An earlier article in this series on Negative list regime discussed the definition of ‘service’ as applicable in the new service tax regime. We would like to further explore one of the detailed aspects of this definition. This is covered by the third explanation to the definition. This explanation creates the legal fiction that two establishments of a person located each in the taxable and non-taxable territory should be treated and taxed as two separate persons. The deeming provision intends to tax the transactions between two branches or between head office and branch office, where one of either is located in the non-taxable territory and the other is located in the taxable territory.
There could be two aspects of the transactions between two such establishments, one where there would be inward remittance of funds into India and the second would be of outward remittance from India. Let’s build a hypothesis to understand the inward remittances received by a call centre, operating out of India, from a branch located in the non-taxable territory. If it was not for the fiction created by explanation 3, the call centre would be providing services to its client, through a branch office. The transaction would take place between the call centre and the client. This would be an export of services, with all the benefits under service tax that are applicable to exports. However, explanation 3 creates the fiction that the transactions between the call centre and the branch would be treated as transactions between two separate persons.
If we put the above service revenue to test under the place of provision rules the place of provision of the services would fall in the non-taxable territory and the service would have qualified as an export. A similar service for a subsidiary company would qualify as an export of services. However, the service tax rules specifically provide that services provided between branches of an enterprise would not be treated as exports, even if they otherwise qualify.
Therefore, the law has a fiction that provides that transactions between head office and branches will be treated as if they were between separate persons; however the benefit of treatment as export of service would be denied to such transactions, even if it were otherwise available. This seems extremely unfair and results in ‘export of taxes’, which is against the very basic tenets of any consumption based taxation regime.
If we go to the second aspect of our original discussion where there are outward remittances. For example, an Indian company has a branch overseas and sends money to its branch for day-to-day expenses which could be rental, employee salaries, telephone bills, etc.
The service tax law specifically excludes services by employees from the definition of service. The fiction in explanation 3 of the definition of service that the branch and head office be treated as two separate entities does not have the result that the salary payments would somehow become something else. Therefore, most branches which are supported by remittances from the head office have salaries as the largest head of expenses. As per the definition of service, salaries are not subject to service tax. One could argue that if these are two different entities, then clearly one entity cannot pay the salaries of another entity. Therefore, these payments should be treated as service payments. However, this would be quite a farfetched conjecture, and create a fiction even though one is not provided in the law.
However, let’s take another example. Let’s say that a manufacturing company in India intends to penetrate overseas markets. They open branches and sell their goods at these branches at a loss as a market penetration strategy. To make good the losses incurred by the branches, the manufacturing company remits money to those stores. Could we, by any stretch of imagination, use this deeming fiction to conclude that these remittances would take the nature of service revenue for overseas departmental stores simply because they are deemed to be two companies?
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It seems that legislature intends to tax such payments, yet a single fiction of treating such establishments as two distinct persons clearly is not sufficient. To bring these payments under the tax net perhaps would require a series of fictions to be created, specifying how each type of remittance between the branches would be treated.
However, this would create a parallel taxation regime within the service tax law that deals with branches in India and head offices overseas (or vice versa) in quite a different way from the reality of the transactions that may take place. It is not at all clear whether this complexity is really required and whether it would achieve some legitimate objective of the Government. Therefore, even where the Government has created a comprehensive and simple regime for service tax, there are some areas that remain unclear, even baffling.
(Supported by Tajinder Singh)
The Author is Leader, Indirect Tax Practice – PwC India pwctls.nd@in.pwc.com