Union Budget 2011-12 has been a bitter pill for developers and units in Special Economic Zones from a direct tax perspective in view of the proposal to engulf them under the minimum alternate tax and dividend distribution tax blanket. On the indirect tax front, matters have not been on a smooth sail for SEZs for quite a while. Some of the issues concerning SEZs include applicability of service tax on services provided from SEZs, exemption from tax on services provided to SEZs, and exemption or refund of VAT for sale from Domestic Tariff Area (DTA) to SEZ.
The Finance Minister has attempted to bring some clarity on the indirect tax front in the matter of exemption from service tax for services provided to SEZ.
The exemption, applicable from March 1, 2011, applies to services provided by DTA service providers to SEZ. The exemption has been granted in the following manner:
- Service tax need not be charged if the services can be said to be “wholly consumed” within the SEZ;
- Refund of service tax paid can be claimed by the SEZ if the services provided by the service provider do not qualify to be “wholly consumed” within the SEZ. Such refund shall be in proportion to the exports of the SEZ vis-a-vis turnover of the entity to which the SEZ belongs.
Unlike earlier, the parameters for “wholly consumed” have been explained by trifurcating the various services into the following categories in synchronization with the Export of Service Rules, 2005:
- Services in relation to immovable property;
- Services based on the place of performance of service; and
- Residual services
While the services in (a) are said to be wholly consumed when they are provided in relation to an immovable property located in the SEZ, services under (b) qualify to be “wholly consumed” only when they are performed wholly within the SEZ. Residual services shall be termed as wholly consumed only when they are provided to an SEZ that does not own or carry any business other than operations in SEZ.
Now from the language of the Notification, certain issues can be foreseen at this stage which may be unintended, but are against the interests of the SEZs, as neither would the exemption be applicable nor would refund provide adequate relief.
Some of the services that fall under (b) above are cargo handling, custom house agent, and clearing and Forwarding. It can be seen from the nature of these services that they may essentially not be performed wholly within the SEZ. For instance, custom house agent shall arrange for clearing goods from authorities at the port or airport, clearing and forwarding agent shall arrange for movement and associated activities outside the SEZ. Thus in such cases, though the benefit of such services shall accrue entirely to SEZ operations due to their performance wholly or partly outside SEZ, such services may not be allowed to be provided without charge of service tax.
In a similar manner, residual services covered under (c) above, such as business support services, business auxiliary services, or chartered accountant’s service availed by a SEZ may not qualify for exemption at the first instance due to such entity operating in SEZ and having other businesses or operations in DTA being a diversified organisation.
What ought to be the criteria for exemption is the enjoyment of benefit of the services by the SEZ or otherwise. It should have been provided that the services should be used, received and paid by the SEZ unit in order to avail the benefit of exemption. In the practical instances seen above, the services would not qualify to be “wholly consumed” within the SEZ and thus shall be charged to service tax by the service provider. The SEZ then shall be required to file the refund claim with the authorities, which may lead to blockage of working capital, rise in compliance costs, and associated transaction costs.
But wait, the plight of the assessee does not end here, since refund claim needs to be filed on a proportionate basis considering the ratio of export turnover to total turnover. Now there could be certain services that may be used entirely by the SEZ units, but since they do not qualify as “wholly consumed” within the SEZ, service tax paid on them needs to be claimed as refund. The formula prescribed for refund enables a refund only in proportion of export to total turnover of the entity. Thus part of service tax paid by SEZ becomes a cost to them. Logically, services which have been used exclusively for SEZ operations should not be subjected to proportionate reversal if they do not have any link with the DTA operations.
In the interest of ensuring the viability of SEZ concept and to rid the exports from SEZ of the domestic tax costs, the formulae for granting refund needs to be relooked into.
The author is National Leader, Indirect Tax Practice, Deloitte Touche Tohmatsu India Pvt. Ltd. Views are personal
