PwC Analysis: Service Tax

Contribution of service taxes to government revenues and introduction of new services.

Six new services brought under the service tax net. Significant categories include services in relation to supply of tangible goods

Impact Analysis
Service tax is progressively becoming a large and significant revenue source for the government. The Centre hopes to mop up around Rs 65,000 crore from service tax in 2008-09, which is significantly higher than the Rs 50,000 crore (approx) that it expects to collect this year. This indicates the huge revenue potential of this "young tax".

The chart below shows the growth in service tax revenues during the past eight years. Also, interestingly, the number of taxable categories of services has increased to 106 in this year's Budget. Clearly, one of the reasons for the buoyancy in the tax collections is the enlargement in the number of taxable services.

This year, the broadbasing of the tax has resulted in six additional services coming within the tax net. One such service is the supply of tangible goods, including machinery, equipment and appliances for use where there is no transfer of right of possession and effective control.

This proposal intends to bring into the service tax net wet lease arrangements that are typically entered into by various airlines, shipping companies & oil and gas companies wherein the lessor provides aircraft/ship/rigs with complete crew, maintenance and insurance to the lessee in return for a consideration based on operating hours. Such arrangements are outside the ambit of value-added tax (VAT) because they lack the essential ingredient of transfer of right of possession and effective control. Through the Budget amendments, these activities will constitute rendition of a taxable service and hence the associated consideration will be chargeable to service tax. Of course, imports of leased aircraft/equipment etc will continue to be outside the purview of VAT but the reverse charge implications of the service tax on imports of services on such wet leases can be significant.

Dry lease arrangements, wherein only aircraft/ship is leased out without crew and maintenance, are already within the ambit of the right-to-use tax under VAT in as much as the right of possession and effective control is transferred by the lessor to the lessee. Such arrangements continue to be outside the purview of service tax based on the categorisation of the lease, as explained below.

Currently, financial leases are subject to tax under both VAT and service tax. With regard to operating leases, only the VAT law was attracted since there was a transfer of right of possession and control to the lessee. With the Budget change in the service tax law, the operating leases where there is no transfer of right of possession and control (wet leases) will now be subject to service tax. Consequently, dry lease arrangements (which are not financial leases), where there is a transfer of right of possession and control to the lessee, will alone be outside the purview of service tax.

The tax will have wide-ranging ramifications across a range of industries. The Exploration and Production (E&P) companies in the oil and gas sector will be majorly impacted since there will be no opportunity to offset these taxes, if applicable, as these companies do not have output Cenvat/service tax liability with regard to the crude oil and natural gas production activities being undertaken by them. There could be other instances of high sticking costs.