Implications of service tax on export of services

As is by now well known, the service tax, which has been in force in India for more than a decade, is intended to operate as a destination based consumption tax.

Consequently, services will be taxed at the place of consumption and, as a corollary, not taxed from where they are exported. Therefore, export of services from India are intended to be exempt from domestic service tax law.

In order to bring about this dispensation, the Government of India introduced the Export of Services Rules, 2005, with effect from March 15, 2005. However, it was not as though that export of services from India were taxed prior to that date.

The erstwhile exemption from the tax which was prevalent prior to the above date did not however lay down rules to determine as to what constituted export of services from India, and was based on the sole condition of receipt of inward remittances of non repatriable convertible foreign exchange.

Thus, the above Rules laid down, for the first time, elaborate criteria for the determination of export of services, besides laying down other conditions, for the exemption from the service tax.

The Rules enable the exporter of services to either not charge service tax on such exports or to discharge the service tax thereon and claim a rebate/refund of the tax.

In both situations, provisions have been made to ensure that the exporter of such services is able to offset/obtain a refund of the service taxes paid on input services/goods used in the provision of the exported services.

As regards the rules for determination of exports, a three-part categorisation of services has been done. The first category relates to a set of 10 services which will be treated as exported from India if the immovable property to which these services relate are situated outside India. The second category pertains to those services which require physical performance and the Rules state that these services will be treated as exports, if the services are either wholly or partly performed outside India. A list of 50 different services has been identified under this category. The third and final category is with regard to services other than those referred to above, constituting 40 in number, which will be treated as exports, if the service is both delivered and used outside India and payment for such services is received by the service provider in convertible foreign exchange.

The Export of Services Rules underwent changes in June 2005 and April 2006, pursuant to the Finance Act 2006, as a result of which the benefit of exemption from the service tax would be available only if the twin conditions of delivery and use outside India and receipt of payment for such services in convertible foreign exchange are met.

It can thus be seen that the erstwhile condition of inward remittances of convertible foreign exchange continue to remain as an essential condition. However, the significant additional condition is that the services should be delivered and used outside India.

This leads us straight to the biggest issue surrounding the determination of export of services, in the absence of rules for determining the fact of delivery and use of services outside India, when provided from India.

The underlined expression is important since the Rules can only come into play if such services are provided from or rendered from India. If the services are altogether performed from outside the country, they would not be covered under the ambit of Indian service tax law at all.

The absence of rules to determine the delivery and use of services outside India has created numerous difficulties for a variety of service providers/services.

Given that services are typically transient in nature and also intangible in character, formidable semantic difficulties arise in determining how and when the services are supposedly delivered to a recipient outside India and also how and when such a service, which is delivered outside India, is also put to use outside India.

Broadly speaking, it could be said that if the service is executory in nature, it will be delivered and used only at the place where it is performed and if the service is advisory in nature, it will be delivered at the place where the recipient, to whom such services are rendered, is located.

However, these broad rules do not clinch the issue in a variety of circumstances where the services are quasi executory and quasi advisory in nature and it becomes imperative in such situations to apply the 'essential characteristic' test to determine the delivery and use of the service outside India, in order to qualify for the exemption.

The other difficulty related to the above is that the service could ostensibly be used, subsequent to its delivery, on a repeated basis and such use could conceivably be both outside and within the country. The question that arises therefore is whether the word 'used' is limited to the immediate use or could it extend to subsequent uses as well.

Several similar and associated difficulties have arisen in specific situations and the absence of clear rules for determination of exports has caused significant concern. An idea of the seriousness of the question can be gauged from the fact that several of the activities/services that are typically performed by the IT and IT enabled services sector, including call centre and back office operations, could potentially not qualify as exports, so as to be eligible for the exemption from the service tax.

Given that India is a significant provider of such services to the wider world, it will be self defeating and entirely negative for India's aspirations, should there be a tax cost of 12.24% on the value of such services.

The second connected problem is with regard to the inability of service providers from India to recoup all input taxes, upon their exporting such services. As indicated earlier, the input taxes can either be set off against output taxes or refunded in cash.

Typically, for exporters of services, such offsets are not possible and hence cash refunds are the only means of recouping input taxes. For all those who are in the know, the fact that till date there is not a single instance of a refund being granted by the authorities to any service provider in India is an indication of the difficulties faced.

While the rules for grant of rebates/refunds for such exports have been in place for more than a year and have also been subsequently liberalised, it is a fact that till date no refunds have been granted.

In conclusion, it is fair to suggest that there has been significant progress in service taxation in India in terms of evolving a comprehensive set of guidelines in the form of the Export of Services Rules.

However, it is equally true that in the absence of rules of determination of the delivery and use of the service outside the country, service exporters continue to face formidable difficulties in determining whether their exports are free from service tax. Clear rules are therefore urgently required to do away with the ambiguities in service tax law relating to exports.

(The author is Leader, Indirect Tax Practice, PricewaterhouseCoopers)