that it was necessary to touch upon this aspect, let us see how it has been dealt with. It proceeds with a totally new concept i.e. taxing of right to use under renting of IP. This is in sharp contrast to the provisions of S. 65(105)(zzzz), which reads as follow:

“Taxable service means any service provided or to be provided to any person, by any other person in relation to renting of immovable property for use….”

3.2   Thus, what is taxable is “renting of IP” and not “right to use immovable property”. Is it the view of the TRU that if, say due to stay by the Court, the tenant is not permitted to use the property, ST cannot be levied for rent received during such period? A tenant derives the right to use the property as a result of the agreement for renting the property. Therefore, the first event is the renting of the property and the right to use is derived there from.  Even in the case, where the right to use the property is suspended, the act of renting continues till the owner gets the possession of the property. In any case, the contention made herein has no bearing on the issue at discussion.

Fallacy No. 2

4.0   Let us look at the second line of clarification. It reads as follow:

Commercial or industrial construction service or works contract service is an input service for the output namely immovable property.

4.1   Yes, it is the outcome of various services as referred to. However, is there any relation to the query raised? No. But in order to reach to a particular destination, background has to be created. Continue to read further and it will be clear why such a route has been selected.

Fallacy No. 3

5.0         Immovable property is neither subjected to central excise duty nor to service tax.

5.1   Yes, it is true. No one has any dispute about it. However, is there anything to do with the query raised? No. But keep in mind that a trap has been laid down here. Since IP is not subject to ED or ST, IS thereof cannot be taken cognisance thereof. Why? Since IP is being used for providing rental services and as ED or ST is not payable there is no question of claiming any CENVAT Credit in respect thereof. Is it so simple? No. Before examining its hollowness let us complete the remaining portion of the clarification.

Fallacy No.4

6.0         Input credit of service tax can be taken only if the output is a ‘service’ liable to service tax or a ‘goods’ liable to excise duty.

6.1   Yes. It is perfectly in order. However, it is half-truth only. For the purpose of claiming input credit, there are other equally valid conditions required to be satisfied. And for obvious reasons, the same are not being referred to.

Fallacy No. 5

7.0         Since immovable property is neither ‘service’ or ‘goods’ as referred to above, input credit cannot be taken.

7.1   Here lies the crux. Who has said that IP is a service or goods? Read the query carefully. It is nowhere stated that since IP is a service or goods, IC should be permitted. IC has not been claimed on the grounds of IP being IS. This is nothing but distracting from the core issue.

7.2   Firstly, look at the provisions of S. 65(105)(zzzz). It says that taxable service is a service provided by a person to another person in relation to renting of IP for use in the course of business etc. It is the act of “renting” the property for “use” in the business. S. 65(105)(zzzz) nowhere states that IP per se is taxable. It is the positive action on the part of service provider of renting his property to a tenant i.e. service receiver, the question of tax arises. In the case of ST, there are two important ingredients viz. Input Service /Inputs / Capital Goods and Output Service. For the purpose of determining eligibility for IC, it is necessary that OS should be taxable. Here, there is no doubt that the SP is providing service in the form of renting of IP. It is this act of SP, which is invoking the provisions of S. 65(105)(zzzz). The SP is not liable for ST for owning the IP.

7.3   Secondly, if renting of IP is OS, which provisions are applicable for claiming IC?  They are Rule 3 and 2(l) of CENVAT Credit Rules (CRR). Rule 3 permits the SP to claim IC for the ST / ED paid. It reads as follow:

(1) A … provider of taxable service shall be allowed to take credit …of -

(i) … (xi) (not reproduced here)

paid on-

(i)            any input or capital goods received in the .. premises of the provider of output service on or after the 10th day of September, 2004; and

(ii)          any input service received by … the provider of output services on or after the 10th day of September, 2004,

including the said duties, or tax, or cess paid on any input or input service…….

Scope of Input Service

8.0   What is Input Service? Read Rule 2(l) of CRR.

2 (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 from the place of removal,

and includes services used in relation to setting up, modernization, renovation or repairs of a factory, premises of provider of output service or an office relating to such factory or premises …… (remaining portion not reproduced here as not relevant)

8.1   Does it sound confusing? Let us combine the provisions of Rule 3 and 2(l) and read it.

A provider of taxable service shall be allowed to take credit of … (for clarity various duties and service tax referred to not reproduced here) paid on any services used in relation to setting up … of .. premises of provider of output service… received by the provider of output services on or after the 10th day of September, 2004 including the said duties, or tax, or cess paid on any input or input service…….

Examining Input Service at Micro Level

9.0   For better clarity, let us examine the definition of IS as referred to in Rule 2(l) and dissect it. It will look like as follow:

Input service means any service used in relation to

Disturbing Scenarios?

10.0  Let us expand the above table at micro level and examine it under various scenarios.

Scenario: 1

Scenario: 2

Scenario: 3

Scenario: 4

11.0  Examine the query raised with reference to Scenario No. 3. Are the IS related to construction / WC are not the services used for setting up of premises of provider of OS? The SP is providing his premises for the purpose of renting services. Are the provisions of rule 2(l) not wide enough it to be treated as IS? If no (as stated in the clarification) what is the relevance of various services covered after clause no. 2 under “includes”? Are they superfluous?

11.1  A question may arise here as to what is the meaning of “setting up”. Its dictionary meaning is “to put into a certain place or abstract location”. Are the services relating to construction / WC which are IS, not putting the IP at certain place or an abstract location?

11.2  And lastly, is the IP given on rent not the premise of SP?

Nelson’s Eye

12.0  Unfortunately, the Circular, for some unknown reasons, turns the Nelson’s eye to the provisions of Rule 2(l) and particularly the extended list of services covered under “includes”.

12.1  Let us examine the fallacy of the argument put forward in the clarification from another angle. Rule 2(a), 2(k) and 2(l) relating to capital goods, inputs and input services clearly defines ingredient of the IC. Look at the provisions relating to IC with respect to inputs and capital goods. Since they contribute directly to OS and, being visible no issue arises. However, there are various IS which are not visible and wherein one-to-one relationship with OS cannot be established. In order to take care of such contingencies, Rule 2(l) makes extensive provisions which are specifically referring to services like setting-up / renovation / modernization etc. relating to IP. Not only that, Rule 2(l) also extends to various other services, which have not even remote direct relationship with the OS. Inclusion of IS like accounting, auditing etc. is in recognition of the principles of levying tax on value addition only and avoiding cascading of taxation. If the kind of interpretation by TRU is extended, there will be large number of services not entitled for IC at all. In the same manner, there will be no need to follow the principles of levying tax on value addition. Is it the intention to go back to the days of levying tax on tax?

Innovative Research

13.0  We must appreciate the methodology followed in the circular to drive-home the point. Extensive research must have been done to deny the IC by diverting the attention from output service to the object in it and focusing on the object rather than the activity performed with the object. Well-done job.