Solve issues on taxability of AEs

Solve issues on taxability of AEs
Vivek Mishra UNDERthe service tax law, the liability to pay service tax arises on collection of service charges. Therefore, accrual of income or recording of book entries were not relevant for service tax purposes. However, through the amendments introduced by the Finance Act, 2008, it has been provided that for transactions between associated enterprises (AEs), the liability to pay service tax will arise on accrual or collection basis, whichever is earlier. This amendment is apparently an anti-avoidance measure. It seeks to cover transactions between AEs wherein service tax has not been paid on the ground of non-receipt of payment even though the transaction has been recognised as revenue/expenditure in the statement of profit and loss account. The concept of AE has been borrowed from the transfer pricing provisions under the Income Tax Act. These provisions broadly provide that two entities would qualify as AEs if one entity is managed or controlled by the other or if the two entities are under common control or management. Further, the amendments to the service tax rules provide that in case of transactions between AEs, payment received for the taxable service would include any amount debited or credited to any account in the books of account of a person liable to pay service tax. This would have a significant impact on the cash flow of the AE providing the taxable services. Take this example. Company X and company Y are AEs. X provides taxable services to Y in June 2008 worth Rs 1 million and passes an entry debiting Y for this amount on July 1 2008. The amount is received by X on November 1 2008. Prior to this amendment, X would have been liable to pay tax on this amount by 5 December 2008. However, as a result of the amendment, X is liable to pay service tax on Rs 1 million by 5 August 2008, the due date for payment of service tax for July 2008. Further, this would set back the cash flow of X as it would need to deposit service tax on Rs 1 million without having collected such amount from Y. The amendment has ostensibly been introduced as an anti-avoidance measure. However, the amendment has created certain ambiguities in the operation of service tax provisions which should be clarified at the earliest to avoid unnecessary litigation. Some of these ambiguities are discussed below. 1. One of the conditions to qualify as export of services under the Export of Service Rules, 2005 is that payment for the service should have been received in convertible foreign currency. Now, in case of export of services between AE, the liability to pay service tax has been shifted from collections to accrual basis. At the time of such accrual, the service may not qualify as export as the payment for the service has not been received. Thus, the issue that arises is whether on such accrual the Indian entity would be required to pay service tax and subsequently on receipt of payment initiate refund proceeding to recover output service tax paid or whether such accrual would be treated as a receipt of convertible foreign currency for the purpose of export rules. 2. With regard to accrual entries made in relation to AE, would the Indian entity be required to pay service tax on the opening balance in the account of the AE as on 10 May 2008 or does this amendment apply only to accrual entries made post 10 May 2008. As per the Cenvat Credit Rules, 2004 credit of service tax paid on input services is available only if the value of input service and service tax has been paid. Given that in case of import of taxable service from an AE, service tax is payable on an accrual basis, an issue that arises is whether the Indian enterprise would be permitted to avail credit of service tax paid on such input service imported though the payment for the value of input service has not been made. Provisions permitting a service provider to adjust excess service tax deposited, where the service charges and service tax thereon is refunded to the service recipient, will not be applicable since there will be no refund of these amounts in case the tax is paid on accrual basis. So, the introduction of the deeming fiction in relation to AE has resulted in various anomalies which should be clarified at the earliest to avoid unnecessary litigation.