MARCH 15, 2016

By P R Chandrasekharan, Member (Retd.), CESTAT

ONE of the proposals in the Finance Bill, 2016, which attracted least attention, is to bring under service tax levy inward freight services provided by shipping lines. This proposal, which is a sharp departure from the international best practice in taxation, has significant implications not only on account of its distortionary effects but also from the point of tax administration. The ostensible reason for this move is to enable domestic shipping lines avail cenvat credit on the inputs and input services used in the rendering the output service of ocean freight. However, it appears that enough attention has not been paid to the implications of this proposal and the government appears to have succumbed to the pressures from the domestic shipping lobby.

2. The proposal introduces several distortions in the tax structure in the context of VAT/GST system of taxation.Inward Ocean Freight is already taxed as import duty as the value for the purpose of levy (of imported goods) is the c.i.f. value (cost+ insurance + freight). It is also subjected to central excise levy through additional duty of customs (popularly called countervailing duty) as inward ocean freight forms part of the value for the purposes of CVD. Is there any need to tax inward ocean freight once again under service tax?

3. The international practice with regard to taxing ocean freight is to treat it as part of the value of goods for the purposes of customs duty at the time of importation. In other words, it is treated as part of “supply of goods” and not as a separate service. In all countries where GST has been in vogue, composite transactions which involve supply of goods as well as services, are treated as ‘supply of goods' if the goods component predominates or ‘supply of services' where the service component predominates. This practice is followed to avoid multiple taxation of the same transaction and thus, has a strong rationaleand logic. That is the reason why international freight, both inward as well as outward, was kept under the negative list of services. However, it would appear that the CBECdoes not understand or believe in best practices universally followed.

4. The effect of the tax proposal as per JS (TRU)'s letter DOF No. D.O.F. No.334/8/2016-TRU dated February 29th, 2016, is as follows:-

"The entry in the Negative List that covers services by way of transportation of goods by an aircraft or a vessel from a place outside India up to the customs station of clearance [section 66D (p)(ii)] is proposed to be omitted with effect from 1.06.2016. Clause 146 of Finance Bill 2016 may please be seen in this regard. However such services by an aircraft will continue to be exempted by way of exemption notification [Not. No. 25/2012-ST, as amended bynotification No. 09/2016-ST dated 1st March, 2016 refers]. Thedomestic shipping lines registered in India will pay service tax underforward charge while the services availed from foreign shipping lineby a business entity located in India will get taxed under reversecharge at the hands of the business entity. The service tax so paid will be available as credit with the Indian manufacturer or service provider availing such services (subject to fulfillment of the other existing conditions). It is clarified that service tax levied on such services shall not be part of value for custom duty purposes."

5. Now let us examine what are the implications of taxing inward freight? As per Indian Shipping Statistics, 2014, the overseas cargo handled by the Indian ports (both major and minor ports) during 2013-14 was 811.11 million metric tonnes (MMT). Of this, the overseas cargo carried by the Indian shipping lines was only 68.94 MMT, that is, about 8.5% of the total cargo. In order to benefit the Indian shipping lines carrying 8.5% of the cargo volume, is it necessary to tax 100% of the cargo? It could be argued that the tax paid on ocean freight can be set off by the service recipients when they discharge central excise or service tax liability. This argument is patently invalid for the reason that the imports by entitities who are not subject to any central excise and service tax are quite huge and the service tax levy will stick on these sectors increasing the cost of such supplies. For example, the estimated thermal coal imports by thermal power plants in 2015 is estimated at 195.5 million tonnes;similarly edible oil imports accounts for 15.7 million tonnes. Manufactured fertilizer imports during 2013-14 was 17.68 Million tonnes. Pulses imports during the same period was 4.4 Million tonnes. Do we want to increase the cost of power generation, especially when customs and excise duty exemptions have been provided to mega power projects? When the Government is subsiding food and fertilizer sector, is there any logic in taxing these sectors which would only lead to higher outgo on subsidies. One could cite such examples ad-infinitum. Thus, from an economic point of view, the idea to tax ocean freight is devoid of any rationale or logic and is downright stupid.

6. Another important consideration which ought to have weighed with the tax authorities pertains to the administrative ease and efficiency of taxation. The import transactions run into millions and so are the importers, a substantial number of whom are trader- importers who are not registered with the service tax department. How does one ensure that they would discharge the service tax liability on reverse charge basis? Unless the service tax is collected at the point of importation, there will be only huge leakages. Besides, the tax can be easily avoided by asking the foreign supplier to pay the freight abroad in which case the service would be considered as supplied abroad, beyond the taxing jurisdiction of the Indian State.

7. The next major issue relates to the possible legal challenge to levy itself? Can we impose service tax levy on a customs transaction? A similar issue came up for consideration before the Appellate Tribunal, West Zonal Bench, Mumbai, in the context of service tax levy on “barging charges” in the case of United Shippers Ltd. vs. CCE, Thane II [2014-TIOL-2500-CESTAT-MUM ]. In the said case, the department sought to levy service tax on barging charges, initially under the category of ‘port services' and later under ‘cargo handling services'. The Appellate Tribunal set aside the service tax demand and held that -

“Thus when the goods are being transported by the barges from the mother vessel to the jetty onshore, that activity is part of the import transaction of bringing the goods into India from a place outside India. The question of rendering any service in respect of such goods by way of cargo handling or otherwise can take place only after the customs transaction is completed. Therefore, the question of levying to service tax the transportation by barges from the mother vessel to the jetty onshore, would not arise at all since the said activity is part of the import transaction leviable to import duty and we hold accordingly.”

8. Revenue challenged the above decision of the Tribunal before the Apex Court by way of a civil appeal and a larger bench of the hon'ble Court dismissed the appeal on merits [2015-TIOL-172-SC-ST-LB] ,thus–

"3. We have heard Shr iMukul Rohatgi, learned Attorney General appearing for the appellant and carefully perused the material available on record.

In our considered opinion, we do not see any good ground to interfere with the judgment and order passed by the Tribunal. Accordingly, the Civil Appeals are dismissed."

Though the above decisions were rendered in the context of barging charges, which is only a small part of the inward ocean freight, the same logic would apply for the entire freight element as well. Thus there is a real danger that the proposed levy might be susceptible to legal challenge.

9. In the light of the foregoing discussion, it appears that the proposal to subject ocean freight to service tax suffers from many infirmities. Neither the economic implications nor the administrative feasibility appears to have been examined in any systematic and detailed manner. The legal sustainability of the levy could also be called to question. It is not necessary that to tax a few, one has to tax all. If the objective was to extend cenvat credit benefit to the domestic shipping sector, there are many simpler and easier ways to do that. I wonder whether thepolitical leadership was made aware of these implications by the mandarins of CBEC. It is another question whether the CBEC officers, who put forth these proposals, were themselves aware of the implications!!

(The author was an officer of the Indian Customs and Central Excise Service for more than 3 decades and retired as Member (Technical), CESTAT, WZB, Mumbai)