APRIL 11, 2005

By S Thirumalai, Former President of FAPCCI

DEFINITION of 'export of service' has been one of the vexed questions in Service tax (Finance Act, 1994). The principle has always been that export of services should not be taxed. In the quest towards a satisfactory test for export of services the inward remittance of foreign exchange in convertible currency with some conditions was followed till recently.

Notification No. 9/2005-S.T. dated March 3, 2005 notified the 'Export of Service Rules, 2005' with effect from March 15. Simultaneously, Notfn. No. 10/2005 dated March 3, 2005 rescinded the foreign exchange test with effect from the same date 'except things done or omitted to be done before such rescission' . There are several cases in which services have been rendered during the currency of the said foreign exchange test in respect of which remittances have been received after the rescission of the same. All such cases would be saved by the fact that the liability had been incurred to pay tax and the condition to extinguish the same would stand fulfilled with the receipt of the foreign exchange on or after March 15.

This takes to the genesis of the search for the definition of 'export of services' that first started after March 1, 2003 when for a period of little over eight months the foreign exchange test was omitted. The Central Board of Excise and Customs (CBEC) issued a circular No. 56/5/2003-S.T. dated 25-4-2003 clarifying that service tax is a 'destination based consumption tax' and it is not applicable on export of services. The CBEC also clarified about the taxability of secondary services which are used by the primary service provider for the export of services that since these secondary services get consumed/merged with the services that are exported no service tax would be leviable on such secondary services. 'However in case where the secondary service gets consumed in part or toto for providing service in India, the service tax would be leviable on the secondary service provider'.

The next milestone was in October 2003 when the CBEC brought out the 'Frequently Asked Questions' (FAQ) . 'Since tax is a destination based consumption tax and therefore, if the services provided are consumed abroad, it is covered under export and therefore, not leviable to service tax'. Some examples were also given. A Management Consultant or a Consulting Engineer if he provides the consultancy to a foreign company situated outside India will not be liable to tax, but a manpower recruitment agency employed by a foreign company for recruitment of personnel will be liable as it does not amount to export.'

The continued dissatisfaction in the CBEC with the foreign exchange test and the clamour for internationally accepted supply of service rules from the trade led to the publication of the draft rules for export of services in December 2003. The said draft had broadly categorized the services based on performance, location of the asset and recipient into three separate categories and laid down some tests that have been carried through ever since into the present Rules with effect from March 15. What is interesting is that the draft rules have provided some clue for the interpretation of the present Rules. The draft Rules explained the expression 'location of the recipient' and 'business establishment'. The location of the recipient meant the location of the business establishment to which the service is supplied and Business establishment was defined to include branch office/division etc.

In August 2004 'draft rules on export of services' were again notified by way of amendment to the Service Tax Rules, 1994. These draft Rules of 2004 and the present Rules from March 15, 2005 provide an interesting reading. The categorization of services remains the same as was contemplated in December 2003. The content in the classification of the services has undergone change. This is a separate exercise that will have to be undertaken to explore the reasons for the shuffling around of some of the services as between 'performance' and 'location of recipient' . But it is in the third category with regard to the recipient of the service that there is need for clarity. A cursory glance at the genesis would show that the expression 'location of the recipient' in the present rules is similar to the expression 'the recipient of the service is located outside India' occurring in the Draft December 2003 Rules. The interpretation is the business establishment to which the service is supplied.

The core issue is that Rule 3(3)(i) lays down the test relating to provision and use of service in relation to commerce or industry and where the recipient is located outside India. The proviso lays down certain conditions as to the placement of the order, the delivery of service to used in business outside India and remittance in convertible foreign exchange. Could it be that under Rule 3(3)(i) mere location outside India of the recipient would qualify for the exemption from tax without any further requirement of the service having to be supplied to the said recipient. A few examples could clarify the issues that may arise:

In the first case, the head office of a Bank in a foreign country is authorized by a customer (business establishment) in that country to instruct the local branch in India to issue demand drafts to a number of beneficiaries in India by debit to a local rupee account in India and the local branch in India is paid for such charges form out of the said account. Will this be a constructive receipt of service by the business establishment outside the country so that the bank charge received by the local branch in India gets exempted?

In the second example, a foreign company contracts with its subsidiary in India to render services that are taxable in India to both the offices of its clients in the foreign country and in India as well. Will the subsidiary be regarded as 'a commercial establishment or any office relating thereto' in the proviso to Rule 3(3)(i)? . If one were to go by the Draft rules Dec 2003 it is only a branch or a division that will be covered. If it is not then the contract between the parent and subsidiary may qualify for exemption as the location of the parent is outside India and the place of supply is immaterial in this view. What is the real intention now under the present rules from March 2005? In any case could the proviso to the Rule 3(3)(i) lay down a test beyond the main provision? Therefore could it not be said to bring in a harmonious construction that the supply of the service should be to a recipient outside India even under the main provision of Rule 3(3)(i). Only then the operation of the proviso could be understood in its proper context and this would be consistent with the legislative background in the quest for a satisfactory definition of 'export of services'.

It has to be pointed out that all this should fit in with the nature of the tax and the character of the levy as explained in the circular of April 2003 of the CBEC, including the provisions relating to exemption for the secondary service provider and the illustration in the FAQ of October 2003 all of which are still in force.

(The views expressed are strictly personal)