Negative list approach to taxing services introduced

By Ranjeet Mahtani and Divya Jeswant, Economic Laws Practice
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The Union Budget 2012-13 has proposed a paradigm shift in the way in which services are taxed, by moving from a “positive list” to a “negative list” approach. Currently, only notified services attract service tax. Under the negative list approach, all services, other than those on the negative list or specifically exempted, will be taxed.

The provisions in relation to the negative list are contained in the Finance Bill, 2012, which has been passed by the Lok Sabha (lower house of parliament) and is currently being considered by the Rajya Sabha (upper house). The provisions will come into force from a date to be notified.

Ranjeet Mahtani Senior associate Economic Laws Practice
Ranjeet Mahtani
Senior associate
Economic Laws
Practice

A definition of “service” has been introduced for the first time under the service tax legislation to take forward the negative list approach. The definition is extremely broad and covers any activity carried out for a consideration (or price). Specific transactions are excluded from the definition, including mere sales of immovable or movable property, “deemed sales” (specified supplies which do not meet the classic definition of “sale” but are deemed to be sales, e.g. works contracts), transactions in money, services provided by employees to their employers in the course of employment, etc.

In addition to the broad definition of “service”, nine activities have been specifically declared to be “services”. This appears to be by way of clarification, to head off constitutional challenge.

The key deemed services are: (1) renting of immovable property; (2) construction of a building where part payment is received from the buyer prior to completion; (3) temporary transfer or permitting the use or enjoyment of any intellectual property right; (4) accepting an obligation to refrain from an act, to tolerate an act or a situation, or to do an act; (5) the service component of specified composite transactions (e.g. works contracts, food catering).

Negative list

The negative list contains 17 service categories, which do not attract service tax. Some of these have been negative listed because they overlap with the taxing powers of the states or because they are already separately taxed by the centre (e.g. trading of goods, manufacture). Others have been excluded from the levy for socioeconomic reasons (e.g. agriculture, education).

It appears that, unlike with exemptions, assessees may not be able to exercise an option to discharge tax on negative listed services in order to unblock corresponding input tax credit.

In addition to the items on the negative list, various exemptions have been retained, including the1 million (US$18,500) threshold exemption, and certain new exemptions have been introduced. Notable examples of the available exemptions are for healthcare service, job work (manufacture by an intermediary) and temporary transfer of copyright in relation to cinematographic films.

Divya Jeswant Associate Economic Laws Practice
Divya Jeswant
Associate
Economic Laws
Practice

Exports and imports

Exports of service would continue to be zero-rated. A simplified refund mechanism for the unused input tax credit would be available.

Imports of service would continue to be taxed under a reverse charge (tax-shift mechanism) in the hands of the Indian recipient. An exception to the tax shift has been carved out in cases where the recipient is a government, a local authority, an individual using the service for business to consumer purposes, or a specified charitable organization.

Place of suppy rules

A set of draft rules to determine the place of provision of a service has been circulated for feedback from stakeholders. These rules would essentially apply to determine whether a service would be brought to tax in the taxable territory, i.e. India, including its territorial waters, continental shelf and exclusive economic zone, but excluding the state of Jammu and Kashmir.

The basic rule is premised on the location of the service recipient. If the service is provided both within and outside the taxable territory, the rules operate so as to bring the entire transaction to tax within the taxable territory, making the place of provision the location within the taxable territory where the greatest proportion of the service is provided.

The Ministry of Finance has clarified that the rules are also expected to shed light on issues in relation to taxation of inter-state services once the goods and services tax (GST) is introduced.

Conclusion

The shift to a negative list regime marks a significant transition in India’s service tax law, which will substantially bolster revenue and pave the way for a comprehensive GST. However, the necessary parity in the availability of input tax credit has not been effected, with no corresponding proposals to liberalize the credit provisions. Coupled with the recent service tax rate increase from 10% to 12%, this will effectively increase tax costs for businesses.

Economic Laws Practice is a full-service law firm with headquarters in Mumbai and offices in New Delhi, Pune and Ahmedabad. Ranjeet Mahtani is a senior associate at the firm and Divya Jeswant is an associate.

ELP

Economic Laws Practice

1502 A Wing, Dalamal Towers

Free Press Journal Road

Nariman Point, Mumbai 400021

India

Tel: +91 22 6636 7000

Fax: +91 22 6636 7172

Email: RanjeetMahtani@elp-in.com

DivyaJeswant@elp-in.com