Concept of negative list for service tax introduced

Service tax in India was first introduced in 1994 by way of taxation of a positive list of three services, namely, telecommunication, insurance and stock broking. This positive list later evolved over the years with subsequent addition of services and covers approximately 119 services on date. The expansion of this positive list over the years has had challenges of overlapping service categories which lead to serious interpretation/litigation of when and under which category specific services were covered. So from that perspective it is better to move towards a negative list concept, a choice which was available to the revenue authorities throughout this evolution. However, many felt that such a concept was best introduced along with the goods and services tax (GST), a view unanimously supported by the industry at large.

The finance ministry’s negative list concept has received mixed reactions from industry Source: www.team-bhp.com

With GST implementation delayed and hazy due to a lack of consensus between the centre and states and to an extent complicated by political compulsions, the government is hard pressed from a revenue consideration and is hence exploring the possibility of introduction of this negative list concept in the Union Budget in February 2012.

Considering such an eventuality, various key issues need to be ironed out before this change can take place. The successful implementation of the regime would depend on the fact that the shortcomings which exist in the current regime are appropriately addressed.

Before we examine the features of the negative list it's important to understand the proposed definition of service, since our current legislation does not have such a definition.

The definition is as follows:

A "service" means anything which does not constitute supply of goods, money or immovable property and includes:

• Right to use an immovable property;

• Construction of a complex, building, civil structure or a part thereof, including a complex or building intended for sale to a buyer, wholly or partly, except where the entire consideration is received after issuance of certificate of completion by a competent authority;

• Temporary transfer or permitting the use or enjoyment of any intellectual property right;

• Obligation to refrain from an act, or to tolerate an act or a situation, or to do an act;

• Service in relation to lease or hire of goods; and

• Right to enter any premises.

But excludes a supply:

• By an employee to an employer in the course of or in relation to the employment of the person;

• By a constitutional authority under the Indian Constitution or a member of an Indian legislature or a local self-government in that capacity;

• That amounts to manufacture of excisable goods or is chargeable as part of the value of goods to a duty in terms of the provisions of Central Excise Act, 1944.

The definition of service itself raises several questions.

For example the "inclusive part" of the definition, from a plain reading, it appears that "obligation to refrain from an act" would include payments for non-compete agreements. Generally, consideration paid for inaction on part of someone is typically not considered a service a may face resistance. Similarly, the inclusion of "temporary transfer or permitting the use or enjoyment of any intellectual property right" within the definition of service could lead to double taxation, as several value added tax (VAT) legislations also treat the same as goods subject to levy of state VAT. Even this is vexed issues with extensive litigations.

To further complicate the matter, the proposed definition of service seeks to include "services in relation to lease or hire of goods" within the ambit of services. Lease or hire of goods is treated as a deemed sale and attracts VAT. There is a thin line of difference, if at all, between lease of goods and service in relation to lease of goods. It is fairly certain that this aspect would get mired in litigation since both the VAT authorities as well as the service tax authorities would seek to levy tax on the same transaction. Further at present, entertainment tax is levied by the states on right to enter any premises which provide entertainment. The levy of service tax on the right to enter any premises would, in effect, lead to double taxation of the same activity under the inclusive part of the definition.

Another point to deliberate is the taxation of composite contracts for supply and services. In India, sale of goods is subject to VAT levied by the states. There is a constant tussle between the state and the centre as to whether a particular transaction would qualify as a sale (attracting VAT) or a service (attracting service tax), especially in the case of composite contracts. The concept paper does not address this issue and proposes to tax such transactions based on "the dominant intent test". The dominant intent in any particular transaction is subject to interpretation and thus litigious (litigation exists in many composite transactions of such nature). Leaving such transactions open to interpretation based on the "dominant intent test" is unnecessary and would lead to continued litigation.

So with the expansion of taxable base under the negative list before the introduction of GST as per the proposed definition, the issue of double taxation by both centre and states would only become more prevalent and litigious leading to inefficiency and cascading. This further underlines the need for introduction of such a negative list concept and expansion of taxable base along with introduction of GST which would have then taken care of cascading.

The definition also has an exclusion part and seeks to exclude certain supplies including supplies by an employee to an employer in the course of employment. The concept paper needs to clarify what would be covered within the ambit of employment. Would casual labour or part time employment be included within this exclusion. Similarly, clarity is required regarding treatment of seconded employees.

