Pragmatic Approach to Exempt Serv. under Common Input Serv.

[This article appeared in “Service Tax today” Volume 13, Part 4 Page No. 88]

Budget 2008 – Pragmatic Approach to Exempt Services under Common Input Services

By CA. Pradip R Shah

e-mail: pradip_shah@vsnl.com

Introduction:

1.0   Permitting credit for inputs / tax on inputs while determining tax liability, is at the core of value added tax system. To the extent input credit is not permitted / denied, the very objective of value added system is defeated, leading to cascading of taxes. However, making provisions for input credit raises host of other issues as well. One of the major issues is to what extent input credit be permitted when output service is partially exempt. Unlike tangible goods where identification of exempt goods manufactured and input thereof is possible, it may not be so in the case of rendering of services. Even in the case of manufacturing operations, identification of all the inputs and input services which goes into manufacturing will not be possible. The case becomes more complex in the case of service provider. The Government cannot permit credit for input services going into rendering of exempt services as there will not be any tax revenue for the output services rendered. At the same time, denial of input credit totally will be unfair and will also pinch the service provider.

Existing Scenario

2.0   As per the provisions of rule 6(2), the SP is required to maintain separate accounts for receipt, consumption and inventory of input and input service meant for use in the manufacture of dutiable final products or in providing output service and the quantity of input meant for use in rendering of exempted services and take CENVAT credit only on that quantity of input or input service which is intended for use in providing output service on which service tax is payable. Barring few cases, this is practically impossible. Apart from that even if one makes an attempt to do so the, ST Department will always include various services and higher proportion thereof for exempt services. All these are bound to lead to dispute.

2.1   In order to overcome this problem CENVAT Credit Rule 6(3) (c) contains provision under which CENVAT Credit in respect of mixed output services are restricted to 20.00% of the amount of service tax payable on taxable output service. Although this may look simple at a glance, it has severe financial implications for the service provider (SP), particularly when output service forms a miniscule part of the total services. Let us examine its salient features and its implications.

1)    In the first stage the SP is required to compute total amount of service tax liability. This will not be inclusive of exempt services.

2)    Secondly, the SP will have to compute CENVAT Credit entitlement. Under the normal circumstances the whole of this amount will be permitted to be adjusted against the tax liability. Excess of credit, if any, will be carried forward to be adjusted against future tax liability.

3)    In the case of exempt services, tax credit as computed above will be pertaining to exempt service as well. Since the SP is not paying any tax on such services there cannot be any question of providing credit for the same. However, in view of practical difficulty, as per the provisions of rule 6(3)(c), the claim for credit is restricted to 20.00% of the taxable output service.

4)    In the case of CENVAT Credit entitlement being more than tax liability on taxable out put services, SP will be required to pay tax. This is despite the fact that substantial amount of credit may be available.

5)    It should be noted that excess amount of credit not adjusted against the tax liability will not lapse. The SP is entitled to carry forward and claim so in the next month / quarter. Thus, the right to claim credit is not lost forever, it only gets deferred.

6)    This may sound reasonable as the right to claim credit remains alive. However, it does affect financial position of the SP adversely. This is for the reason that entitlement to credit arises only when payment for services have already been made. In terms of provisions of rule 6(3)(c), the SP is required to make payment of tax as well. Thus, there is double payment of tax i.e. once at the time of making payment input services and secondly as provided under rule 6(3)(c). This will block the liquid resources of the SP for an indefinite period. This is for the reason that full credit can be availed only when there is no out put service which is exempt.

7)    The problem becomes acute in the case of SP having continuous stream of exempt output services, making it impossible to avail credit to the full extent.

8)    The option provided under rule 6(3) (c) can work in the cases where value addition on the part of SP is substantially more, making the proportion of credit of less than 20.00%. In real life, very few services can have that kind of value addition. Thus, the provisions of rule 6(3)(c) always resulted in favour of the Revenue as the SP was required to pay ST and carry forward the credit.

