Seeing cost sharing from a service tax perspective

By Kulraj Ashpnani and Rajat Chhabra, Economic Laws Practice
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The Finance Act, 1994, which provides for the levy of service tax in India, began its journey modestly with three taxable services. Now more than 118 taxable services fall within its ambit. Despite this, strangely, what constitutes a “service” is not conclusively comprehensible even today.

By contrast, the law on value added tax (VAT) on the sale of goods defines both “sale” and “goods”. The Central Excise Act, which provides for duty on the manufacture of goods, defines the term “manufacture”, and umpteen landmark judgments provide further clarity on its meaning.

Defining service tax

Some judgments have elucidated the concept of service tax. For example, in All India Federation of Tax Practitioners v Union of India (2007), the Supreme Court observed that service tax “is a value added tax which in turn is a general tax which applies to all commercial activities involving production of goods and provision of services”.

Kulraj Ashpnani Associate Economic Laws Practice
Kulraj Ashpnani
Associate
Economic Laws
Practice

In CCE, Vadodara v Schott Glass India Pvt Ltd (2009), the High Court of Gujarat stated: “The taxable event in relation to Service Tax is admittedly the rendering of taxable service.”

In Re: Thyssen Krupp JBM Private Limited (2005), the Commissioner (Appeals) said: “The relationship between the service provider and the service receiver is a crucial element to be considered for the purpose of levy.”

It is, therefore, clear that service tax is a tax on value addition and for addition in value, rendering a taxable service is a prerequisite. From this, it can be concluded that where no taxable services are rendered or provided (or where there is no relationship of service provider and service recipient in a given transaction), there ought to be no service tax.

This position in law is fortified by two provisions of the act. Section 65(105) defines “taxable service” as “any service provided or to be provided”. Section 66 starts with the words: “There shall be levied a tax at the rate of ten per cent of the value of taxable services …”

Cost-sharing arrangements

So far as service tax on cost-sharing arrangements among group companies is concerned, the foremost issue is whether costs and expenses recovered or to be recovered can be attributed to the rendition or provision of taxable services. It is possible to argue that the companies do not intend to provide services to each other and what is envisaged is that under the arrangement, certain costs/expenses are intended to be shared in order to reap the benefits of economies of scale.

Rajat Chhabra Associate Economic Laws Practice
Rajat Chhabra
Associate
Economic Laws
Practice

If it can be determined that the cost of a transaction is indeed being recovered under a particular arrangement for rendition or provision of a taxable service (from one company to another), within the meaning assigned under the act, service tax has to be levied and paid; otherwise, there should be no charge of service tax.

The agreement underlying the arrangement, which alone would form the basis for a determination of the intent of the parties, is therefore vital. In effect, if the companies intend to share costs/expenses, the purpose must be suitably demonstrated through the agreement, which must support the inference that no services were at all intended to be provided. This should take the sharing of costs/expenses by the group companies out of the purview of tax unless the underlying transaction involves rendition or provision of taxable services.

Going too far

In the UK, the transfer of services among group companies is not liable to VAT, except for specified services which, if provided from a group’s own resources, also are not subject to VAT. Nonetheless, the Indian tax authorities have always been eager to levy tax on such cost/expense sharing arrangements among group companies under the taxable category of “support services of business or commerce”, especially since the insertion of the words “operation or administrative assistance in any manner” into the definition.

The authorities’ intention to catch as much as possible in the service tax net can be inferred from a recent circular relating to the levy of service tax on distributors/sub-distributors of films and exhibitors of movies. In this circular, the tax authorities have turned the tax position on its head to say that the arrangements between a theatre owner and a distributor, even if on a principal-to-principal basis, would be subject to service tax under the relevant taxable category.

In order to have clarity and certainty on the issue, the industry argues that the policy makers must include such cost/expense sharing arrangements in the negative list proposed under the goods and services tax regime.

Kulraj Ashpnani and Rajat Chhabra are associates at Economic Laws Practice. ELP is a full-service law firm with offices in Mumbai, New Delhi, Pune and Ahmedabad.

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