The definition of services also raises several Industry specific issues.

In almost all jurisdictions taxing of financial sector within the purview of GST has been a subject of debate and challenge. Indian revenue authorities even in the current positive list mechanism have over the years tried to cover several transactions. The concept paper continues in this direction of trying to tax the sector in a significant way with a negative list of transactions. For example sale, purchase or acquisitions of securities and debts on a principal to principal basis have been excluded. Also interest, dividend on investments and inter-bank sale and purchase of foreign has been excluded.

However clarity is required regarding the meaning of interest, the term interest is capable of varied interpretation under different enactments and could lead to disputes unless specifically defined. Ideally, interest should also include indirect interest such as discounting, purchase of negotiable instruments, bills of exchange etc. Also it's better to treat interest as zero rated instead of exempt to avoid credit leakage. Further, terms such as principal to principal securities and acquisition are ambiguous and clearly need to be defined. There is a need to include sale, purchase or acquisition of actionable claims in the negative list.

For the insurance sector, clarity is required regarding the taxability of premium as well as other charges such as surrender charges, late payment charges, policy discontinuance charges and policy reactivation charges.

The telecom sector, even under the current regime, is grappling with various issues such as taxability of recharge coupon vouchers (RCVs). RCVs should be treated as actionable claims since they represent a contract or right to receive services in future. However, states seek to levy VAT on RCVs (by treating them as goods). The concept paper is silent on the treatment of RCVs although the paper only provides exclusion for goods (and not actionable claims) from the definition of services.

Similarly, clarity is also required regarding the treatment of intangibles, such as ringtones, wall papers, games and other value added services, which also attracts litigation regarding whether such intangibles constitute supply of goods or services (state VAT laws provide that permanent/ temporary transfer of IPRs shall be treated as goods liable to VAT). The concept paper proposes to include "temporary transfer or permitting the use or enjoyment of any intellectual property right" within the ambit of services thus, resulting in possible double taxation, continued litigation and cascading.

The inclusion of "right to use an immovable property" in the definition of services would greatly affect the real estate sector. Service tax is only attracted on renting of immovable property for business purposes.

Specific exemptions are provided for vacant land or buildings used for residential purposes. As it is, service of renting of immovable property has been questioned and is being litigated in the courts. The definition of services enhances the ambit of renting of immovable property and seeks to levy tax even on residential property (above a specified threshold). Challenges in defining an appropriate threshold limit (since rentals would vary across cities and rural areas) would make it preferable to completely exempt rental of residential property as is the practice in most international jurisdictions.

This is a key sector which on date is proposed to be outside the ambit of GST. The industry is seriously concerned with this development as this will lead to severe cascading. With the proposed negative list, a larger basket of services would now attract service tax, which would make the problem of cascading even more acute. These sectors would, in all probability, pass on the additional tax burden to the consumers in the form of increased prices unless these prices are administered and fixed by the government which will only result in increasing subsidy and fiscal deficit.

The healthcare sector has been sought to be kept out of the service tax net. In this regard, the negative list proposes two alternatives for the healthcare sector. The first option envisages a limited exclusion of only services provided by clinical establishments with a turnover below Rs40 million ($813,000) and certain other limited exemptions. Whereas the second option is a larger exclusion and excludes hospital, medical care, diagnostic, para-medical services except services in relation to preventive health check-up within a clinical establishment, cosmetic or plastic surgery.

Presently, only specific services in relation health check-up and treatment attract service tax. There had been an attempt to apply service tax on the health care sector on a larger gamut of services at a reduced rate with no credit in the last budget. However, the proposal had to be rolled back due to stiff resistance from the sectors. Healthcare is a key requirement for India, especially for the less affluent sectors of society and in the absence of a robust social security system. It appears that the second alternative to exclude all healthcare services except preventive healthcare may find favour.

Another aspect which needs to be clarified is the treatment of abatements/ exemptions available for service providers. For instance, the hospitality industry, including hotels, restaurants, convention centers, tour operators, has been accorded various abatements on payment of service tax. There is no clarity on whether these abatements would continue under the Negative List.

One could also debate on whether it may be preferable to have a negative list versus a list of services which are zero rated. Any form of exemption or exclusion results in an economic distortion through the blockage of input credits. No tax is applied to services exempted from tax, but, at the same time, no input credit is allowed for the tax paid on inputs acquired for use in providing those exempt supplies. This blockage of input taxes gives rise to cascading of tax, competitive distortions and economic non-neutralities.

