Indian companies and multinational corporations (MNCs) operating in India in order to derive the benefits offered by globalization have started to get their goods manufactured outside India through contract manufacturing.
A popular business model
Contract manufacturing is the manufacture of components or products by a company for an external customer. Companies often use contract manufacturing as an alternative to operating and maintaining their own factories.
Products such as printers, mobile phones and computers are created using this method. Normally, the customer is expected to supply drawings and specifications for their desired product as well as the quality control criteria.
Establishing a foreign subsidiary as a contract manufacturer can have favourable tax benefits for a parent company, allowing it to reduce overall tax liabilities and increase profits. These benefits are, however, largely dependent upon the activities of the contract manufacturer.
When engaging in contract manufacturing, companies must always consider their tax liabilities, particularly the levy of service tax since central excise duty is cannot be levied on goods manufactured outside India.
With the expansion of the service tax net and government endeavours to tax value addition even in the manufacturing sector, service tax issues will find a place in almost every business deal. Section 65(105)(zzb)(v) of the Finance Act, 2004, defines the taxability of “business auxiliary services”, stating that any processing or production for, or on behalf of a client, will be considered a business auxiliary service and liable to service tax. However, the explanation to that section states that if a product is manufactured in terms of section 2(f) of the Central Excise Act, 1944, then it will not be tax-liable.
An unanswered question is whether the non-levy of service tax is only applicable to manufacturers in India, and whether it excludes manufacturers outside India, if the conditions of section 2(f) of the Central Excise Act are satisfied.
Neither the Finance Act nor the Central Excise Act throws any light on the issue. Recently, a Customs Excise and Service Tax Appellate Tribunal (CESTAT) bench of west zonal Mumbai, by an interim order in Rubicon Formulations v Commissioner of Customs and Service Tax held that “what has been excluded from the definition of business auxiliary services is ‘manufacture’ within the meaning of Section 2(f) of Central Excise Act, 1944 which prima facie would mean that it is only manufacture of goods liable to Central Excise Duty which would stand excluded from the purview of business auxiliary services.” It is pertinent to note that this is an interim order and the observations made by CESTAT are only prima facie.
The Central Board of Excise and Customs (CBEC) also issued a circular F No. 249/1/2006-CX.4, dated 27 October 2008, stating that two conditions must be satisfied for the levy and collection of central excise duty: (a) the process undertaken must amount to manufacture as defined under section 2(f); and (b) the result of this process should be the creation of excisable goods as outlined in section 2(d).
What emerges is that some manufacturing processes may fall within the definition highlighted in section 2(f), however, these may not always result in the emergence of an excisable product.
This clarification by the CBEC contradicts the interim order of the tribunal. While the order states that if no liability towards central excise duty exists then service tax liability cannot be excluded, the CBEC clarifies that this exclusion is available even if there is no liability on central excise duty.
However, neither CESTAT nor CBEC clarify whether goods produced or processed outside India are covered under the definition of manufacturing outlined in section 2(f).The criterion for determining service tax liability is whether the manufacturing process falls under the ambit of section 2(f). Therefore, it seems that goods produced or processed outside India as defined under section 2 (f) may not be liable to service tax.
From the above, it can be said that the goods produced or processed outside India by manufacturers under section 2(f) are not liable to pay service tax under the category of business auxiliary services. However, unless a final determination comes either from CESTAT or the department, uncertainty may reign.
Ravi Singhania is the managing partner and Sunil Kumar is a partner in the tax practice at Singhania & Partners. The firm is headquartered in Noida and has offices in New Delhi, Mumbai, Bangalore and Hyderabad.
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