MARCH 08, 2011

By Harsh Shah and Abhishek Jaju

“…A new scheme is also being introduced by which units in SEZs will be able to obtain tax-free receipt of services wholly consumed within the zone and get their refunds in a much easier manner.”

While the Finance Minister has sought to provide some relief to SEZ Developers and Units in his Budget 2011-12 by way of Notification 17/2011- ST dated March 1, 2011, it appears that the issue of levy of service tax on services to Special Economic Zone (“SEZ”) still has some more rounds of litigations. The SEZ Developers and Units are facing sweeping pronouncements on the subject of indirect taxation, the most recent being Hon'ble Allahabad High Court decision regarding levy of Central Sales Tax on sale from SEZ to Domestic Tariff Area (“DTA”).

Notification 17/2011-ST is in supercession of Notification 9/2009-ST dated March 3, 2009 and seeks to simplify service tax implications on services provided to SEZ with an apparent intent that service tax paid does not become a cost in operations of SEZ units. It may be worthwhile to note that the instant Notification has also exempted the service tax payable on reverse charge mechanism under Section 66A of the Finance Act, 1994 (“the Act”) which was not the case earlier. Thus, service tax need not be paid on services received from outside India that are taxable in hands of recipient of service if the services can be said to be “wholly consumed” in the SEZ.

The exemption by way of impugned Notification has been provided in a twofold manner:

++ Non levy of service tax by the service provider or non-payment by the SEZ Developer or Unit under reverse charge, where applicable, in case the services qualify to be “wholly consumed” within the SEZ; and

++ Exemption by way of refund in case the services fail to qualify as “wholly consumed” within the SEZ. In case of such services, the exemption shall be available by way of refund claim proportionate to export turnover of the SEZ unit.

The services shall be treated as “wholly consumed” based on their categorization under the Export of Services Rules, 2005 (“Export Rules”). The concept has been explained as under:

++ Location of immovable property based services as per the Export Rules shall be treated as wholly consumed if the services are in relation to an immovable property located in SEZ;

++ Performance based services as per the Export Rules shall be treated as wholly consumed if the services are wholly performed within the SEZ. It may be important to note that the requirement is entire performance of the services within the SEZ as compared to part performance outside India in case of performance based services to qualify as export under the Export Rules;

++ The remaining services can be considered to be wholly consumed within the SEZ only if provided to a Developer or Unit who does not own or carry on any business other than operations in SEZ.

While it may be fair and just to classify services related to immovable property wholly consumed only if the services are in relation to immovable property located in SEZ, the difficulty in implementation of the remaining two criteria cannot be undermined.

Some of the services falling under list two of Export Rules such as Cargo Handling services, Customs House Agent etc. may not be entirely performed in SEZ at times though the benefit of the same shall accrue only to SEZ operations. Services by Customs House Agents, Cargo Handling service providers, etc. may infact be required for clearance of goods at the port or airport and movement from such areas to SEZ premises which albeit not performed in SEZ, is being used, received and paid by SEZ Unit or Developer and is exclusively for the said purpose. In such a case, it may not be equitable to exclude these services from ambit of “wholly consumed” services and force proportionate reversal of credit pertaining to same based on the place of performance of these services.

In a similar fashion, a SEZ Unit or Developer may be engaged in other businesses as a diversified conglomerate and carry on the business under same legal entity. Now in such a case, since clause 2(a)(iii) of the Notification provides that services rendered to such an entity shall not be treated as wholly consumed, this may leave no option to the concerned SEZ Unit or Developer but to claim a refund. This shall be a paradoxical situation where services which may be exclusively provided in relation to SEZ operations shall be subject to proportionate reversal though they may have no co-relation with the activities other than SEZ.

A service which may have no linkage between the operation of SEZ Unit or Developer and operations in DTA would thus face unmerited adverse treatment. For instance, services rendered by a Chartered Accountant such as attestation of records pertaining to SEZ or issuance of certificates for SEZ exports, etc may entail a proportionate reversal despite the fact that they are exclusively used for SEZ operations. A SEZ Unit or Developer avails services of promotion or marketing classifiable under Business Auxiliary services from outside India in relation to export of goods or services from such SEZ. Then in such a case, although services are exclusively used for SEZ operations but due to the fact that the Unit or Developer has business operations from DTA as well, service tax exemption by way of non-payment of Service tax may not be available to such a Unit or Developer.

It is also to be noted that one of the conditions for availing benefit under this Notification is that CENVAT credit of Service tax paid on specified services shall not be taken. In such a situation, CENVAT credit balance on which refund is not available as per the proportionate method becomes a cost to a SEZ Developer or Unit. This shall create disparity between two SEZ Units having DTA operations amongst which one opting for this Notification and the other one availing credit on such services and utilizing the same against its DTA liability and not resorting to this Notification. .

But as it is said, where there is a will, there is a way. Clause 2(d) of the Notification 17/2011-ST mentions:

where the specified services received by Unit or Developer, are not wholly consumed within SEZ, i.e., shared between authorised operations in SEZ Unit and Domestic Tariff Area(DTA) Unit , refund shall be restricted to the extent of the ratio of export turnover to the total turnover for the given period to which the claim relates, i.e.,…

Can an interpretation be drawn from the above that any service which is not shared between SEZ and DTA operations of the Unit or the Developer can be said to be wholly consumed even if it is second or third category service and the SEZ Developer or Unit has DTA operations as well?

Keeping the intent of the legislature in mind, it should be a case where services prima facie not wholly consumed within the SEZ under the above Notification should further be bifurcated into those used exclusively for the purpose of SEZ operations and those commonly for SEZ and DTA operations. The Notification as it is shall lead to denial of credit in hands of SEZ Units and invite litigation. It is requested that suitable amendments or clarifications are brought out to address these issues at the earliest.

(The authors are Senior Manager and Assistant Manager respectively with Deloitte Touche Tohmatsu India Private Limited. The views expressed herein are personal)