9)    An offshoot of the provision is that the SP is not permitted to claim the unutilised amount of credit as expenditure for computing Income tax liability. This is for the reason that under the mercantile system of accounting, the amount to be claimed as credit is required to be shown as claims receivable and appears under Current Asset. In the case of SP having continuous stream of exempt services claims for credit will start forming substantial part of Current Asset. 

2.3   Since option under rule 6(3)(2) was not feasible the SP did not have any choice but to opt for the provisions of rule 6(3) (c) perforce.

Ray of Hope

3.0   Budget 2008 proposes to amend the said rule. Its salient features are as follow:

3.1   As per the first alternative, the SP can either reverse the credit attributable to the inputs or input services used for providing exempted service. However, the methodology to be followed for determining credit attributable to the inputs and input services has not been laid down. This option seems to be more rational. There cannot be any argument against reversal of credit attributable to exempt output services. Only thing remain to be seen is the methodology proposed.

Shape of things to come

4.0   Rule 6(3)(d) throws some hint in this respect. Budget 2007 implemented a proposal for SP in respect of General Insurance wherein CENVAT credit is allowed on the basis of provisional computation of proportion of exempt and taxable services. In the first place credit is computed provisionally and at the end of the year final computation is being made. The formula being applied is as follow:

1)    Determine, provisionally, the amount equivalent to CENVAT credit attributable to exempted services, in the following manner, namely:

(2) Pay the amount attributable to exempted services determined as above for each month, on or before 5th day of the following month;

(3) Determine the CENVAT credit attributable to exempted services for the whole financial year in the following manner, namely:

(4) Pay an amount equal to the difference between the amount determined as per item (3) and the amount determined as per item (1), on or before the 30th June of the succeeding financial year, where the amount determined as per item (3) is more than the amount paid;

(5) In addition, the SP is required to pay interest at the rate of 24.00% p.a. from the due date i.e. 30th June till the date of payment, where the amount short-paid is not paid within the said due date. (Isn’t it exorbitant?)

(6) Where the amount determined as per item (3) is less than the amount determined and paid as per item (1), adjust the excess amount on his own, by taking credit of such amount. (What about interest thereon? Interestingly, rules are silent about interest to be paid to the SP.)

4.1   SP rendering services for the first time will face a problem as there will not be figures for the previous year. In such cases, it is provided that SP will have to pay CENVAT credit attributable to exempted services for each month but determine the CENVAT credit attributable to exempted services for the whole year as prescribed and pay the amount so calculated on or before 30th June of the succeeding financial year.

Apart from this certain procedural requirements like intimation to ST Authorities etc. have also been laid down. In nutshell, the provisions herein are rational.

Second Alternative

5.0   As per the second alternative, SP will be required to pay tax @ 8.00% of amount of the value of the exempted service. Under this option, tax is proposed to be levied on the exempt services but at a lower rate. This lower value of services will take care of credit element involved in rendering of exempt services. It is proposed to amend S. 67 of the Finance Act and lay down rules for methodology to be followed for determining lower amount of exempt services. Thus, the SP will have to pay tax on exempt services @ 75.00% of the normal rate of tax i.e. 67.00% of 12.00.

In either case, the SP will be permitted to utilize CENVAT credit to the full extent.

An analysis

6.0   At a glance, both options appear to be simple. However, for the purpose of working out cost-benefit analysis, the SP will have to undergo complex process of computation. In order to appreciate the concept, it will be necessary to examine various elements involved and how it gets impacted. Look at the following table.

Conclusion:

7.0   In the absence of rules laying down methodology to be followed for the purpose of re-computing the value of exempt service and reduction in CENVAT Credit, it will not be possible to make detailed computation. In any case, the SPs have been given a fair opportunity of choosing the option. It is for this reason the approach to the issue appears to be pragmatic.