The exemption from service tax to services received by SEZ developers and units has been significantly recast by notification 17/2011-ST of 1 March that replaces notification 9/2009-ST of 3 March 2009.
Notification 17/2011 continues the earlier scheme of exemption, viz. services consumed wholly within an SEZ enjoy an upfront exemption (the service provider need not charge service tax), whereas for services not consumed wholly within the SEZ the exemption is available through a refund mechanism (the service provider charges service tax, which is refundable to the service recipient).
What constitutes consumption wholly within the SEZ has been a vexing question and the seed of many disputes with the tax authorities.
New can of worms
While notification 17/2011 provides the definitional clarity required it opens up several new issues. The term “wholly consumed” has been defined on the basis of criteria similar to those used to define an export of service, i.e. either location of immovable property, or place of performance, or location of service recipient, depending on the taxable service in question.
The criterion linked to the location of the service recipient also requires that the developer or unit should not own or carry on any business outside the SEZ. It appears that this condition was added to provide an objective test that the benefit of the service has not been received outside the SEZ. However, many entities will fail this additional condition and will be disqualified from the upfront exemption, even if the service has qualitatively been consumed wholly within the SEZ.
Various additional conditions have been prescribed for availing the exemption. For instance, the SEZ’s approval committee has to approve the list of taxable services required by each developer or unit. Another crucial condition is that no central value added tax (CENVAT) credit should have been availed on these services.
Formula for refund
Notification 17/2011 apparently assumes that services that do not meet the relevant test for being considered wholly consumed within the SEZ automatically constitute services shared by SEZ units and domestic tariff area (DTA) units. Further, the formula that it sets out for computing the quantum of refund available uses the ratio of export turnover of the unit to the total turnover of the enterprise to restrict the refund amount.
The computation methodology of notification 17/2011 appears to overlook the fact that SEZ units can undertake transactions in the DTA and therefore refund ought not to be based on the quantum of their exports.
The consequences of the formula set out in notification 17/2011 will depend on specific fact profiles. Enterprises with only SEZ units (and no DTA units) that receive services that do not qualify as wholly consumed will only be entitled to a proportionate refund, based on their ratio, if they have any DTA supplies.
This would also be the outcome for an enterprise that has SEZ and DTA units, and where services are qualitatively consumed wholly by the SEZ unit, because the DTA unit may be unable to take CENVAT credit (since the service will not have been received in and used by the DTA unit). For an enterprise that has SEZ DTA units, and where the services in question are actually shared by these units, it would make sense not to avail of the refund under notification 17/2011 and to avail CENVAT credit in the DTA unit.
The two pluses of notification 17/2011 are that it allows exemption and refund for services taxed under the reverse charge mechanism, and extends the time limit for filing a refund claim from six months to one year.
For supplies to SEZs, it is also pertinent to note that the CENVAT Credit Rules have been amended to do away with the credit restriction for service providers providing services to SEZs when those services enjoy upfront exemption.
As such, despite providing much needed clarity in relation to upfront exemptions, notification 17/2011 leaves SEZ developers and units worse off than before on account of the proportionate refund formula. This may be resolved by making CENVAT credit possible on the amount for which refund is not granted (i.e. proportionate to DTA sales).
It should also be kept in mind that any restriction on the exemption from service tax to SEZs is at odds with the Special Economic Zones Act, 2005, which specifically exempts services provided to a developer or unit from service tax, and whose provisions override any other legislation.
Economic Laws Practice is a full-service law firm headquartered in Mumbai with offices in New Delhi, Pune and Ahmedabad. Udayan Choksi, an associate partner at the firm, and Divya Jeswant, an associate, can be reached at firstname.lastname@example.org and email@example.com.
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