Therefore, the concept paper could consider having a list of services which could be zero rated, especially on B2B transactions with fully taxable persons such as supplies to special economic zones. Similarly, the services provided by educational institutions and hospitals could be zero rated. This would release the blocked input tax on supplies received by these sectors, thereby reducing the cost of provision of services. There are very strong social reasons for zero rating of these sectors in India.

One of the key factors in any successful indirect tax structure is the elimination of tax cascading. indirect tax, being a tax on consumption, should be neutral with respect to business to business (B2B) transactions, with effectively no tax being levied on intermediate consumption. Either no tax applies on B2B transactions, or the tax is fully credited. However, the current credit regulations in India are woefully inadequate in implementation of this principle.

The current Cenvat Credit Rules, which regulate the availment of credits for manufacturers and services providers, are complex and subject to varied interpretation. Therefore, to avoid litigation on account of interpretational issues, many Industry players have deliberately chosen to adopt conservative positions vis-à-vis taking of credit of inputs under these rules, resulting in further tax cascading. This predicament has been augmented with the budgetary amendments in 2011 which, in effect, further restricted the credit availability to the Industry. It is recommended that along with a comprehensive taxation regime, one should also have a robust credit mechanism with minimal restrictions which at least reduces, if not eliminates, the cascading of taxes.

Another prerequisite for the successful implementation of a tax regime is the introduction of specific rules for import and export. The export and import rules under the current regime, which frames specific rules for each service category, has been relatively easy to frame. Nonetheless, despite this, there is ongoing litigation on qualification of a service as an import or export. With the negative list, the government should to frame a simple and consolidated place of supply rules based on certain tangible criteria which can be easily interpreted and implemented.

It is also fundamental that an appropriate threshold is defined, so that tax compliance and administration is not onerous while at the same time keeping in view the revenue considerations. The government needs to ensure that the changes in the existing rules are simple, easily implementable and not open to interpretational issues. These changes should also include transitional provisions which are easily implementable and do not pose any undue burden on the Industry, especially for treatment of contracts which attract tax under both the current and the new regime.

Another issue is whether the introduction of a comprehensive taxation regime should be accompanied by a reduction in the tax rate. The principle of revenue neutrality suggests that any increase in the tax base which results in a higher revenue generation for the government should also be accompanied with a reduction in the tax rates. On the other hand, we should keep in mind that the current rate of service tax (10.3%) was introduced to align the service tax rate with the excise duty rate on manufacture of goods in India. Given this situation, although a reduction in the tax rate on account of a higher tax base is ideal, the same does not appear to be a practical reality.

The move towards taxation of services by way of a negative list is a move in the right direction and brings us one step closer to the GST regime. It is an important milestone in the overall structure of indirect tax reforms in the country paving way for a simplified tax structure. The concept paper, being the first step in ushering this change, is a commendable effort by the Ministry of Finance and needs to be applauded.

We only hope that the government considers the views of the Industry vis-à-vis its timing and address their concerns in drafting a final legislation which is simple, easy to implement and equitable.

Views expressed are personal.

Biography
		Harishanker Subramaniam Ernst & Young Golf View Corporate Tower-B, Sector 42, Sector Road, Gurgaon, 122002, Haryana, India Tel: +91 124 464 4103 Fax: +91 124 464 4050 Email: harishanker1.subramaniam@in.ey.com Harishanker Subramaniam (Hari) leads indirect tax practice of Ernst & Young India. Hari qualified with a masters degree in Chemistry, but became a licensed customs broker and streamed into indirect tax consulting. He has been an entrepreneur, has hands on experience in the industry and Big 4 for more than 25 years. Hari has advised and assisted various multinational companies on resolution of import pricing at arm’s length on customs special valuation representations, export incentive programs, besides assisting in setting up of export oriented units (EOU), software technology parks (STP) and special economic zones (SEZ). He also has expertise in advising EPC companies for bid evaluation on contracts and highlighting the key impact from an indirect tax perspective. He has been involved across diverse industries namely oil & gas, automotive, telecom, information technology, media & entertainment, infrastructure & real estate, advising clients on cross border transactions, tax structuring, tax efficient supply chains etc.